We’ve previously discussed the latest fad amongst Pentagon leadership:  the notion that the DOD needs to focus on weapon system “affordability”—and that the primary means for doing so is to focus on cutting contractor overhead.  In this article, we reported that DOD intends to “identify and eliminate non-value-added overhead and G&A charged to contracts” (among other actions), so that affordability will be “restored” to defense goods and services.  It’s as if the entire national security leadership woke up one morning and suddenly realized they all were overdrawn at the bank. 

“Gosh!  How could this have happened to such outstanding managers?” they would have cried.  “Our defense goods and services are no longer affordable!  Since it can’t be our fault, then obviously it must be the fault of all those greedy contractors!” 

We reply to that hypothetical (yet all too real) assertion using the immortal words of Cher Horowitz (played by Alicia Silverstone) in the 1995 movie, “Clueless”—

“As If!”

Lt. Gen. Larry Farrell (USAF, Retired), recently used the cliché “perfect storm” to describe the situation facing the military services and their contractors.  General Farrell, who currently serves as President of the National Defense Industrial Association (NDIA), wrote—

The wars in Iraq and Afghanistan are now consuming in the neighborhood of $200 billion a year, which despite a defense budget just north of $700 billion, have dragged funds away from needed modernization. Recall that Congressional Budget Office projections from 2005 even then indicated that Defense Department funding was running $100 billion a year short of what it needed to fund the modernization programs planned at that time.

Then came the 2007 recession, now extending past 31 months, which is the most protracted since World War II. Along with the downturn are unsustainable federal budgets and projections of more than $1 trillion in annual deficits out through 2020. The national debt is approaching $20 trillion and interest on the debt will be around $900 billion per year in 2020 — larger than the ‘projected’ defense budget that year. The unsustainable nature of this budget projection has now been recognized as a national problem that can no longer be ignored.

In response, President Obama this year appointed a National Commission on Fiscal Responsibility and Reform. The so-called Deficit Commission is due to report in December. In anticipation, Congress has deferred action on the 2011 budget, which is normally scheduled to become law Oct. 1. …

Senate Finance Committee Chairman Max Baucus, D-Mont., said he sees three areas of focus: ‘the tax gap, the spending gap and the productivity gap.’ Since it’s fairly certain that government doesn’t directly legislate productivity, it is a safe bet that specific tax and spending recommendations will come from the Deficit Commission in December. …

All of these developments could begin to cause turbulence around December. The major unstoppable weather vector is the dire financial condition of the United States. The other converging elements — tax and spending reform and defense spending and reorganization — are minor by comparison.

Recognizing the “turbulence” coming their way, we’ve noted that defense contractors have been moving and restructuring, and re-org’ing and trimming, while nervously eyeing the Pentagon as if it was their sugar-daddy who had recently found a brand-new—younger—mistress to support.  That trend continues unabated.

The mega-sized provider of professional services, Accenture, recently reported that, “Pressures to reduce costs will be the primary drivers of decisions by aerospace and defense (A&D) companies to use external engineering services during the next two-to-three years.”  The firm issued a report entitled “Engineering Services in Aerospace and Defense:  Meeting the Sourcing Challenge,” available here.  The Accenture report stated—

Ninety percent of the executives interviewed cited cost reduction pressures as their top challenge, followed by supplier consolidation (52 percent) and increased competition from new players (36 percent). Consistent with these findings, the research revealed that 61 percent of these executives are buying engineering services to better manage production costs; 65 percent of them cited the need for improved efficiency and productivity.

Accenture’s bottom-line conclusion was that A&D companies will move to source engineering expertise and services from low-cost global providers—though the report acknowledged that the strategy contained challenges that would need to be overcome.  The benefits include lowering costs, shoring-up scarce skill sets, and more easily fulfilling offset obligations, while challenges include concerns about potential compromises of confidentiality and quality.  To those concerns we would add the worry about compliance with export controls.  Nonetheless, Accenture seems confident that A&D companies will embrace those challenges in order to lower their program costs.

Meanwhile, Navistar, the hugely successful (formerly) commercial manufacturer of Mine-Resistant Ambush-Protected (MRAP) vehicles, has announced “another round” of layoffs at its Mississippi production facility.  The linked-to article reports that—

John Munro, plant manager for Navistar in West Point, said the plant has some contracts which will last until 2013, but the high-volume MRAP production will end in 2011, leading to an unknown number of layoffs. The plant currently employs 505 workers.

Not to be outdone, Northrop Grumman issued a press release that announced “consolidation” of its Louisiana and Mississippi shipyards, a “winddown” of production at its Avondale, Louisiana shipyard, and closure of two more Louisiana yards.  Any remaining work (i.e., that related to the LPD-17 ships) will be performed at NGC’s Pascagoula, Miss. shipyard, according to the linked-to article.  The article reports that—

Northrop Grumman is considering a possible spinoff of its shipbuilding business, including a yard at Newport News, Va., into a separate company. Credit Susse has been hired as lead financial adviser on alternatives for the shipbuilding unit.

What’s driving Northrop Grumman’s decision-making?  According to the NGC press release (link above)—

‘Our decision to consolidate the Gulf Coast facilities is driven by the need for rationalization of the shipbuilding industrial base to better align with the projected needs of our customers. The consolidation will reduce future costs, increase efficiency, and address shipbuilding overcapacity. This difficult, but necessary decision will ensure long-term improvement in Gulf Coast program performance, cost competitiveness and quality,’ said Wes Bush, chief executive officer and president.

The consolidation of Gulf Coast ship construction is the next step in the company's efforts to improve performance and efficiency at its Gulf Coast shipyards, which began with the integration of its shipbuilding operations in early 2008.

As a result of the consolidation, the company expects higher costs to complete ships currently under construction in Avondale due to anticipated reductions in productivity and, as a result, is increasing the estimates to complete LPDs 23 and 25 by approximately $210 million. Of this amount $113 million will be recognized as a one-time, pre-tax cumulative charge to Shipbuilding's second quarter 2010 operating income. The balance will be recognized as lower margin in future periods, principally on the LPD 25. The company also anticipates that it will incur substantial restructuring and facilities shutdown-related costs including, but not limited to, severance, relocation expense, and asset write-downs. These costs are expected to be allowable expenses under government accounting standards and recoverable in future years under the company's contracts. The company estimates that these restructuring costs will be more than offset by future savings expected to be generated by the consolidation.

Obviously, Northrop Grumman is willing to invest a significant fraction of a billion dollars in order to trim future operating costs.  As it notes in its press release, it expects to recover much of its “investment” against its current and future government contracts as “allowable expenses.”  We wonder what the Pentagon leadership thinks of that plan?

While industry is undertaking these significant cost-cutting actions, the Pentagon is taking some of its own actions.  On July 13, 2010, Brett Lambert (Director, Industrial Policy) issued a Memorandum to the Defense Industrial Base.  When last we discussed Mr. Lambert’s Directorate, he stated his focus was on early identification of “points of failure” in the defense industrial base, so that the Pentagon might avoid “costly rescues of failing companies.”  In addition, his Directorate was focused on “the financial health of critical suppliers,” as well as the need to preserve “skills necessary to support our war fighters in the near term and long term.”  How’s that going, Mr. Lambert?

Mr. Lambert’s Memorandum to the Defense Industrial Base of July 13 did not address any of those prior focus areas.  Instead his new focus is on learning “to do more without more”—i.e., implementing the DOD’s new “Efficiency Initiative.”  Toward that end, Mr. Lambert announced a strategy involving “interacting parallel tracks, with close coordination.”  The effort will “drive fact-based recommendations” to Dr. Carter (USD, AT&L) for consideration and action.  Mr. Lambert’s plan involves five “issue focus groups,” an Industry Working Group (IWG), various Military Department Groups (MDGs), two Executive Directors, and a Senior Integration Group (SIG), which will be chaired by Dr. Carter.  In the words of Mr. Lambert’s Memorandum to the Defense Industrial Base—

There will be five government focus groups reporting to the Senior Integration Group (SIG) through two Executive Directors; Military Department Groups for each service will solicit ideas for the five Focus Groups to analyze; and I will lead an Industry Working Group that will collect ideas from industry and provide a feedback mechanism for industry to comment on the ideas we are considering. The groups will be comprised of government employees, although the Center for Strategic and International Studies (CSIS) will assist in administrative functions.

The five Focus Groups will address the following areas:

• Affordability
• Sharpening Contract Terms
• Reward Productivity Growth
• Measure Productivity Growth
• Create Tradecraft in Services Acquisition

Mr. Lambert’s Memorandum to the Defense Industrial Base concludes with the following request for industry participation in the Efficiency Initiative—

In order to reach the broadest possible base and ensure that we are inclusive of those in our industrial base willing to assist us in this effort, we will begin the process by asking that a simple form be filled out, which will be available on our website (http://www.acq.osd.mil/ip/). The form can be submitted directly to our offices via email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it . Please note that this form is not a survey and participation by industry is undertaken as a voluntary act, without direction by the Department.

So what is one to make of the foregoing?  We have a couple of thoughts to share with you, if you will.

1. It is clear, from this article and from others we’ve posted over the past year or two, that the defense industrial base is already moving to cut overhead and increase productivity.  We don’t see what value the Pentagon adds to the efforts that are already in process, and to those that will be undertaken in the coming months.

2. Note the new bureaucracy announced by Mr. Lambert.  Were one to read SECDEF Gates’ original remarks at the Eisenhower Library, one might reasonably conclude that SECDEF Gates was less concerned with contractors’ overhead and efficiency, than he was with the overhead, bloated bureaucracy, and lack of efficiency within the Pentagon.  He said, “Another category ripe for scrutiny should be overhead – all the activity and bureaucracy that supports the military mission. According to an estimate by the Defense Business Board, overhead, broadly defined, makes up roughly 40 percent of the Department’s budget.”  He also said, “The private sector has flattened and streamlined the middle and upper echelons of its organization charts, yet the Defense Department continues to maintain a top-heavy hierarchy that more reflects 20^th Century headquarters superstructure than 21^st Century realities.” That doesn’t sound to us as if he were overly concerned about contractors’ overheads.

3. Moreover, SECDEF Gates wanted the Pentagon to clean-up its own house.  He said—

Going forward, some questions to be considered should be:

• How many of our headquarters and secretariats are primarily in the business of reporting to or supervising other headquarters and secretariats, as opposed to overseeing activity related to real-world needs and missions?
• How many executive or flag-officer billets could be converted to a lower grade, with a cascading effect downward – where two-star deputies become one-star deputies, assistant secretaries become deputy assistant secretaries – to create a flatter, more effective, and less costly organization?
• How many commands or organizations are conducting repetitive or overlapping functions – whether in logistics, intelligence, policy, or anything else – and could be combined or eliminated altogether?

In considering these questions, we have to be mindful of the iron law of bureaucracies – that the definition of essential work expands proportionally with the seniority of the person in charge and the quantity of time and staff available – with 50-page power point briefings being one result.

So, instead of focusing on cutting bureaucracy, Mr. Lambert’s Memorandum for the Defense Industrial Base announces the creation of more bureaucracy.  The action being taken is exactly the opposite of what is being sought by the SECDEF Gates, as if to prove by direct action his reference to the “iron law of bureaucracies.” 

We see quite a bit of activity throughout the defense industrial base as contractors prepare for the upcoming “turbulence” noted by General Farrell.  We see quite a bit of activity at the Pentagon, as the bureaucracy gears up to assist the contractors do what they are going to do anyway.  (In fact, General Farrell wrote, “Carter has invited the defense industry to participate in the coming decision-making and execution process. We intend to do so.”)   What we fail to see is any activity by the DOD bureaucracy and military services to address the very issues that the Secretary of Defense directed them to address.