Is This the Twilight of the Defense Industrial Base?

By Sandra I. Erwin
One of Washington’s most influential insiders, John J. Hamre, president of the Center for Strategic and International Studies, is warning that the defense industry is in danger of becoming increasingly irrelevant and helpless in overcoming hostile political forces.
In a May 10 letter to the CSIS board of trustees, titled, “An Honest Look at the Military-Industrial Complex,” Hamre said he worries that arms manufacturers, while perceived as powerful members of the Pentagon-Congress-industry triad, are rapidly losing clout.
“One of the enduring myths of Washington politics is that the defense industry is an ominous, all-powerful puppeteer, manipulating the actions of politicians, political appointees, generals, and admirals,” Hamre wrote. “I have been observing this community for nearly 30 years, and the truth is that it is the weak partner to the Defense Department.”
Hamre cited several reasons why he believes the defense sector is fading into the background. One is that the industry is “not sitting at the table when hard budget choices are made in the Pentagon.”Government leaders have been reluctant to downsize the civilian workforce and Congress insists that no base or installation can be cut, he said. Military commanders focus on funding for operations and readiness on the premise that the United States cannot afford to have a “hollow force,” Hamre said. “Among these powerful forces, the defense industry is a feeble voice.”
Government policies also undermine defense industry, Hamre said in the letter. “We have had an accretion of laws, regulations, reporting requirements, and mandated procedures that are choking the system,” he noted. “The contract to send a man to the Moon and bring him back safely was written on a single sheet of paper. Now the system is choking on procedures that are sapping energy and enormous sums of money.”
The Pentagon's budget priorities put contractors in a tight corner, said Hamre. One-third of Pentagon procurement dollars is going to “overhead,” much of it dictated by the choking layers of redundant overseers, he added.
Most government employees have no experience in the private sector, Hamre said. As a result, they fail to understand the true cost of doing business. “They look at program X and see that the estimated price is $400 million. But a third of that is for government activities and testing outside the contract. The contractor may be given $250 million and be allowed to harvest an 8 perfect profit. When the government employee thinks that project is worth $400 million to the contractor, in reality it contributes $20 million to the bottom line.”
Given the political paralysis and budget stalemate in Washington, the future looks grim, Hamre said. “We are crippling our economic future. And we are damaging an essential component of our national security in the process. It is time that we wake up, before it is too late.”
Hamre’s cri de coeur comes less than three months afterautomatic budget cuts across the entire federal government went into effect. Before the sequester became law March 1, the defense sector was convinced that Congress and the Obama administration would work out an 11th hour deal to spare the military budget. No such break came, and Pentagon contractors are still gauging the potential damage from the cuts.
Having served as Pentagon comptroller and as deputy secretary of defense during the Clinton administration, Hamre has deep insight into the budget process, and his latest warnings should come as no surprise to beltway insiders.
CSIS analysts Clark A. Murdock and Ryan A. Crotty published a study last month that paints a dark picture of the future of the defense sector. The Pentagon’s budget, they noted, “Is being hollowed out from within by internal cost growth.” The costs of operations, maintenance of aging equipment and personnel have been on an “unsustainable trajectory for decades and, when combined with the declining top line due to budgetary and economic pressures,” spell tough times for contractors, Murdock said.
The Defense Department has recognized this problem but has thus far failed to rein in overhead spending, he said. “This growth of costs within the department sets up an unforgiving trade-off between maintaining end strength, sustaining readiness, or continuing technological investment.”
Equipment modernization accounts — which fund the military’s hardware and weapons programs and all research and development have accounted for nearly a third of the defense budget. By 2021, if costs in other accounts are allowed to continue to climb at current rates, less than 5 percent of the budget will remain for modernization, CSIS estimated. 
Other think tanks have reached similar conclusions, including the Pentagon’s advisory group, theDefense Business Board, theStimson Center and the Center for Strategic and Budgetary Assessments.
CSBA’s top budget expert Todd Harrison said defense industry is on the losing end of a guns-vs-butter struggle that is taking place within the Pentagon’s budget. As spending goes down, the cuts will fall disproportionately on programs that are performed by the private sector because there is no political will to touch military pay, benefits or reduce the size of the civilian workforce, Harrison said at a Washington, D.C, conference last week. 
If the sequester stays in place as stated in the law until 2021, by then, personnel and operations costs will consume 86 percent of the Pentagon’s budget, said Harrison. That would leave only 14 percent for everything else, and it is conceivable that there would be little to no money left for procurement of new weapons, he said. The only way to fix this is by doing “politically difficult things” such as reforming military healthcare, retirement and overall compensation, and closing unneeded bases in the United States and overseas, Harrison said.
Defense Secretary Chuck Hagel ordered a “strategic choices management review” that is expected to help set priorities as budgets decline. But defense industry should not expect the outcome of this review to help its cause, suggested James McAleese, an industry adviser and principal of McAleese & Associates.
“The more aggressive the SCMR becomes, and the longer the sequester goes on, the Defense Department will be less and less able to protect the industrial base as we've known it historically,” McAleese said May 14 at a U.S. Naval Institute conference. It will be market forces, rather than Pentagon policies, that will determine what companies survive the downturn, McAleese said.  “There will be ‘bet the company’ competitions that will determine winners and losers.”
McAleese said the nation’s largest defense contractors will be among the winners because of their dominant market positions. He noted that the value of defense stocks has stayed about 5 percent above the S&P 500 index. The concerns about sequester have been priced into defense contractors' stocks, he said. Even after sequester took effect, top Pentagon suppliers — including Lockheed Martin, Northrop Grumman, Raytheon, General Dynamics and L-3 — projected modest sales reductions of 2 percent for next year. The largest contractors’ performance is “defying sequester,” said McAleese.
Former Pentagon comptroller Dov S. Zakheim, a senior advisor at CSIS, echoed Hamre’s concerns that the industry is headed for rough waters.
“People are beginning to take the sequester for granted,” he said at the USNI conference. “This is the first day of Noah's 40 day flood.”
Zakheim cited a stream of think tank studies over the past several years that proposed ways to cut defense spending “smartly” by shedding wasteful overhead and preserving military capabilities. These reports, however, are mostly pie in the sky, Zakheim said. “The problem in all those recommendation is that in most cases they require congressional activity” that will never occur, at least not in the foreseeable future, he said. “These reports talk about health reforms. We've been trying that for a very long time. They talk about acquisition reforms. We passed several acquisition reform acts. The Defense Department is dealing with acquisition reform,” said Zakheim. “In theory you can find the economies that would mitigate sequester. In reality you'll have to fight for every single dollar of those economies and hope for the best."
Photo Credit: Center for Strategic and International Studies

Topics: Business Trends, Defense Contracting, Defense Department, Civilian Workforce, DOD Policy, Procurement, Acquisition Reform

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