The Defense Industrial Base is still quite vast, but it’s steadily shrinking.

The latest edition of an annual report by the National Defense Industrial Association suggests that even though thousands of new companies are winning their first-ever DoD contracts each year, those new entrants aren’t nearly enough to offset  the number of firms who are leaving the Defense market.

The latest figures NDIA compiled show the Defense market suffered a net loss of 3,300 companies in fiscal year 2021, the latest statistics available. Although more than 8,300 firms sold goods and services to DoD customers for the first time in 2021, even more left the Defense space. The industrial base has been declining every year since 2017, from 76,700 companies in that year to just under 60,000 in 2021.

David Norquist, NDIA’s president, said the latest declines don’t appear to be driven by industry consolidation, but by companies simply deciding not to do business with DoD.

“What you’ve seen mostly in the more recent time is a drop in firms who are willing to enter the Defense Industrial Base, or firms who are already here leaving,” Norquist, a former deputy secretary of Defense said during testimony Wednesday before the House Armed Services Committee. “For the smaller firms, the ones you’re trying to grow and get to come in, what are the barriers that we are putting in their way? Why are people not staying, and how do we draw people in? Because that’s the best way to sustain competition.”

According NDIA’s survey of its members, 42% now say they’re the government’s only supplier for at least some of the products they sell.

And of the companies who are selling to DoD, 66% said dealing with the department is “very difficult” or “somewhat difficult.” For comparison’s sake, only 9% of the same companies characterized their private sector customers that way.

The biggest challenge is the bureaucracy of the DoD acquisition process, according to 30% of the respondents.

“We’re poised for peace in terms of our processes, how we invest, and we’ve got to move dramatically away from that to a sense of urgency,” Eric Fanning, the president and CEO of the Aerospace Industries Association said during Wednesday’s hearing. “Our foreign military sales (FMS) process is a good example of that. When we transition from giving things to Ukraine to selling things to Ukraine, it’s going to grind down to a very slow process in the FMS system. I think there are a number of things we have to do to streamline the process, and it’s really going to take dedicated senior leader attention.”

In NDIA’s survey, another 22% of companies said the lack of stability in the federal budget is their biggest challenge.

Fanning, a former secretary of the Army, said the regularity of continuing resolutions in every appropriations cycle is a particular problem.

“Over the last 25 years, Congress has passed more than 120 continuing resolutions instead of on-time appropriations bills, and we are still digging out from the effects of sequestration a decade ago,” he said. “I saw some of these effects firsthand during my time at the Pentagon, but others have taken years to manifest and could take years to unwind without a sense of urgency. One result of these many years of successive decisions is an industrial base maximized to meet peacetime needs. This means excess capacity for surging is not always built into the system … The growing bipartisan, bicameral support for increased funding in recent years has been an important signal to industry. But it’s also critical that this funding is on time and predictable.”

Inflation is also a major issue for companies; 11% said it was their biggest single concern.

And while it’s a problem across the broader economy too, it can be especially challenging in certain government contracts, like in the case of multi-year firm-fixed price agreements that companies agreed to before inflation became a major consideration.

“The absence of economic price adjustments in existing contracts is a real challenge for some of the small businesses I’ve talked to, because often the government will award a five year contract where, since there wasn’t much inflation, the out-years only went up by 2% a year,” Norquist said. “They know that they can’t keep those employees with only 2% raises going forward. On new contracts, they can get awarded at the new rate, but those old ones really put them in a bind and risk losing their workforce.”

And companies say broader workforce challenges are an even bigger issue than inflation. In NDIA’s survey, 23% of companies said finding and retaining talent is their single biggest challenge.

Industry representatives say many of the other problems companies face in the Defense market also play into their workforce challenges. Uncertain budgets, for example, make it difficult to know how many people they need to hire and train.

Predictability is especially important in capital and labor-intensive portions of the Defense sector, like building and maintaining ships, said Matthew Paxton, the president of the Shipbuilders Council of America.

“Ship maintenance and modernization goes through a lot of ups and downs,” he said. “When we try to get somebody in our trades, they go through our apprenticeship programs to become a machinist or electrician or a welder, and they have a sense of belonging. But then companies have to let some of that workforce go because work flows don’t come into the home port like they were predicted. That tradesman was going to be a project manager or a supervisor, but it takes about five to eight years for that to happen. A lot of the guys in our shipyards are generational; they’ve had a mother or father that’s worked there, and they want a career. But when we have instability in the work forecasts, it creates real disruption with that workforce and the supply chains.”

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