Industry Wary Of 'Productivity' Moves

It was not another April 6, nor a third Last Supper, but Ash Carter's briefings today should mark the beginning of long-term changes for the defense industry, changes which industry sources view with worried eyes.

Carter, the military's head of acquisition, said the Pentagon did not mean to cut industry profits but wants 'productivity" gains, just as happens in private industry where there are often scores of competitors and the race often goes to the swift, the flexible and the prudent. Carter made a pretty clear case. The defense budget will grow at slow rates -- 2 percent to 3 percent -- for the foreseeable future. But to do that and keep procurement and R and D accounts primed efficiencies must be found.

He said commercial industry regularly eked out productivity gains. The monopsony that is the defense industry had not. "More has been costing more," Carter said during his afternoon press conference.

He dismissed industry worries that his measure might affect profits. "This is about costs, not profits," he said. If the department can lower costs, it should be able to buy greater capability for less cost, he argued.

Over the next few weeks, Carter said he would offer detailed proposals that would flesh out the memo he issued today.

Industry stood back and said, hmm. "Carter's memo is a mixed bag for defense contractors -- it depends upon whether a company's product is considered meat or fat. Carter does promise to bring in more competition, which may help the smaller and mid-sized companies," said Jeff Evanson, a defense technology analyst at Dougherty & Co.

The Professional Services Council, which represents companies most likely to be hit hardest by changes Carter has proposed, praised his effort but worried about the content.

“We share the goals that Undersecretary of Defense Carter has identified for the department and while many of the recommended guidelines—such as increasing competition and choosing the right kind of contract—are laudable, PSC is concerned about how the department proposes to implement them,” Alan Chvotkin, the Professional Services Council's executive vice president, said after being briefed by Carter this morning. "For example, the department is right to focus on choosing the right contract vehicle, but why take a tool out of the toolbox by eliminating time and material contracts?"

And the PSC noted this is not the first go round for some of these proposals. "While many of the preliminary initiatives the department proposes have been tried before, the environment under which they are being discussed is different and the approach being taken appears to be different," Chyotkin said.

America's largest defense contractor, dependent on the Pentagon for the single largest defense program in history, was more positive about Carter's moves.

"We see the world through exactly the same lens as Secretary Gates and Dr Carter, and we intend to be relentless in focusing on program execution, on continuously improving our quality, and on driving affordability into every process and every program. We've already made changes with the Secretary's goals in mind -- and those changes have resulted in reduced costs in several areas -- but we've just started," CEO Bob Stevens said in a statement.

Lockheed, worried about any possible threat to the Joint Strike Fighter, has moved fast and hard to publicly address cost issues. The company has clearly made strategic decisions that guaranteeing JSF cash flow stands as a paramount institutional goal. With that in mind, perhaps the most interesting sentence in Stevens' release was the final one: "We welcome this opportunity and believe that working together, we can achieve better buying power for the warfighter and taxpayer, improve defense industry productivity, remove government impediments to leanness, and avoid boom-and-bust program turbulence."

Loren Thompson, who was briefed on Carter's measures last Friday and had time to think about them over the weekend, said the proposed changes "are long overdue, and may help to shield contractors from more draconian cuts imposed by Congress or the White House as pressure to reduce deficits mounts." But, as Thompson knew, defense companies "will fear that targeting overhead costs endangers industry profits. Those profits are already at risk due to $330 billion in weapons cuts recommended by Secretary Gates last year and insourcing initiatives aimed at pulling contracted services back into the government. When combined with the more demanding acquisition procedures imposed by recently-enacted reform legislation and the prospect of reduced funding for overhead functions, the emerging pattern is far from encouraging for key sector players."

One sentence in Carter's memo stood out, and it gives a clear picture of just how gradual the changes will be. Carter wrote that new contracts will be the focus of the department's efforts. So it will take years to achieve productivity gains and existing programs -- like the JSF -- are unlikely to feel the sting.

Smaller companies and those who don't concentrate on defense may view this as a good time to bail out. Thompson concluded that the latest moves "will accelerate the plans of some" companies to leave the defense business "before valuations begin to erode in response to softening demand."