James Hasik

Waging No War on Profits, but Never "Of A Type"

I am quoted twice in this week's Defense News, and with each story, my brief comment merits some exposition. Today, I'll cover my assertion regarding the "of a type" brouhaha.

Those three words in the US Code allow federal contracting officers to avoid demanding cost information from prospective suppliers when the goods and services offered are "of a type" offered commercially. For bespoke military items, cajoling contractors into open kimono bidding shifts power to the government, and ratchets down the margins attainable to whatever the contracting officer thinks is appropriate, and the company will tolerate.

This frequently doesn't work with companies oriented on commercial markets, particularly if they're not particularly beholden to government contracting. Successfully bidding for a contract whose provisions were known to be founded on a full-disclosure process would be highly deleterious to future negotiations with less powerful prospective buyers. For whatever the government got, the next counterparty could reliably take as a low-ball bid that the supplier might very well accept. That's not the sort of information that a profit-maximizing firm wants floating around.

The Pentagon's Director of Defense Pricing, Shay Assad, is a long-time federal official who's pretty experienced in this sort of thing. As I wrote about him when he took the job, his job is a big one. And on that job over the past few years, he now relates that the "of a type" clause is the one that his contracting officers find the law is being "abused"—traditional military contractors are asserting that items analogous to those sold openly and commercially should fall into this category, and are thus refusing to reveal their costs to the government.

What's unclear to me is how this is abuse. As Alan Chvotkin of the Professional Services Council observes in the article, "the vendor can say no, but so can the contracting officer"; that is, no data, no sale is always an option for the government. Shay wants the Congress to delete "of a type" this year specifically to tie his own people's hands—to remove their managerial discretion, as if the bureaucrats can't stand on their own in negotiations. That's not a ringing endorsement of the staff's skills and backbone.

But what's even less clear to me is how this is not part of that feared "war on profits" that Mr. Obama's officials in the Pentagon have repeatedly declaimed as never their intention. Or, as I'm quoted as saying (slightly edited),

This sounds like a complaint about contractors' profits, because if the government is looking for information on their underlying costs, the government wants to get at that so that they can claim that they're taking too big a profit margin. Is there another reason?

To explain, let's review the possible courses of action once the costs are revealed, and in terms of what supply chain management people call total cost of ownership (TCO). The government's total cost includes not just the purchase price from the supplier—what the government oddly calls procurement cost—but the costs of receiving the item, servicing it, fueling it, training people to operate it, and anything else we want to add for the purpose of the analysis. Call all of this stuff the government's internal cost (GC), and we'll illustrative the relationship with a very simple equation:

TCO = P + GC

Next, we can break down that price into several parts. There are fixed costs (FC) in production and overhead. There are variable costs (VC) to production, and the variable costs by unit (vc) we'll assume to vary linearly with the quantity (Q) produced, such that VC = Q(vc). On top of all this, there's a profit (π), and the whole relationship is then roughly

TCO = π + FC + Q(vc) + GC

Thus, there are four big buckets in which to look for reductions in TCO. The first place to look should be those governmental costs, as these are subject to the greatest control: one needn't negotiate with an external party to affect changes, but can just order up action. That's just getting one's own house in order first. With this information, and cost information from the contractors, the government could open frank discussions about how to pull common costs from their mutual supply chains. This works for lots of top-drawer industrial enterprises worldwide because, the cleanliness of the equation notwithstanding, GC and FC and VC are not purely separable. There are effectively countless examples of commercial efficiencies found in changing packaging, changing grades of material, rerouting transportation, shifting productions sites and the like to reduce the overall cost to both supplier and buyer.

Ford and General Electric and Boeing know how to do this, and they do it all the time. But this doesn't so frequently happen in military contracting in the US, and for two reasons. To begin, it's not part of the culture: those contracting officials are often quite good at playing "I've got a secret" with the actual contractors, at least when competition is involved, if only because they fear the appearance of impropriety. Call this a vicious unforeseen consequence of the Congressional mandate that losing bidders have the opportunity to whine to the GAO any time they like. This is simply no way to do business, but it is the way the Pentagon does business all the time.

The second problem is the actual information: while Pentagon should know its own GC, it frequently doesn't, because the US Defense Department still can't manage to produce an auditable set of books, and frequently has no clue about its operations and maintenance spending (more on that later this week). Together, these problems limit the government's ability to tackle its own internal excesses, and so for savings, it looks to the contractors' part of the equation.

What does this leave? The government presumably knows Q, its own quantity demanded, so it's asking for FC and vc and π. (Even if it doesn't demand knowledge of the margin, it can back that out of the purchase price.) The government's financial analysts could then scrutinize the prospective supplier's models and books for cost-reduction options to recommend. But if the government can't figure out its own costs, it's in no position to tell manufacturers how to run their plants. It's almost ludicrous to suggest so.

Of course, that's really not what's in the offing. For what's left after the government costs and the contractors' costs and their mutual costs are left unattended? The contractor's profit. Or as Shay himself is quoted in the article,

This is all about how do we make sure that we're paying a fair and reasonable price. It's that simple. There's nothing beyond it.

Fair and reasonable—honestly, I have no idea what those terms mean. As a professor of mine at the University of Chicago once told me, the closest anyone can come to a workable definition of fair is "I like it." Shay basically wants lower prices for the government, within a system that continues to provide long-term incentives for the suppliers to stay in the business. Since Shay is the director of pricing, it's his job to get those, and they're a laudable goal. It's just that he and his people should call a spade a spade, and admit what they're doing, whoever they're doing it to.

Shutting down remanufacturing of the US Army's Abrams Tanks: the analogy of the US Navy's battleships after WWII

"Sometimes, you need to keep buying military equipment, even if you don't need it, so that you can still buy it later, when you might need it." 

I heard that as an explanation of recent goings-on from a student who had recently taken a graduate course in The Political Economy of National Security. I must say that it's not clear what's Economical about that, but the concept has been solidly in the press over the past few weeks in the dispute of the US Army's proposal to stop buying remanufactured M-1 Abrams tanks.

The Army, as one headline in the trade press put it recently, has been signaling "thanks, but no tanks" to Congressional interest in extending purchases, to cover a planned gap of three years between FYs 2014 and 2016. Production lines are not faucets, after all, so there are shutdown and startup costs to be paid. The Army figures these at perhaps $600 million; prime contractor General Dynamics Land Systems assets that the figure is somewhere above $1 billion. That the military and its contractor would come down on those sides of the estimation range is, of course, unsurprising. But GDLS further claims that remanufacturing any fewer than 120 tanks annually really isn't economical, so the company would have to consider unilaterally shutting down if the Army couldn't guarantee that much work.

To understand these figures, it's important to know some figures about the Army, the National Guard, and the Marine Corps' tank fleets. The services have almost 6,000 Abrams in their inventory, but between all three, do not need more than 2,000 in their force structures. The rest will remain mothballed, as they have been since the end of the Cold War. As for the 2,000 on active service, they're in remarkably good shape. GDLS has been rebuilding them so effectively and fiercely at the Lima Army Tank Plant (er, "Joint" Systems Manufacturing Center Lima) that the average age of the fleet is about three years. That's a quote from Chief of Staff General Martin Dempsey last May before the Senate Appropriations Committee, so it's not likely wildly inaccurate.

Three years is pretty impressive for military equipment these days. Truth be told, the alternative pattern has persisted for centuries: note that HMS Victory, Nelson's flagship, was 40 years old at the Battle of Trafalgar, and still engaged the enemy more closely. In the modern context, the US Air Force is just now getting around to recapitalizing its aerial tanker fleet, and yet its last KC-135 was built in 1965. The youngest one is thus 46 years old, and still flying. The tankers—like the equally venerable B-52s—have all been re-winged and re-engined, but there is no active program to continue doing so now. It's far from clear that there should be.

Thus the US finds itself with 2,000 nearly new tanks, no real peer opponents, and no solid reason to get involved in another land war in Asia—the only conceivable place one would use 2,000 tanks. The need for yet more new tanks is thus hardly obvious, which takes us back to that build-now-to-keep-building explanation. The choice has been framed as one of either continuing production, or shutting down for a fashion. I propose a third option: shutting down without any expressed intent of restarting production. In that event, the restart funds are not budgeted, and I argue for this as a more than just an accounting gimmick, but rather, a real plan.

One must admit that the heavy tank is yet quite relevant on the modern battlefield, but its importance has been overstated. To that point, Stephen Biddle's Military Power (Princeton University Press, 2004) did an excellent job of showing the importance of that infantry-centric model towards which the Army has been leaning, and which the Marines have always had. It's not just that the services have so many nearly-new tanks; they're tanks that are arguably amongst the best in the world. An economic order quantity of 120 is also a rather high number: the French Army only has about 250 LeClerc tanks in active service; the Bundeswehr only about 300 Leopard IIs. Neither has what one would call a hot production line of that volume, but like the USAF with its airplanes, neither is deeply worried.

So, what if the US did the same, and just totally got out of buying new tanks for the sake of buying new tanks? In the event of some unavoidable Asian land war in ten years, somehow requiring new tanks, would the Army and the Marine Corps be able to restart procurement? There is an analogy that suggests a qualified 'yes'.

Heavily armored, expensive mobile assets with big guns—to a navy, those are batteships. In the US Navy, all procurement of new articles was halted in 1943—something about the lessons of Pearl Harbor, I think—and the last ship, USS Wisconsin, was commissioned in April 1944. By 1948, with the emergence of jet aircraft and nuclear weapons, all but USS Missouri (the personal favorite of Harry S Truman) had been decommissioned and mothballed. By the end of 1951, all were back in commission, and several were at times in the firing line off the Korean peninsula. By 1958, all four of the Iowa class were again in mothballs, and they stayed that way until 1968, when USS New Jersey was returned to service to bombard Vietnam.

Note that no American battleships were in service during that early part of the Cold War for some ten years. That gap recurred after the Vietnam War: in 1981, when the Reagan Administration began refurbishing the ships once again, just to scare the pants off the Soviets, no American battleship had been in service for twelve years, and all four of them were at least 37 years old. The recommissionings occurred about every two years, and at least the first seems to have taken nearly two years from start to finish. With rather few sailors and shipbuilders available who knew the inner workings of an Iowa-class battleship, some considerable organizational relearning was needed before much progress could be made. That said, a 40,000-ton battleship is a rather more complicated asset than a 70-ton tank, and yet back into commission they all went. 

The exercise wasn't academic: the New Jersey shelled Syrians in Lebanon in 1983; the Missouri and the Wisconsin shelled Iraqis in Kuwait in 1991. But consider this problem from the vantage point of 1958, when the US Navy was at last without a battleship for the first time since the concept of the battleship had been dreamt up. Even after the experience of the Second World War, when huge naval battles in several oceans were fought with battleships in only a supporting role, the retreat from the type was heart-wrenching for more than a few enthusiasts. Of course, it's not as though the return of the battleships after 1958 was ever decisive, and with crews of some 1,500 sailors, they were rather expensive to operate. All the same, back in the day, the Navy shrink-wrapped its ships, figuring that one-never-knows, and thus having a few handy might be worth the trouble.

That option is a bit further off now, as the ships have been turned over to museums for display. But the example persists, so how might this apply to the Abrams, the Bradley, or any other capital item in the military's inventory? The battleship story shows that an industrial base can be reconstituted from scratch, given enough lead time, even after a gap of ten or twelve years. In the case of the battleships, no serious maintenance was in progress in those periods. In the case of armored vehicles, funded upgrade programs could continue—just not the more expensive full rebuilds that the Army would like to discontinue. The permanently parked stock would continue as is, and the equipment at Lima—the little there that is used in what is actually a rather labor-intensive process—would be shrink-wrapped as well. The economic effects on the town would be unfortunate, but jobs-for-the-boys is no reason to buy weaponry. Besides, GDLS does have a contract at the factory to build Namer troop carriers—as heavy as tanks—for the Israeli Army through 2017, at least.

At some point in the future, should the US Army or the USMC decide that it wanted to buy remanufactured Abrams again, either service could dust off the plans: the government owns the technical data rights, and has the technical data package. Either could hire a contractor competitively to relearn the processes, or retain GDLS without competition, if it believed that the old guard was clearly best placed to recover the capability. Restarting the line would take some time—it's hard today to know how long, but it clearly could be done. Let's remember that back in 2003, the US MRAP industry was basically one company in South Carolina, but Force Protection hardly constituted an "industrial base". Somehow, within a few years, US companies (including FP) were churning out thousands of them.

What is easier to know is the effect on the outcome of a major war: probably not much. Fact is, the aforementioned Big Asian Land War scenario is probably irrelevant. For Iraq in 1991 and 2003, the US Army had about six months notice for its big campaign. That was no time in which to even ramp-up existing tank manufacturing or remanufacturing. Korea, Vietnam and Afghanistan have been wars primarily for the infantry, given the terrain. While tanks were important in those first two campaigns, neither would have stressed even today's abbreviated inventory. And not a single US tank has gone to Afghanistan. But more to the point, modern high-intensity land wars don't tend to last long: the weapons are very accurate, and the loss rates thus very high, as the Israelis discovered with alarm in 1973. So whether or not one was actively remanufacturing at the start of a campaign just isn't going to matter.

Then what's all this fuss about? Methinks something other than military necessity. That's a fine-and-self-interested argument for anyone to make, but it should be seen as such. It may indeed be time to stop hanging on to this remnant of presumed industrial preparedness, and find better uses for those hundreds of millions of dollars. Such as not borrowing it in the first place—now there's an idea!

Senator Hutchison, call your office—Some thoughts on the immediate need for another BRAC

In response to the call by US Defense Secretary Leon Panetta for another two rounds of the Base Realignment And Closure (BRAC) process, Senator Kay Bailey Hutchison (R-Texas) released last Thursday the following to the press:

I am strongly opposed to another BRAC round. It is simply premature to assess our requirements for domestic installations until we have made cuts in the large number of overseas bases. Moreover, the Pentagon does not need a BRAC or Congressional authority to close unnecessary overseas bases. Given our troubling economic situation, Secretary Panetta should immediately take action to dramatically reduce our military presence overseas, close bases and return those forces to America, where they can better train and deploy and be closer to their families.

I also remain very concerned that the Administration's planned cuts of approximately 100,000 soldiers and Marines will leave our nation vulnerable. This changes America's defense policy to only prepare for the eventuality of one major conflict. So, if a strong enemy sees our troop strength committed to one area, it leaves us at risk for a strike in another region.

The investments made in our largest Army bases—such as Fort Bliss, Fort Hood, and Fort Bragg—have built maneuver space, ranges, combined arms training opportunities, and rapid deployment capabilities that are not available at any foreign bases. These capabilities are unique to America because of the size of these bases. It is in the best interests of the Army and our national security that we continue to make the best use of these important domestic installations and never signal to our enemies that we can fight only one major regional conflict at a time.

There have been lots of tirades about another BRAC or two in the past week; I'm picking on Kay Bailey most out of proximity (I'm a Texan), and because her remarks bear either a contradiction or a salient view of American security. Let me summarize her position with a few statements:

1. If the US cuts 100,000 ground troops, then it will need to base those troops more centrally, for more flexibility in responding to an attack on an ally somewhere.
2. This means closing bases overseas in preference to closing bases in the US.
3. The secretary doesn't need congressional authority to shutter bases overseas, so he should do this first, particularly in places where troops serve unaccompanied tours.

If one buys the argument of a centralized, rapidly-deploying force (a 'rapid deployment force'? yeesh), then this sound appealing. It gets more interesting when one considers where those unaccompanied tours are—mostly in South Korea and the Middle East. So, it sounds like the senator is saying that the Army ought to pull its brigades out of more than just Germany, where their continued presence is even harder to justify. I truly wonder whether that's what she meant.

In the interests of full disclosure, I will note that I spent much of 2005 as an adviser on the BRAC process, helping companies figure out what would be good or bad for them about particular potential decisions, whether they should lobby for them, and how they could prepare for or react to them. So, more BRAC rounds would be good for business. But I will argue that two more would be exceptionally good for federal finances, which remain disastrously unbalanced.

The excess is obvious. Consider the US Air Force, which is arguably the service whose infrastructure exceeds its needs by the widest margin. The USAF has retired about 500 aircraft in the past decade, and is now planning to cut another 65 C-130s, 27 C-5As, 24 F-16s, 120 A-10s, and its entire fleet of C-27Js. How could it possibly still need all the ramp space that it forecast, back in 2005, that it would still need? It can't, and if the USAF doesn't close bases, it's paying for towers, hangars, warehouses, and gate guards that it just doesn't need. In short, its overhead (nasty word that) will increase in proportion to its warfighting capacity. Now which congressman wants to defend that?

Thus, I'm not looking for Mr. Panetta to close foreign bases first, and then sort out what to do in the US. Things are bad enough that his people ought to be making lists all over the world, and submitting them simultaneously: this is what we'll do overseas regardless, and this is what we want a commission's authority to do here at home.