Fresh Strategy Needed to Preserve Industrial Base

By Dale W. Church
It has been reported that more than 50 percent of the critical companies in the Joint Munitions Command’s conventional munitions minimum sustaining rate (MSR) database are considered to be in financial distress. This is defined as where the return on investment for a company’s facility is below the minimum needed to remain financially viable. 

Future projections show the situation is worsening as the government is forced to buy smaller quantities because of reduced budgets. In addition, reduced budgets mean sacrifices will have to be made to modernization. In order to offset this, it would be wise to keep some critical capabilities alive by sponsoring prototype competitions for advanced design and development.

The problem is caused by insufficient annual orders for specific products to maintain a profitable facility. This is obvious at the prime-contract level, but it is often even more prevalent and not apparent at lower tiers in the supply chain. Profitable production requires a constant flow of work matched to the size of the facility. Temporarily closing production can cause a facility to take months, if not years, to restore production and, even then facilities often have to overcome significant problems before reaching efficient levels of output. 

Conventional munitions design, development and production need highly skilled managers, scientists and workers. It often requires years of training and experience to understand the nuances of energetics and its artisan skills. The acquisition strategy must be designed to provide sufficient incentives to keep the facilities operating as efficiently as possible at less than optimum levels of production.

The conventional munitions industrial base includes production facilities known as government owned government operated (GOGO), government owned contractor operated (GOCO) and contractor owned contractor operated (COCO).

The GOGOs are not operated on a profit-and-loss basis, and their continuance is supported by the political concerns of those who represent the community in which they are located. They need to be consolidated or closed where they do not constitute a single point of failure.

Government owned contractor operated facilities are run under contract provisions that do require attention to efficiencies but are not operated as a facility on a profit-and-loss basis. However, the contracts are competed, and contractors can and do lose money if not bid with sufficient margin. These facilities often represent significant job numbers, so there are political concerns. 

The third type of facility is contractor owned contractor operated. Facilities are operated like any corporate concern on a profit-and-loss basis. The contractor has no obligation to maintain the facility that is operating at a loss once he completes the contracts. They are generally supported by their political representatives but have no obligation to operate on a loss basis. Considering the current budget uncertainties, there is no guarantee that these companies will continue to operate these facilities once all contracts are completed.

One of the objectives of any acquisition strategy should be to provide sufficient incentives to ensure that the industrial base is preserved. The approach applied in the past has been to order sufficient quantities to keep production open at whatever cost and to allow a profit for the supplier. This approach assumes sufficient funding to continue production. But this may not be affordable under shrinking budgets. In fact, there may already exist sufficient munition stockpiles to satisfy operational and training requirements. 

In order to keep production facilities staffed and running, the cost of maintaining them must be at a production level which is not ideal. Stated simply, we will be paying more for less. There may be temptation to buy from a cheaper foreign source. This may look like a bargain but could force the closure of the only remaining domestic source. That source may not be easily recoverable, if at all. There needs to be an evaluation of the business case and the industrial base impact.

What is needed is a fresh acquisition strategy that takes into account how to maximize efficiency while producing at less than optimum production rates and thereby maintaining an essential industrial base. 

In many cases this will involve contracting with a single source. Because many variables exist in production, the contractor needs to be rewarded for minimizing the costs. A contract based on cost plus percentage of cost leaves out the need to control cost. The contractor should be rewarded by providing items at cost-plus incentive fees that are based on minimizing expenses. It will be rewarded for saving the government money.

This approach could be used in both GOCOs and COCOs. The difference would be in GOCOs the contractor would have fewer variable control points than in COCOs because the government controls the facility. This strategy could save many contractor owned contractor operated situations where there is no incentive to keep a facility open that is operating at a loss.

Dale W. Church is a former deputy undersecretary of defense for acquisition.

Topics: Business Trends, Doing Business with the Government, Defense Department, DOD Budget, Strategic Weapons

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