Is it crunch time for the aerospace industrial base? A wide consensus says yes.
"It seems hard to believe: At a moment of historic highs in defense spending, there is growing concern about the future of American defense industry as well as the national security industrial and scientific base," said Michael E. O’Hanlon and Peter W. Singer in a February Brookings Institution study.
"Since the space age began, we have rarely been so reliant on so few industrial suppliers," testified US Strategic Command’s Gen. C. Robert Kehler in March.
The F-22 production line in Marietta, Ga
The 2010 Quadrennial Defense Review contained pointed industrial policy language: "Unfortunately, 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."
Although the Department of Defense appeared more ready to take action, top-level Pentagon policymakers stumbled over a second, surprising obstacle to formulating industrial policy: strong sales. Ironically, genuine concerns about the industrial base come on the heels of a prosperous decade for most defense firms.
By any economic measure, the defense industry is coming off a healthy run due to global market growth, spending for Iraq and Afghanistan, and recapitalization programs of the past decade.
The aerospace industry was part of this trend. US Department of Commerce called the years from 2001 to 2008 "the largest upturn in the US aerospace market since World War II." Last year, US firms logged $171 billion in sales. Just over half came from defense sales totaling $86 billion, while civil sales accounted for $85 billion.
Aerospace makes a big splash in the balance of payments. The US exported $77.8 billion in total civil and military aerospace products in 2010 and imported $34.2 billion, for a trade surplus of $43.6 billion, according to the Department of Commerce. Government statistics on the workforce—which make no distinction between defense and commercial work—tell the same story. Aerospace parts and product manufacturing employed 501,180 in all occupations as of 2009.
Viewed from the perspective of recent corporate earnings, most of the major defense firms are in good shape. According to the Pentagon’s Office of Manufacturing and Industrial Base Policy, five major prime contractors have procurement orders stretching out for 10 years. In that group, Lockheed Martin and Sikorsky "have programs identified today that will carry production for the next 20 years," reported DOD.
Getting to a more nuanced assessment is tough. What’s at stake is not the profitability of the aerospace industry itself or even its marquee names. The question is whether the cumulative impact of consolidation and cutbacks are endangering the capacity to design and produce the most technically demanding new aerospace systems. From engines to laminates, concerns abound.
The aircraft sector is a prime example. Recent assessments remain rosy. "The aircraft industrial base sector is projected to remain healthy, despite ongoing market pressures, as the vast majority of DOD aviation production programs continue to be supported near-term in the budget process," the Office of the Secretary of Defense’s mandated annual report on industrial policy noted for 2010.
But this is where a broad look at sector financials fails to tell the story. Observers agree that slack in the research and development accounts for aircraft is a scary sign. The 2010 report to Congress did acknowledge the problem. "With the shutting down of the F-22 and soon the F/A-18E/F/G production, there is significant concern for the potential loss of essential military-unique design and engineering capabilities."
An E-8C JSTARS aircraft undergoes an engine upgrade at a contractor facility.
Boeing Phantom Works President Darryl Davis hit the nail on the head: For the first time in industry history, there are currently no new, ongoing US military, manned, fixed-wing development programs. (The newly approved KC-46A begins life as a commercial airframe.)
Two factors have long held back discussions of industrial policy. The first is a longstanding assumption that market forces should sustain military industrial capability with little Pentagon intervention.
There were concerns with the industrial base back in the 1990s as procurement dipped after the Cold War and the Department of Defense famously encouraged industry consolidation. It also stepped in occasionally, such as when it stretched out solid rocket motor production for strategic missiles.
But for the most part, defense industrial policy could be summed up in two words: market forces.
An example was the 2009 Annual Industrial Capabilities Report to Congress. "The industrial strategy of the Department of Defense is to rely on market forces to the maximum extent practicable to create, shape, and sustain those industrial and technological capabilities needed to provide for the nation’s defense," it stated.
Secretary of Defense Robert M. Gates appeared to be fully on board with that stance when he delivered the Obama Administration’s first round of defense program cuts in April 2009. Gates admitted to reporters that the industrial base wasn’t considered. "It did not play a significant role in most of the decisions," Gates told a media roundtable on April 7, 2009. "You guys know better than I do that most of these companies have multiple programs with us," he added. Congress is concerned with this attitude. The sweeping Weapon Systems Acquisition Reform Act passed in 2009 inserted a measure requiring DOD to examine industrial base effects of termination of specific major weapons systems.
Frank Kendall, the Pentagon’s deputy acquisition, technology, and logistics executive, told lawmakers May 5 that DOD does "not foresee a precipitous decline" in acquisition spending like the one at the end of the Cold War. The Defense Department expects market forces to continue as "the primary mechanism by which industry responds" to coming changes, however, and DOD will only intervene "in rare exceptions" when it deems it necessary to protect critical capabilities or ensure competition. The Pentagon is launching a review to identify efficiencies and potential cuts over the next 12 years, and Kendall said the industrial base will be a factor in that review.
The Defense Science Board previously chastised the Pentagon for talking transformation without revamping its relationship with the defense industry. "There is a critical need for DOD to establish a national security industrial vision, working with industry to ensure realization of an improved customer/supplier relationship," its 2008 report concluded.
F-35s on the moving line. The plan for an alternate engine for the aircraft is in serious jeopardy. Moving forward with just one engine for the F-35 would save money but reduce competition in a critical area for the industrial base.
The Aerospace Industries Association fired its shots with a major report on the industrial base in summer 2009. "A significant gap has developed between DOD’s view of industry as an always-ready supplier of military capabilities and how industry actually makes decisions on what capabilities to offer," said AIA. "And that gap is widening."
"What Washington has not explained is how it’s going to sustain a defense industrial base when it doesn’t buy anything. ... Washington has not seriously worried about the industrial base since the end of the Cold War," wrote James Jay Carafano, of the Heritage Foundation, in the Washington Examiner in August 2009.
To their credit, some new Obama Administration officials at the Pentagon were quick to pick up on the concerns.
"I feel industrial base issues are completely legitimate because having the best defense industrial and technology base in the world is not a birthright," said Undersecretary of Defense for Acquisition, Technology, and Logistics Ashton B. Carter, in a Defense News interview shortly after his appointment in 2009. "It’s something we have to earn again and again, and that’s particularly true in a globalizing and commercializing world."
In the same interview, Carter also removed one stigma by making clear that industrial policy was not a jobs program. "It’s not about jobs; it’s about very rare kinds of skills that are not easily replicated in the commercial world and, if allowed to erode, would be difficult to rebuild."
New programs spend dollars first on research, development, test, and evaluation (RDT&E). They move to production funding only as they pass through system development and demonstration and achieve low-rate initial production. This is partly why major manufacturers can show strong sales from production while critical RDT&E accounts wither.
Big companies aren’t the only ones to feel the effects of the decline. Suppliers may experience it first. As OSD’s industrial policy explains, "The reduction in RDT&E funding does not bode well for companies and their subcontractors without long-term production programs. The lower-tier supplier base continues to consolidate as the number of military programs reduces over time. Suppliers not associated with future production programs (for example, suppliers not participating in the F-35 or UH-60M) will be impacted the most."
Delving into the supply chain could be an important step.
Brett B. Lambert, deputy assistant secretary of defense for manufacturing and industrial base policy, put the problem in his sights. He immediately initiated more contacts with industry and focused attention on suppliers as well as primes.
Secretary of Defense Robert Gates with Marine Gen. James Cartwright, vice chairman of the Joint Chiefs of Staff. Gates has said industrial base concerns are typically not a major factor when DOD makes program decisions.
Lambert’s office is concerned about lower-tier suppliers and has an in-depth review of key sectors under way, with outbrief scheduled for late 2011.
Of course, details are hard to unearth, especially when civil and defense sales are mixed in.
Fighter aircraft engines are a case in point. Air Force Materiel Command and the Air Force Research Laboratory sponsored a study of the aircraft gas turbine engine market. It projected sales of $295 billion in this market from 2009 to 2018—a bonanza at first glance.
The study details told a different story. First, 55 percent of projected sales would come from commercial engines. The next 34 percent would come from maintenance, repair, and overhaul. Total new military engines made up just 11 percent of the projection. An even smaller slice would be high performance fighter engines.
A Supply Chain Drain
Major engine makers compete but also form alliances and consortia. The problem is not the collapse of entire firms but declining competition, capacity, and innovation in the most elite types of engines. In this case, advanced research sponsored by AFRL is helping to fund some progress. What’s uncertain is whether small, focused research efforts are enough to sustain forward momentum without major programs to focus demand and stimulate innovation.
With the engine industrial base, improved engine performance is a key parameter for new programs such as next generation long-range strike. However, DOD policies, such as the elimination of the General Electric-Rolls Royce F136 engine for the F-35 program, have not been formulated with industrial policy in mind. Although GE and Rolls Royce remain leaders in commercial engine work, moving forward with just one engine type for F-35 reduces competition in this critical area of the aerospace industrial base. This is just one example of how difficult it is to fit industrial policy into overall DOD decisions.
OSD Industrial Policy issued a fairly strong warning in its 2010 report. Any impact of top line budget constraints on future RDT&E funding levels, and on future industry design and development capabilities, has yet to be determined, the department noted.
Another major drop will come when F-35 production ramps up, shifting most money out of research dollars. Suppliers supporting the F-35 may not have the opportunity to link up with new programs. In that case, the supply chain may atrophy.
"These suppliers will be forced to either exit the business or find new non-DOD programs for their products," acknowledged OSD in its 2010 industry policy report.
The snapshot of production spending and profitability reflects Cold War assumptions that industrial policy is a relatively simple matter of ensuring surge capacity at a range of firms. By this way of thinking, an aviation firm busy with civil aircraft work can switch nimbly to specialized design and production for advanced military systems.
An HH-60G Pave Hawk takes off on a medevac mission from Bagram Airfield, Afghanistan. The H-60 is still in production, but DOD acquisition chief Ashton Carter said having the best defense industrial base is not a birthright.
Sophisticated capabilities require focused development and must draw on a base of talent and innovation already in place.
Take the plans for a next generation long-range strike family of systems. Modest research efforts are planned. The government may fund two or three teams to produce proposals with advanced designs for a bomber platform. However, within a few years, one team would be selected to work toward low-rate production, leaving other teams without fresh projects.
Plans for a sixth generation Air Force fighter are years away. By that time, it’s impossible to say which aerospace companies will still field advanced design teams to compete for the work. Future teams will not have the benefits from working on other programs in the interim. The very worst case could be technology stagnation—which will come with a high cost to recapture innovation.
As with aircraft manufacturing, the space sector is coming off a boom cycle—and faces its own concerns. Total world space industry revenues more than doubled from $40 billion to about $100 billion between 1996 and 2006.
Spending by the US government drove its share as well. US government spending grew 40 percent from 1997 to 2007 driven mainly by a surge in DOD spending. Significant investment over the past decade has recapitalized much of the space portfolio. Robust sales in space systems and services led the Pentagon to pronounce the sector healthy.
But big shifts have occurred in market fundamentals. "It’s a far more competitive environment," observed Deputy Secretary of Defense William J. Lynn III at a Center for Strategic and International Studies forum on Feb. 16. "Twenty, 25 years ago, the US had two-thirds of the space market. Now, we’re still a leader in space, but our share of the market is now 35 or 40 percent," Lynn estimated.
US trade policies for space products are highly controversial. Tight export controls implemented in the 1990s restricted US firms in the global marketplace. Foreign firms are known to advertise space systems with "no-ITAR" (International Traffic in Arms Regulations) components, meaning customers can avoid hassling with US export controls. As a result, US firms are losing out.
"Many struggle to remain competitive as demand for highly specialized components and existing export controls reduce their customers to a niche government market," said Kehler. Future US leadership in the domestic commercial space market and the competitiveness of certain industrial segments face challenges from the growth of foreign competition. The Pentagon has acknowledged the problem. "Our current export control regime costs us jobs and fails to protect our security," said Lynn at an April 2010 Space Foundation symposium. "The President and Secretary Gates both recognize the self-imposed folly of this system."
Closely linked to space is the problem of solid rocket motors. The missile sector—one of the Pentagon’s seven key categories—has long been a worry. Kehler also expressed concern for solid rocket motor manufacturing, "an industry we cannot afford to lose."
Missiles stand alone without commercial applications in their sector.
Two Navy F/A-18 Super Hornets patrol over Afghanistan. Soon, F/A-18 production will end, further raising concerns about the potential loss of essential military-unique design and engineering capabilities.
According to DOD, the number of missile manufacturers shrank from 12 firms in the early 1990s to just six today. Lockheed Martin and Raytheon together account for about 85 percent of missile procurement, while firms such as ATK with the Advanced Anti-Radiation Guided Missile (AARGM) and General Dynamics with its 2.75-inch Hydra rockets are prime contractors for only one missile program. Funding across the sector is projected to decline as much as 50 percent from its 2007 peak.
On strategic missiles at least, industrial policy has tried to reach out. The Department of Defense intervened in 1995 to stretch out production rates for the Navy’s Trident missile. "In part to forestall industrial base erosion, the procurement rate for Trident II (D5) SLBMs is being slowed, thus extending production into the next century," DOD wrote in its 1995 annual industrial report. It also pledged to explore "new ways to preserve key industrial technologies; re-entry vehicle and guidance technology are particularly problematic, given the lack of commercial applications."
In recent years, manufacturers worked on programs such as the Minuteman III and NASA’s Ares rocket (until its cancellation). Now the large solid rocket motor base is at risk again and limping along with slow D5 missile procurement.
No new programs are in sight. The Navy is committed to stretching out D5 motors through 2042. But, as OSD notes, this approach "does not adequately address maintaining the design and development skills required for developing our next generation strategic systems."
Is DOD ready to move beyond its laissez-faire approach? If so, the authorities exist. Title III of the Defense Production Act authorizes DOD to invest in critical segments of the industrial base if they are deemed close to failure.
"We are accustomed in the American public debate to praising men and women in uniform, and yet we often ignore or even pillory those who equip and support them," remarked Brookings’ Singer and O’Hanlon. The pair notes that it has been "the scientists, engineers, industrialists, investors, and workers who make the equipment that [have] allowed the United States to dominate most forms of warfare for the last few decades."
The Pentagon pledged in QDR 2010 to "create an environment in which our industries, a foundation of our nation’s strength, can thrive and compete in the global marketplace." Future Air Force capability depends on it.
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