DoD has worked to become a smarter customer—pushing for efficiency and value from suppliers and better access to commercial and international suppliers—while working to ensure that essential defense industrial capabilities are available to the Department as it prepares to move into the 21st century.

DoD is undertaking policies to ensure that adequate competition is retained for future DoD programs, that essential capabilities are not lost, and that industry can take the necessary steps to operate efficiently and effectively.

The reduction in the Department’s procurement budget since FY 1985 spurred a dramatic increase in the number of mergers and acquisitions in the defense industry. Such transactions permit companies to reduce overhead, eliminate excess capacity, diversify product lines, and cut costs. However, they also can eliminate competition that is necessary to reduce costs and spur innovation. To determine the effects of mergers on DoD programs and advise the appropriate antitrust agency, the Department reviews each transaction carefully.

DoD reviews address four questions: First, will the merger result in a loss of necessary competition? Second, will the merger have an adverse effect on programs because of buyer/seller relationships between the two firms? Third, does the merger present potential organizational conflicts of interest? Fourth, what costs or savings could accrue to the Department as a result of the acquisition?

Since March 1995, the Department has reviewed about 35 transactions; eleven of these were completed in FY 1997. During this period, a number of these transactions have proceeded only on the basis of consent agreements between the companies and the Department of Justice or the Federal Trade Commission. These agreements have required divestitures of businesses, agreements not to enforce exclusive teaming arrangements, and firewalls.

Once mergers are consummated, the Department will pay its fair share of restructuring costs. As required by law, DoD must audit corporate proposals and certify that overall savings exceed costs by a factor of two-to-one. DoD pays its share of amounts spent for severance pay, relocation assistance, retraining, and retention of medical benefits. DoD will not pay for any portion of the cost of making the acquisition, bonuses, or executive severance packages. Restructuring costs have been certified for six major combinations since July 1993, and for one other combination where a certification was not required by law. For these seven, the DoD share of the costs was $765 million versus a projected Department savings of more than $4 billion over five years.

Vertical Integration—Defense Science Board Report and DoD Actions

Last year, the Department became concerned that vertical integration in the defense industry could have a potential effect on product competition and innovation. To address these questions, the Department requested the Defense Science Board to establish a Task Force on Vertical Integration and Supplier Decisions. In May 1997, the task force reported that vertical integration does not appear to be a systemic problem for DoD products today, but that it might pose future concerns. The task force also recommended a number of steps to address such concerns. DoD endorsed the report’s findings and began a series of policy and procedural changes to improve its ability in its ongoing acquisition processes to address problems that may emerge from increased vertical integration.

First, to improve subtier visibility, DoD began an effort to identify and monitor the competitive health of selected, important subtier markets. Second, DoD initiated policy revisions requiring its acquisition personnel to devise program strategies that help foster competition at both prime and subtier supplier levels. Third, DoD began to examine how science and technology investments can shape and enhance future competitions. Fourth, the Department began revising curricula at defense acquisition schools to improve understanding of industrial issues among the acquisition work force. Finally, DoD established a dedicated line for firms to report anonymously exclusionary behavior on the part of other firms. These actions are intended to ensure the Department’s continued access to the competitive, innovative subsystems, and components that help provide the leading edge in weapon systems.

In 1997, DoD began to evaluate and address changes in key component and material providers which supply many programs, affecting competition and innovation, and product availability. The Department evaluated industry segments that supply microwave power tubes and carbonizable rayon fiber. Microwave power tubes generate and amplify microwave energy for DoD applications in radar systems, electronic warfare systems, and telecommunications systems and for Department of Energy applications in high energy and nuclear physics, and materials science research. The National Aeronautics and Space Administration and DoD use carbonized rayon fiber-reinforced composites in solid rocket motor nozzles and in reentry vehicle heat shields. In each case, DoD and the appropriate agency established mechanisms to ensure that industry restructuring in response to reduced spending would not impact DoD’s ability to meet future mission requirements.

Small business is an important source of the industrial capabilities supporting defense needs as well as an important element of the economic fabric of the United States. Small businesses bring critical innovation to the defense marketplace. Additionally, small business is an engine that provides for job creation and ensures that a greater number of citizens receive benefits from defense procurement dollars.

In FY 1996, DoD completed its most successful year in the history of the small business program. In FY 1996, $25.4 billion (23.2 percent) of $109 billion awarded to U.S. business concerns was awarded to small businesses—unequaled in the last 30 years. In addition, DoD prime contractors awarded $19.8 billion in subcontracts to small business concerns (41.8 percent of the $47.4 billion in total subcontract awards reported).

DoD awards to small disadvantaged business (SDB) concerns were similarly unprecedented, with prime contract awards equaling $6.9 billion (6.3 percent) and subcontracts equaling $2.8 billion (2.6 percent) for a combined total SDB performance of 8.9 percent—the highest ever reported both in terms of dollars and percentage accomplishments.

In the women-owned small business (WOSB) program, during FY 1996 DoD awarded $2 billion in prime contracts and $1.5 billion in subcontracts. Together they represent 3.2 percent of the total prime and subcontract awards. The Department continues a series of initiatives which support the program objectives to enhance WOSB participation and meet and exceed the government-wide 5 percent goal.

The Mentor-Protege Program is a valuable tool in the Department’s success in meeting its SDB prime and subcontracting goals. Over 200 large business mentors have provided over 300 proteges with the business and technical assistance necessary to participate more effectively in the complex DoD marketplace. For their efforts, the mentors receive either reimbursement or credit toward their small disadvantaged business subcontracting goals. The objective of the DoD Pilot Mentor-Protege Program is to provide incentives to major DoD prime contractors to assist small disadvantaged businesses or qualified organizations employing the severely disabled to enhance their capabilities and to increase their participation as DoD subcontractors or suppliers.

The Mentor-Protege Program has resulted in win-win results for small disadvantaged businesses, large prime contractors, and the Department. For example, one SDB concern has expanded from a manufacturer of custom-molded ceramic shapes to the manufacture of high temperature ceramic dies, bringing this technology out of the research and development (R&D) laboratories into full production for use in building the F-22. Not only did this provide for expansion of the potential market for the SDB, but cost savings to the Air Force.

In another effort, an emerging Native American owned company participated in the DoD Pilot Mentor-Protege Program for 28 months. The central thrust of this agreement was the transfer of technology in hot-form titanium processing for firewall assemblies on military/commercial helicopters. An extensive training program was developed and implemented consisting of Statistical Process Control, blueprint reading, metrology, use of hand tools, hot-press on-the-job training, team building, management of growth, cost awareness, and job yield factors. The protege firm now has the capability to process Electronic Data Interchange orders, bar code customer shipments, and use computer numerical control programming. The firm was formally recognized by its mentor as SDB Supplier of the Year based on measured performance criteria of delivery, quality, and total cost (best value).

DoD’s Small Business Innovation Research Program (SBIR) funds approximately $530 million each year in defense related R&D projects at small technology companies. The program has received consistently favorable reviews for its contribution to U.S. military and economic capabilities in independent evaluations by the General Accounting Office, National Academy of Sciences, the National Bureau of Economic Research at Harvard, and others.

About 65-70 percent of the life-cycle cost of a major weapon system is incurred after the system is fielded. As systems age, Operation and Maintenance (O&M) costs tend to grow. Because of the large inventory of legacy systems that must be maintained well into the future, reducing O&M costs is a major thrust for DoD.

The Commercial Operations and Support Savings Initiative (COSSI) is designed to test a way to routinely reduce O&M costs by developing repair or upgrade kits that incorporate commercial technological advances that have occurred since the system was designed and manufactured, and inserting those kits into fielded systems. The use of partnerships and consortia is encouraged allowing the talents of firms in the defense and commercial sectors, academic institutions, and nonprofit organizations to be combined and complemented.

COSSI is a two step process. In Stage I, DoD and a firm or consortium enters into a cost sharing arrangement to develop and qualify a prototype repair or upgrade kit. Cost sharing provides assurance that the industry partner is committed to the project and believes in the viability of the outcome. Stage II is implemented where Stage I has been successful. In Stage II, the military customer can use normal procurement procedures to purchase production quantities of kits.

COSSI was implemented for the first time in FY 1997. Initial indications suggest the COSSI business model is both attractive to industry and capable of generating substantial savings for DoD. Eighty-one industry proposals were evaluated and 30 were selected for Stage I funding. The government cost share for Stage I is $97 million, with the proposing firms contributing $91 million. If all Stage I projects proceed to Stage II, the net present value of the O&M savings these projects are expected to generate over a ten-year period is approximately $3 billion.

Diminishing manufacturing sources critically challenge DoD’s ability to maintain older weapon systems. As the service lives of weapon systems are extended, parts never projected to be replaced are wearing out. Shortened production periods of electronic parts are the result of rapid technological obsolescence. Manufacturers no longer produce the parts, and drawings and other technical documentation are no longer available. The Defense Microelectronics Activity was created to concentrate on problems unique to integrated circuits. The Virtual Parts Supply Base was established to capitalize on integrating the expertise already addressing instances of diminishing manufacturing sources in centers of excellence.

The purpose of the Defense Production Act Title III Program is to establish, maintain, modernize, or expand the domestic production capacity for technology items, components, and industrial resources that are critical to DoD and for which a viable domestic capacity does not exist or is insufficient to meet defense needs. The Title III program has unique authorities that enable it to employ a wide range of financial incentives which reduce the risk of establishing the needed capacity. These authorities have proven invaluable in addressing industrial capacity issues by providing business incentives that ensure timely, assured, and affordable access to sources for defense critical materials, components, and processes. Key technology areas targeted for Title III action include:

U.S. forces often fight or work alongside the military forces of other nations. Deploying forces in cooperation with those of other countries places a premium on interoperability—ensuring U.S. systems are compatible with allied systems.

International armaments cooperation is a key element of DoD’s acquisition and technology efforts to field the most capable force possible. International armaments cooperation, in its many forms, enhances interoperability, stretches declining defense budgets, and preserves defense industrial capabilities. Successful efforts require that DoD engage allies in discussions at the earliest practicable stage to identify common mission problems and to arrive jointly at acceptable mission performance requirements to balance cost, meet coalition military capability needs, and assure interoperability.

Some of the more notable success stories in international industrial cooperation include the F-16 Falcon, AV-8 Harrier, T-45 training aircraft, CFM-56 engine, the continuing cooperative efforts under the NATO Airborne Warning and Control System (AWACS) program, and the Multifunctional Information Distribution System. The Department is now working with allies in Europe and Asia to explore other cooperative programs, including the Medium Extended Air Defense System (MEADS) and NATO Allied Ground Surveillance efforts. The International Cooperative R&D program has led to sharing of military technology among allies, as well as to development of joint equipment to improve coalition interoperability. Frequently, these R&D investments provide the cooperative linkage required to leverage independent national developments and enhance military capabilities. Such items include advanced aircraft, combat vehicle command and control, communications systems interoperability, and ship defense. These cooperative programs also foster closer international and military to military relations.

International defense cooperation is also enhanced through the Foreign Comparative Testing (FCT) program, which evaluates foreign nondevelopmental items for DoD use. Twenty foreign countries have been active participants in the FCT Program. The Services and the United States Special Operations Command have procured over $4.5 billion worth of foreign equipment as a direct result of successful equipment evaluations. By purchasing foreign nondevelopmental items, the DoD has realized research, development, test, and evaluation cost avoidance of over $2 billion while providing earlier fielding of quality items to U.S. warfighters.

As DoD takes greater advantage of the opportunities in international defense cooperation and commerce, it continues to address the risks of the proliferation of weapons of mass destruction and advanced tactical systems. DoD has worked to ensure that the Services and defense agencies understand the nature and importance of the February 1995 Conventional Arms Transfer policy and take its tenets fully into account when pursuing cooperative international defense programs and sales. As a result, both economic security and national security interests are pursued and protected.

DoD has also taken steps to improve the effectiveness and efficiency of international cooperation. An International Armaments Cooperation Handbook has been developed to provide a compendium of current policy, key processes, and points of contact for use by persons working cooperation issues in the Department.

The Department is examining the potential for international collaboration on upcoming major systems acquisitions. As part of the Department’s review of potential opportunities for cooperation on upcoming major system acquisitions, the Armaments Cooperation Steering Committee (ACSC), the senior armaments cooperation policy and oversight body within the Department of Defense, is implementing a disciplined process for identifying new opportunities for international cooperation. A major ACSC initiative deals with the formation of International Cooperative Opportunities Groups (ICOGs) to identify and recommend specific new opportunities for armaments cooperation.

ICOGs are looking at areas of common need, and seek to establish early communication with allies to create opportunities earlier in the acquisition process. The ICOG process has identified programs as candidates for potential cooperation based on several factors: the degree of requirements commonality; the extent to which the technologies, strategies, and budgets of the potential partners are complementary; the potential for international industrial teaming; and the perceived benefits and risks associated with execution of such a program.

The U.S. military has a wealth of experience and expertise that it can share with other nations. DoD’s environmental programs are becoming another important tool in which to engage the armed forces of other nations. Working with other U.S. government agencies, DoD is implementing environmental cooperative initiatives with civilian and military leaders from other countries. With its unique and long-standing relationships with other military forces around the world, DoD has an unrivaled ability to teach, educate, and train.

Through military-to-military cooperation, DoD conducts bilateral/multilateral environmental cooperation with Australia, Canada, Germany, Norway, Sweden, Russia, Poland, the Czech Republic, Hungary, and South Africa, while discussions for such cooperation are under way with several others. In addition to promoting stability through engagement, DoD gains useful information from these exchanges in support of the Department’s environmental responsibilities as it takes advantage of the perspectives that other nations offer.

DoD also engages in agreements such as the Arctic Military Environmental Cooperation Program (AMEC), which is a trilateral forum for dialogue and joint activities among U.S., Russian, and Norwegian military and environmental officials to address critical environmental concerns in the Arctic. One of the main objectives of AMEC is to help the Russian military address its radioactive and nonradioactive waste challenges in the fragile ecosystem of the Arctic. DoD, together with the Department of Energy and the Environmental Protection Agency, will leverage U.S. expertise in environmental techniques to address radioactive and chemical waste associated with nuclear submarines. More importantly, this unique effort is helping to build trust and understanding among these three militaries.

In November 1996, DoD established the Defense Export Loan Guarantee (DELG) program pursuant to congressional direction. This program enables the Secretary of Defense to guarantee payment of loans made by commercial lending institutions to eligible foreign governments.

During FY 1997, Congress granted DoD authority to guarantee up to $15 billion in loans made for the purchase or long-term lease of U.S. defense articles, services, and design and construction services to eligible foreign governments. DELG program procedures closely follow those of similar programs administered by the Export-Import Bank of the United States. The program is available to support Foreign Military Sales or direct commercial sales through the Arms Export Control Act process. The DELG program provides no subsidies and operates at minimal expense to the U.S. government by charging users an array of fees to defray administrative costs.

Industrial capability reviews and international programs serve a central role in the Department’s interface with industry to provide equipment and capabilities for the warfighter. DoD will continue to work with industry to eliminate unused capacity and lower overhead costs, while ensuring that industrial capabilities are sufficient to meet DoD’s needs. DoD will continue improving its relationships with allies through increased cooperation and interoperability. These efforts will enhance the Department’s capability to promote competition, seize the opportunities presented by innovation, and respond rapidly to warfighter needs.