Changes Are A Comin’ to DoD Contractor Product Support

Aug 10
2010

The U.S. Department of Defense is the biggest purchaser of Product Support expenditures in the world; it annually buys an estimated $50 billion dollars worth of such goods and services.

The last ten years has proven to be an especially favorable period for military contractors; overall DoD spending has increased from $300 billion per year to $700 billion, or 130%, and America now employs nearly half of all global military resources.  It is estimated that Contractor Product Support expenditures rose at a 150% to 200% rate during the ten year period.

As a result of the large build-up in DoD expenditures, the US currently generates 50% of the global military expenditures, but the US economy only generates 25% of the global economic output…this imbalance will most likely be realigned back to a historical ratio of 1:1 between the US economic output and defense spending.  

When many contractors have only one customer that matters financially, options are limited as to generating additional sources of revenues to compensate for lost Product Support revenues.

Even the biggest military contractors claim less than five percent of the Pentagon’s budget, so a contractor’s fortunes is influenced more by how defense dollars are spent than by the size of the budget. For example, contractor revenues can decrease, even when military spending remains high, if money migrates out of weapon system acquisition and into uniformed and civilian manpower.

Below are some of the primary trends driving down Contractor Product Support expenditures:

  1. Reduction in overall weapon system OPTEMPO due to the scaling back the size of the US military deployment in SW Asia. With an estimated 25% of all weapon systems in theatre and their OPTEMPO an estimated 100% higher than those systems not in theatre, it is estimated that overall Product Support expenditures will decrease by 15%-20%, with contractors experiencing an estimated 20%-30% drop in Product Support revenues
  2. The current fiscal challenges of the Federal Government to finance all their budgeted programs will most likely result in the military being a “victim” of fiscal austerity. It is quite feasible that 15-20% of DoD weapon system inventories will be stored long-term in order to reduce Product Support expenditures. Given the US Congress and the power of the depot-lobby, many of the systems stored will be those currently primarily supported by contractors
  3. The emphasis that Secretary Gates has put on “rebalancing” the defense strategy. Rebalancing means putting less emphasis on conventional, industrial-age warfare, and more emphasis on non-traditional skills like counter-insurgency warfare; this strategy will reduce complex weapon systems that require a complex Product Support Enterprise. There will be more an emphasis upon COTS items being integrated into a solution for the warfighter. COTS Product Support expenditures are often materially less than that of Developmental Items, thus resulting in overall lower Product Support expenditures
  4. The move to “in-source” Product Support management jobs previously contracted out to industry by the Program Offices and Life Cycle Management Commands. The Government is actively recruiting “seasoned” professional from contractors; either the professionals join the Government or they lose their job.

Each of the major weapon system contractors will be encountering different Product Support issues:

  • Northrop Grumman (NG) has decided to remain primarily focused upon new weapon system deliveries. It recently sold its services unit, TASC, due to conflicts between its OEM business and its Product Support business. This was a major policy change for NG
  • General Dynamics (GD) has generated material Product Support revenues from Interim Contractor Support (ICS) programs for the communication communities, especially for weapon systems in theatre; a GD Contractor Field Service Representative (CFSR) in theatre generates almost $500,000 per year of revenue. Supplemental funds have been an engine of growth for GD Product Support programs; this will be going away sooner, rather than later
  • Raytheon is less exposed than other primary OEMs due to the nature of their products being electronics; Product Support expenditures, at least at the organizational maintenance level, is much smaller than that of weapon systems that have more mechanical parts
  • Lockheed Martin (LM) will encounter many challenges in the Product Support area. The company needs to generate $130 million in new sales every day just to stay where it is, and that won’t be easy in a down market for Product Support.

There will be many challenges in the area of DoD Product Support over the next few years. Adding value to DoD, rather than filling positions to perform routine Product Support tasks, will differentiate winners from losers. And let us not forget that Outcome Based Product Support programs will be the rule rather than the exception for all future Product Support contractor offerings; that will be the only way that DoD will be able to manage Product Support processes more effectively for less costs.

For a more detailed discussion on the above topic, review the recent conference discussions at the Lexington Institute.

The “Miracle” of COTS Products

Jul 09
2010

The Department Of Defense and its research organizations have always been touted as working on the “bleeding edge” of a multiple array of technologies. This is often true, leading to more effective (i.e. lethal) mission capabilities, but rarely are these initiatives more efficient (i.e. cost per outcome) in completing a mission.  See Undersecretary Carter’s comments regarding this issue here.

When we move to the COTS product world, the employment of COTS products in the processes of everyday life has resulted in both improvements in effectiveness and efficiency. In a recent article in the Journal of the American Enterprise Institute,  a striking comparison of what could be purchased in 1964 and today with the same purchasing power (price as a % of average salary) was illustrated below based upon an average one month salary.

1964:
 A moderately priced Radio Shack stereo system.

2010:
Panasonic Home Theater System, Insignia 50″ Plasma HDTV, Apple 8GB iPod Touch, Sony 3D Blu-ray Disc Player, Sony 300-CD Changer, Garmin Portable GPS, Sony 14.1-Megapixel Digital Camera, Dell Inspiron Laptop Computer, TiVo High-Definition Digital Video Recorder.

Also note that a personal computer in 1978, the Radio Shack Model 1, with 4K of RAM, a tape recorder as a data storage device, a green screen and little application software cost $600, or equivalent to about $3,000 today.

The above are stunning testimonials as to the value of COTS products and the inevitable greater and greater employment by DoD. Though our enemies have the same access to COTS products, it is the Acquisition corps that has to use their prowess at COTS product integration in developing solutions for the Warfighter. The US is second to none when it comes to integration and our enemies will never be able to duplicate our COTS products integration efforts resulting in our remaining the most efficient and effective military force of all time .

Outcome-Based Pricing Offerings, Industry Leaders Agree

Jun 03
2010

Traditional pricing models of cost-plus and transaction-based for system/equipment product support offerings are changing today. This is being driven by end-users wanting to materially shift their risk of unfavorable availability, reliability and Total Ownership Cost (TOC) to their suppliers. This new pricing model is referred to as outcome-based. It can be quite profitable for a supplier, if the operational aspects are managed well, as well as be highly advantageous to maintenance organization…or it can generate significant levels of red ink if the supplier doesn’t do its homework, and the maintenance organization’s operations may become less effective. These pricing programs can be offered in the following packages:

  • Fixed price per unit of system/equipment output (i.e. Power By The Hour; customer doesn’t pay for reliability problems)
  • Fixed price for a period (i.e. extended warranty; customer doesn’t pay for reliability problems)
  • Fixed price for performance (i.e. pay for uptime; customer doesn’t pay for reliability, nor for materiel availability problems)

The above presents revenue recognition issues and cost accrual challenges for the finance organization of the supplier providing the above offering; the financial analysis should be done by a managerial accountant and not a financial accountant; from my experience financial accountants will often destroy an outcome-based pricing program due to their lack of the knowledge of the operational drivers for such a program.

Giuntini & Co. isn’t the only one to agree that these pricing models are the way of the future. Read further on the general subject matter related to pricing models from TATA Consulting’s website: http://www.tcs.com/offerings/platform_BPO/resources/Documents/Platform_BPO_White_Paper_Transaction_Based_Pricing_in_BPO_05_2010.pdf

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