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U.S. Defense Secretary Gates To Industry CEOs: Work With Me

By Vago Muradian and John T. Bennett

U.S. Defense Secretary Robert Gates told industry executives last week that his efficiencies push is largely meant to stave off White House officials who want to slash the Pentagon budget, sources say.
In a July 29 meeting at the Pentagon, sources said, Gates said that if the Defense Department cannot show progress in shifting billions of dollars from overhead and other unneeded costs to modernization, the White House and Office of Management and Budget officials will likely shift money themselves — from the Pentagon to domestic programs, deficit reduction, and economic stimulus.
Sources said Gates told the executives buying into the effort was in their interests.
“The secretary made clear he has taken the lead on this instead of having others take the lead,” one industry source said.

The meeting included 15 senior executives from Aerospace Industries Association member companies, plus Deputy Defense Secretary William Lynn and Pentagon acquisition chief Ashton Carter.
During the meeting, execs from firms with both commercial and defense divisions told Pentagon leaders that if their military profits shrink, they would reduce investment in that division, the industry source said.
Gates reassured execs, who worry about the savings drive and a companion effort to revise DoD acquisition policies and practices, that he’s not looking to shrink industry profits, sources said.
The industry source said there was general agreement that “it’s not in anyone’s interest to see an industrial base that can’t make a profit.”
Carter reiterated in a July 28 interview that a “vibrant defense industry is in the national interest.”
“It is increasingly becoming clear to industry that any alternative that comes from the White House or Congress would be much worse than what Gates is proposing,” said Loren Thompson of the Arlington, Va.-based Lexington Institute. Behind the scenes, “industry is pushing policymakers to preserve profitability. So far, Gates and Carter are showing they hear the message and understand it.”
The execs also pressed the Pentagon officials to set weapons specifications as early as possible and keep expensive changes to a minimum.
And they stressed the need to reform export controls — “which would be a big help” and bring some major savings — and “take a hard look at its physical and organizational infrastructure,” the source said.
Thompson said a top industry concern is that DoD won’t achieve Gates’ yearly belt-tightening goals for each service and agency, which would mean “the burden would then fall on industry.”
Earlier this month, Carter proposed ways to cut the cost of weapons, systems and services and formed working groups with industry and Congress to shape final policies by September.
Senior executives are supportive of Carter’s initiatives, but during interviews at the Farnborough air show outside London the week before Gates’ meeting, they urged DoD to consider all consequences of new guidelines.
“I am encouraged that DoD wants to engage us in discussion, but I have been around long enough to know that the devil is in the details and getting it right means we both work it together, and we are going to work it together,” said Bill Swanson, Raytheon’s chairman, president and CEO. “You need to get all the stakeholders at the table to get the really good answers… but we need DoD to think things through, because when you make a decision, that should be the easy part. The hard part is figuring out the second- and third-order effects.”
Industry concerns include:
*The Defense Contract Management Agency and the Defense Contract Audit Agency are embedding more auditors at defense production facilities. Execs said the move may drive up costs as companies scramble to satisfy more requests for information.
*Some government contracting officers, pressed to save money, are becoming increasingly confrontational with industry. Execs fear that if DoD spending drops, the trend will worsen.
*New restrictions are reducing the markups that prime contractors usually charge on subcontractor-supplied components and subsystems.
Such “pass-through” profits have been allowed since the late 1990s, when defense spending bottomed. But execs say banning them might lead larger firms to buy up suppliers, the kind of vertical integration the Pentagon is currently trying to dismantle.
“If the fee structures aren’t aligned right — in the sense that if you are managing subcontractors and suppliers and you have a lower fee rate than managing yourself — the tendency is to do all the work internally,” Swanson said.
“So when you make your decisions, you have to think through the overall impact. If you don’t want vertical integration, then don’t come up with profit incentives that will put you in that category. I’m not saying that’s the case, but you have to think through that to figure out the unintended consequences because people are smart.”
What would help save money, Swanson said, is moving faster.
The government should adopt the “mentality we have in the business world that shorter time is less money,” he said. “If we can lop three, four months off the schedule, we would all be better off.”

More Auditors
There also is growing concern that thousands of new auditors and contract specialists being hired by the government to increase oversight over suppliers will drive up costs. One senior executive said the new people are badly needed, but will force industry to employ more of its people to react to auditors’ requests, increasing costs.
Jim Pitts, president of Northrop Grumman’s Electronics Systems sector, notes that this is happening just as defense companies are retooling their organizations to remove layers of management and cut head count. He and others worry the relationship between contractors and their governmental overseers is growing more adversarial.
“What I haven’t seen is the government formulate a cohesive strategy that the entire acquisition work force understands,” Pitts said. “That makes it very difficult for industry to respond in a cohesive and responsive manner.”
Linda Hudson, the president and CEO of BAE Systems Inc., said cooperation, not confrontation, is the way to go.
”What we have been seeing, and I think will likely continue to see for a while … is a more adversarial situation and a view that the way to drive cost out of the business to over-manage the contractors,” Hudson said. “I’m not so sure that’s the right way for us collectively to get to where we need to go.
“We need to do it tighter. We need to get cost out on both sides of the equation. We need to figure out how to collaborate more effectively and incentivize both of us to do our jobs better,” she said. “Not quite sure how to do that yet, but that’s what we’re all trying to figure out.”

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