Affordability in the U.S. Defense Department. A better approach to dealing with declining DoD budgets

Transcription

1 Affordability in the U.S. Defense Department A better approach to dealing with declining DoD budgets

2 Authors Randy Garber, partner, Washington, D.C. Bob Willen, partner, Washington, D.C. Alan Heckler, principal, Washington, D.C. Tyler Skarda, consultant, Washington, D.C.

3 The entire defense value chain stands on the precipice of significant change triggered by severe budget pressures. During the past 10 years the defense budget has experienced unprecedented growth. Now that trajectory has stopped and the Department of Defense stands at a crossroads in which the alternative paths to meeting its budget challenges imply very different consequences namely, reduce scope, or maintain scope and dramatically change the way business is done. Successes in the commercial sector offer government and the defense industry a way forward, but they also beg a key question: Can defense value chains respond similarly? Budget cuts are increasing pressure in every direction along the U.S. Department of Defense (DoD) value chain from customers (PEOs, SPOs, war fighters), prime contractors, and subtier suppliers, to funding providers such as those on Capitol Hill and Wall Street. The pressure is forcing the government and its suppliers to dramatically challenge the status quo. A.T. Kearney interviewed 18 defense-sector senior officers and executives from various areas along the defense value chain. They presented a wide range of perspectives on improving affordability suggesting that defense acquisition (buy side) and development, production, and sustainment (sell side) are ill equipped to meet today s new realities. For example: Acquisition processes are cumbersome The acquisition workforce lacks critical affordability-mandated skills and tools Customer requirements are fragmented with little or no portfolio commonality Prime contractors bureaucracy mirrors that of their government customers, and they have grown accustomed to cost-plus economics Sub-tier suppliers face tremendous uncertainty and challenges in bringing new technology to market (see sidebar: About the Study on page 3). In addition, defense faces a number of other changes that demand greater transformation of its value chain. Among them are a general decrease in requirements for mass firepower and support of large-scale wars against nation-state adversaries; more need for agility, situational awareness, interoperability, and pinpoint precision to succeed in asymmetric warfare; and a faster developmentto-delivery product cycle time putting singlepurpose technology in the hands of the war fighter quickly rather than resorting to complex, costly products that require years to make their way into the fight. Finally, if meeting affordability needs is not a big enough challenge, other values must be considered concurrently while cutting costs for example, social goals in contracting, building the AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney 1

4 supply chain for congressional support, and trying for zero-risk instead of balanced-risk management. Challenges, Choices, and Consequences Faced with these challenges, the Department of Defense has a choice of two possible courses of action: Reduce or maintain scope. Reduce scope. The historical path, and most expedient one, is to reduce scope, which may include targeting specific programs to reduce volumes or capabilities, or outright cancellation. An even more draconian measure is mandating a percentage cut across the board. This path, particularly if it is the principal means to accomplishing severe budget cuts, implies increased operational risk to military personnel, reduced readiness and responsiveness, more costly recovery decisions later, and erosion of the industrial base. Maintain scope. A better course is to change the way business is conducted to realize more value per dollar expended while maintaining readiness, capability, and performance in other words, drive affordability. If successful, combat effectiveness, development and production processes, and support for critical industrial base capabilities should continue uninterrupted. In view of the prevailing budget pressures, the reduce scope path is faster and arguably easier to implement because new conditions can be unilaterally imposed (see figure 1). The maintain scope path implies significant business process and organizational change, requiring cooperation and collaboration among many stakeholders across the value chain in an environment that typically exemplifies rigidity. 1 Our perspective, nonetheless, is that while the United States may be forced to pursue both paths, the defense industry government and suppliers must pursue the affordability path with a vengeance. It is hard to imagine there will ever be a more urgent need than now to undertake the transformational changes that real affordability requires. Throwing money at challenges is no longer an option. Given the magnitude of the Figure 1 Two paths to meeting budget challenges, with very different consequences Historic response to budget cuts Reduce scope: Cut or downgrade systems or services which hurts readiness, capability, and performance Alternate response to budget cuts Maintain scope: Realize more value/dollar in systems or services while maintaining readiness, capability, and performance Consequences Introduces operational risk to war fighter Costs more to add or reverse decisions later Hurts critical good programs and suppliers (more so than the unnecessary ones) Consequences Meets and even enhances the effectiveness of the war fighter Preserves and rewards the truly good programs and suppliers Makes long-term commitment to often difficult changes Source: A.T. Kearney analysis 1 The term value chain is used broadly to include the network of processes and participants in product design and development, material and sub-system inputs, production (assembly, integration, and testing), delivery, post-delivery sustainment and support, and refurbishment and retirement. 2 AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney

5 cuts, pursuing both paths may be necessary, but changing the business approach and maintaining as much scope as possible is far preferable from a national security perspective. Observations and Options Our study indicates that the rigidity of the defense value chain is a pervasive impediment to improvement. In fact, this inflexibility, which is largely imposed by the government and reinforced by its own resistance to change, drives a host of related barriers to increasing productivity or redefining solutions. As a result, the defense value chain is neither as agile nor adaptive as those of other industries. This inflexibility was made clear by our study findings and by our own perspective developed from years of helping businesses transform their commercial value chains in the face of daunting customer issues, changes in the nature of demand, a declining market, or other concerns. In these situations, successful organizations displayed flexibility albeit sometimes painful that enabled them to transform their value chains and thrive in the face of austerity. Commercial value-chain flexibility has been a source of value creation and competitive advantage, as outlined in the sidebar on page 4: Taking a Page from the Heavy Equipment Industry. In spite of the challenges and impediments, our study suggests two compatible approaches to maintaining scope through improved affordability (see figure 2 on page 4). Increase productivity. This means delivering specified product or service level performance by better leveraging of labor or capital across the value chain than is reflected in current business processes and organizations in short, delivering existing products or services more efficiently. Redefine the solution. Here, a new paradigm is implemented to meet a capability need. The About the Study Study participants contributed under conditions of anonymity and include senior officers and executives from the following: Government, including active and retired members of the Office of the Secretary of Defense, policy organizations in the service branches, and program executive officers and directors Defense industry, including prime contractors, established Tier 1 and Tier 2 suppliers, and start-ups Industry observers, including Wall Street analysts and policy experts from various think tanks Our focus was on external valuechain expenditures not cost reductions within the organic civilian and uniformed forces. The predominant question we asked the participants: What structural changes and actions must be taken to meet affordability targets without sacrificing near- or long-term mission readiness and capability? Our interviews, while grounded in this core question, were far ranging and allowed each participant to express fully a unique perspective and offer suggestions and recommendations from his or her specific viewpoint. In conducting this study, we wanted to understand firsthand the impediments and potential actions for improving affordability that could be influenced or implemented by value-chain participants not high-level changes such as congressional actions that are largely beyond the participants direct control. We were particularly interested in understanding the implications for, and the role of, sub-tier suppliers. Our goal was to put together a set of practical recommendations that could be addressed now. We sought actions that the Department of Defense (DOD), the military services, or prime contractors and sub-tier suppliers could perform collaboratively. AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney 3

6 Figure 2 Maintain scope is the preferred path to budget cuts Maintain scope: Realize more value/dollar in systems or services while maintaining readiness, capability, and performance Improvement levers Increase productivity Deliver specified product or service level performance by better leveraging labor and capital across the value chain Increase productivity Redefine the solution Reduce profit margins USD for AT&L refers to the Under Secretary of Defense for Acquisition, Technology, and Logistics Source: A.T. Kearney analysis Redefine the solution Implement a new paradigm for a needed capability New product or service New technology Existing technology (adopt or adapt) Reduce profit margins (Not pursued) Stands as a short-run strategy Becomes a lose-lose if supply base fails to earn its cost of capital leading to exit or underinvestment Leads to unstable supply base and erodes capability Is not supported by USD for AT&L Taking a Page from the Heavy-Equipment Industry An industry with some parallels to defense is heavy equipment. Similar to many defense products, heavy equipment manufacturers produce a relatively small-volume of large, complex, and costly products in a mainly oligopoly market structure. These companies are largely global and manage complex extended value chains for both production and sustainment worldwide. New product development requires significant investment over an extended horizon with considerable business risk. Because of intense competitive pressures, challenging demand, and changing customer needs, leaders in this industry such as Caterpillar, John Deere, and Komatsu have transformed their supply chains into high-performing, efficient, innovative, and flexible value chains. This provides a foundation for delivering more value to customers and capturing competitive advantage. Makers of heavy equipment have well-developed production and supply-chain systems, leveraging their best internal and external practices. Most use aggressive efficiency programs to drive out waste in their value chains while committing to improved quality and reliability. They recognize the importance of aligning and building relationships with key suppliers to increase value creation well beyond the traditional buy and sell relationships, as exemplified in Deere s Achieving Excellence and Komatsu s Midori Kai programs. Both Deere and Komatsu embed technology in their products to increase speed and agility, and to redefine customer solutions (Komatsu s Komtrax system, for example). Competition and collaboration that led to major improvements in the heavy-equipment industry, today provide a best practice perspective for the U.S. defense industry. 4 AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney

7 new paradigm may include developing and deploying a new product or service solution, new technology, or new adoption or adaptation of existing technology in short, changing the nature of the game through innovation. Arguably, a third option for maintaining scope exists attacking supplier profit margins. However, we summarily rejected this option as a shortsighted, short-run strategy that ultimately results in lose-lose outcomes if the supply base enterprises fail to earn their cost of capital, leading to exits or underinvestment. While pockets of excess profits may exist in the U.S. defense industry, government will not materially meet its budget challenges by striving to reduce profit margins. Correctly, in our opinion, the Under Secretary of Defense for Acquisition, Technology, and Logistics explicitly opposes an attack on supplier profit margins. To make significant inroads against defense budget cuts, increasing productivity and redefining the solution must encompass more than incremental approaches, which, with reference to our earlier point on value-chain rigidity, means significant change must occur for all value-chain participants government, primes, and sub-tier suppliers. These changes cannot be unilaterally mandated. Rather, they will require an unprecedented degree of collaboration a new government and business relationship and way of doing business. Attributes of Top-Performing Value Chains As indicated in our heavy-equipment industry case study, and in numerous examples from other industries, value-chain transformation is possible and can have dramatic results. In charting a path forward for government and the defense industry, understanding the characteristics or attributes of top-performing commercial value chains represents a good starting point. These commercial organizations leverage the contribution of all participants to improve productivity and generate innovation. Their value chains consistently exhibit the following three attributes (see figure 3). Efficient execution. Efficient value-chain execution is a source of significant cost reduction and, when combined with high quality performance, provides a critical driver of superior value creation, competitive advantage, and ultimately Figure 3 Attributes and guiding principles of top-performing value chains Attributes of top-performing value chains Efficient execution Guiding principles Passionate focus on productivity and value capture by government in acquiring and managing products and services, and by suppliers at all levels in the value chain Maximum contribution from supply markets Dynamic approach to supply markets that maximizes value creation in costs, schedules, and performance along the entire network and life cycles of products and services Speed, agility, adaptability Rapid technology mobilization along the entire value chain from concept and design to deployment and sustainment, in a secure open architecture environment Source: A.T. Kearney analysis AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney 5

8 improved market share. Value-chain partners with clearly defined roles and responsibilities operate as a collaborative, synchronous network. Particularly in monopoly and monopsony or oligopoly situations, the collaboration includes the customer. Maximum contribution from supply markets. Commercially, value-chain configuration is considered a source of competitive advantage. The scale and scope of the extended enterprise are leveraged to achieve cost advantage and operational complexity management. Suppliers are empowered to provide their best solutions to deliver requirements as opposed to responding to rigidly defined requests for proposals (RFPs). Visibility, alignment, and engagement exist beyond the customer or prime level. Speed, agility, and adaptability. Product development, production, and delivery cycle times are critical competitive factors. External innovators are identified and brought into the value chain early in the product development process. Commercialoff-the-shelf (COTS) technologies are quickly adopted. Open-system architectures enable external developer contributions rather than heavy or sole dependence on sequential internal development. Value-chain configuration has the flexibility to meet changing customer requirements, exploit new opportunities, and mitigate emerging risks. These three attributes suggest solid principles for defense value-chain transformation in both government and industry. Drawing on input from our study participants and our work in the commercial sector, we identified 10 improvement levers for government and suppliers pursuing value-chain transformation. Five of the levers fall under the banner of increase productivity and three under redefine the solution, with two levers sharing characteristics of both (see figure 4). The following outlines all 10 levers and some of the activities required in a value chain transformation. Figure 4 10 improvement levers in a value-chain transformation Attributes of top-performing value chains Improvement levers Increase productivity Redefine the solution Efficient execution Maximum contribution from supply markets Speed, agility, adaptability *Commercial off the shelf 1. Improve collaboration among all participants (government, primes, sub-tiers) 2. Reconfigure the value chain to reduce costs and improve performance 3. Leverage buying power across the portfolio 4. Use incentives to boost productivity 5. Optimize stability of production volume 6. Enable competitive market forces to shape best solutions 7. Reduce development and production cycle times 8. Lower barriers to new or non-traditional entrants 9. Streamline adoption of COTS* solutions 10. Adopt open system architectures Source: A.T. Kearney analysis 6 AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney

9 Attribute 1: Efficient Execution In general primes are reluctant to collaborate closely with peers or subs... they don t want them in their backyard. Program manager Tier 1 supplier 1. Improve collaboration among all participants (government, prime contractors, and sub-tier suppliers) Maintain open dialog across the value chain throughout the product life cycle Raise the level of transparency between the government and suppliers across the value chain this requires accompanying rules of engagement and, likely, non-traditional forms of program governance Engage in joint process improvement initiatives in all major cost, schedule, and performance areas; the initiatives should be focused in terms of scope, objectives, work plans, timelines, metrics, and accountability 2. Reconfigure the value chain to reduce costs and improve performance Regularly evaluate make or buy decisions Engage in supplier development with key valuechain partners to ensure capabilities grow with changing requirements and enable technology developments Maintain value-chain flexibility to incorporate new participants that provide cost, schedule, or performance innovation; and new capabilities Attribute 2: Maximum Contribution from Supply Markets By the time I get the RFP, there is no room for new technology, or the lag in getting the RFP out is so long that technology has moved beyond that anticipated in the RFP. CEO Tier 3 supplier 3. Leverage buying power across the portfolio Leverage government-buying scale and scope to enable mega-buyer and mega-supplier sourcing and relationship management Establish a government portfolio view to capture economies, synergies, and commonality opportunities across programs particularly where programs share facilities and workforce 4. Use incentives to boost productivity Establish risk-reward opportunities to encourage improved performance Align profit opportunities with programspecific, long-range annual performance improvement targets Make rewards sufficiently substantial to warrant attention and provide incentive for change and urgency 5. Optimize the stability of production volumes Establish business case economics recognizing trade-offs of stable production volumes and economic order quantities versus flexibility Improve funding stability through sanctioned management reserves 6. Enable competitive market forces to shape best solutions 2 Modify the RFP and source selection process to enable the use of collaborative optimization and expressive bidding as opposed to rigidly defined, prescriptive RFPs 2 Levers 6 and 7 pertain to both increased productivity and redefine the solution categories. AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney 7

10 Attribute 3: Speed, Agility, Adaptability The private sector is able to deliver capabilities and improve those initial deliveries on a 12- to 18-month cycle. Defense IT systems typically take 48 to 60 months to deliver. IT developer 7. Reduce development and production cycle times Adopt a modular good, better, best product development mindset set targets and criteria early and embrace the relative difference in each Empower program managers on both the government and supplier side to reduce multiple layers of low-value oversight and obstruction by the multitude of minions Provide critical path transparency and adjust resources accordingly 8. Lower barriers to new or non-traditional entrants Actively engage non-traditional suppliers and streamline the certification process; this implies understanding the real cost of risk as opposed to using it as a convenient excuse to prevent change Facilitate access of non-traditional entrants through venture capital or incubator-like models such as DeVenCI and In-Q-Tel Go beyond passive solicitation postings on fedbizopps to actively facilitate access to buyers via B2B websites Establish a chief innovation officer position in the DOD similar to that in the commercial sector 9. Streamline adoption of COTS solutions Establish tailored procurement processes for rapidly changing technology Adopt commercial best practices to leverage COTS information technology Develop technology road maps recognizing overlapping multi-program capability requirements Limit tailoring of COTS solutions to a minimum 10. Adopt open system architectures Outline common standards for systems and sub-systems to be universally adopted and enforced where appropriate across the DoD. While many contractors and services already define native open-architecture standards, the real bang for the buck lies in taking a department-level view. Encourage independent parties, large and small, to design and develop interoperable modular components that all work together under specified standards thereby lowering overall development, modification, and operating costs across the life cycle. Get the architecture right the first time. This requires not only defining and adopting an open-architecture philosophy, but also building out government and contractor system engineering capabilities to understand the planned architectures inherent trade-offs. Focus on the Opportunities Together In the new environment of significantly reduced defense funding, the value chain status quo is unsustainable, pressuring virtually all participants on both the buy and sell side of the equation to act differently. There are challenges and opportunities ahead. Those that focus on the opportunities specifically, the value-creation opportunities to improve productivity and accelerate innovation can maintain and even improve their profit margins. But none of this can be accomplished alone. All players in the defense industry, from sub-tier suppliers to government customers, will have to make significant changes to their value chains. The good news is that the commercial sector already offers a how to perform a valuechain transformation. Following the three guiding principles outlined in this paper, combined with prioritized affordability plans, will help ensure that the maintain scope option prevails over the reduce scope option as the most expedient, long-term remedy for the defense industry. 8 AFFORDABILITY IN THE U.S. DEFENSE DEPARTMENT A.T. Kearney

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