Facing New Realities in the Defense Market

Photo: Air Force

Defense contractors are adjusting their strategies to account for shifts in budgetary, programmatic and political factors that have recently come into focus. 

The balancing act between revenue and profit has become more challenging over the last few months, requiring contractors to not only be much more proactive, rigorous and creative in examining cost drivers, but to also start this much earlier in the capture process.

Prior to 2017, it was assumed that the Defense Department would struggle to find sufficient funding to pursue major planned procurements for new aircraft, ships and satellites in the 2020s. This is because the volume of significant new programs in the span of a few years was not attainable in the funding environment that existed before Inauguration Day and would have required program delays, volume reductions or outright cancellations. 

However, the Trump administration has not only prioritized increased defense spending, but is proposing major cuts to other agencies to make funds available for defense programs. While this might at first suggest that the rising tide that lifts all boats has come again, the administration has also put public pressure on defense contractors to reduce margins, rein in costs and reduce schedule overruns, which represents an unexpected but crucial twist. 

As an example of the changes required, “price-to-win” analysis needs to start much earlier. Rather than conducting it after proposals have been drafted and as request for proposals due dates approach, bidders must start earlier and proactively to undertake design-to-cost and price-to-win efforts even before a draft RFP release. 

How might we drive better value through different partners or work-share agreements, without affecting the probability of winning? What fundamental process and efficiency improvements could we undertake if we had to reduce our price substantially to win?  

With major procurements, accepting a 20 percent smaller workshare — which would enable a lower price — can mean the difference between winning and losing. Protecting revenue in the bid will increasingly lead to losing it all as value for money becomes increasingly more important. These steps take time, thus starting them early enough in the process will enable bidders to restructure their offer to enhance their ability to win on price and value while also safeguarding profitability. Finally, bid efforts may be longer and more expensive, requiring more deliberation on whether to go “all in” or decline to bid.

Many defense contractors, particularly tier-two or tier-three suppliers, often struggle with the early assessment of a government procurement opportunity and whether they will be able to successfully compete to win the program. This difficulty can stem from many factors, including the lack of a formalized opportunity vetting and capture strategy process, limited internal resources or an unfamiliarity with the procurement process. Improper vetting of opportunities, or lack of preparation during pursuit, will hurt a bidder’s value proposition, technical solution, ability to help the customer mature their requirements, ability to assess competitors, understanding of the competitive bid range and ultimately the cost volume. 

More rigorous and creative price-to-win analysis conducted earlier in the process, in combination with design-to-cost analyses, must become a standard tactic for defense contractors as they review new opportunities. This type of shift comes from the top down, thus it is necessary that corporate leadership drive this mindset and engage throughout the procurement timeline. If leadership is disconnected from the process or continues to follow old practices, the bidder is more likely to make a late — and therefore costly — decision to either propose a losing offer or no bid the opportunity for the sake of protecting profit. Given the fact that winning bids is likely to require more effort going forward, it is critical to make earlier decisions on when to no bid — before heavy spending.

High-profile examples of no-bid decisions occur every year, underscoring the strategic importance of understanding the key drivers of cost earlier and the criticality of early identification and assessment of improvement options.

 In 2009, Northrop Grumman withdrew from the Air Force tanker program, with CEO Wes Bush stating the program implied “financial burdens on the company that we simply cannot accept.” In 2015, General Dynamics decided to no bid the Army Rifleman Radio competition due to concerns over attainable profit margins on the program. Multiple firms have withdrawn from the Air Force T-X trainer competition, due in part to concerns over the financial business case. And, in 2015, United Launch Alliance withdrew from the Air Force GPS-3 Launch opportunity, citing multiple factors including concerns over its ability to be cost-competitive. All of these bids required major effort before withdrawal, and in an environment of increasing bid effort, companies must focus their limited resources on fewer, higher-probability pursuits.

There is little doubt that changing the current practice will be difficult, especially given that the existing norms for developing the cost and technical solution for a major procurement are already well-ingrained in processes, institutional memory and individual experience. And with these norms, prime contractors stumble in their attempts to understand and then implement cost-reduction options that enable a more competitive bid. 

Often times, proposal teams assume a price-to-win — an estimate of the most competitive bid range based on DoD and competitor positions — without first fully assessing the design and manufacturing levers that drive their own — let alone competitors — overall cost. To avoid late rework of the cost and technical approach and the risk of a late no-bid decision due to financial limitations, prime contractors must proactively undertake bottoms-up design-to-cost analyses to inform their top-down price-to-win analysis. Implementing this approach will help contractors adapt their proposed solution if the bid is too low for their technical approach to prevail profitably. 

Indeed, with so many delayed RFPs, the pre-RFP process is an ideal time to conduct such a review, which allows the necessary time for a core capture team to get up to speed with the details of the relevant technologies and pursuit options.

Next, contractors should impose a thorough pre-RFP assessment of supply chain strategies and manufacturing processes in order to provide a proposal team with leverage to improve their business case and price position early in the competition. A fundamental factor in crafting a competitive cost volume is a bidder’s ability to optimize and manage its supply chain. Suppliers also tend to be risk averse, basing prices on stated program volume requirements rather than considering the market potential from additional volume through other customers. Thus, conducting a strategic analysis of the supply chain helps to identify opportunities to partner with a few key suppliers to gain their confidence in offering bids that consider follow-on sales potential. 

In addition to suppliers’ general unwillingness to offer aggressive component pricing, they also have the power to greatly impact the prime’s delivery schedule and final quality. Bidders must grapple with how and whether to shop component contracts around, when to start ordering components to create a suitable production buffer in the event that supply delays occur, how much planned internal content should be price-compared to external resources and how aggressively to negotiate with selected suppliers. Ultimately, the ability to reduce suppliers’ pricing by just a few percentage points can translate into major cost volume reductions over the life of a program.

Evaluation of possible improvement options gives the knowledge needed to consider how aggressively to use learning curve assumptions or other reductions in the cost volume. In a recent Acquisition Category 1 Air Force competition, identified improvements in manufacturing processes combined with learning curve efficiencies over the total likely market for an aircraft production program would reduce touch labor and enable cost reductions of 15 percent on the 15-year production contract. Using the pre-RFP time window to scrutinize planned manufacturing processes adds rigor and confidence to bidders’ efficiency assumptions and helps in making a strong business case to corporate leadership.

With strategic threats growing, stretched budgets and increased scrutiny of contractors’ margins, end customers and source selection committees will continue to be cost-focused and risk averse. For example, the Air Force’s T-X and Army Maneuver Support Vessel-Light opportunities included firm-fixed price criteria combined with indefinite delivery, indefinite quantity contracting constructs, which added substantial risks and uncertainties for the prime. While it is unlikely that there will be a dramatic shift from best value constructs in Defense Department competitions, evaluation criteria will increasingly be molded to emphasize price, which is always easier to assess than value. 

Bidders are always confident that they have the right technical solution for requirements; otherwise, they would not pursue an opportunity. But in today’s environment of growth with scrutiny, it is not enough to have the best technical approach. It takes early, focused effort to determine how to reshape the technical solution to be affordable for the end customer and worthwhile for the contractor. 

To thrive in this new era of defense contracting, primes must do their homework, and do it early, in order to identify the appropriate design and manufacturing levers to pull — and how hard — so they can drive a winning cost. The quality of their homework will be tested during delivery after the euphoria of winning has faded. If they did it well, they will be able to achieve a strong financial result while growing share. Those that did not do their homework may find that the profits are diminished or the return on sales significantly diluted. 

Annassa Brindley, Bob Wood and Tom Mullen are advisors to the aerospace, defense and security industries at PA Consulting Group.

Topics: Acquisition Programs, Aviation, Business Trends, Defense Contracting, Defense Department