The COVID-19 pandemic imposed supply chain and labor shortages on the defense industrial base, earning the current business climate a failing grade from the National Defense Industrial Association (NDIA) in its third annual report on the health and readiness of the defense industry.
NDIA scored the business environment as 69 on a 100-point scale, citing COVID, cyber espionage, and Congress’ inability to pass timely defense budgets as key factors in its “Vital Signs” report. Developed in cooperation with the federal spending data firm Govini, the latest report represented a decline from a “C” in 2020, and NDIA suggested scores could get worse before they get better.
Vital Signs is based on a survey of 400 businesses that work in the defense sector, both large and small. It examines their experiences on workforce availability, intellectual property rights, the speed of obtaining security clearances, workplace productivity, regulatory burdens, public opinion, and profitability, among other factors.
NDIA President and Chief Executive Officer Gen. (Ret.) Herbert J. “Hawk” Carlisle said the survey offers a “sobering” indicator that dangerous military shortages could loom without greater attention from Congress and the Pentagon.
“We can’t admire the problem anymore,” Carlisle said. The pandemic has had a “moderate or large negative” impact on business, according to 71 percent of respondents, and they expect that to be a lasting effect; only 14 percent said they don’t expect their business to return to pre-pandemic norms.
“We expect scores to be further impacted next year as supply chain disruptions and inflation rise as concerns with the continued follow-on effects of the pandemic,” the report said.
NDIA offered no recommendations or legislative prescriptions. Wes Haulman, NDIA’s senior vice president of strategy, said the unique value of Vital Signs is that it is the only comprehensive and unclassified assessment of the defense industry’s health.
A huge drop—36 points—was recorded in the “cash conversion cycle,” which illustrates how quickly companies “regain a dollar invested in product inventory as cash receipts,” the NDIA said. Longer cycle times indicate that companies “face greater difficulty in relying on sales for the liquidity necessary to fund critical operations.” There were also inventory problems—an eight-point decline from a score of 75 last year—and only 12 percent of respondents said they expected supplier networks would be more reliable in 2022.
Haulman said that a possible “silver lining” of the pandemic is that it’s highlighted underlying supply chain issues, such as the availability of computer chips and reliance on overseas suppliers. He added, NDIA now has a “company by company” visibility into supply chain problems. Inflation pushed indices lower on supply, broadly.
Competition remains under threat, the report shows, with“30 percent of respondents … [reporting] that they were the sole eligible provider of a product” for the Defense Department. “This is a risk to innovation,” NDIA noted, citing “an overreliance on a smaller pool of entrants [that] may create production or innovation shortages in the future.”
This dwindling supply base, Haulman said, creates “more and more fragile networks.”
Govini CEO Tara Murphy Dogherty said government must make working for the Pentagon more attractive to small, innovative businesses. Perhaps the most troubling vital sign was industrial security, according to NDIA, citing a grade of just 20 out of 100. Cybersecurity vulnerabilities “continue to rise at a very high rate,” NDIA said, describing “steadily declining” new intellectual property investigations by the FBI and an uptick in “newly reported common IT cybersecurity vulnerabilities.” Industrial security faces “escalating risk” in the future, it said.
Of the companies surveyed, 78 percent said that the availability of skilled labor was a “moderate or significant problem.” The report said the industry’s “output gap,” a proxy indicator for the ability to surge defense production, plunged in 2021, falling from a score of 48 to 20.
The impact of COVID “continues to reinforce” the need for surge capacity, the NDIA said, noting that “surge readiness” scores fell to 52 from 67 in a year.
The slow pace of security clearances also continues to hinder business. Nearly two in three respondents called this a moderate or significant problem, even as they reported a somewhat quicker speed of clearing workers. Companies face similar difficulty finding workers with clearances, trade skills, or STEM—science, technology, engineering, math—degrees.
In its “political and regulatory” section, the report compared the number of hearings and examples of congressional interest from year to year, showing growth in attention to artificial intelligence, microelectronics, and biotechnology, but a decline in interest in hypersonics, space, directed energy, autonomy, and other key fields since 2019. The NDIA cautioned that, due to its reliance on unclassified data, the reality may be a little bit different than the numbers suggest.
“Evidence points toward a significant drive for technological innovation by members of Congress,” the report noted. “For example, the creation of a Congressional Hypersonics Caucus is a strong indication of continuing interest in that area, despite a drop in hearings.”
Carlisle cited the damage and disruption of continuing resolutions (CR) to fund defense, mentioning delays to new starts and uncertainty as undermining orders for long-lead-time materials and supplies.
Haulman added that Senate delays in confirming nominations also puts a drag on the Pentagon. Nominees “need to set a strategic vision and they need to carry [it] out,” but many nominations languish, he said.
“Without having those folks there, we lose something we can never get back, and that is time,” Haulman said. “We harp on the fact that time wasted is time that we actually cede to our competitors.”
China and Russia do not have to operate under a CR, which only exacerbates the uncertainty of doing business with the government.
“We need to leverage the creativity” of the civilian economy, he said, and CRs discourage companies “to make those investments … or jump into this sector,” Haulman said.
Mark Lewis, head of NDIA’s Emerging Technologies Institute and the former Pentagon deputy undersecretary of defense for research and engineering, said declining government investment in basic research is also troubling. NDIA reported that “between 2011 and 2016, U.S. government funding for R&D projects fell by 12 percent in absolute terms.” By contrast, Russia increased R&D investment by 13 percent and China by 56 percent over the same period. The score for corporate R&D investment also declined by two points since 2019. Healthy investment by both industry and government in basic R&D is “crucial” to innovation, the NDIA stated.
NDAA said raw materials supplies, particularly for rare earth elements sourced from overseas, remains a problem, but companies seem less concerned than in prior years.
Nick Jones, NDIA regulatory policy director said the U.S only has about 32 percent of global rare earths mine production, so “it’s definitely an area of concern,” but the industry perceives improvement, with the Vital Signs score rising from 10 to 39 in the past two years. Concern over rare earths prices also improved slightly, from 75 two years ago to 83 today.
The economic disruptions of 2021 indicated how crucial it is to keep Congress focused on the health of the defense industrial base, Carlisle wrote in the report. It is a reminder that: “Our industry’s work … can never be taken for granted.”