Canaries in the defense budget coal mine

The chattering class and the political voices are nattering on about the fiscal cliff. Meanwhile, the best canaries in the defense budget coal mine are the people keeping an eye on the long-term trends. With or without cliff diving, the defense budget is in a secular decline and they have known it for a while. And they know that this long-term decline will change the face of the industry.

The latest bit of evidence that the industry is working to get ahead of the game comes from a document called "2013 Defense Industry Perspective," provided yesterday by strategic consulting firm Booz and Company.

The six-page comment makes no mention of the fiscal cliff, but it does say "the defense sector is undergoing the kind of correction that happens once every 20 or 30 years." That is the right timeframe, and, as I have written before, procurement is always the first to go in a defense drawdown. In the defense drawdown of the 1980s and 90s, part of which I spent at OMB, DOD procurement spending fell 50 percent over ten years, while the overall budget was only going down 30 percent.

Booz and Co. point out that this process is already under way, and has been since Fiscal Year 2008. The budget for procurement and R&D has already fallen roughly 30 percent since that year and is projected to grow only minimally over the next five years. Moreover, if this drawdown is consistent with prior ones after Korea, Vietnam, and the end of the Cold War, a deeper reduction is likely. Falling off the fiscal cliff would reinforce that trend.

The Booz canary says something else interesting: the defense industry is changing, and will change even more as DOD spending goes down. The industry is no longer dominated by large companies that sell almost exclusively to the Pentagon; Booz points out that what they call "nontraditional companies" are succeeding in selling to DOD. Companies like Accenture, Airbus, Apple, Cisco, Dell, Eurocopter, and Pilatus. Setting aside Cold War systems, Booz says these kinds of commercial, high-technology firms account for nearly 40 percent of U.S. spending on defense acquisition.

As the budget goes down, the defense industry of the future is going to look like the U.S. and global economy. A company like Boeing, which straddles the commercial and defense markets (the new tanker is based on Boeing’s commercial 767, and the P-8 patrol plane on the 737), is more nimble in this market. And the other players are not going to put up with an acquisition system that is riddled with paperwork and takes forever to make a decision.

The old defense industrial base is not the same; defense, like everyone else, now draws on the broader, deeper commercial technology base, both American and international. As the budget declines and such programs as cyberoffense and cyberdefense, communications, information technology, and unmanned aircraft grow, this trend can only grow with them.

Interesting to listen to the canaries, sometimes. They tell you when the explosion is coming and what it will be about, something to which the fiscal cliff chatter pays little attention.