BREAKING: Report Sends ‘Wake-Up Call’ for Health of Defense Industrial Base

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The ongoing COVID-19 pandemic, cybersecurity attacks and supply chain disruptions have weakened the United States’ already declining defense industrial base, according to a new report released Feb. 2.

In the annual report —“Vital Signs 2022: The Health and Readiness of the Defense Industrial Base” — the defense sector received an overall “unsatisfactory, failing” grade of 69. This marks the first time the DIB has not received a passing grade since Vital Signs was first released in 2020.

Vital Signs is an annual study published by the National Defense Industrial Association in partnership with decision science company Govini. NDIA is also publisher of National Defense.

“While technically one point short of a pass mark, specific signs provide cause for real concern,” the report read.  The report’s final score of 69 was three points lower than last year’s score of 72.

“This failing score is a wake-up call to all the decision makers on Capitol Hill and the executive branch and the [Department of Defense] that care about national security and this nation,” NDIA President and CEO Hawk Carlisle said during a press conference unveiling the report.

Although Carlisle acknowledged disruptions to the U.S. economy caused by COVID-19 — such as a shrinking workforce, inflation and supply chain shortages — played a role in the score, he also emphasized other challenges the industrial base is facing.

“Many of these challenges were there before COVID. The pandemic served to highlight and accelerated these challenges,” Carlisle said. “The aggressive Russian military buildup on the Ukrainian border and the … rapid military modernization efforts of the People's Republic of China remind us that our industry’s work of providing superior products and services to armed services so that they can compete and win and all domains of warfare can never be taken for granted.”

Vital Signs analyzed eight different areas that shape the operational environment of the U.S. defense industrial base: demand for defense goods and services; cost and availability of production inputs; innovation in the defense industry; supply chain performance; market competition; industrial security; political and regulatory activity; and productive capacity and surge readiness.

Researchers analyzed over 50 publicly available statistical indicators that serve as empirical proxies, converted them into an index score scaled from 0 to 100, and evaluated three years of scores for each. With the exception of data from an August survey of NDIA members, the Vital Signs study's data sets are “lagging indicators” that were fielded before the United States’ nationwide inoculation effort against COVID-19 began, the report noted.

“This data was pulled when we were at the yearlong point in the COVID crisis, so this is the first year we're seeing the impacts of COVID,” said Wes Hallman, NDIA’s senior vice president of strategy and policy.

This year, five of the eight areas analyzed scored a failing grade, according to the report. This indicates the defense industrial base is experiencing COVID-19’s negative impacts just as other industries are, it read.

The pandemic played a large role in the 8-point drop in the "supply chain performance," vital sign, which earned a failing grade of 63.

“This decline reflects the significant turbulence introduced into the economy during the first year of the COVID-19 pandemic,” researchers noted in the report. “We expect that next year’s report will reflect even greater supply chain challenges wrought by the pandemic.”

Hallman said COVID-19 has put a spotlight on the supply chain issue. The drop is attributed to a decrease in the average cash conversion cycle for companies, which dropped 32 points itself from last year, the report said.

“The 36-point drop was specifically looking at supply chains through that financial lens,” said Robbie Van Steenburg, a regulatory policy associate at NDIA. “Looking at the cash conversion cycle — how efficiently do companies pick something, buy the resources they need, turn it into a product and sell it?”

The "productive capacity and surge readiness" sign demonstrated one of the largest drops in this year’s Vital Signs report, decreasing from 67 to 52 in 2021. This was driven by a steep decline in output efficiency, which helps determine the economy’s ability to a surge in defense-related demand, the report said.

“The need for an increase in defense production often appears suddenly, leaving little time for defense suppliers to ramp up production to fulfill a surge in demand for their goods, services, or materials,” the report said.

"Cost and availability of production inputs'" failing score of 67 can also be attributed to COVID-19, researchers found, as the dense sector heavily relies on the cost and availability of skilled labor, raw materials and intermediate goods and services.

The "cost and availability of production inputs" sign saw the largest decrease in 2021 due to pandemic disruptions, the report said.

“Defense contractors consume intermediate goods and intermediate services when performing their defense contracts, and rising costs can negatively affect productive capacity,” the report read. “Changes in production input costs can force producers to adapt their production plans by changing their per-unit cost structure of final products, altering production volumes, or passing along additional costs to the government customer.”

With a score of 50, "industrial security" earned the lowest grade for the second year in a row. It has continued as a thorn in the side of the industry as intellectual property theft, acts of economic espionage and ransomware hacks continue. Although the score increased slightly in 2021 — by just one point — the report noted this improvement was caused by a lack of new FBI investigations into IP rights violations that come after years of enhanced law enforcement.

New cybersecurity vulnerabilities have risen by 263 percent since 2016, indicating the threat itself needs to be approached as an adaptive one, Hallman said.

“You’re never going to be able to solve this, per-se, it’s not going to go away,” he said. “It’s something that you mitigate through having a system that incentivizes a constant adaption to the threat as it’s coming in.”

The score for "political and regulatory conditions" dropped by four points, receiving an overall score of 72. Researchers analyzed public opinion on defense spending, the congressional budgeting process and regulatory burden to assess this area.

Of the three, public opinion scored the lowest. A poll of U.S. adults conducted by the Gallup Organization suggests the pandemic has spurred some anxiety in the public regarding defense spending, the report stated.

In early 2020, prior to the onset of the pandemic, 50 percent of participants believed that defense spending is "about right," which marked a 7 percent increase from 43 percent in 2019, the report said. “This 2020 result of [50 percent] is the highest percentage of ‘about right’ responses for this question since Gallup began asking it more than 52 years ago,” the report said.

"Innovation in the defense industry" remained stagnant, receiving an overall grade of 69 once again from researchers. Between 2011 and 2016, U.S. government funding for research-and-development projects fell by 12 percent in absolute terms, according to the report. “Over the same time frame, Russia and China grew public investment in research and development by 13 percent and 56 percent, respectively, it added.

Dr. Mark Lewis, executive director of NDIA’s Emerging Technologies Institute, said the decrease in basic research reported by the study was troubling.

“That’s eating our seed corn,” he said. “So as we talk about future emerging technologies, we won’t have the next set of emerging technologies if we’re not investing in the basic research that will get us there.”

Despite the challenges the DIB has faced, the report highlighted some positives. "Demand for defense goods and services" received the highest score of 94, also increasing by 6 points. This derives from an 8 percent rise in contract obligations issued by the Defense Department, the report said.

Foreign military sales also contributed to the positive score, researchers noted. “Foreign military sales saw a significant increase from 2019 to 2020, enjoying an over [30 percent] increase in sales totaling over $50 billion, which represents a significant departure from the last several years where foreign military sales totaled in the mid-$30 billion,” the report said.

Additionally, the "market competition" sign also received a high score of 88 — the same as last year, the document said.

“This high mark was driven by several high-scoring factors including a low level of market concentration for total contract awards, the low share of total contract awards received by foreign contractors, and a high level of capital expenditure in the DIB,” the report said.

Topics: Defense Department