The budget impasse has been settled for the time being, so the question of the day is where things are headed for the defense enterprise.
The Defense Department’s budget for the next three years is projected to remain essentially flat, with minor adjustments for inflation. The top line number is slightly less than $500 billion, and growing very gradually.
Barring any unforeseen crises or a major geopolitical event, it appears that military spending will be stable for the next three years. Budgets, however, are below what the Obama administration had requested in recent years for the Defense Department, approximately $25 billion to $30 billion less. The bipartisan budget deal gave the military some modest relief from the Budget Control Act caps. Now the military services have a reasonable glide slope to a smaller force structure while sustaining better readiness and more stable investment profiles than under the strict sequester.
Every service is contemplating reductions in personnel and force structure, with the Army perhaps facing the steepest cuts. The Air Force expects to make some reductions, and the Marine Corps already announced it would trim its force down considerably. No major force structure initiatives have been announced by the Navy, although the number of capital ships continues to decline slowly. There is a commitment, however, to build back to 303 capital ships eventually.
The 2014 Quadrennial Defense Review might have something to say about Navy force structure. How this will be explained in light of the “pivot to the Pacific” strategy will enlighten all other approaches to force structure decisions.
The Air Force finds itself in the middle of a heated debate about its future. The National Commission on the Structure of the Air Force recently issued a set of recommendations that call for substantial realignment of the service. The commission’s report clearly advocates for increased reliance on the Air National Guard and Reserve components. The call is for better use of talent, lower personnel costs and preservation of funds for operations, maintenance, procurement and recapitalization.
The report avers that the reserve component is generally less costly, but that its use in active roles is not necessarily cheaper. An interesting concept in this discussion is “continuum of service,” which means an easier flow back and forth between active and reserve components. Another call is for elimination of headquarters and staff, as well as command chains that are redundant. To be sure, there is a lot of that everywhere.
The active-reserve mix should not drop below 55 percent active, the commission suggests. It calls for an operational tempo, or deploy-to-dwell ratio for active forces of 1:2 (one year deployed, two at home), and 1:5 for reserves. This will be a departure for the Air Force that has advocated the need for ready forces 24/7 as opposed to tiered readiness.
Army leaders have already declared that reserve components and active forces are not interchangeable, but that thinking may have to change. Eventually, the reasoning about force mix that is already underway in the Air Force is likely to catch up to the Army.
If one looks at the combination of personnel and operations costs out to the 2021 timeframe, the concern is that all investment costs are crowded out. It is unavoidable that something, somewhere, has to give to create room for investment in research, development and procurement of equipment. Somewhat smaller forces and tiered readiness seem to be an easier answer at this point.
As the service structure adjusts to the new budget realities, industry must do the same. As many companies are publicly traded, they are under growing pressures. The first and most pressing mandate is to provide high-quality weapon systems to the nation’s war fighters. But CEOs also have obligations to company investors, and the need to preserve the financial health of corporations is a concern that is equally as fierce.
Last year many defense industry stocks soared on beating earnings projections and increasing international sales. In the early months of 2014, many companies are continuing this pattern, and are outperforming the S&P 500. Industry analysts have identified this trend, but some of them doubt that it can be continued into 2016 through 2018. Everyone seems to be wondering if the latest budget deal can be extended into the future. So far the news seems positive and several firms are seeing improved valuations. The big question is whether these trends are short term.
The future of the U.S. industrial base and the procurement system which bring the military’s weapon programs into service have been of special concern to NDIA. The association recently announced initiatives to study the industrial base and to support reform efforts for the procurement system. These efforts are intended to identify major issues and solutions for the industrial base going forward in the current and projected fiscal environment. The goal is to suggest modifications to the procurement system that can actually work and make lasting and meaningful improvements to the process. All NDIA members have been invited to weigh in.
The budget agreement that is in place now is a stabilizing mechanism at best. It does not answer or solve all of the major resource issues. It gives some time to make needed adjustments — in force structure, readiness, active-arc mix, personnel costs and procurement system effectiveness.
We have been given time to address critical issues, and the clock is ticking. It is time to rock and roll.
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