If the bleak findings of the bipartisan deficit reduction commission released today weren’t enough to get defense contractors thinking about diversification, then maybe the Army’s revised solicitation for a future Ground Combat Vehicle (GCV) will do the trick. GCV is all that’s left of the family of networked combat vehicles conceived under the canceled Future Combat Systems program. The bold vision of an agile, net-centric combat fleet has given way to more prosaic plans for a well-protected vehicle that can carry an entire nine-man squad and be fielded in seven years. Of course it won’t be, but Army modernization planners usually rotate out of their jobs before experience undermines their optimism.
What industry and the investment community are noticing about the revised solicitation is that instead of being structured as a cost-plus-fixed-fee contract, it is a fixed-price-incentive-fee contract. Fixed-price contracts are a reasonable approach to the serial production of mature systems, but in this case the Army proposes to use an inflexible contracting vehicle for the high-risk technology development phase of a program in which there is considerable “trade space” for competing design concepts. Any cost overruns would have to be absorbed entirely by the contractor — despite a high likelihood the service will make changes as the effort progresses that contractors cannot anticipate when they prepare their initial proposals. Add to that the fact that three highly qualified teams will likely be competing aggressively to win and execute development contracts, and you have a prescription for somebody losing a lot of money.
Not that the Army doesn’t understand incentives. It will allow contractors who spend less than their allotted funding to keep a princely 20 percent of the savings. Nonetheless, some analysts think the Ground Combat Vehicle solicitation sounds pretty risky. Goldman Sachs put out a note commenting, “We believe this clearly supports our continued view that defense company margins are at peak levels and are likely to decline as the Pentagon shifts risk from the customer to the contractors, and that consensus estimates are too high.” By the way, did I mention the projected unit cost for the vehicle, about $10 million each, is so high that the program is sure to be politically controversial and therefore suffer much the same fate the Marine Corps Expeditionary Fighting Vehicle has? You know — a series of cuts to the production goal that eventually make the unit cost look so astronomical the program ends up being killed (but only after billions of dollars have been wasted).
My point here isn’t that we need to introduce market-based reforms into the defense acquisition system or implement some other process change before another weapons program crashes and burns. No structural adjustment will change the fact that the Pentagon procurement system is run by a collection of academics, bureaucrats and warfighters who have little grasp of the business world. My point is that defense companies need to start thinking seriously about diversifying their product mix away from a capricious government customer. Diversification is the “D” word defense investors are loathe to voice, but look at what General Dynamics accomplished by its foray into business jets and you begin to see a way forward for defense companies in what could be a very bleak decade. The message of the revised GCV solicitation to military contractors is that it is time to reduce their exposure to a customer that will never understand what it takes to survive in today’s unforgiving capital markets and investment climate.
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