Mil-Tech

Military-Industrial Complex

Every four years or so the Defense Department conducts its Quadrennial Defense Review. The Obama Administration submitted the results of their first review along with the latest federal budget during the first week of the month. The review is a Congressional-directed examination of the U.S. strategy and force structure. One of the main results of this review is for the Executive Branch to try and prioritize which programs will be developed and acquired.

The Executive Branch’s decisions are critical intel to defense contractors as the decisions influence which of their products will be developed and bought. The 2011 QDR Report did include one major change for the U.S. Department of Defense. The force structure will now no longer plan on fighting two major conflicts simultaneously. That had been a requirement of the U.S. military since the 1980s. That decision alone will drive many procurement decisions, because it is likely to shrink the Air Force and Navy.

The QDR report has a chapter on the acquisition system and industrial base concerns. The report states that “the federal government as a whole and the Pentagon in particular have not adequately addressed the changes both within the industry and in the Department’s needs in the current strategic environment.” The Obama Administration wants greater engagement between the industry, Congress and itself to ensure development of necessary systems. One goal is to ensure that “rapid evolution of commercial technology” will be fitted into defense systems and plans.

Of course, none of this is new. For the last sixty years the Government has been hoping to integrate new technologies developed in the private sector for military use. In many cases the military services have successfully done this. The military has been able to take advantage of the increases in processing power, for example, as the few CPU chips developed specifically for defense use have been quickly outpaced by Intel (INTC) and others.

One hindrance to the rapid government integration of private-sector advances is that the runway for weapon development is so long that the commercial technology available at the end is much better then what was available at the start of the program.

Another factor that has slowed the development of new military technology is the withering of the U.S. industrial base since 1991 due to a fall-off in demand. When the Defense Department needs a lot less product there will be a lot less capability to deliver it. The situation with the new KC-X aerial tanker is a case in point. When there are only two corporations in the world — Boeing (BA) and Airbus, EADS (EADS:P) subsidiary — that can meet the military’s needs, there is little or no competition.

One thing that the QDR does address is the realization that the industrial base is no longer made up of big corporations like Boeing, Lockheed Martin (LMT) and Northrop Grumman (NOC). These companies now rely on several thousand second-tier suppliers to deliver key components in small quantities to produce large, complex weapon systems. A good example is II-VI Inc (IIVI). This advanced optics and semiconductor producer just won a contract from Lockheed worth $40 million to provide sapphire windows for the F-35 Joint Strike Fighter (JSF) targeting system. II-VI has been making small lots to support the development and testing aircraft but now must plan to ramp up its production to support Lockheed’s increased deliveries of the F-35. The JSF program will benefit many different companies across the world like Alcoa Aluminum (AA) who delivers fuselage assemblies.

Since the company had net earnings of $6 million last quarter this contract represents a significant level of work for it. IIVI’s component may be small in scale but it is crucial for the aircraft. Lockheed has tens of these contracts; without them, the aircraft would not be manufactured on time and with the correct capability.

In the 1990s, due to the decline in the defense budget, many of these second-tier suppliers stopped producing defense products or went out of business. There was no demand. The QDR describes a policy that will somehow keep the industrial base in the United States capable of providing this support. That policy may demand increased quantities of products at certain times despite the need for them or direct investment in key technology production. Without these suppliers the modern weapon systems the U.S. wants would not be developed or built. Export control laws limit what technology may be moved to offshore production and the U.S. defense production could become open to boycotts by these foreign suppliers over U.S. policy.

The QDR report recognizes that the industrial base must be protected and developed. This has to be done within the demands for competition, cost and international trade agreements. Relying on U.S. suppliers only will increase cost as there is less competition, higher labor rates and more regulation. Refusing to buy from foreign producers may lead to World Trade Organization (WTO) violations and counter tariffs and boycotts. Rebuilding the base to what it was prior to the 1990s will take a great deal of money and changes in the whole defense acquisition system.

Comments are closed.