US defense spending has grown significantly over the past decade. Now, however, we are entering a cycle where the top-line budget for the US Department of Defense (DoD) could flatten and not keep pace with inflation. In addition, all the services have urgent and competing modernization and recapitalization needs. As a result, the Pentagon will need to make hard choices about program funding levels.
The budget isn’t the only thing that is changing. Defense leaders have renewed interest in incorporating innovative technologies, such as quantum computing, artificial intelligence, and hypersonic weapons, into the DoD’s systems and are actively seeking vendors that could help with these strategic priorities. (Of course, leaders also want to maintain their flagship programs simultaneously.) Defense companies that develop innovative technologies could assume some risk, as they are venturing into an untested area, but they may find that their products are in high demand.
In this evolving landscape, how can defense companies prioritize their affordability efforts over the next five to seven years to remain competitive against peers? A large part of the solution will involve keeping their costs in check by taking a new cost-reduction approach that sets market-backed targets across all areas: external spend, internal manufacturing, functional support for programs, and indirect costs. This approach to target setting and cost reduction, which is designed to help deliver products at unit costs that suit customer budgets, applies across all stages of the program life cycle: bid and proposal, development, and production.
Some defense companies may be skeptical of any new cost-reduction initiatives because many of their prior efforts in this area have fallen short of the mark, even when they applied lean principles, undertook intense supplier negotiations, and applied other time-tested techniques. The new approach may deliver better results, however, since it goes beyond traditional cost levers by focusing on cost in multiple areas (exhibit).
Key activities will include the following:
- Improving the bid and proposal process. Typically, defense companies have focused on shaping customer requirements and determining the price to win before submitting a bid. To help companies create more competitive bids, the new approach leverages digital tools and market-backed analyses to identify investment opportunities and strategies that will minimize costs throughout the program life cycle.
- Using analytics to enhance development. Analytics have always been a part of development, but defense companies have typically relied on basic models to assess traditional cost drivers. Although this method has delivered some wins, it has never given companies a comprehensive view of program costs. In consequence, defense companies frequently overlook important opportunities, especially those related to improving engineering efficiency, minimizing product defects, and ultimately reducing cost. Under the new approach, companies apply a multivariate machine-learning model to analyze programs. The assessment includes a close look at data from across the enterprise to identify both expected and unexpected factors that can cause delays or avoidable defects. In addition to improving program schedules, such analytics can help companies identify problems early and implement solutions.
- Managing production costs through a control tower. If individual functions cannot reduce costs to meet customer targets, a defense company might sacrifice its management reserve or suffer reduced profit margins to meet customer demands for low prices. These stopgap measures are not sustainable over the long term, however. As an alternative, companies could consider building a cost-control tower (CCT), which looks at costs across the entire organization to create a single source of truth, set targets in line with customer requirements, and manages costs across functions. Affordability teams play a central role in the CCT, rather than sitting on the sidelines. Through the integrated CCT approach, companies can reduce cost while simultaneously giving customers a clear understanding of their efforts and improving the employee experience.
- Taking a comprehensive view of overhead and indirect costs. Defense companies should consider addressing these costs, as well as related productivity issues, throughout the entire program life cycle. Mostly, companies have looked at their internal operations and have focused on only the present, rather than considering long-term strategies for winning future business. A better strategy involves benchmarking internal costs against competitors and determining where cuts are needed to remain competitive and drive growth.
In response to slowing growth in defense spending, defense companies are devoting more attention to cost reduction, but this alone will not produce the desired gains. To stay competitive, they should consider going beyond their typical efforts by implementing a comprehensive, analytics-driven approach that focuses on costs, including overhead and indirect expenses, throughout the entire program life cycle. By changing their tactics today, defense companies will be better prepared not only to win more bids over the short term but also to position themselves for even greater growth in the future. We will discuss elements of our approach in future articles.