Diagnostics for the Defense Industry

26 January 2022 • 0 Comments

The so-called health of the defense industrial base is receiving a lot of worried attention these days. Dour diagnoses are regularly torn from headlines reporting supply chain disruptions, the sector’s middling performance on Wall Street, or the missed milestone of an acquisition program. At the same time, quarterly earnings calls are mostly upbeat and technical achievements continue to astound. So, is the patient diseased and disabled or fit and flourishing?

To figure it out, I recommend we start by shifting the metaphor from personal medicine to habitat management. I worry that the focus on diseased trees, so to speak, may be obscuring our appreciation of the forest, which I contend is far more verdant than barren.

Even more comprehensive assessments tend mostly to amplify anxiety that our industry is in decline. See, for instance, the Pentagon’s annual Industrial Capabilities Report to Congress, the Reagan Institute’s recent report of its Task Force on National Security and U.S. Manufacturing Competitiveness, and Vital Signs, an annual  report of the National Defense Industrial Association (NDIA) on The Health and Readiness of the Defense Industrial Base. NDIA’s Nick Jones wrote earlier this month that its forthcoming report for 2022 will show “soberingly low marks”. More than half the attributes it measures, including productive capacity and propensity to innovate, now rate a failing grade.

While I commend NDIA for taking the initiative to amass data which enable trend-analysis of important indicators, a careful consideration of its report shows that making a proper diagnosis from them is fraught. To begin with, there is no consensus about what constitutes the industry’s “health”. Customary measures tend to reflect the preoccupation of one or another of the industry’s stakeholders, whose perspectives are often in tension. Are returns on invested capital which exceed risk—a metric of cardinal importance to investors—a mark of vitality or an indicator that a professorial senator would regard as economic rents sapping the industry’s productive potential?

On top of that, the metrics themselves are problematic. As always, input measures of indeterminate significance abound—factory floorspace, employment levels, contract obligations—while output measures of undisputed merit, like quality, performance, and even cost, are elusive. Harder still is the integration of these disparate measures into a summary “grade”, which would require a sophisticated model of their relationships. Vital Signs, for instance, calculates its summary score by taking a simple average of the index values it assigns to eight attributes, and yet it’s easy to imagine how even a slightly differentiated weighting scheme could generate substantially different results.

My own sense of what matters most to the health of an industry would overweight indicators of its propensity to attract talent, raise capital, and apply technology. The markets for technical talent, risk capital, and advanced technology are hotly competitive for all industries, and as the needs of the defense sector increasingly converge with those of non-defense industries, it’s not surprising that defense is feeling the heat. And still I believe the defense industry is doing fine.

Sure, defense companies are having to adapt, but in doing so, I find evidence that they are in fact holding their own:

  • In a 2021 survey by the brand research firm Universum of a quarter-million students attending university in the world’s 10 largest economies, aerospace and defense was found by engineering students to be their most preferred industry—#1 of 20!
  • Over the past five years, the SPADE Defense Index, a fund of more than 50 stocks in publicly-traded companies addressing defense and homeland security, has increased in value by 80 percent.
  • The most recent of the US government’s Business Enterprise Research and Development Surveyof nearly 50,000 companies shows the R&D intensity (i.e., R&D costs compared to sales) of the aerospace industry group exceeds all but two other manufacturing industries and remains well above the average for all industries.

While these few citations unto themselves are hardly conclusive of the defense industry’s health, still other observations compound my glass-half-full view of the industry’s fitness. Most especially am I heartened by the many entrants—from the biggest and most diversified, like Amazon and General Motors, to the entrepreneurial, like Anduril and Redwire—which are now competing to win business in defense, each bringing with it that combination of talent, capital, and technology which are my trifecta of good industrial hygiene.

These positive indicators notwithstanding, I concede that the defense sector needs still better habitat to fulfill what national strategy requires. But greening that ecosystem is the work of constant gardening, not a reclamation project.

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