Sequestration and COTS

Story

September 04, 2012

Large defense budget cuts are hitting primes hard, but they also mean a boost for COTS providers.

Sequestration is coming, and with it more than $500 billion in cuts to the U.S. defense budget in addition to almost half a trillion dollars in defense cuts already being proposed by the Obama Administration. The thought is quite scary to those employed by prime contractors and system integrators, who have already made drastic layoffs just to meet the current funding reductions. Yet suppliers of Commercial Off-the-Shelf (COTS) technology might see some opportunity in this environment.

The single greatest challenge to the U.S. defense industry is the looming threat of sequestration, says Bob Stevens, Chairman and CEO of Lockheed Martin. “Sequestration is a meat axe … a blunt force trauma … tearing the fabric of the supply chain and industrial base in a significant way. Cutting across the board is an inefficient way to manage a business. The budget ought to be aligned with the mission to be accomplished – this goes for civil budgets as well.”

Some industry analysts disagree with the doom and gloom scenario, saying the defense industry has been through worse. They also see growing opportunities for COTS suppliers even with sequestration. The Department of Defense (DoD) will be forced to embrace an 80 percent solution, getting what they need to keep programs running and getting industry to pick up the development cost – which is essentially what COTS providers have been doing for years.

“I think to a degree, the primes and most people in the industry have factored sequestration into the equation,” says Michel Merluzeau, Managing Partner of G2 Global Solutions. “Those who see sequestration as doomsday are incorrect. The COTS guys should do well because they are naturals at bringing to market low-risk, high-value solutions. That is what military users are looking for – proven solutions, proven technology, and low risk as far as integration is concerned.”

“There are a number of scenarios that can happen,” says Ron Stearns, Research Director at G2 Global Solutions. “At one level, Congress will cleanse its hands of the issue by essentially saying, ‘We didn’t do this; it just happened.’ That’s one possibility. Another is that they punt somehow or pass a continuing resolution to keep funding at [an] approximate level if it does. There is a cycle to defense funding going back all the way to World War II based on peacetime versus wartime conditions. The smart people in the industry know that and anticipate these cycles.”

“The primes got bloated because of programs like Future Combat Systems and needed to be slimmed down, but the government is not stupid enough to destroy the supply chain,” says Ray Alderman, Executive Director of VITA. “While the big money that goes into platforms such as weapons systems may be diminished, more money will shift to advanced radar and sonar systems, electronic warfare, signals intelligence, and communications,” all of which means growth for COTS suppliers. All of these applications need supercomputing-like performance – radar especially – Alderman adds. New high-performance radar systems are going to take advantage of VPX technology, which is “becoming supercomputing in a box.”

It also helps that COTS is not a four-letter word among prime contractors as it was 15 years ago. Back then COTS carried a “sold at Radio Shack” connotation, and many questioned its reliability for military applications. That is no longer the case, as many suppliers of COTS VPX systems or other standards-based products have proven track records, meet MIL-STDs for ruggedization, and have high Technology Readiness Levels (TRLs). This trust level and history of success also make it unlikely the DoD will go back to the old way of procurement when funding levels increase again.

Yet, while COTS suppliers will have opportunities in a sequestration environment, there is no doubt the prime contractors will take a major hit. The impact of sequestration on the defense industry will be significant layoffs resulting in a loss of learning and talent as well as an erosion of quality, Stevens says. Lockheed Martin has already reduced their workforce by 18 percent because of the economy, budget cuts, and the additional cuts being proposed by the Administration, he adds.

“For suppliers it will be key how they manage internal resources to match the reductions in procurements,” Merluzeau says. “Preserving the knowledge base is very important because eventually the economy will regain strength and defense contractors need to ensure they are not letting go of talent and expertise they will not be able to regain down the road.”

For more on the defense electronics market and forecasts from industry analysts, including Stearns and Merluzeau, see our Special Report on page 20.

John McHale, [email protected]