As U.S. national security procurement becomes more demanding and competitive, incumbent OEMs need a new strategy to stay ahead
The landscape is shifting for U.S. defense procurement. After decades of spiraling costs, bloated schedules, and quality issues, the Department of Defense (DoD) has signaled that it will no longer accept “business as usual” performance from contractors. There are several factors challenging incumbent contractors, including the Ukraine conflict; China’s rising military threat to Taiwan; the aftermath of COVID; inflation; aggressive competition for talent from outside the defense industry; and new market entrants flush with private capital and ready to invest heavily to meet DoD’s needs.
The DoD is committed to becoming a more cost-effective and demanding customer. DoD has been clearly signaling over the last several years that contractors who are not committed to reforming their business model, increasing private investment, and limiting reliance on cost-plus contracts and private data rights, will forfeit business to new players who are.
To underscore this point, U.S. Space Force (USSF) procurement chief Frank Calvelli outlined nine “tenets” for space acquisition in an October memo to staff. While issued in the context of USSF concerns, they should be analyzed as a representative window into the entire DoD purchasing enterprise’s mindset.
The DoD's wishlist for reform
Items 3, 5, and 6 on this list are both out of the direct control of contractors and, if anything, would probably be a relief to industry, so we do not address them in more detail here. Here is a breakdown of the remaining six points that pose performance challenges for OEMs:
1) Build smaller systems maximizing use of existing building blocks
In 1984, former Lockheed Martin CEO Norm Augustine famously stated that -- at the current rate of cost growth -- by 2054 “the entire defense budget will purchase just one tactical aircraft. This aircraft will have to be shared by the Air Force and Navy three-and-a-half days each per week except for leap years, when it will be made available to the Marines for the extra day." This quote has aged well. Ensure that what you are delivering is the true minimum viable product customers really need- not the most exciting technology that your engineers may want to build.
2) Tighten the acquisition strategy; lean heavily on fixed price, putting much clearer statements of work putting critical responsibility on the contractor and role of incentives
The government is clearly signaling an intention to increasingly utilize fixed-price contracts that transfer more financial risk onto the contractor. The classic industry response to the imposition of FFP contracts has been to increase the front-end price dramatically. However, with the emergence of aggressive new venture-backed entrants, this strategy now carries a real risk of lost market share. Evaluate whether your pricing is really “zero baselined,” including only those components truly needed to meet the customer’s requirements. Contractors should never just take “the last thing we did” and add ill-defined “risk adjustments” to it – often, this procedure is the norm for setting pricing. But additional time and care spent on determining true should-cost pricing can lead to a more robust and commercially competitive offer to your customers, as well as better profit margins for you (because you will have an improved understanding of your own cost structure).
4) Enforce realistic cost and schedule targets and reject underbids to win work
Historically, contractors have been incentivized to underbid to win work, and the government would reliably “get them well” via follow-on or sustainment orders. As evidenced by significant write-downs across the industry in recent years, this contract strategy is no longer tenable. During pipeline reviews, carefully consider whether you can realistically deliver the work at a profit. Not all revenue is profitable if significantly underbid, and therefore not all wins are positive for the bottom line. If your assessment of the true cost and schedule is misaligned with the competitive range, consider no-bidding the work and doing a deeper dive into how your competitors are able to deliver at lower prices than your organization can. Either your competitors are putting themselves in a compromising financial situation, or they have cracked the code on efficient execution. If the latter, you may want to consider options to acquire that knowhow.
7) Deliver ground systems before launch of the space segment
While this tenet is specific to space, the underlying principle is more general: are your support systems in place? For example, is your software to manage distribution of spares functional and ready for distribution? Do maintenance crews in the field have the tools they’ll need to do critical repairs? Have you prepared a thorough and field-tested training program? Do you have the jigs and fixtures necessary to mount hardware while it is being worked in the factory? The unglamorous parts of the overall program are every bit as critical to successful delivery of a customer’s capability as the more visible components, but rarely receive anywhere near the same degree of attention from management.
8) Hold industry accountable; penalize contractors for poor performance
When the customer is more aggressive about holding a contractor to strict contractual terms, the contractor must review whether they are really delivering what they promised. If not, ask yourself, what changed? How robust are my program management capabilities? Did I inform my customer and discuss it with them? Bad news never improves with age – a culture of transparency and honesty within your own engineering organization will result in a virtuous cycle in which the customer learns of problems earlier and, as a result, has more options to address the issue collaboratively with you before the problem becomes existential for the program or your contract.
9) Prioritize delivering of capabilities that work as per the contractor promise
The soldier in the field doesn’t care about what was written in the contract; they care about whether the capability works when they are counting on it. Contracts lay the groundwork for meeting requirements, but they are only as good as the signatories’ good faith. Your organization should have an ethical north star manifesting itself in the commitment to delivering in line with a) customer expectations, and b) what you represented to the customer that you could do. If you’re arguing about line items in the SOW with your customer, you have already lost, regardless of who is “right.”
Getting ahead when it really matters
The best time to get ahead of a changing situation is before those changes become the status quo. DoD is cracking down on poor contractor performance in a political environment unfavorable to OEMs. If incumbents are not sufficiently agile and responsive to the DoD’s new way of doing business, there is no shortage of aggressive upstarts with deep pockets and motivated talent pools who will eagerly take their place -- regardless of their level of technical expertise. DoD is currently competing once-in-a-generation fleet recaps in GEO and LEO, and those who don’t win now will be left behind for a decade or more. Meanwhile, epoch-defining awards in other domains, including air, land, and maritime, are already reshaping the competitive landscape permanently.
Effective program management and smart pricing and bid strategies will be the key to incumbents looking to succeed in the new normal. Strategically intelligent players are always on the lookout for solutions, including industry best practices such as use of should cost benchmarking and development of a continuous improvement culture – and, just as important, truly living those philosophies, not just using them as buzzwords. This is how OEMs can bring their costs down and stay competitive with new, leaner, more efficient entrants in the new normal for DoD contracting.