A recent study by the Center for Strategic and International Studies estimates that from 2001 to 2015, 17,000 companies ceased to be prime vendors for DoD… For example, the single domestic source for large thin wall castings for rotary wing gearboxes filed for bankruptcy in 2016, putting programs such as the AH-64E Apache, the V-22 Osprey, and the CH-53K Heavy Lift Replacement Helicopter at risk.
That was from a Sep. 2018 defense industrial base report to President Trump. 17,000 firms stopped dealing directly with the government–whether exiting all-together or working solely as a subcontractor–over a period where the DOD budget basically doubled.
The report also outlined 300 weak spots in the DOD industrial base:
The 300 weak spots are a mix of sole-source suppliers who could disappear from the market; suppliers that have already decided to leave the defense market; and suppliers that are foreign-owned and could potentially pull the plug in a critical situation.
How will more than a third of these weaknesses be addressed within a year? The DOD will pay for the necessary capital outlays to private firms who are willing to do the job.
Part of the reason these first 100 or so issues can be addressed in the next year is due to… the Defense Production Act Title III authorities, which create a fund for supporting endangered industrial suppliers with critical parts.
An example of how the Defense Department can quickly act to secure industrial base vulnerabilities is laid out in the decision — announced concurrent with the report’s release — to invest $70 million for a plant that produces gun components, in order to launch modernization and risk mitigation programs. A smaller investment of about $1 million went to the facility that produces the Abrams tank, to procure better tooling.
This is just an explicit statement of what regularly happens. One big DOD contract had an $8 billion CLIN just for tooling! Defense firms don’t appear to make substantial capital investment themselves unless the Government pays for it upfront, or unless there’s an agreement that it will be reimbursed fully over time in their overhead rates.
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| An Abrams tank outside of Lima, Ohio tank production plant. It received $1 million in extra tooling to cover supplier gaps. |
As I understand it, if the government directly pays for capital, then the supplier must return the capital to the government after execution. I doubt this really happens, especially when it is for a production line programmed over the next decade or more. What will the government do with $8 billion in specialized tooling, for just one instance?
The capital give-away is a big incentive. The government will pay for all capital, labor, and other overhead expenses. They then target 10-15% profit on sales. But the company invested almost nothing themselves, and maximize profitability by outsourcing as much as possible. I’ve seen returns on investment (ROI) approaching 100% pretty regularly. I’ll post later on how the profit game in the DOD works. Here’s a taste.
Back to the storyline. The DOD’s renewed interest in industrial policy is unsettling. The DOD already manages the investments and operations of the big prime contractors. The result is that we cannot identify which party is the source of errors. Who is responsible? No one is responsible!
I’ve been told many times that the DOD has a poor understanding of its subcontractors. One should hope that it doesn’t try to direct the operations of all firms in the supplier base as it does the major primes. Then there’ll be no where for firms to run except totally out of the defense industry. [Note, the headline 17,000 firms stopped being primes, but they may have become subcontractors.]
Many economists have pointed to the industrial policy of first the Soviet Union, then Japan and South Korea, and now China, as the efficient means of building national capabilities. Far too often have they misunderstood the role of markets and profit incentive which has proven to out-coordinate centralized industrial policy.
Interestingly enough, when it comes to the defense industry itself, perhaps the China, like the Soviet Union before it, is more market-oriented in reality than its American counterpart.
The DOD already decides through central planning and standard processes what systems will be bought. We know exactly how much money is going to every project in the DOD. No other country in the world outlines its defense projects so thoroughly. The DOD manages the business base of defense firms to keep an eye on overhead rates. The idea that the DOD doesn’t plan industry enough is laughable on its face.
Consider how a monopolist is born when the Government fills a gap by choosing a supplier for capital investment. Then there will be calls for data reporting and auditing to make sure those firms don’t overcharge. They will be indistinguishable from the big primes which become shockingly unproductive due to their protected status.
The DOD’s problem is that it plans the industrial base too much from the top. I don’t see anything good from the DOD picking winners and losers not only at the prime level, but down the supplier tiers. Government consensus is not the way to pick winners and losers in a dynamic, technologically demanding, environment.
Perhaps the DOD needs more planning from its program managers. Knowledge about the location of production gaps is surely dispersed across the program managers. There must be some funding or contractual problem that precludes them from fixing it directly. But maybe then again, the government manager deals largely with the prime and might simply not know of the gaps. That would be a more damning charge.
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