2018’s Executive Order 13806 report on production risks to critical defense industrial supply chains starkly framed the health of the U.S. defense industrial base as key to the readiness of U.S. armed forces to confront near-term threats and compete long-term against strategic adversaries. Despite its high-resolution snapshot of the defense industrial base’s present challenges, the report does not provide the public and the defense policy community either an unclassified summary measurement of the health and readiness of the defense industrial base or a simple way of tracking such a measurement over time.
To fill this gap, the National Defense Industrial Association (NDIA) has piloted what is intended to become an annual project by writing Vital Signs 2020. In order to provide a comprehensive assessment of the defense industrial base, our procedure involved standardizing and integrating different elements of both the defense sector and the business environment that shapes its performance.
2020’s mediocre “C” grade reflects a business environment characterized by highly contrasting areas of concern and confidence. Deteriorating conditions for industrial security and for the availability and cost of skilled labor and materials emerge from our analysis as areas of clear concern. Favorable conditions for competition in the defense contracting market and a rising demand for defense goods and services reflect recent year-over-year growth in the defense budget. This first iteration of an expected annual study contributes to the debate about national defense acquisition strategy by offering a common set of indicators—vital signs—of what some have called America’s “sixth service,” the industrial partners who equip our warfighters with their capability advantages.
In order to complete this assessment, we conducted a months-long study of data related to eight different dimensions that shape the performance capabilities of defense contractors: market competition, cost and availability of skilled labor and critical materials, demand for defense goods and services, investment and productivity in the U.S. national innovation system, threats to industrial security, supply chain performance, political and regulatory activity, and industrial surge capacity. We analyzed over 40 longitudinal statistical indicators, converting each of them into an index score on a scale of 0 (bad) to 100 (excellent). By evaluating three years of data for these indicators, we obtained a three-year running average and controlled for data spikes such as the 2018-2019 government shutdown. Once we aggregated the individual indicator scores into scores for each dimension, we did so into an overall composite score for the defense industrial base, which turned out to be 77 out of 100 for this year—a passing C grade but with a worrying downward trend.
Areas of Concern
Industrial security scored the lowest among the eight dimensions with a 63 for 2019. In fact, industrial security has gained prominence as massive data breaches and brazen acts of economic espionage by state and non-state actors plagued defense contractors in recent years. To assess industrial security conditions, we analyzed indicators of threats to information security and to intellectual property (IP) rights. The indicators of global information security threats were already failing in 2017 and scored even lower in 2019 given the rising annual average number of new cyber vulnerabilities documented by MITRE, which almost doubled between 2016 and 2018 when compared to the period between 2014 and 2016. The score also incorporates MITRE’s annual average of the threat severity of the new cyber vulnerabilities, which improved slightly between 2016 and 2018 but remains high. In contrast, threats to IP rights scored 100 out of 100 for 2019 as the number of new FBI investigations into IP rights violations steadily declined since reaching an all-time high in 2011.
Defense industry production inputs also scored poorly in 2019 with a 68, exhibiting a decline from an already barely passing score of 70 for 2017. Major production inputs include the skilled labor, intermediate goods and services, and raw materials used to manufacture or develop end-products and services for Defense Department consumption. Relatively low 2019 index scores for defense industry workforce size contributed to this dimension’s low score. Our estimate of the size of the defense industry workforce, currently about 1.1 million, falls substantially below its mid-1980s peak size of 3.2 million.
Security clearance process indicators also contributed to the low overall composite score for production inputs as backlogs shrink but persist. Onboarding new personnel in the defense industry often requires navigating the security clearance process. Defense contractors face a security clearance management process that became more complicated from 2017 to 2019. The index scores for the annual average number of pending security clearance investigations declined for 2019 with much of that decline due to issues with initial top secret clearances.
Areas of Confidence
The state of defense contracting competition and the state of demand for defense goods and services offer the defense industrial base a favorable outlook. An analysis of the top 100 publicly traded Defense Department contractors demonstrates that competition conditions in the defense industrial base earned a composite index score of 96 for 2019. Several high-scoring indicators drove the strength of market competition conditions, including the availability of cash assets, the low level of market concentration of total contract award dollars, the relatively low share of total contract award dollars received by foreign contractors, and the high level of capital expenditures. Additionally, the defense industrial base earned a solid score of 88 for profitability for 2019 based on index scores for the average return on both sales and assets.
Demand for defense goods and services received a high score of 94 for 2019, which constitutes an increase of 16 points over the year 2017. This result comes from an increasing financial volume of contract obligations issued by DoD. In fact, total contract obligations issued by DoD grew from $306.7 billion in 2016 to $368.7 billion in 2018. Acquisition expenditures also grew in all categories, rising by 11% for aircraft, ships, and land vehicles; by 33% for electronic and communication equipment; by 35% for weapons and ammunition; by 39% for sustainment; and 23% for knowledge-based services. In the same way, foreign military sales (FMS) in aircraft, ships, and land vehicles grew by 113% between 2016 and 2018 while related services grew by 100%.
Conditions in the other dimensions of the defense industrial base conform to the pattern of moderate but declining health and readiness. For example, innovation conditions within the defense industrial base received a score of 74 for 2019, two points down from its 2018 score. Accordingly, the U.S. share of international patent applications—a measure of innovation competitiveness—received an index score of 69 for 2019, four points down from its 2018 score. Similarly, the share of global research and development (R&D) comprised by U.S. R&D expenditures saw its index score decrease between 2018 and 2019 from 75 to 74.
Political and regulatory conditions earned an overall index score of 79 for 2019, dropping precipitously by 13 points from a 2017 index score of 92. Congressional defense budgeting process indicators contributed to this decline since their composite index score decreased from 90 for 2017 to 77 for 2019. Congressional interest in major defense acquisition programs (MDAPs) decreased over this same period as mentions of MDAPs in congressional hearings decreased from 86 in Fiscal Year (FY) 2016 to 18 in FY 2018, which is echoed in an index score drop from 97 in 2017 to 54 in 2019. Regulatory conditions also eroded between 2018 and 2019; the index score for our “red-tape ratio” of nonrestrictive rules to new restrictive rules decreased by 18 points from 100 to 82.
Can the Defense Industrial Base Meet Surge Demand?
The capacity of the defense industrial base to grow its output and fulfill a surge in military demand stands as a key test of its health and readiness. Production capacity earned an index score of 77 for 2019, a 9-point increase from its 2017 index score. Gains in output efficiency and stability in capacity utilization contributed to this rising trend. An assessment of the surge capacity of the defense industrial base using industrial input-output analysis uncovers fewer shortages in critical defense supplier industries than estimated for the defense industrial base of the early 1980s, which constitute the last era of great power competition. The defense industrial base of that time operated under a dramatic “buildup” in defense spending and force posture that began during the Carter Administration and accelerated throughout the Reagan Administration. The Carter-Reagan buildup involved a 31% surge in DoD expenditures; we estimate that the defense industrial base circa 1980 experienced shortages in the productive capacity of 54.5% (6 of 11) of critical defense supplier industries. Presently, 27.3% (3 of 11) of critical defense supplier industries would likely experience shortages in the event of a surge in demand for combat-essential defense programs equivalent to the Carter-Reagan buildup of the late 1970s through the mid-1980s. As a result, the industrial surge capacity indicator scored 100 for 2019.
The health and readiness of the defense industrial base pose a challenge to the defense acquisitions community. With the growing expectation of the defense industrial base to rise to unprecedented challenges, Vital Signs 2020 highlights several hurdles that the defense industrial base will face in doing so. The overall defense industrial base’s health score of 77 out of 100 suggests a satisfactory ability to meet current mission requirements. However, the fast-moving era of great power competition requires more, including the delivery of extraordinary capabilities to reverse the erosion of the capability advantages we hold over our competitors. Further, the vulnerabilities shown in this study—industrial security and production inputs to include workforce—indicate a need for urgent attention and action. It is fortunate that the areas of confidence highlighted herein should confirm that the fundamentals of America’s defense industry remain a sound foundation on which to build.
The ideas and findings in this report should not be construed to be official positions of either any of the organizations listed as contributors or the membership of NDIA. It is published in the interest of information exchange between government and industry, pursuant to the mission of NDIA.