DoD and industry need relationship counseling

For more than 15 years, the number of companies working with the Department of Defense has been declining — and the trend has continued in recent years. Recen...

This column was originally published on Roger Waldron’s blog at The Coalition for Government Procurement and was republished here with permission from the author.

For more than 15 years, the number of companies working with the Department of Defense has been declining — and the trend has continued in recent years. Recent analysis suggests DoD has lost more than 25% of its contractors over the past decade. This comes despite a flurry of efforts aimed at recruiting new businesses, particularly those specializing in innovative technologies, to enter the defense marketplace.

These recruitment efforts began in 2016, with the establishment of the Defense Innovation Unit, increasing use of other transaction authorities, and the beginning of an acquisition overhaul that would result in the Adaptive Acquisition Framework. These combined changes reflect the recognition that the Defense Industrial Base (DIB) is no longer positioned to deliver the capabilities and innovative technologies that DoD needs to meet the challenges of the 21st century. In essence, the DIB was not mirroring the innovation, speed, and competitive climate of the larger dynamic American economy.

The state of the DIB is being driven by two related challenges: DoD is both unattractive to new entrants and difficult for existing partners to continue working with. It is time for DoD and Congress to make an honest appraisal of how we got here and what can be done to stop the bleeding and tackle the challenge of retention.

The effort to supply Ukraine with weapons and munitions from long-term industry partners has highlighted the challenges industry partners face. To deliver capabilities to Ukraine, DoD must use rapid acquisition authorities (like the Defense Production Act, Other Transaction Authorities, special acquisition authorities for Ukraine and other authorities for urgent and compelling scenarios) that waive bureaucratic hurdles endemic to defense contracting. This effort has also highlighted that numerous capabilities are provided by single companies and fragile supply chains that are unable to ramp up quickly because of DoD’s Just-in-Time and drive-down-cost-at-any-cost policies. This approach has often left only one company standing in critical supply chains — and too often those still standing are on the edge of leaving the defense market.

As anyone who has weathered a long-term relationship knows, maintaining a healthy relationship requires a different kind of attention than the courtship that got it started. That is the situation DoD currently finds itself in with the defense industrial base.

We will focus on three that were identified by a survey we conducted of current defense contractors in the past year. When asked “Has your company considered pulling out of any government markets,” 25% of respondents answered yes. When asked what factors most influence whether their companies participate in government contracts, half of respondents indicated “government-specific regulations that make it too hard or not worthwhile to work for government” as a strong or very strong factor. This top concern was closely followed by “concerns over intellectual property integrity” and then “insufficient levels of cash-flow or profit margins.” Other factors were also mentioned, like the requirements process, but we will focus on the three most cited issues.

First, the number of requirements and prohibitions unique to defense contractors continues to grow, with dozens of new provisions added every year. On March 1, there were at least 11 prohibitions or restrictions working their way through the rule-making process, including prohibitions on certain semiconductor products or services, and Unmanned Aircraft Systems from certain foreign countries. They also included specialty metal restrictions, requirements to meet cybersecurity disclosures and standards, increasing domestic content thresholds for the Buy American Act and disclosing employees working in China on DoD contracts. Some of the prohibitions related to China and cybersecurity are national security issues of great import and need to be implemented. Other restrictions are not real security issues and mostly serve to complicate the system and dissuade companies from staying in the defense market. And some prohibitions are constantly moving the goal posts. The Cybersecurity Maturity Model Certification requirement, announced in 2019, has undergone numerous changes and is yet to be implemented. This is just one in a laundry list that creates extended uncertainty for companies doing business with DoD.

Second, too many contracting professionals do not understand how to negotiate for intellectual property rights. While DoD needs access to some IP and technical data to avoid vendor lock, most companies are unwilling to sign away blanket rights to their IP, which are critical to market competitiveness and future revenue. Despite the work of the DoD IP cadre of experts that was established at the behest of Congress,  there is still insufficient IP expertise across the Department and too much conflicting and outdated guidance.

Third, companies are driven by cashflow and profit margins, which are critical to remaining competitive and innovative, and in attracting investors and leveraging financial markets to promote company health and growth. If cash flow and profit margins were consistent and attractive, more companies would flock to the defense marketplace and competition would increase. But far from attracting new entrants, the data reflects that more companies are making the business decision to leave the DIB. In short, DoD is losing the competition for business partners to the commercial marketplace.

Selling to the government incurs unique risks and expenses not faced in the commercial marketplace. Companies that choose to stay should be rewarded for their loyalty (but not allowed to price gouge). Limiting profits to arbitrary percentages takes a myopic view of the larger long-term needs of the relationship between DoD and the DIB.

Collectively, these issues create an unhealthy relationship in which DoD takes its incumbent business partners for granted — asking for increasing sacrifices with decreasing rewards. Many of these challenges can be resolved with better communication throughout the lifecycle of the DoD-industry relationship.

The first step is to remove many of the outdated requirements that predetermine the way DoD and industry interact. Neither DoD nor Congress conduct holistic reviews of past regulatory, legislative or policy requirements, many of which were created to address issues that are no longer relevant or do not match the current economic landscape. Have current requirements for cost and pricing data, for instance, achieved their intended goal? Have all dollar thresholds been updated to account for inflation? Have requirements for baselining resulted in better adherence to cost, schedule and performance goals?

It is equally important to let companies behave like private sector companies and not try to remake them in DoD’s image.  To capture the innovation and creativity of the commercial marketplace, allow companies to operate as much like commercial companies as possible, which includes letting profit margins, cashflow, and business operations reflect commercial business practices.

Many of these requirements are codified in Title 10 of the US Code, which is a cluttered mess.  Simply understanding these regulations is nearly impossible. The recent move to reorganize these provisions is an important first step in creating clarity, but the notes must be harmonized, and outdated or conflicting laws and regulations must be repealed or modernized for the project to be complete.

This decluttering project will support the larger goal of taking a holistic view of the hundreds of requirements in statute, regulation, policy, and practice that relegate defense acquisition to a mechanistic — rather than a personalized — process. This review could be tied to the periodic release of the National Defense Strategy.

DoD and industry are in a long-term partnership that must be flexible enough to adapt to changing threat landscapes and business environments. By removing those requirements that create a legalistic relationship, both parties can work together to create new expectations and incentives for each other as they work on the shared goal of keeping the country safe.

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