Analysts: U.S. Procurement Drop Coming as Costs Mount
By ANTONIE BOESSENKOOL
Published: 11 Nov 2009 12:50
NEW YORK - Veteran analysts painted a bleak picture for future defense spending at a meeting of investors here, projecting a drop in weapon spending in the face of mounting military personnel and operations and maintenance costs, and a growing federal budget deficit.
Michael Bayer, the chairman of the Defense Business Board said that cost growth in defense programs and rising personnel costs are among the pressures that will affect defense procurement. (M. Scott Mahaskey / Staff)
Despite a 2009 defense budget of more than $651 billion, military spending is likely to further increase to cover the costs of the drawdown in Iraq and ongoing operations in Afghanistan.
That said, historical spending trends, external defense budget pressures such as debt service tied to government stimulus spending, and internal defense budget pressures such as growing maintenance and personnel costs, mean "there's a storm gathering" for future defense budgets, said Michael Bayer, the chairman of the Defense Business Board.
Bayer said he was expressing his own views and not those of the department and the Defense Business Board at the investor conference hosted by Bank of America Merrill Lynch and Defense News in New York City.
The last three up-and-down cycles in U.S. defense spending from the Korean War to the present indicate that in constant dollar terms, defense spending is poised for a downturn.
And in such downturns, procurement "makes a precipitous fall," Bayer said.
"Generally, the first thing to go is procurement," he said. With the spending declines following the Vietnam War and the post-Reagan years, the decline in procurement was steeper than the rate of decline in the overall defense budget.
What makes another procurement drop likely is what Bayer referred to as "internal erosion" of the defense budget. Services contracts, military benefits and personnel costs increased from 1963 to 2003, even as the active duty end-strength has decreased. Since 2003 medical costs and benefits for soldiers have sharply increased and are projected to keep growing.
One solution is to cut the level of people employed by the military.
"Two-thirds of [the military's] costs are people," Bayer said. "Making small changes in people expenditures - either numbers or what they're doing - has a profound impact in the out years on what the budget situation looks like.
"You've got to have all these people in uniform [be] deployable," he added. "In the out years it's going to be very difficult to have nondeployable people. By job or individual, in uniform, they're the most expensive people you've got. ... Given the nature of a sustained engagement in a regular global counterterrorism [operation], you've got to be able to get the most number of forces that you've got out. You can't have, as some of the services do, at least a full third of their force not being deployable in their current status. It's just way, way too expensive."
Another internal pressure is the cost growth in defense programs, Bayer said. Between 2000 and 2007, cost growth in major defense acquisition programs, including the Joint Strike Fighter and Future Combat Systems, totaled $401 billion; half of that growth came from just five programs, Bayer said.
Outside the Pentagon, federal spending trends will pressure defense spending as well, as mandatory spending and debt service continue to grow, Bayer said.
In 2013, projections are that interest payment on the national debt will be $800 billion, by 2017, nearly $1 trillion, he said.
"These things, in my mind, create a significant amount of out-year pressures, and when you listen very carefully to what the president says and what the [Office of Management and Budget] is saying, this sort of devil's calculus is weighing very heavily, I believe, on their minds," Bayer said.
Pierre Chao, the managing partner of Renaissance Strategic Advisors, echoed Bayer's comments, adding that the trend of weighting discretionary spending to defense is now shifting in the other direction.
But, Chao, also a member of the Defense Business Board, added that defense companies are relatively healthy, in terms of debt levels and performance, for example, headed into a likely slow-down in defense spending. They're also well-positioned to take advantage of spending at other government agencies, given their experience in dealing with government customers.
"If you think about defense contractors, they're also very good companies at dealing with government as a core capability," Chao said. Companies that proactively respond to changes in government spending priorities, such as health care, stand to have an advantage, he said.
Chao described the Pentagon's acquisition strategy as focused on the Army, rapid acquisition, small company suppliers and immediate needs on one end, and large networks, the Air Force and Navy and large integrators on the other. In that context, budget restraints are forcing the services to decide between modernizing and recapitalizing equipment worn out by the wars.
In the last cycle of a downturn in defense spending in the 1990s, "The companies that figured out strategies the fastest, the earliest and rolled them out aggressively outperformed everybody else," Chao said, whereas those that were passive as defense spending decreased performed poorly.
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