February 22, 2005    Volume 12, No. 4

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What Is The Real Health Of The Defense Industrial Base?

For many in the defense community concerned about the health of the U.S. industrial base, one person is believed to stand in the way of persuading the Pentagon to do something new and perhaps radical to reverse the slide of U.S. industry. That person is Suzanne Patrick, Deputy Undersecretary of Defense for Industrial Policy, who argues that by most measures the U.S. defense industrial base is innovative and healthy.

But there has been growing pressure on the Pentagon to begin developing strategies to avert the loss of strategic industries. As much of this pressure -- or perhaps more -- is coming from conservative hawks in the defense community concerned about the rise of Communist China as from liberal doves concerned about the loss of good-paying jobs.

Those wanting a more aggressive response to the decline of manufacturing have anecdotal stories of companies and industries that no longer produce in the United States. But Patrick has what her opponents generally do not possess: data and detailed studies assessing the health of specific sectors and the overall health of the U.S. defense industrial base.

Her office is tasked with investigating claims of national security lapses due to loss of industry. Most times, her staff has found that the items in question -- such as rare-earth magnets produced mainly by Chinese-owned companies -- can be supplied by numerous firms both in the United States and in allied nations, or through alternative technologies.

Patrick's office is in the process of finishing a comprehensive series of studies on the technological underpinnings of five broad military "capabilities" that the Joint Chiefs of Staff says are the key to military success in the future. These assessments, called the "Defense Industrial Base Capabilities Studies," represent one the most intensive government efforts in the past decade to chronicle the development of critical technologies down to individual company level of expertise.

These studies, which are available to the public, indicate that many of the most advanced technologies needed for future military systems are well represented by American companies, but that there are some areas that need additional government investment. Patrick's office has proposed the creation of a $100-million defense "Industrial Base Implementation Fund" to support the adoption of innovative technologies throughout the U.S. arsenal.

Patrick has successfully argued that a "Buy American" approach aimed to improving the U.S. industrial base would have "egregious impacts" on the industrial base. "We have tried to see it their way and we have studied it their way," says Patrick, whose sometimes contentious nature has ruffled feathers on Capitol Hill. "But we simply do not come to the conclusion that appears to motivate" those who are calling for a protectionist response to shoring up the defense industrial base. "We just cannot find a national emergency in foreign content."

Patrick also encourages all current and potential military contractors to use the capabilities studies as a means to position themselves in the military market.

"As a body of work, we intended [these studies] as a translation service for companies so they can better understand how they fit into the defense enterprise," says Patrick. "If you are interested in engaging the department in a contract for hardware, this provides you with a way to assess your own industrial capabilities relative to the warfighting capabilities required by the industrial base of the future."

The reports also provide other countries with a framework to develop their own defense industries, says Patrick. "One of the things we have learned is that because of the scope of the [studies], we have unintentionally pre-done a lot of the work that any country or any super-national organization interested in industrial base state matters would have to do for themselves," she says. "If you are a country interested in assuring sufficiency in your own industrial base, you would probably take a subset of our warfighting capabilities, choose which ones are the most important to you, assess your own industrial base capabilities and see how you stack up."

The real value of the reports, says Patrick, lies in their appendices, where there are exhaustive lists of future military requirements and descriptions of the hundreds of companies that can fulfill them.

Once the last capability study is finished in May on "Focused Logistics," Patrick's office will begin a larger communication and implementation strategy throughout the Defense Department to assure the future supply of critical technologies. "We want to have a complete view before we begin implementation because there may be synergy issues we want to address before we begin to implement the findings," says Patrick.

The reports are worthy of downloading and can be viewed at http://www.acq.osd.mil/ip.

Patrick sat down in her office in the Pentagon with Manufacturing & Technology News editor Richard McCormack. She was joined by Gary Powell of her staff. Here is some of what they had to say. The full interview is available for subscribers.

Q: There is growing concern over the broader U.S. industrial base upon which the defense industrial base depends. DOD is dependent on the health of these industries to generate revenue to fund R&D for the next generation of technology. Do you feel that there is a need to look at the trends in these broader industries and where they are going, similar to the study you are conducting on the semiconductor industry?
In many of the broader manufacturing industries -- the materials and metals industries and the machine tool industry -- we are typically a minute fraction of overall production. The department directly buys only 0.4 percent of steel production. We are not a big player. We don't exercise a lot of leverage. We consume 1 percent or so of global IT, so we don't have a lot of leverage.
In many cases, there is a cyclicality to our views on developing and accessing new technologies and materials. We may in essence invent an industry, but then be very content to see it commercialized and then globalized as it matures. This is because as it is commercialized and then globalized the industry becomes exposed to global competitive pressures and myriad other forces that result in ever-faster innovation and of course the benefit of much lower costs.
It's a much more complex picture than some would indicate in their statements. Where we are a very small buyer, we have to be vigilant -- as we have been with regard to the issues of trusted sources for semiconductors or with stockpiling or producing beryllium. We are also beginning to look at the impact of major metals and materials inputs to our weapons systems where prices may have been driven upwards by high Chinese demand. We look at those things and we react as proactively as we can.
When it is something of critical importance, we have to be careful and perhaps intervene. But if it's not an issue of critical importance and it's a capability where we don't necessarily have to enjoy a generation or more technology lead over adversaries or global competitiveness levels, then we must acquit ourselves well in the reality of what is often a global commercial market.

Q: The location of the physical production as opposed to who owns the production seems to have a lot of people concerned. In a variety of industries that production has moved or is moving to places where people do not feel overly comfortable and confident that it's in a secure location. How do you deal with the issue of globalization?
There are a number of criteria that we must satisfy for ourselves with regard to location of supply. First of all, we're always very intent on ensuring the security of that supply through the ability and volition of suppliers to deliver to us on schedule and in keeping with terms of the contract. We furthermore make sure that the company in question shares a sufficient amount of our corporate culture to be able to function well as a defense supplier. We also are very intent to make sure that we can impart to those companies our strategic direction for what's important to us. So we actually do spend a lot of time and effort ensuring that our suppliers are suppliers that we can trust.
Powell: The Department has negotiated Declarations of Principle Agreements mostly with European countries but also with Australia that look at various ways in which we can cooperate. Within these broad agreements, we are also negotiating bilateral security of supply agreements. The idea is to establish a reciprocal agreement where if they buy things in the United States and if they need things in a hurry we'll help them and if we're buying things from them and we need them in a hurry, they'll help us. It's an attempt to try to address these problems. We have entered into agreements with the UK and Sweden and we are discussing them with Italy, Norway, the Netherlands, Spain and Denmark.

Q: Is the Department of Defense concerned that the semiconductor industry is putting most of its new production in China rather than in the United States?
From the extensive semiconductor study we have underway it appears that for most of the military requirements, we currently have a sufficiently large and robust semiconductor industry here in the United States -- domestic capacities significantly exceed the demand for defense-specific semiconductors. The fact that our semiconductor companies are responding to global demand elsewhere by building additional facilities to address that demand only will strengthen the commercial viability, innovativeness and pricing capability of those companies, to our advantage.

Q: Are you concerned about the impact on business conditions in the United States from the investment in new capacity that is not being made here but in China and elsewhere?
We believe that remedies such as those the Department of Commerce is proposing in their "Manufacturing In America" report make sense: that economic conditions must be addressed on a broader scale. DOD has no ability to address or to influence broader economic issues like tax laws or health insurance issues.
Patrick: In terms of an attractive investment climate, the U.S. aerospace sector in the United States that we draw upon is among the most attractive sectors in the United States for foreign direct investment -- in both aerospace firms and the facilities that they build from the ground up in our country. Global suppliers are increasing investments in our defense industrial base. Certainly from the viewpoint of the global industrial base, we are one of the most attractive sites for direct investment. In the aerospace sector and in the defense sector we compare very favorably to all other sectors of the U.S. economy.

Q: Isn't that because DOD is such a huge part of the aerospace market and those foreign companies have to be here physically to serve that market?
Their calculus is an economic calculus. Clearly proximity to a large market would be important and is just as important for a global defense supplier considering a greenfield facility in the United States as it is for Intel considering building a fab plant in China. Those are the realities of the global marketplace. But it's not as if our industrial base does not attract investments; quite the contrary.
The other point that has to be made is that in terms of the vitality of the aerospace industry as measured by exports, unlike most of the rest of the U.S. industrial base, the overall export ratio in aerospace is 12 to one. So by any sort of objective global economic measure of attractiveness, either flow of exports or foreign direct investment, one would have to conclude that we are a very attractive market and a viable, competitive industry.

Q: There are still concerns in that industry. The Aerospace Industries Association put together a panel three years ago chaired by [retired] Rep. [Bob] Walker saying there are problems and the U.S. could lose its aerospace industrial base unless there was a new investment strategy.
AIA has certainly revised its tune in that regard. They might have been a bit excessively pessimistic at that point in terms of likely financial developments in the U.S. aerospace industrial base. Statements of late from AIA are quite different from the statements you refer to.

Q: There is still concern among the producers of components and sub-components. The aerospace suppliers in Connecticut created the group "Save American Manufacturing." They're seeing United Technologies buying the same components from Poland for one-eighth the cost. So there is still a lot of concern in that community.
From the Department's and from the warfighters' perspective we certainly would not be good stewards of the warfighter if we were to overpay routinely for defense material.

Q: The concern is the money is going overseas to build competitors' capabilities, while at the same time the U.S. is losing that capability, and there are greater societal costs that are difficult to measure. So for want of saving $10 it's going to cost the society $100, with companies going out of business and workers having to take low-paying jobs.
I think what's important to remember is that we are chartered to provide the best capability to the warfighter that is possible. The warfighter is our primary constituent and we certainly have to procure the best that is available for the warfighter in order to meet that charter. That is actually the charter the taxpayer has laid on us as well.

Q: People who perceive problems in the industrial base believe it is an ideological stance that prohibits you from seeing the point of view that a [Rep.] Duncan Hunter [R-Calif.] or [Rep.] Don Manzullo [R-Ill.] would otherwise be promulgating. For a lot of people, they view it as an ideological opposition to getting more active in preserving the industrial base.
Our viewpoint is simply not ideological in the way that you frame it. We have the responsibility to make assessments as to what is critical to the warfighter. When we find that something is critical and our capability to deliver that to the warfighter is insufficient, we take proactive measures. Not everything that is insufficient or in short supply in the views of other actors will necessarily be critical or insufficient or important in the same way when subjected to our construct for assessment, which focuses first and foremost on providing the best warfighting capability to the warfighter.

Q: In the mid 1980s, the Joint Chiefs of Staff was concerned about foreign dependence on machine tools and they took action. Since then the United States has become even more dependent on overseas suppliers of machine tools.
It has arguably not hurt us that our suppliers have been able to procure machine tools from foreign suppliers at substantially less than American offerings or where the only suppliers in fact were foreign. It has not adversely impacted the warfighting capability of the United States.
Powell: A lot of things have changed since the mid-80s. The mid-80s were about fighting a land war in Europe against the Soviet Union that was going to take a protracted period of time. It was going to take years. You were going to be building and fighting with what was constantly coming off the production line. We don't plan on fighting that kind of war. You fight from stockpiles. With limited exceptions, you fight with what you have and surge production of some items as required, which is what we did successfully in OIF [Operation Iraqi Freedom].

Q: I'm told by military people concerned about the industrial base that the United States won the Cold War because of the country's economic and technological prowess, and it's losing that now, so they ask: how are we going to win the next war?
First, we have to remain globally competitive to have economic prowess. Second, we have to carefully focus on the most critical and demanding of warfighting capabilities in order to have warfighting prowess and if we don't do both of those things well we will have neither economic superpower status nor will we have the capability to build the futuristic weapons systems that we will need as we move into the 21st century.
We are in the process of conducting a very comprehensive Global Shipbuilding Industrial Base Benchmarking study. It will publish in March. It will be followed by a similar Global Shipbuilding Industrial Benchmarking study that will focus on the smaller yards that we will publish towards the end of the year. You can deduce from that that we have concerns about the vibrancy of our shipbuilding industrial base and we are assessing how best to remedy any issues we might identify.

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