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Harvard Business Review

May-June 1977

cently cost-of-capital was made an "allowable" cost. But clearly this is just the beginning. Many more actions are required; and many more new ideas need to be heard

planned economy at these levels is not only inconsistent with the American system but less efficient. To create a market economy at the lower tiers would mean that DOD and its prime contractors would have to make significant changes-for instance, far less use of "military specifications," greater use of commercial equipment and suppliers, encouragement of multiple sources, and discouragement of vertical integration by the prime contractors. The only government planning required at the supplier level would be to ensure that an adequate number of suppliers be maintained in each critical product area to provide competition and a "production surge" capability.

The source of the new ideas must be defense and civil industrial leaders. They must propose new procurement changes, if they don't, the wrong actions may be taken. What is more, neither reiterations of the problem nor general suggestions will suffice. The proposals have to be specific if they are going to have much effect. I recognize that this is no easy task. It takes creativity and guts to suggest that the old and comfortable way must be changed.

However, the possibility of free market operation at the prime contractor level is not as clear. In some cases (shipbuilding), the government must seek to create more sources. In other areas, such as aircraft production, the government must seek to reduce the number of sources, or at least get involved enough to allow the market to work and let some of the large companies leave the business. With the government being the sole buyer in many cases, and with a very few large contracts to be awarded, some form of industrial base planning will probably be required.

In addition, industry can begin to take certain actions on its own. For instance, it can suggest ways to improve efficiency and/or preparedness rather than just say, "If you want it that way, and you'll pay for it, we'll do it." Industry can begin to combine its defense and civil production operations, in order to lower costs, smooth out the defense cycles, and increase its "production surge" capability. In sectors where there is overcapacity, companies can stop the practice of increasing capacity every time they get a big contract, only to come later to the government for more support saying, "But we just built this plant for you-now what are you going to put into it?" Also, industry can do more to create multiple sources at the supplier level.

In fact, at the prime contractor level a large amount of planning is already being unofficially performed by DOD. The need for some of this planning is obvious. For instance, DOD must consider the timing of major programs; it must encourage consolidations in industries where there is excess capacity; it must schedule the use of resources, including both gov. ernment-owned and privately owned industrial plants and equipment; it must encourage certain capital investments and low-cost equipment designs.

Naturally, Congress is involved in all this. Its willingness to make legislative and budgetary revisions to allow the necessary changes in policy is crucial to the prospects for improvement,

Such actions clearly involve changing the way DOD does its business. They mean moving in the direction of more commercial-like business relationships with far more of an atmosphere of mutual respect and trust based on results than exists in the current situation, where there is sometimes an adversary relationship evidenced between business and DOD.

In broad terms, the need is to "institutionalize" the concept that the defense industrial base is a national resource. As long as nations may be forced to go to war, this resource must be protected and managed with great care, just as we try to do with other great national resources, such as timber, oil, education, and science. If our defense industrial base is respected here and abroad, if it is efficient, and if it is able to respond quickly and effectively to changing needs, we will have a more credible defense deterrent. Also, if necessary, we would have a better chance of preventing a military conflict from "going nuclear" after the initial stocks of conventional military equipment are used up.

What business leaders can do

The kinds of changes mentioned are not simply drawing-board ideas. DOD has already begun putting some of them into practice. For instance, in 1976 DOD announced a new profit policy to reward corporate investment in modernization. Also, re


ANALYTIC SCIENCES CORP. Mr. GAXSLER. Thank you very much, Mr. Chairman. I appreciate this opportunity to appear at these hearings in connection with the defense industry.

As you have just stated, I recently left the Federal Government. However, my interest in this vital sector of the U.S. economy, and of America's overall defense posture, has in no way diminished. I would, in fact, describe myself as a strong supporter of both sides of the socalled military-industrial complex. On the Department of Defense side, I believe it to be an extremely well managed organization-perhaps the best managed in the Federal Government-based on criteria of economic efficiency, relative ability to control costs on large Government programs, modern management techniques, et cetera; on the Defense industry side, as the worldwide leaders in the development of advanced technology; the leaders in the management of complex, multidisciplined programs; and the world's leaders in the production of complex equipment.

Finally, and perhaps most important, on both the military and industrial side, I am continuously impressed by the dedication to the national interest. Clearly the data shows that the U.S. defense industry has served us well in the 200-year history of our country, and that it is still a vital and dynamic industry today.

However, I personally believe that there are significant improvements which can and should be made to bring this defense industrial base more into line with the demands and conditions of the post-Vietnam era. This recent environment includes the relatively long period of low procurement levels, the recent high levels of foreign military sales, the continued growth in unit cost of equipment, with the resulting small quantities being procured, and the extremely high technology being utilized in the advanced weapon systems, which limits the number of companies—particularly the small ones—that can participate in this market.

The overall effect has been to present some trends which give cause for future concern. It is toward addressing these potentially serious future problems that I believe studies and future corrective actionsare appropriate. Many of these trends are reported on in my article in the May/June issue of the Harvard Business Review, which I understand you will include in the record as part of my official testimony.

What this article, and other studies that have been done over the past year, essentially conclude is that, for a variety of reasons-primarily having to do with the structure of the industry and the process by which defense acquisitions are made-including the role of Congress——there are many areas in which the normal free market is re. strained from operating or, at best, operates extremely slowly. Thus, I believe there is a significant role for the Government to play in both improving the economic efficiency and the surge capacity of the defense industrial base.

First, however, a few definitions would be appropriate. To begin with, when I refer to the “defense industrial base" I am speaking of both that portion which is in the public sector as well as that in the private sector. I might note, parenthetically, that for a variety of historical reasons the current distinction between the private and public sectors of this industry is quite vague, and the criteria-including relevant legislation-are both ambiguous and in many cases arbitrary. I personally believe that this is an area for fruitful future studies.

Next, let me consider the frequently asked questions : "Is this defense industrial base eroding ?” The problem I have with this question is that the terms of reference, or the criteria for measurement, are rarely stated. The following five “objective functions“ have, at one time or another, and in various forms, been given for the U.S. defense industry.

1. To achieve maximum production efficiency for the long and short term, within the given resources-dollars, plants, equipments, et cetera. This might be viewed as "economic efficiency” of the production process; that is, to avoid “waste" in the production of military products. Examples of concerns include: Optimum production rates; full plant utilization; modern manufacturing methods, et cetera.

2. To provide the maximum deterrent/defense equipment capability for the dollars allocated. This is a requirement placed on the weapon system's performance; that is, on the "types of outputs," and the numbers of each different product produced. This contrasts necessary equipment military performance with economic desires for low cost.

3. To provide for sufficient "surge" capability—that is, ability to rapidly increase production rates—for "likely” emergency scenariosranging from "proxy wars" (such as the 1973 Mideast war) to various levels of wartime mobilization. Naturally, this is an economic, as well as strategic, consideration; since dollars for providing surge capability are contained within the total peacetime dollars allocated for U.S. defense.

1. To achieve maximum technological advancement, for military advantage in the future; again, within the resources available. The danger of not maintaining research and development leadership, in the military area, is particularly critical-but this is always an investment for future needs, and must be balanced against current requirements.

5. To have minimum adverse societal and political impacts. This ranges from items such as minimizing the nise of "defense priorities" over civil demands, to accepting the role of Congress in the procurement process, and to carefully weighing the political impact of changes in the existing industrial-Government structural relationship.

Personally, I believe that a number of the current problems of the defense industry result from trying to satisfy these five goals either simultaneously or, even worse, totally independently. It is basically an attempt to achieve a "best of everything" world. The net result has frequently been to argue, for example, for the preservation of surge capacity at “any cost," rather than to treat the interrelationship, and frequently conflict, between these various objectives.

In my opinion, the problem is better understood by defining a single "objective function"; namely, that of peacetime economic efficiency of production of defense equipment (goal No. 1 above), and treating the other four goals as "constraints.” Thus, the provision of additional surge capability, or the requirement for pursuing different technologi

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