The Pentagon for years has said it would intervene to protect vulnerable areas of the industrial base during a period of declining defense spending.
Now it’s acting on that policy.
Senior US defense officials last week said the Pentagon’s fiscal 2015 budget proposal, which is being sent to Congress on March 4, would put money toward preserving at-risk sectors of the industrial base to protect technological know-how.
At the center of the effort is a $1 billion investment in next-generation jet engine technology. The goal is to reduce fuel consumption and maintenance needs.
“This new funding will also help ensure a robust industrial base, a very strong and important industrial base, itself a national strategic asset,” Defense Secretary Chuck Hagel said Feb. 24 when he previewed major decisions in the Pentagon’s 2015 budget.
Just one problem: The effort will not begin until 2016 and would go away if Congress does not raise defense spending caps in that year and through the remainder of the decade.
This comes at a time when the Pentagon could use science and technology investments to help dig itself out of the budget hole.
“If we can make key investments in areas we know are really important, [that] is going to be the big thing,” Mica Endsley, the Air Force chief scientist, told Defense News on Feb. 24.
Endsley pointed to the cost savings that could result from more efficient engines and noted two Air Force projects that could one day yield 25 percent to 35 percent fuel efficiency savings.
“I think there’s a lot of our technology investments that can also help us with our costs over the long run, but you have to be able to make those up-front investments to do that,” Endsley said.
More efficient engines could prove a game changer in operations and make existing aircraft more lethal, said Todd Harrison, an analyst with the Center for Strategic and Budgetary Assessments think tank.
A 10 percent efficiency improvement could increase the range and payload of the F-35 joint strike fighter, he said. It could also reduce the reliance on refueling tankers.
In addition to the engine initiative, DoD’s $496 billion 2015 budget proposal would look at designs for a new combat vehicle and next-generation aircraft, Frank Kendall, DoD’s acquisition chief, said on Feb. 25 at a conference sponsored by McAleese and Associates and Credit Suisse.
As the defense budget shrinks and the Pentagon looks to tailor its strategic investments, Christine Fox, the acting deputy defense secretary, warned that DoD and industry will likely not see eye-to-eye on everything.
“Clearly the department needs a more cooperative, transparent and ... realistic relationship with the commercial sector,” Fox said at the same conference.
Hagel also announced the Army would terminate its Ground Combat Vehicle (GCV) program. Instead, Kendall said last week, DoD would look at designs for a next-generation combat vehicle.
“We’re going to go back and take a look at that and try to advance technologies so that we have more capability than GCV was going to give us, hopefully with less weight and the equivalent protection, but with more capabilities in other areas as well,” Kendall said.
Army officials are laying out the details of the GCV follow-on, Army acquisition executive Heidi Shyu said at the same conference.
In addition to that project, DoD also plans investments to sustain rotary and design teams, and the Defense Advanced Research Projects Agency is looking at ways to maintain air dominance 30 years from now.
DoD Contracts Declining
Just before defense spending caps kicked in last year, the Pentagon began slowing contract awards in an effort to save money. Even though Congress has injected more money into DoD’s coffers in 2014 and 2015, Pentagon spending has not picked up.
“As it sits right now, looking at it from an industrial base point of view, contract spending, ’12 compared to ’13, is down at least 15 percent,” said David Berteau, an analyst with the Center for Strategic and International Studies.
“That’s a huge decline,” Berteau added, noting his estimates include both DoD base and war funding. “It’s looking like [research and development] took the biggest part of that hit.”
Berteau said he has not seen evidence that the Pentagon is buying back the deferrals it made last year.
“We know that DoD deferred a number of contracts in 2013 because of sequestration. We know that there is no headroom in the budget to compensate for those deferrals,” he said. “What we don’t know is how are those deferrals being accommodated in the outlays and obligations in current FY14 spending. The real impact on the industrial base depends upon the specifics of those questions.”
Many details of the Pentagon’s 2015 spending plan have not been released yet, making it tough to gauge the entire five-year outlook for the industry, Berteau said.
Still, it appears the Obama administration will continue investments in shipbuilding and rotary wing aircraft, he said. Army vehicle production is a little more unclear with the cancellation of the GCV.
Defense companies have a large backlog, high profits and every expectation of continued business, just at a lower level, said Gordon Adams, an American University professor who oversaw defense budgeting during the Clinton administration.
The large contractors — which are more diversified, particularly with commercial business — face less of a problem as defense spending declines compared with the first two tiers of subcontractors, Adams said.
Third-tier and fourth-tier suppliers are generally commercial-focused, producing technology, widgets and parts, and tend to be more agile, he said.
More Uncertainty
The Pentagon’s five-year spending plan raises numerous questions and poses new uncertainty for defense companies, experts say.
Several factors complicate matters. First, DoD’s five-year spending projections between 2016 and 2019 are $115 billion over federal spending caps that only Congress can modify, which is unlikely.
While the 2015 budget falls in line with spending caps, it will include a separate $26 billion measure, which would make up the shortfalls caused by sequestration. The extra money in 2015 money would go toward training, upgrading aircraft and weapons systems, and facilities repairs, said James Swartout, Fox’s spokesman.
“To me the industrial base is a captive of the same dynamic as the overall budget,” Berteau said. “The uncertainty of what it is we’re planning for and what we’re going to execute, not only permeates military thinking and how you plan and scope your force structure and your requirements to support that, I think it permeates industry as well. How do you know where to invest? You can’t tell with this gap of $140 billion over a five-year period.
“Industry lives inside that $140 billion gap,” Berteau said. “How can you do good industrial planning at the corporate or facility level without more certainty?”
As spending contracts, the Aerospace Industries Association has continued its push for a defense industrial base strategy.
“As this Congress and the administration consider future defense planning, we advocate that our leaders adopt an industrial base strategy to mitigate looming investment deficits and sustain the US defense industrial base,” Marion Blakey, Aerospace Industries Association president and CEO, told the House Armed Services tactical air and land forces subcommittee last week. “We should identify and protect core, military-unique private sector capabilities that are most needed to defend our homeland and build security globally.”
Reaction on Wall Street
Wall Street seemed to take the early preview of budget decisions as a sign defense companies would have a brighter future, with stocks climbing after Defense News first reported details of the 2015 budget Feb. 23 and Hagel previewed some of the budget decisions that would be part of the Pentagon’s submission the next day.
That optimism was built on the back of planned personnel cuts and compensation reform that might allow the Defense Department to protect its acquisition spending and, by extension, the industrial base.
But those plans depend on billions of additional dollars of funding and congressional approval for reform that might not materialize, said Byron Callan, an analyst for Capital Alpha Partners.
“This idea that modernization is going to be shielded or protected may be unfounded,” Callan said. “The consensus seems to be built around the idea that DoD is going to do something about compensation, but they really didn’t touch retirement, and it’s really debatable that Congress is willing to touch compensation.”
While there may be some optimism that companies could fare better than thought, the important decisions that will shape the industrial base won’t be available until the full budget is released this week. Those include questions about how production lines and shipyards could be impacted by the reduction in the planned littoral combat ship order, details of which won’t be part of the 2015 budget but will begin to appear as part of the future years’ defense plan.
Despite what may be optimism on the surface, Callan said that the mid-level personnel who drive defense firms understand that the burden of cuts hasn’t suddenly been lifted.
“I just don’t get the sense that people are of the mindset that wow, we’ve made it through and we’re all clear ahead, despite what some of the CEOs have said,” he said. “People in the mid level of these companies are pretty realistic.”