Military transformation requires new suppliers: Pentagon study says more innovative companies needed in defense sector.

The Pentagon's latest study on the defense industrial base confirms what has become increasingly obvious to experts and observers: the Defense Department and its top contractors are hindering the entrance of new firms into the marketplace.

Sizeable increases to the defense budget alone are not enough to widen business opportunities for non-defense contractors, which often have a hard time breaking into a market where a handful of big players rule.

The defense industry as it exists today--dominated by a cluster of giant conglomerates--may not be nimble enough to adapt to new requirements for future weapon systems, experts noted.

An important question for the Defense Department is, "Can the industry support transformation?" said Kent Kresa, chief executive officer of Northrop Grumman Corp.

Kresa, who runs the nation's third-largest military contractor, said that the Defense Department should revamp antiquated regulations and ensure intellectual property is protected, in order to attract non-traditional suppliers into the defense sector.

Companies such as General Motors, Texas Instruments and IBM have exited the defense industry, "even though the government has tried to make defense work more attractive to non-defense companies," Kresa said in a speech to the American Institute of Aeronautics and Astronautics.

The reluctance of many businesses to get involved in the defense industry is "not encouraging," Kresa said. "Today, smaller firms are hesitant to deal with the government. Most are not equipped to navigate the demands of federal acquisition regulation. Many firms fear the loss of their intellectual property or other restrictions on their use."

A study due out this month--sponsored by the office of the deputy undersecretary of defense for industrial affairs--says that the current makeup of the industry is adequate to meet near-term national defense requirements, but also alerts to potential shortfalls in the industry's ability to meet the needs of the future.

Military priorities, such as chemical-biological defense, cyber-warfare and the growing demand for high-speed communications are unlikely to be satisfied entirely by large defense firms, said the study, which Kresa cited in his remarks.

According to the study, smaller firms historically have contributed the most to defense innovation. Approximately 35 percent of future technologies are likely to come from non-traditional suppliers. Foreign firms are expected to supply about 18 percent.

"The conclusion is obvious," Kresa said. "We in the defense industry have to become more proactive in working with smaller and non-traditional suppliers, both domestic and foreign. ... By broadening our technology pool, we will be able to better tackle the daunting challenges that we have."

The weaknesses in the defense technology base include the lack of adequate bandwidth, the vulnerability of computer systems and the high cost of satellite launches, Kresa said. Another vexing problem is the incompatibility between U.S. and allied forces.

"The government, for its part, needs to make it more attractive for commercial and foreign suppliers to participate," he said. As incentives, for example, the Defense Department could create more R&D opportunities, relax export-licensing regulations and relieve smaller companies of the burden associated with acquisition rules.

Specifically, the Pentagon should make it easier for large prime contractors to work with small commercial suppliers while waiving FAR (federal acquisition regulations) requirements, Kresa said. "Small suppliers could then use the [large] systems integrator's resources, without having to support the overhead requirements to deal with the government procurement system.

Large companies, he said, are better qualified for "network centric warfare and interoperability" but may not be as capable in niche technology areas.

If the Defense Department wants to see changes in the industry, Kresa said, "the most critical element is the development of an acquisition process." Much can go wrong in defense programs: late deliveries, budget overruns, product disappointment and incompatibility with legacy systems, he said. "We may never be able to eliminate these problems entirely."

Nevertheless, innovation and open-mindedness should move to the forefront in the acquisition process, Kresa said. "This represents a dramatic departure from the way we've done business before. ... Reforming our acquisition process will go a long way to achieving transformation."

The director for force structure resources on the Joint Staff, Lt. Gen. James E. Cartwright, USMC, agreed that procurement regulations must change if the Pentagon wants more companies to participate.

"There is still a lot of legislation out there that makes it very difficult to play in this game, if you are not one of the leading companies," Cartwright said. He said he is optimistic that reforms currently under way, such as the rewrite of the so-called 5000 series regulations, will help expand opportunities for non-traditional contractors.

A business environment that is as risk-averse as the defense sector stifles innovation, said Rear Adm. Jay Cohen, chief of naval research.

"I know no program manager who has been rewarded for raking risk," he said at the AIAA conference. "Until we fundamentally change that paradigm, I don't think we will fully transform."

A glaring example of the industry's poor record in innovation is the shipbuilding sector, which for decades has refused to embrace composite materials and other advanced technologies used in other countries. "The resistance in the shipbuilding industry at the working level to go to composites is depressing," Cohen said.

Large defense contractors often should be blamed for putting their own financial interests ahead of the government's long-term priorities, Cohen said. "A major problem I see in this country is the 'not-invented here' syndrome." The dominant players tend to shy away from products that were not developed "in-house," said Cohen.

A case in point was an attempt by a major contractor to "kill" an Office of Naval Research project, called Affordable Weapon, which aimed to develop a low-cost (about $30,000) extended-range missile that would be used aboard Navy ships. "The contractor, who shall go nameless, was building larger missiles for the Navy," Cohen said. This company's tactics could be described as, "let's shoot Affordable Weapon in the Lice, because it might be competitive with our order-of-magnitude more expensive weapon," Cohen said. "That is a prime example of how innovation is squelched periodically for other goals."

The Pentagon's second-largest contractor, meanwhile, is leading an Army project that requires them to reach out to innovative firms. As the lead systems integrator for the Future Combat System, the Boeing Co. is responsible for recruiting suppliers that typically would not seek defense contracts, said Jerry W. McElwee, FCS program manager. "From an LSI perspective, the continuing objective is to bring those folks on board. We need to help bring them to the Defense Department," he said.

RELATED ARTICLES: Space command ready to support war needs.

Elizabeth G. Book

The Air Force Space Command (SPACECOM) is readying itself to take on an increased role in the war on terrorism, said Air Force Gen. Lance Lord.

"We've got space guys hunched over laptop computers, you've got them integrated into what is going on day to day," said Lord, the commander of SPACECOM, at Peterson Air Force Base, in Colorado Springs, Colo.

"The military center of gravity is emerging in space," he told defense reporters. Lord is the first SPACECOM commander who is not a "three-hatted commander," also in charge of Northern Command (NORAD), and United States Space Command (USSPACECOM). In April 2002, the Pentagon made Air Force SPACECOM a separate four-star combatant command, distinct from the commanders of US Space Command and NORAD. Though NORAD is still based at Peterson Air Force Base USSPACECOM was absorbed into Strategic Command (STRATCOM), which is based at Offutt Air Force Base in Nebraska.

Lord said that two of his priorities are to organize and train space forces, and to support the Intercontinental Ballistic Missile Defense program.

"We want to get beyond what we are doing right now, which is tracking objects in space, to space-based space surveillance. It is easier to look at space from space than it is to look through the Earth's atmosphere," he said.

He noted that the nation's communications satellites will be in adequate shape to support a possible conflict with Iraq. "We've worked hard as a force provider and force enabler with our friend [Air Force Lt. Gen.] Harry Raduege, who runs the Defense Information Systems Agency (DISA). Harry has worked hard to make sure that we have the kind of connectivity to enable and provide the linkages in satellite communications. We are ready to support not only what is going on, operationally, now, but what, if the president chooses, to take action on in the future. And those communications are prepared and ready to go," he said.

SPACECOM, Lord said, is part of every service chief's area of responsibility, "because every combatant commander needs space."

Lord said it was important for space technologies to be allowed to mature. "First off, we've got to make sure we've got a solid operational concept," he said. But sometimes concepts need time to fully develop, he said. When the technology is identified and it is at the right maturity level, then "we can move on," Lord said. "Then it is a matter of devoting the resources."

Investors not likely to depart defense sector.

A new breed of institutional investor has helped prop defense stocks during the past two years, but the outlook for the industry may not be as bright in the years ahead, if the technology sector makes a comeback, said Lucy Reilly Fitch, vice president for acquisitions and strategy at BAE Systems.

These institutional investors that have emerged on Wall Street she said, "know nothing about defense, but they have stayed over the last year. I think they will leave as technology stocks start to rebound."

Fitch noted that 58 companies have left the defense business over the last 10 years, and that the largest five defense contractors today used to be 75 companies only decade ago. The sector, however, will remain strong as the government will continue to fund new programs in homeland security transformational technologies and precision weapons, she said.

"You can expect to see a lot smaller companies with niche capabilities, particularly in the areas of information technology and services," Fitch said. "Wall Street analysts are starting to cover some of the firms they didn't even know about a few years ago."

Elizabeth G. Book

In fiscal 2002, Defense Department prime contract awards totaled $170.8
billion, $26.2 billion more than in fiscal 2001. The top 10 defense
contractors for fiscal 2002 were:

1.  Lockheed Martin Corp.                     $17.0 Billion
2.  The Boeing Co.                            $16.6 Billion
3.  Northrop Grumman Corp.                    $8.7 Billion
4.  Raytheon Co.                              $7.0 Billion
5.  General Dynamics Corp.                    $7.0 Billion
6.  United Technologies Corp.                 $3.6 Billion
7.  Science Applications International Corp.  $2.1 Billion
8.  TRW Inc.                                  $2.0 Billion
9.  Health Net Inc.                           $1.7 Billion
10. L-3 Communications Holdings Inc.          $1.7 Billion