Magazine article National Defense

Defense Industrial Base Remains at Risk

Magazine article National Defense

Defense Industrial Base Remains at Risk

Article excerpt

President's Note: Phil Odeen received the NDIA Industry Leadership award this year. His comments on that occasion reflect his concerns about the defense industrial base. The following article is extracted from those comments and will not benefit from anything I could add.-Larry Skibbie

The U.S. defense industrial base faces difficult challenges, and its ability to serve the Defense Department well a decade hence is at risk.

The industry is in the midst of a significant transformation, indeed a new paradigm. From World War II to the end of the Cold War, the Pentagon depended almost exclusively on a captive defense industry. It set the rules and conditions, and the companies developed the required technology and produced the weapons in quantity. This has changed, and even greater changes lie ahead.

Long production runs are a thing of the past. Today, the Pentagon buys fewer new platforms, extends the life of older ones, and updates its "black boxes."

Much of the critical technology that the military needs today-software, networking, biotechnology and communications-is developed and provided by the commercial sector.

The defense prime contractors often are integrators, drawing on technology and products from a variety of sources, many of them commercial companies. As a result, the Defense Department is forced to rely on a broad range of different suppliers who don't and won't do business on government terms. This has been a difficult transition for the Defense Department, and it is still incomplete.

For these reasons, the department must develop a new way to use its industrial base.

In the 1960s the federal government funded about a third of our nation's research. Today it funds less than 5 percent.

Information technology, biotechnology and telecommunications research work is dominated by commercial companies.

An increasing share of technology is developed outside the U.S., and regulatory barriers make it difficult for the Pentagon to access those capabilities.

But the picture is nor entirely bleak. Areas of notable progress include sharp reductions in the use of military specs, and expanded use of waivers and higher thresholds for cost accounting standards. Yet, a number of serious barriers still exist and complicate government access to commercial technologies. For example, the criminalization of regulatory areas (such as the Civil False Claims Act) is a serious disincentive for commercial firms considering defense work.

Many American companies have sold their defense businesses (examples are Texas Instruments, General Electric, Ford, IBM, Chrysler, Hughes and GTE) because of limited growth potential, the risks involved and low returns on investment. Other companies refuse to deal with the Pentagon, except to sell commercial products.

The defense industry has been a cyclical business. Spending increased strongly in the 1960s and 1980s, but stagnated or declined in the 1970s and 1990s. As the budget top-line waxes and wanes, the procurement budget varies even more widely, accounting for much of the change in total spending. Funding for personnel, training, maintenance, and operations tends to be fairly stable.

Despite these periodic swings in procurement spending, the defense industry traditionally had been a reasonable investment. Profit margins were modest, but the defense industry had good cash flow and return on investment. As a result, stocks were valued fairly and at times earned a premium.

This is no longer true. Profits, cash flow, and return on investment, have weakened. The stock market has responded accordingly, driving stock prices down sharply. …

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