Should the Pentagon Rescue Ailing Suppliers?

Many Pentagon contractors will not survive the defense budget cuts that began in 2010 and will continue through the decade. While the shrinkage of the defense industry is certain, it is less clear whether or how it might affect the military.

It is an inevitable consequence of plunging budget cycles that suppliers go out of business, and the Pentagon typically has favored a laissez-faire industrial policy even though the defense sector is far from a free market.

“Our market-based approach has served DoD well,” says the Pentagon’s annual report to Congress on industrial capabilities. The underlying theme of the report is that, except for a handful of unique components and materials that only the U.S. military buys, there is ample manufacturing capacity in the United States and abroad that the Pentagon can tap.

The problem for the Defense Department is that, outside the top contractors that make big-ticket weapons, it does not know precisely what suppliers are truly essential. When vendors go out of business, the Pentagon will not notice until a need arises that cannot be met. The Army learned this in 2003 when the United States invaded Iraq and soldiers did not have adequate body armor or armored trucks that could survive mine explosions, nor did it have enough electronic bomb-jamming devices.

“The service economy is great if you don’t have to field an army,” the Army’s then procurement chief Lt. Gen. Joseph L. Yakovac Jr., noted in 2005. “You need some type of indigenous manufacturing capability, and that’s been our problem,” he told a gathering of industry executives. “Nobody wants to hear it, but there have been some things we’ve been slow to provide because there is no industrial base, or there is just one supplier.”

Flush with war funds, the Army threw billions of dollars at the problem and was able to buy the armor it needed, although it took a couple of years to ramp up production.

Top prime contractors, whose financial performance continues to be rewarded by Wall Street, are not at risk. But second and third tier vendors that lack the cash flow to survive during lean times will either be acquired by larger firms or disappear altogether, says Brett Lambert, the Defense Department’s former director of manufacturing and industrial base policy. It is tough to predict what the next critical supply shortage might be, although the Pentagon could cushion the blow by becoming better informed about the state of its lower-tier suppliers, he says.

While in office, Lambert led a so-called “sector-by-sector, tier-by-tier” study of the U.S. defense industry that he conceived purposely to help the government identify the weak links in the supply chain before they snapped. Lambert spent four years on that effort and concedes it’s not perfect. “We often found it difficult in DoD to collect information from industry,” he says. Companies are naturally disinclined to reveal they are in trouble, particularly to the Defense Department. “There is distrust of what we would do with that information, and legal concerns,” Lambert says.

In his post-government life, Lambert has volunteered to lead a similar sector-by-sector study under the National Defense Industrial Association. He is hopeful that companies will participate in the study and will furnish information that the Defense Department should have but is afraid to, or cannot ask. “Often the supply chain is not willing to disclose vulnerabilities or issues that might be of concern to them. It’s understandable in this business environment,” says Lambert. Regardless, it is important that the Pentagon identify “at-risk critical suppliers and skills.”

Prime contractors often say they fear they will lose lower tier suppliers as orders for new weapons dwindle. They will not say what their backup plan is for when that day comes. Lambert would like the Pentagon to have deeper visibility into the supply chain. “The lower tiers are very important,” he says.

As to what specific supplies or skills the Pentagon should protect, Lambert defines them as “defense-unique, will have future demand, may be relevant to many platforms, relies on specialty materials, uses highly-skilled labor, cannot be sourced from allies, requires special design team skills, has a high reconstitution cost, has no technology alternatives, or is a long-lead item.”

The Defense Department has some authority to rescue companies that are sole suppliers of essential items that the government cannot obtain elsewhere. For instance, the Pentagon could stockpile products that are “unique and vulnerable to industry exits,” Lambert says. In other cases, the Defense Department could determine a minimum rate of production that is required to keep a company alive, with enough capacity that it could ramp back up if needed. Pentagon acquisitions chief Frank Kendall has suggested funding high-tech research projects that would produce prototypes of next-generation systems. That would at least keep designers and engineers employed, he said. In this context, the Pentagon is seeking more than a billion dollars over the next five years to develop a fuel-efficient jet engine.

During a budget crunch, says Lambert, the emphasis should be “on the industrial base we need, not the one we have.” When military spending soars, the tendency is to solve “million-dollar problems with billion-dollar solutions,” he says. “Instead of understanding the true, critical nature of the lower tiers of the industrial base, there was an effort to preserve platforms to help all suppliers survive.”

Lambert’s observations are a reminder that the defense industry is no longer that mythical manufacturing juggernaut that built the Arsenal of Democracy. It is dramatically smaller, and makes up a tiny, although consequential, fraction of the national economy.

“The reality is that the money is not there anymore,” says Lambert. “We need to get our factories leaner. We need our industrial base leaner and more efficient.” That applies to government-owned industries, too. Congress has resisted closing military bases, and the Defense Department remains saddled with unneeded infrastructure that drains funds from investment accounts. “That’s money that we can’t use to support the war fighter,” says Lambert.

Budget battles aside, the Pentagon has to pay attention to what happens in the supplier base, he says. “The Pentagon has options to sustain critical and fragile programs — if we know that industrial problems exist before it is too late to reverse them.”

Topics: Business Trends, Defense Contracting, Defense Department, Defense Watch, DOD Budget, Procurement, Defense Department