ROCHE OUTLINES INDUSTRY CONCERNS

"I am deeply concerned about the need our nation faces to reinvigorate our defense industry so it does not lose the advantages of competition, or the incentive to innovate," said Air Force Secretary James G. Roche at the Aerospace and Defense Investor Conference in New York May 14.

"Over the past several years, our aerospace industry has undergone one wave of consolidation after another, from more than two-dozen leading contractors to a handful of giant firms, complemented by a few niche companies," he explained. "At the same time, our government was seduced by the siren song of Total Systems Procurement Responsibility into abrogating essential program management responsibilities that any effective monopsonist must bear. This is not what I would call a macro-environment conducive to innovation or long-term cost efficiencies.

"I've talked about the downside of industry consolidation for a number of years. The difference today is, now I am living with the consequences. With the size of today's industry, the government has an obligation to think more strategically in terms of managing our defense industrial affairs.

"We must foster increased competition to ensure the long-term health of an industrial sector critical to our national security. Absent competition, there is little incentive for innovation over the long term.

"I am very worried about companies in this industry consolidating to the point where the Air Force will be stuck buying that which someone wants to produce, compared to being able to challenge the industry to come up with ideas that may lead to major breakthroughs in combat capabilities.

"I just don't think the government can manage a monopoly, or an asymmetrical duopoly, and get innovation out of it. We simply do not have the right set of positive or negative incentives, including executive compensation that currently is tied more to stock price than program performance.

"Innovation will not survive in a scenario where we are left with only two choices - 'Sears or Roebuck?' And in a duopoly, what are the incentives governing the executives?

"Some people talk about the nature of competition and all the reasons we have to go to monopolies: it's due to our inability to sustain the number of contractors we now have or it's because "that's just the marketplace." That was part of the conventional wisdom of the 1990s, and like so much conventional wisdom, we've found that it was flat wrong.

"In the business of national security, the monopsonist not only has a right, but an obligation, to worry about the competitive dynamics of its supplier base in the long run. In most market segments, we now have monopolies or duopolies that serve a monopsony. When I hear arguments about efficiencies gained from consolidation and cost cutting, my argument is: Fine, but you forget you are in a protected industry. We're not going to let all of you go out of business. Period.

"We are never going to go buy Chinese-made radars or Russian airplanes. So let's stop already with all of this pseudo-market economics that do not apply, even though your senior managers are compensated on levels comparable to executives at companies who must deal with the vagaries of an intensely competitive commercial environment.

"We have a clear and present obligation to ensure competition in order to preserve national security. Where we have competition, we have seen stunning results. Take the Joint Strike Fighter, for instance.

"That was a good case where two great fighter and two great radar houses went after each other to do their very best - and both produced rather dramatic technology. The fire control radar in the F-35 will be cheaper than either the electronic warfare system or the communications package. Why? Competition!

"After a year on this job, I am ever more convinced that the most direct way to drain innovation and cost savings out of programs is to deaden competitive pressures. Excessive consolidation, unfortunately, does just that.

"Take any organization in which people talk about all the consolidation savings by centralizing everything.

"I think the Communist Party of the Soviet Union made the best case for such an approach when Stalin unveiled the first five-year plan back in 1928. And up until the collapse of the Soviet Union, there were still academic papers which praised the central staff Gosplan approach to industrial affairs as the cheapest and smartest thing to do. So, while it may sound good in the short-term; in the long-term, it's not. It never is, it never will be.

"Any approach that condones the formation of a monopoly in exchange for promised future savings constitutes a simplistic answer to a remarkably complex problem that will continually grow more acute.

"So we have learned, and hopefully not too late, the things we should not do:

"For example, a prime should not be the only influence in determining who is going to be around for the long term at the next tier, and make decisions based on who gave them the sweetest deal, not who did the best for the country. Total Systems Procurement Responsibility is dead! Furthermore, it was a misguided idea from its inception.

"We are working on several initiatives that I support and will continue to pursue:

** I would like to see expanded government involvement in subsystem competitions early in the process now overseen by prime contractors;

** To do this effectively, we need officers and civil servants with the training and expertise to make sure the government stays effectively engaged.

** Further, we need to turn our focus to the rival design teams that still reside in companies, and fund them to develop creative ideas to keep their skills sharp.

** We will be rigorous in reviews of mergers and acquisitions that would form either monopolies or foster vertical integration-when the company that produces major systems also makes key components that comprise the finished product.

** And in the case of program management in a consolidating industry, we are trying to get involved and spot troubles earlier; calling in the companies and visiting them; and we are encouraging them to spend more independent research and development monies.

"If the Air Force can begin to solve these issues, we will be well on our way to completing the transformation our service began years ago, and which our president and Secretary (of Defense Donald) Rumsfeld have envisioned for the future.

"As technology evolves through this century, we will see an increase in the use of emerging, transformational capabilities to protect our national security.

"This is why we remain dedicated to transforming our organizational structures, strategic principles, and operational systems. And we must learn to think differently.

"The challenges we face in defining and shaping the future of national security systems are formidable. But so are the opportunities.

"It is simply a matter of finding complex answers and solutions to these complex challenges and issues. We must have innovation, efficiency, sensible and responsive plans, and the continued dedication of talented and expert personnel."

--courtesy USAF News Service, June 2002.