I thought I would begin this morning by taking you back exactly one year ago and paint a picture of a typical day during the air campaign in the Balkans. In the skies over Kosovo, unmanned aerial vehicles hover above, and hunt for, Serbian forces. In space, satellites focus in on Serbian targets no matter the weather or the time of day. Aircraft from thirteen nations take to the skies. Taking off from Missouri, B-2s fly non-stop across the Atlantic, refueling twice in midair, suing 16 bombs to hit 16 targets all within a few feet, and then returning to base, all with a crew of just two. F-15 crews readjust their targets in flight, hitting targets selected only minutes before. With a handful of exceptions, 26,000 munitions, many guided by the Global Positioning System, hit their targets with astonishing accuracy.
I begin with this picture because it reminds us what brings us together today. As illustrated in Kosovo, the United States has the finest fighting force in the world. This is, in part, because we have the most innovative weapons, tools and technologies in the world. This, in turn, is because we have the finest and most innovative industrial suppliers in the world. Indeed, we look to you – market-driven, creative thinkers – as the well-spring for the weapons our warriors need today, and will need tomorrow.
So I want to use my time this morning to touch on three main points: How we view the health of an industry that is so critical to our national security; Where we believe the industry needs to go in the coming years, and; Steps we can both take, government and industry together, to get there.
First and foremost, let me be clear about how we view the industry’s current state of health. The aerospace industry is by no means a "sick" industry. The difficulties experienced in recent years, while unsettling, were not unexpected. Periods of intense consolidation, no matter the industry, are often followed by periods of transition. What were once some 50 companies ten years ago are now the top 5 defense firms, and the management restructurings, the dislocations and the debts inherent during such times had an inevitable and profound effect in the markets.
However, in recent months the ten largest firms have seen a resurgence in value. Such swings, of course, are not without precedent. In the 1980s, this industry faced the challenge of too much money. Today, there is the challenge of too little money. Our challenge, therefore, is to step back from the a narrow focus on quarterly earnings and take a broader, longer view based on our key requirement: Do we have an industry capable of providing our warriors the weapons, tools and technologies they will need in the 21st Century?
The answer is yes. This is a robust, competitive industry that is providing affordable, highly sophisticated and innovative products like the F-22. Still, the future will likely remain a time of transition. We expect fewer contracts with lower production quantities and longer intervals between programs.
Which brings me to my second point. What are the attributes of an innovative industry that supplies innovative products? While the business climate in which you operate has endured a sea change, the fundamental needs of the Department have not. We still need leading-edge approaches, so we want an industry that is technically viable. We still need vigorous research and development, so we want an industry that is financially viable with access to capital.
We still need competition, so we want an industry that is structurally viable. We still need industry to serve as our intellectual reservoir, the well-spring of the latest technologies, so we want an industry that competes with the most innovative products.
How do we ensure such an industry? Above all, we need to look beyond a quarter-by-quarter approach and thereby ensure the long-term health of this industry. Moreover, we need to recognize that the answers to these questions cannot come from either government or industry alone. Answers have to be grounded in a genuine partnership. With that, let me start with the steps that industry can spearhead with government support.
First and foremost, there is a clear need for further streamlining of industrial capabilities.
Note that I did not say consolidation. We, of course, welcome mergers that produce savings and efficiencies for the Department. After all, since 1993 the Department has accrued over $3.5 billion in certified consolidation savings. At the same time, we need competition. We simply cannot fall into a sole producer, monopolistic environment that undermines innovation and affordability.
So we are going to carefully review mergers from a competition standpoint. In some defense markets where consolidation has resulted in only several producers, this analysis is going to be more complex than in the past. Moving from 3 to 2 suppliers is inherently more difficult from a competitive standpoint than moving from 5 to 4.
In contrast, below the level of the larger prime contractors – the level where consolidation has not proceeded as far -- there are still opportunities for realignments. That is why we reviewed some 46 mergers and acquisitions last year and approved all but two. That is why we will continue to encourage similar transactions in the future.
While consolidation has therefore occurred at a firm level, there remain significant opportunities for additional production efficiencies. It isn’t enough for companies simply to merge. Mergers need to be followed by real and meaningful elimination of excess overhead. Raytheon’s missile production facility at Tuscon, Arizona is a prime example. As Dan [Burnham; Raytheon] could tell you, consolidations there have led to dramatic reduction in weapons prices, in one case by 25 percent.
We realize that the Department does not provide as many incentives to streamline in this manner as we could. Under current regulations, we reap most of the cost savings. Moreover, you face incentives not to streamline, reluctance form employers and other interests, much as we do when we try to downsize and close bases. So we are considering ways to create more incentives to streamline.
Another challenge for the defense industry is to avoid any further Balkanization from industry as a whole. We talk of a rising Fortress America and Fortress Europe internationally.
We cannot afford a Fortress Defense Industry domestically. We still have too few companies seeking to do business with the Department. We still have too many simply refusing to work with us altogether. That the company founded by [former Deputy Secretary of Defense] David Packard is no longer willing to work with us is sad commentary indeed.
Such a state of affairs is bad, both for companies and for the country. It is bad for companies because in recent years dedicated aerospace defense companies have not performed as well as firms with commercial operations. It is bad for the country because an increasingly isolated defense industry will drawn less on cutting-edge technologies in the commercial world.
Here again, we realize that the Department is not an innocent bystander. In some cases, our own rules and regulations make us our own worst enemy. That is why we continue to simplify, or eliminate altogether, many of our defense-unique procurement and accounting practices. That is why we are considering breaking down barriers to accessing commercial technology.
Finally, I would say that there needs to be a renewed commitment to investment in research and development and in people. R&D is the very fuel for this Revolution in Military Affairs that is giving us the remarkable performance we witnessed over Kosovo. Yet these budgets are the first to be targeted when earnings falter. We need a renewed commitment to R&D by both industry and government.
Still, only a world-class workforce can turn emerging technologies into advanced tools for our warfighters. The allure of the new economy is a formidable force. We have to somehow find a way to stem the so-called "brain drain" of crucial scientific, technical, managerial talent. We have the best and brightest warriors in the military. We need the best and brightest engineers, scientists and technicians in industry. And we want to work with you to find ways to ensure both.
Further streamlining. Greater integration with the commercial sector. Investments in people and in research and development. These are some of the areas in which industry can take a lead, with government support. They are matched by steps that we can take in government, and, I would repeat, not merely for the health of this industry, but for the very security of our nation.
First, we can become a more reliable customer. There is enough inherent instability in the market already. You don’t need additional unnecessary instability from us. We need to be honest about this. In a democracy, business conditions in this industry will always be driven in great measure by government, budgets will always have an element on unpredictability and, there will always be some degree of inefficiency that normal market pressures might reject but which political pressures mandate. Moreover, in a dangerous world, there will always be certain limits on foreign sales.
However, even within this environment, we can become a more reliable customer with more steady, stable defense budgets generally and more stable programs specifically. At the budget level, we realize that roller coaster funding can be damaging. So we now have the first real increase in modernization in some 13 years, with an annual budget of some $60 billion. At the program level, we realize that scares like last year’s over the F-22 undermine your confidence and send ripples of instability throughout the industry. So we continue to work with Congress to forge partnerships and consensus that allow for more predictability.
We also can become a more reliable customer by ensuring that Department policies and practices, at a minimum, do not unnecessarily perpetuate economically inefficient practices.
As you know, the Defense Science Board is examining how our policies influence the industry, and I know that a number of you have met with the Board. We will consider the report and its recommendations very seriously.
Yet even without a DSB report, we know there are things we can do as a Department to help ensure that our industry partners remain able to provide the weapons our warriors need at an affordable price and in a timely manner. Some I have already mentioned: Incentives to promote further streamlining; More robust funding to encourage research and development and; Backing away from defense-unique rules and regulations to encourage more commercially oriented suppliers.
We are open to other changes to our policies that would foster a more healthy industry.
We want to help put you on the same footing as similar industrial firms in the commercial world, so we are open to revisions to current profit policy. We want to preserve competition in an increasingly consolidated world, so we are making the health of the industry a part of our procurement decisions. Consider the Joint Strike Fighter. We want a clear winner. At the same time, we want an affordable program and healthy competitors after that decision. So we are now examining how we might achieve both.
At the same time, we seek a more competitive international industrial base. Here again, the consequences to our warfighters reveal the consequences of inaction. I began by reciting some of the strengths of the air campaign over Kosovo. Equally well known are some of the shortcomings. In some cases, lack of secure communications forced pilots to speak over open channels. Lack of certain agreements on command and control led to less than ideal performance in tracking, identifying and striking mobile targets.
Coalitions are only as strong as their weakest links. In the case of the NATO Alliance, that weakest link may well be the lack of interoperable equipment perpetuated by a lack of industrial cooperation. Indeed, it is no exaggeration to say that we cannot fight together if we do not first build together.
The very cohesion of the Alliance rests in no small measure on the collaboration of industry. This is why the fortress mentality that we’re seeing on both sides of the Atlantic is so troubling. No one benefits – in the long run, not even companies themselves – when two firms, as is the case in Europe, control so much of the market. No one benefits when nationalistic desires trump what should be economic decisions.
The solution is as clear as the problem. So long as they increase efficiencies, ensure competition, and protect technology, we need more transatlantic cooperation, whether it be joint ventures or lower-tier mergers. We need more linkages between more firms on both sides of the Atlantic competing in markets on both sides of the Atlantic.
Here too, we realize that some of our own policies have been among the greatest barriers.
For example, even with a Dutch request for expedited review, it still took almost three months to review the export license for digital maps of Bosnia for use in their Chinook helicopters, which, as a result, were never deployed to Bosnia. During the air war over Kosovo – and I know John [Douglass; Aerospace Industries Association] is familiar with this -- it took more than two months to approve the sale of flares to the Italian coast guard for use in the potential rescue of downed Allied, including American, pilots. Without question, an export control system designed in the mid-20th Century to protect American lives and security is in some cases not doing so in the 21st.
In part because of strong encouragement by the AIA, we are making progress. We are processing more licenses more quickly. As you know, we have worked extremely hard with the White House, Congress and the Departments of State and Commerce and have proposed a Defense Trade Security Initiative to modernize our export controls. We want special limited exemptions from export rules for certain nations that agree to take down barriers to cooperation while at the same time putting up stronger walls to prevent re-export of technology to third parties. The recent U.S.-U.K Declaration of Principles is a roadmap for this kind of cooperation in which we have lower walls between partners, but higher and stronger walls around us.
Perhaps naturally, some point to the difficulties of reforming the current export control system. I would point to the consequences of not reforming five, ten, or fifteen years from now. Technology continues to accelerate. Archaic export controls allow American and European industry to drift further apart. More isolated industrial bases lead to less competition. Which leads to less innovation. Which could lead to less interoperability. Which could lead to tools and technologies in the hands of our warriors that fail to keep pace with those of our adversaries. Which could lead to real and inexcusable risks to the lives of our men and women in uniform. That alternative is simply unacceptable. That is why we have worked, and will continue to work, so hard to reform our export control system.
Allow me to close by recounting a theme of history. Almost 60 years ago, this nation entered the Second World War. Some 53 years ago, we found ourselves in a Cold War. In both cases we faced grave threats to our very survival. In both cases we prevailed because of the power of our military forces, the power of our democratic ideals, and the power of our industrial capacity.
While the challenges may be different in our time, the surest path to ensuring our national security has remains the same. The safety of our men and women in uniform, and the very security of our nation, remains absolutely and indispensably tied to the health of our industrial partners. We cannot have a strong national defense if have weak defense companies. Ensuring both, now and into the future, is the challenge we face as a nation. It is the challenge we face as Department, and it is the challenge we face as defense partners.
Thank you very much.