A version of this article appears in the May 12 edition of Aviation Week & Space Technology.
John B. Johns has seen tough challenges in his career. After a year advising Iraqi military and security officials how to establish a mature logistics and maintenance, repair and overhaul (MRO) capability in their war-torn country, he did the same in Afghanistan.
But now Johns, the U.S. deputy assistant secretary of defense for maintenance, sees the military MRO sector in jeopardy of being hugely disrupted in the coming years, and he is on a mission to warn industry executives and government officials alike. The threat: a potentially sudden and steep drop-off in U.S. military MRO spending due to dwindling war-related budgets, known as Overseas Contingency Obligations (OCO), the vast majority of which is devoted to operations and maintenance (O&M) funding.
“It will go away,” Johns says of off-book, supplemental OCO spending, which at $85 billion this fiscal year accounts for around 15% of all Defense Department appropriations. “Sometime in the relatively near future—especially if we pull out of Afghanistan relatively quickly—that OCO budget is going to be under severe pressure. And with that kind of percent contribution to the total budget, we have some serious things to consider as to how we’re going to shape our industrial base.”
The global military MRO market is plateauing this year at the 2013 level of about $61 billion, according to Michael Howard, a principal specializing in military MRO at consultancy ICF International. He says $60.7 billion in work was recorded last year, excluding China, Russia and other impenetrable sectors. “Generally speaking, it’s a very, very flat market,” he says.
Moreover, according to MarketsandMarkets, the global military aviation MRO market is expected to see a compound annual growth rate of only 3.35% through 2024, barely above expected inflation of 2% maximum used in Congressional Budget Office estimates over the decade (see chart, page 26).
Wars winding down are one reason for the comparatively somber outlook, particularly relative to the annual spikes in work during the height of Iraq and Afghanistan combat operations, according to analysts, officials, consultants and executives speaking at Aviation Week’s recent Defense Technologies and Requirements and MRO Military conferences. But so are proposed cutbacks in U.S. military force structure, especially older equipment in need of repair, as well as a palpable decline in performance-based logistics (PBL) contracts. Finally, there is lingering fear that as the federal government is forced to shrink—by design or by default as political gridlock in Washington persists—military depots and shipyards will be protected at the expense of the private sector (AW&ST April 29, 2013, p. 38).
Federal budgets, however, remain the immediate concern. With its longevity dating to 9/11 and Iraq operations, particularly to pay for surges in military operations there and in Afghanistan, OCO has become an expected allotment by industry. The baseline budget, meanwhile, also continues to be reined in by so-called sequestration-level spending caps that sprang from the federal debt ceiling fight on Capitol Hill starting in 2011, and that have been only moderately ameliorated in recent deals such as the 2013 Bipartisan Budget Act. “We don’t know where the bottom is,” Johns says of overall spending. “My guess is it still is going to go down.”
The Pentagon will be taking other cost-saving actions, too, starting with aircraft retirements and acquisition reform efforts. The U.S. defense maintenance sector counts total inventory of more than $350 billion worth of aircraft, missiles and other vehicles, with annual maintenance costing more than $80 billion. Johns says 650,000 military and defense civilian personnel and “thousands” of companies depend on that portfolio.
But to help it meet so-called sequestration caps, for instance, the Air Force is proposing to retire entire fleets of A-10 and U-2 aircraft, as well as certain types of F-15s, F-16s and UAVs, which directly cut industry’s MRO work potential. If sequestration-level spending limits in fiscal 2016 and beyond are not raised, disposal of fleets such as the KC-10 also could occur, officials warn. Likewise, instead of overhauling an aircraft carrier, the Navy is considering retiring it and its associated air wing early, as well as mothballing six destroyers.
“The KC-10 and the A-10 are the two biggest issues,” Howard says, noting that they are followed by set-aside warships.
At the same time, new military aircraft coming online—such as the Lockheed Martin F-35 Joint Strike Fighter (JSF), Boeing KC-46A and P-8—provide the Pentagon and allies the opportunity to change how they sustain them. Changes in government processes are likely to have an outsized effect on industry as the few new types replace old aircraft.
“The biggest area of opportunity is in sustainment,” stresses Shay Assad, director of defense pricing and acquisition policy. “Do we really want to create this environment where we have no alternative but to go through this single supplier forever? JSF is young enough now that we can actually have an effect on it.”
According to Howard, roughly 11,000 aircraft will be delivered in the next 10 years, but 75% will replace retirements. Indeed, the majority of retirements will come from large, installed base fleets such as Lockheed F-16s and Sikorsky S-70 helicopters. “This creates the potential for surplus material to cannibalize sales of new material,” he says. “Also, it reduces the MRO activity by retiring more maintenance-intensive aircraft.”
Any spending reductions will feel even sharper to companies because the Pentagon accelerated outsourcing of MRO in 2009-13, representing a combined 10% increase in contracting-out for airframe, component and engine depot maintenance, according to an ICF study. The downshift to just 55% in-house, or “organic,” military MRO equated to almost $3 billion in additional industry revenue over the four years.
In addition, the Pentagon started embracing PBL in that time period. PBL contracts increased to 35% of outsourced activity last year from just 25% in 2009, according to the ICF. But executives and consultants fear they could fall off even faster.
For starters, the majority of PBL contracts are for material or supply chain services that focus on inventory management and availability versus labor. Next is the fact that as budget wars in Washington have made long-term planning nearly impossible, long-term contracts such as PBLs have lost ground to short-term deals that allow the government greater response and control. Not surprisingly, the overall number is dropping. Mark Schroeder, senior program manager at Raytheon, says Pentagon PBL contracts once counted above 200 but now number about 80.
Underlying the downturn is a sense that a wave of PBL advocates inside the Defense Department last decade has crested and the tide is receding, leaving an acquisition workforce trained heavily in transactional logistics—versus performance logistics—while still living under threat of long-standing criminal penalties for malpractice turning away public-private partnerships. “There really are only a handful of folks who a) understand the performance-based logistics model, and b) understand commercial industry,” says Al Banghart, senior advisor at Deloitte Consulting.
Certainly, not everyone inside the department is convinced that PBL contracts should be the default. “The reality is, it really has been a mixed bag,” Assad stresses. He admits part of the problem has been on the Pentagon’s side. “Where we have really fallen down on our faces is properly defining the requirement. What we did in many instances is we over-specified the requirement . . . when 80% would have been fine,” he says.
But Assad also does not see an unraveling of the so-called 50-50 MRO outsourcing rule enshrined in law since after World War II, when Washington became worried about losing “core” military sustainment capability as contractor business cycles up and down. Over the decades, depots and shipyards were seen by many observers as bloated and parochial jobs providers, but that has changed, the pricing official says. “We have some depots out there that are very, very competitive, in comparison to industry,” Assad says. “There’s this natural thought that if we give it to industry we’ll save, and it will be a better deal. I don’t think so, not if you look at the real numbers.”
Assad doubts that legislation will change the status quo, but Johns thinks change is almost inevitable, considering budget cuts. He is trying to drive the conversation toward protecting “critical” MRO capabilities, rather than just core ones. “We can no longer deploy organic capability without considering the commercial capability that goes with it,” Johns says.
In the meantime, he expects that defense officials will focus on making better decisions on new contracts and facilities. “The services will hold on to everything they have until the very last moment, and only then let it go,” Johns says. “So unless there is legislation that enables and encourages this, the only thing we can do is make very careful decisions about where new capability should go.”
Still, national security remains the priority, Johns says, for contractors and government workers alike. Profits and jobs are important, he acknowledges, but lost capability demands the spotlight.
“Saying I’ve lost 20% of my budget—who cares? Of course you did,” Johns says. “But if you can say that cost me 100 naval aviation assets and I can’t deploy two carrier strike groups because of that, now you’re talking in terms of impact in the world.”