chapter 7 – business: a new model for the aerospace sector...evidenced by the decline in sector...

7 - 1

FINAL REPORT OF THE COMMISSION ON THEFUTURE OF THE UNITED STATES AEROSPACE INDUSTRY

Chapter 7 – Business: A New Model for the Aerospace Sector

To retain its vitality, the aerospace industry must beable to attract private investment in the highly com-petitive global capital markets. The investment com-munity values companies with predictable revenueflows, sustainable growth in sales and earnings,strong positive cash flows, healthy profitability, inno-vative capabilities, and a vibrant workforce.

For the past half-century, the U.S. aerospace anddefense industry has been inextricably linked to adefense budget characterized by a “10 years up, 10years down” cycle. A vibrant, productive, enduringenterprise is not consistent with this “boom-and-bust” cycle, and aerospace companies must bevibrant, productive, and enduring. Our armed forcesrely on advanced technology for awareness, protec-tion, and instruments of action. Our governmentmust provide for the many needs of our society, sovalue for money efficiently spent on security must bedemonstrated. Our aerospace systems are designed toperform for decades, with some extending through a

Chapter 7

Business: A New Modelfor the Aerospace Sector

RECOMMENDATION #7: The Commission recom-

mends a new business model designed to promote a

healthy and growing U.S. aerospace industry. This model

is driven by increased and sustained government invest-

ment and the adoption of innovative government and

industry policies that stimulate the flow of capital into

new and established public and private companies.

375

350

325

300

275

250

225

200

Source: FY03 Budget of the U.S. Government, Historical Tables

52’ 57’ 62’ 67’ 72’ 77’ 82’ 87’ 92’ 97’ 02’ 07’

Billi

ons

$

Year

Projected

Figure 7-1 Defense Outlays from 1952-2007 inconstant FY 1996 dollars

7 - 2


Aerospace Commission

half century of service, and companies must be in aposition to support customers through their evolvingand demanding missions.

Historically, investors have characterized the aero-space industry, including the commercial business, asa low-growth sector, chronically hampered by highcyclicality, low margins, revenue instability, andinadequate returns on investment, amplified by theuncertainty in the government budgeting and acqui-sition process.

As a result, the relative importance of the aerospacesector in the global marketplace for capital has sig-nificantly diminished over the last two decades asevidenced by the decline in sector market capitaliza-tion. In 1980, the aerospace sector had a market cap-italization of $13 billion, equivalent to 2.4 percent ofthe total Standard and Poors (S&P) 500. In 1990,the sector dropped to 1.8 percent of the market, anddeclined further to 0.9 percent in 2000. Today, evenwith the largest proposed defense budget in historyand the longest bear market since World War II,aerospace comprises 1.4 percent of the S&P 500—well below the sector's comparative value just priorto the Reagan defense buildup. See Figure 7-2.

The most compelling determinant in an investors’decision-making process is their expected risk-adjusted return on investment. By this standard, the aerospace sector is unattractive. From 1997-2002,the returns on investors’ capital from aerospaceinvestment lagged behind even the risk-free rate ofreturn on Treasury securities. See Figure 7-3.

During the last “bust” cycle that impacted the indus-try during the 1990s, more than 50 companies werecompelled to consolidate into today’s “Big 5”:Boeing, General Dynamics, Lockheed Martin,Northrop Grumman, and Raytheon. See Figure 7-4.While successful efforts to consolidate capacitywithin the framework of current government regula-tions are clearly evident, significant over-capacityremains. To fuel the consolidation process, the use ofdebt was significantly expanded across the sector,reducing financial flexibility, increasing leverage,straining coverage and liquidity, lowering creditquality, and increasing capital costs. Furthermore,the industry lost more than 600,000 scientific andtechnical jobs in the past 13 years significantlydepleting intellectual capital and experience andincreasing the average age of today’s workforce (seeChapter 8). In important and enduring aspects, theindustry has been weakened.

Some observers of the current equity markets notethat selected aerospace firms with little commercialmarket exposure appear to be doing comparativelywell with regard to other stocks given the renewedinterest in defense spending. The Commission notesthat this perceived strength in the sector is transient,as the industry is for the moment enjoying theimproved funds flow of the “boom” portion of thedefense cycle while the rest of the economy is in

4.0%

3.0%

2.0%

1.0%

0.0%

4.2%

1960 1970 1980 1990 2000 2001 2002

3.8%

2.4%

1.8%

0.9% 1.0%1.4%

Source: Morgan Stanley

LT Gov’tBonds

Technology

$0 $5,000 $10,000 $15,000 $20,000

Aero /Defense

Financial

ConsumerStaples

T-Bill30 Day

Healthcare

Value Today with Total Annual Return in parentheses

$16,208 (10.1%)

$13,732 (6.5%)

$12,380 (4.4%)

$11,379 (2.6%)

$11,349 (2.6%)

$9,039 (-2.0%)

$6,479 (-8.3%)

Source: Morgan StanleyFigure 7-2 Aerospace/Defense Sector as aPercentage of the S&P 500 Market Cap

Figure 7-3 Total Five-Year Return onInvestment by Sector (1997-2002)—Valuetoday of $10,000 investment made in 1997.Source: Morgan Stanley

7 - 3



recession. History suggests that the sector willdecline as the broader economy recovers. Where his-tory will fail, however, is in support of the assump-tion that a call to action may be unnecessary—thatindustry will endure and recover as it has throughpast cyclical declines without immediate and sub-stantial attention—because history does not accu-rately reflect the current weakened state of the indus-try throughout its entire supplychain.

Without significant change tothe business model upon whichthe sector relies, the industrywill be unable to survive thenext downturn in either thecommercial or military aero-space cycle. The Commissionhas identified several elements ofU.S. government policy as wellas industry practice that, if implemented, would sig-nificantly improve the industry’s position in the cap-ital markets.

Objective: Aerospace IndustryAttractive to InvestorsInnovative industry-government initiatives arerequired now to sustain the preeminence of theAmerican aerospace industry, ensuring industryhealth and producing sustained contributions toboth the economic performance and national secu-rity of the United States. The U.S. government mustinitiate measures to establish and maintain a stableand predictable budget for aerospace investment and remove government constraints to reasonableprofitability, thereby reducing risk and improvingreturns such that the industry can better attract cap-ital. A government focus on essential core competen-cies will stimulate long-term investment in bothfacilities and the best and the brightest talent, ulti-mately spawning new cycles of exciting technologydevelopment.

Innovative partnerships among global suppliers ofadvanced technology are needed to assure the inter-operability of systems while fostering the pursuit ofnew opportunities through assured open marketaccess. Efficiency within the industry can be stimu-lated by a further revolution in business affairs thattransforms all processes and practices to a single,integrated industry-government model that employs

the maximum use of commer-cial business practices and inno-vations. A solid framework of balanced export and tax policies will safeguard vitalnational security informationand protect intellectual propertywhile allowing successful indus-try competition in the globaleconomy.

The future economic vitalityand national security of the United States dependson a strong, vibrant, and flexible aerospace industry.The Commission views these initiatives as essentialsteps necessary to establish a successful and enduringgovernment-industry partnership.

The future economic vitalityand national security of theUnited States depends on astrong, vibrant, and flexible

aerospace industry.

7 - 4



Figure 7-4 20 Years of Industry Consolidation

* Merger Pending Approval

Boeing

Raytheon

LockheedMartin

NorthropGrumman

GeneralDynamics

Lockheed MartinGD Ft. Worth

MEL Defense SystemsSanders Associates

LockheedGE Aerospace Business

Martin MariettaGould (Ocean Systems)

GD Space SystemsHoneywell (Electric-Optics)

Fairchild Westan SystemsLoral

Goodyear AerospaceBDM International

LibrascopeLTV (Missile Business)

IBM Federal SystemsUnix (Defense Electronics)

Comsat

BoeingHughes Electronics Satelite

Jeppensen SandersonHughes Helicopters

McDonnell DouglassBoeing

Argo SystemsLitton Precision Gear

Rockwell International - AerospaceAutomatic

RaytheonMarine Sys Grp of Allian Tec

CAE LinkMagnavox ElectronicsGD (Missile Business)

Radiffusion SimulationHughes Aircraft

GM (Hughes Aircraft)Corporate Jets

RaytheonE-Systems

Chrysler Tech AirborneTI Defense

Northrop GrummanAvondale Industries

TASCPRC

GI DefenseLitton Industries

Varian (Solid State Elec.)Sperry Marine (Storage)

GrummanNorthrop

Voight AircraftWestinghouse Defense

SysconLogicon

GeodynamicsRyan Aeronautical

Comptekfederal data

Steering SoftwareAerojet

Newport News ShippingTRW*

General DynamicsPrincess Technologies

GTS Govt SystemsNASCO Holdings

Teledse Vehicle SystemsBath Iron Works

Cesna AircraftChrysler Defense

General DynamicsCeridian's Computing Devices Int'l

Defense & Anament SysAdvanced Technology Sys

Gulf Stream AerospaceK-C Aviation

Galaxy AerospaceMotorola Info Sys Group

19811980 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1996 1997 1998 1999 2000 20011995

L-3 Communication

FIRST WAVE SECOND WAVE

7 - 5



IssuesThe U.S. government budgeting and procurementsystem is extraordinarily complex and inefficient,driving up the cost of needed national security sys-tems while delaying the introduction of new capabil-ities. This observation is hardly new. Since shortlyafter the end of World War II, about a dozen majorstudies and literally thousands of lesser assessmentshave cited this finding. Furthermore, sound govern-ment acquisition reform initiatives have been pro-posed and debated for more than 40 years, but onlymarginally implemented. Because we have failed tosustain the will necessary to secure lasting change, weare today spending more for national security andgetting less.

To the casual observer, this proposition may seemdramatically counterintuitive—do we not have thefinest, best equipped military on earth? The directanswer is “yes”, but it was purchased decades agounder conditions that do not exist today. Many ofthe systems in use now are a result of the Reagandefense build up of the 1980’s when defense spend-ing was approximately 5 percent to 8 percent ofGross Domestic Product (GDP). Today that spend-ing is about 3 percent.1

A greater proportion of total spending then wasdevoted to “investment funds”, i.e., Research andDevelopment and Procurement, which expandedscientific frontiers, engineered leading edge solutions, attracted talent to the industry, stimu-lated interest by the capital markets, and fieldedcapabilities that won the Cold War and performedsuperbly well in Operation Desert Storm. Todaymore funds flow to Operations and Maintenance,the fastest growing segment of the defense budget,the bulk of which pays for health care, military train-ing, support of aging systems, equipment mainte-nance, and other support activities.

The overall budget, therefore, remains insufficient tomaintain existing capabilities, meet operationaltempo needs, fulfill our commitments to militarypersonnel, protect our homeland, and assure trans-formational capabilities are fielded in a timely man-ner to meet 21st century threats across a broadening

and increasingly complex spectrum. Funding sourcesmust be adequate, reliable, and stable. Acquisitionand program management practices require simplifi-cation and reform. Trade and tax policies need to bestreamlined and harmonized.

The Commission has strong and unanimous convic-tion that without immediate initiatives to address thelong-term health of this indispensable industry, theU.S. aerospace sector will lag in the capital markets,lose global market share, provide a reduced contri-bution to the U.S. balance of trade and the U.S.economy, atrophy its essential core competencies,and lose high-tech and high-paying jobs to overseascompetition. The Commission believes this down-ward drift and dissipation of potential, no matterhow difficult to discern on a day-to-day basis, isnonetheless occurring and constitutes an unaccept-able risk to the U.S. economy and national security.

ISSUES

• Budgeting and Funding

– Investment funding

– Financial Flexibility

– Program Management

• High-Tech Partners and Suppliers

– Contract Reform

– Privatization, Competitive Sourcing, and Public-PrivatePartnerships

– Commercial Acquisition Practices

• Domestic and International Business Climate

– Foreign Sales Corporation (FSC)/Extra Territorial Income (ETI)Resolution

– Research & Experimentation Tax Credit

– Percent of Completion Tax Accounting

– Export Control

– Airline Bankruptcy and User Fees

• Long-Term Growth and Financial Health

– Personnel Training

– Global Mergers and Acquisitions

7 - 6



Budgeting and Funding: Unpredictable andUnstableThe overall defense budget has two broad provisions:one for near-term personnel, operations mainte-nance costs, and one for investments to fulfill ourlong-term need for technological advancementthrough research and development (R&D) and pro-curement. Despite budget increases over the lastdecade, growth in investment funding remains rela-tively small, especially as a share of the federalbudget.

In the past, the Department of Defense’s (DoD)promised growth in investment funding has notmaterialized adding to the complexity of capacityplanning and labor force management while dimin-ishing overall efficiency. At the same time, systemcosts continue to be underestimated by both thegovernment and industry due to the pressure toadopt the optimistic scenarios necessary to accom-modate limited funding, the progressively aggressivebidding behavior that results as companies with

excess capacity resist being marginalized in the com-petition for a diminishing number of new programopportunities, and the desire to incorporate everincreasing program capability requirements. Withinthis unpredictable framework, many programs arealso changed annually through the Congressionalauthorization and appropriation process or repro-grammings. See Figure 7-5.

Government-unique acquisition processes and pro-cedures are cumbersome and unnecessarily complex,adding time and expense to systems development,and are not complementary to healthy commercialpractices. Finally, any failure to perform on contract,at times induced by program and budget instability,exacerbates the tensions between government andindustry and heightens the tendency to impose evenmore oversight and financial penalties on contrac-tors. These factors create a cycle that contributes tothe diminished return on the government’s invest-ment in national security capabilities and serves as animpediment to long-term industry excellence.

90

85

80

75

70

65

60

55

50

451994 1995 1996 1997 1999 20011998 2000 2002 20072005 20062003 2004

Cons

tant

FY0

3 $B

Actual Projected

Fiscal Year

Figure 7-5 Actual Procurement Spending has Consistently Fallen Below ProjectionsSource: Morgan Stanley

7 - 7



The government must stabilize program require-ments and protect adequate long-term investmentfunding, enact reforms that increase the financialflexibility of companies and the government, andimprove program management stability and conti-nuity. Industry must focus on performance and exe-cution and deliver on contract commitments. Thesechanges will help provide the resources necessary todrive competition, incentivize research and develop-ment, and enhance industry’s performance on con-tract and in the investment markets.

Protect Investment Funding. As discussed inInterim Report #2, a stable long-term investmentbudget is critical to the modernization and transfor-mation goals of the ArmedServices. However, thebulk of recent DoD fund-ing increases has been con-sumed by costs associatedwith operations, fuel, payraises, and health-care. Toprotect investment fund-ing, the Commission reit-erates its recommendationscontained in the interim report, that governmentestablish and maintain a stable investment budget inthe Future Years Defense Program (FYDP), pro-tected from reductions to cover unbudgeted opera-tions and support (O&S) and other support and per-sonnel costs. In addition, the Commission suggeststhat DoD study the management of O&S costs, withthe goal of better estimating and annually budgetingfor these costs, rather than continuing to tap theinvestment accounts to pay unanticipated, unbud-geted “must pay” O&S bills.

The Commission also reiterates its recommendationin the interim report that DoD require industry andthe military Services to develop realistic cost esti-mates and fully budget for those program costs in theFYDP. The Commission believes this action is neces-sary to reduce the current tendency to understateprogram costs in order to include unaffordableprograms within the FYDP, and will also precludecontractor and DoD investment in programs thatcannot be realistically completed.

Increase Financial Flexibility. The Commissionbelieves that both the government and contractorsmust do a better job of realistically estimating program costs. The Commission also believes thecurrent financial system is overly restrictive in that itallows only very limited financial flexibility, once thebudget is formalized, to address unanticipated costsor requirements as individual programs progressthrough execution. The “color of money” and inade-quacy of program reserves preclude program managers from making common-sense adjust-ments within a program, and decades-old repro-gramming limitations preclude the government fromeffectively managing its budget to reflect changes in program priorities or performance.

The Commission advocatesincreasing the government’sfinancial flexibility to makefunding adjustmentsamong and within pro-grams. Program managersshould have the authorityto move funds from pro-curement to R&D to cover

unanticipated development and sustainment costs,or to apply unused R&D funds to procuring theweapon system. Reprogramming thresholds for allaccounts should, as a minimum, be doubled toaccount for 20 years of inflation since their lastadjustment. Such action will provide governmentwith the needed flexibility to meet higher priorityrequirements as they arise, make the best use of costsavings in any program phase, and resolve problemsearlier.

Streamlining cost principles, the elimination ofstatutory cost principles, and the use of GenerallyAccepted Accounting Principles will benefit the sec-tor by eliminating unnecessary and duplicativerequirements and allow government contractors whoalso have significant commercial business to use asingle accounting system across the enterprise. TheCommission concludes that the government shoulddevelop a proposal to implement cost principles andaccounting standards that are more commerciallyoriented.

Reprogramming thresholds for allaccounts should, as a minimum, bedoubled to account for 20 years ofinflation since their last adjustment.

7 - 8



Realignment of the Defense Working Capital Fund(DWCF) will provide DoD managers with accurateand reliable cost information to manage their opera-tions, while improving weapon system readiness andthe total cost of ownership. The fund had beendesigned to provide an effective mechanism forfinancing, budgeting, accounting for, and control-ling the costs of goods and services. In practice, theDWCF is structured to support and maintain logis-tics stovepipes in terms of supply management,maintenance, and transportation, thus limiting theability to meet DoD customers’ new product sup-port challenges. The Commission urges ongoingGeneral Accounting Office (GAO) managementreview of the DWCF, as well as an allowance forrestructured costs and a shift to performance orprice-based acquisition structures.

Revise Program Management. As discussed in theCommission’s Third Interim Report, theCommission believes the use of multi-year fundingand contracting for both procurement and R&Dprograms will not only improve program stabilityand performance, but produce needed cost savings.The Commission reiterates its recommendationsfrom Interim Report #3 for expanded use of multi-year procurement contracts and milestone-to-mile-stone budgeting for development programs, includ-ing the incorporation of spiral development andevolutionary acquisition principles into these long-term contracts.

In addition, the Commission supports the immedi-ate repeal of the June 2002 DoD FinancialManagement Regulation that establishes an artificialand unnecessary ceiling on unfunded cancellationcosts in multi-year contracts. The Commissionbelieves the prudent use of multi-year contracting,applied to stable programs that are performing well,makes unnecessary the establishment of financinglimitations that will stifle innovative acquisitionstrategies.

The ability of the government to become a “worldclass” buyer of research, products and services is anessential element of acquisition excellence. A

Commission-sponsored study on the application ofSmart Price-Based Acquisition reviews the currentcost-based and price-based approaches to govern-ment procurement and recommends a progressiveand evolutionary roadmap for implementingchanges to more fully capitalize on the price-basedacquisition of goods and services.

The report cites the wide variance in federal depart-ment and agency contracting that is in need ofreview, and recommends moving to price-based,rather than cost-based acquisition under certain con-ditions. First, the government must be able to clearlyand adequately define its requirements for the prod-uct or service. Second, there must be a commercialmarket for the product or service, or the governmentthrough past or ongoing government unique effortsmust have a sufficient basis of price comparison.

The report correctly states that, while the utility ofprice-based acquisition for government procure-ments is evident, it is not meant to be viewed as anacross the board solution for all government pro-curements. For example, research and developmentinitiatives where requirements cannot be clearly andadequately defined due to dynamic situational analy-sis and/or there is high risk in the potential utiliza-tion of technologies, must remain cost-based. Thereport also cites the reluctance of the DoD to lever-age its buying power and the power of electroniccommerce by utilizing the General ServicesAdministration’s (GSA) Federal Supply Schedule andFederal Technology Services for certain procure-ments, as permitted by current law. While someagencies are required to purchase items through GSAschedules, the DoD—through the Defense FederalAcquisition Regulations—does not mandate the useof GSA schedules and continues to issue their owncontracts for GSA-available items.

The report cautions that, if the requirements ofsmart price-based acquisition are to be met, the gov-ernment must have a procurement workforce thatunderstands market prices and the capabilities of themarket. In order to create an appropriately trainedprocurement workforce, the organizational structure

7 - 9



for federal procurement must be redesigned to focuson development and maintenance of market knowl-edge. The ability of the government to leverage itsbuying power and centralize “smart buying” func-tions will enable better performance management ofits many providers.

The Commission views the recommendations in thisreport as one of many possible approaches to stream-lined acquisition of products and services, especiallywhen procured as part of a stable program involvinglow-risk technology and clear requirements. As ageneral rule, the Commission does not endorsegreater use of fixed-price contracting for programsthat do not meet these criteria. The Commission fur-ther believes that the report supports the existingFederal Acquisition Regulations (FAR), concerningprice-based acquisitions. Neither does theCommission view the report as advocating such anapproach across-the-board. Instead, the Commissionreads the report as recommending an option for astreamlined acquisition process that could producenot only a more efficient and less burdensome con-tracting process, but could also produce savings inpersonnel costs and time that could be allocated tohigher-priority national security requirements.

Other reforms to be considered include:

• Implementation of a requirements process that issupportive of evolutionary acquisition and spiraldevelopment.

• Development of an acquisition approach for sys-tem-of-systems efforts, rather than a component-based approach.

• Provide adequate profit on R&D contracts so con-tractors do not wait until production contracts torecoup lost profits.

• Separately funding R&D on key components andsub-systems that are not integral parts of majorsystems.

• Facilitating incorporation of commercial technol-ogy in current weapons systems by expanding useof the FAR (Part 12, commercial buying) forR&D.

• Expanding the potential for contractors to earnhigher profit margins and providing other incen-tives to drive and reward positive performance.

The following table summarizes recommendedreforms, the specific participants responsible for eachreform, and the near and long-term actions necessaryto achieve the objectives earlier described.

Reforms Actors 18-month Enabling Actions Long-term Actions

BudgetReform

FinancialReform

ProgramStrategyReform

OMBDoDNASACongress

OMBDoDCongressIndustry

DoDNASACongress

•Establish/maintain stable top-line for DoD investmentin the FYDP (see June 26, 2002 interim report)

•Fully fund programs within the FYDP(see June 26, 2002 interim report)

•Enact proposals to increase DoD financial flexibility(see June 26, 2002 interim report)

•Realign Defense Working Capital Fund

•Expand the use of multiyear procurement contracting,and implement multiyear milestone budgeting fordevelopment programs.

•Repeal the June 2002 Financial ManagementRegulation establishing a 20% ceiling on unfundedliability costs in multiyear contracts.

•Expand use of performance-based acquisition.•Allow contractors to earn higher profit•Develop and implement a new system-of-systemsacquisition approach.

•Provide adequate profits on R&D contracts

•Study and develop methods forcentralized management ofnon-program specific O&S costs.

•Streamline cost principles, andeliminate statutory cost principles.

•Revise cost accounting standardsto move toward GAAP.

•Develop and implement anevolutionary/spiral requirementsprocess.

•Expand FAR Part 12 commercialbuying for R&D.

•Separate R&D funding forcomponents that are not integralparts of major systems.

7 - 1 0



High-Tech Partners and Suppliers: Difficult toAttract and Retain While it is sometimes convenient to refer to the aero-space industry through the short hand of the “Big 5”referring to the five largest aerospace systems compa-nies, it is important to note that the government andcommercial “industry” for aerospace products andservices in fact extends through a network of pur-chasers, subcontractors, suppliers, and partners,sometimes referred to as the supply chain. Each ofthe participants in the sector is intrinsically tied tothe factors affecting the industry. Encouraging a cli-mate that is attractive to new entrants while stableenough for current players will promote competitionand innovation, add to efficiencies, and lower costs.In addition, steps must be taken to establish a stableand predictable business climate (see section entitled“Long-term Growth and Financial Health: InJeopardy” for additional information).

Contract Reform Must Focus on Simplificationand Innovation. Successful implementation ofacquisition reform is a profound challenge thatinvolves two distinct and interdependent elements.The first, culture change, involves evolving the behavior of acquisition personnel from the tradi-tional “buying of resources under a design specifica-tion” to the “buying of results under a performancespecification”. Today, an extraordinary amount of government talent, time, and resources aredevoted to the process of refining and detailing com-prehensive design specifications. Despite good inten-tions and considerable effort, this practice yieldsquestionable value added and should be discontin-ued. Contemporary acquisition management prac-tice demands a shift away from the emphasis on purchasing assets to a focus on the delivery of capa-bilities. Second, the implementation of new contracting rules will foster understanding of theconceptual and pragmatic nature governing thebuyer-seller relationship.

Building on the Commission’s earlier findings con-cerning expanded use of multi-year contracting, theCommission calls for the consideration of multi-year

leasing arrangements as well as multi-year contractsfor the procurement of goods and services.Developing stable baselines and establishing andprotecting current and future year funding for programs not only provides cost savings, but allowsfor the use of innovative procurement strategies suchas buy-to-budget in which quantities procured arelimited only by available funding. Long-term excel-lence in this area is further enabled by near-termreforms, such as utilization of “other transactionauthority” and implementation of efficiency savingsand share-in-saving strategies that recognizes thebenefits of productivity improvements and right-sizing of workforce and facilities, that can improve,streamline and strengthen technology access, encour-age open-market competition and implement tech-nology-driven prototyping.

The Commission notes that certain changes toDoD’s “shared savings” initiative since theCommission’s endorsement of that effort in itsMarch 20, 2002 interim report have caused theCommission to reconsider its recommendations.The Commission is concerned that these changes tothe efficiency savings initiative will so limit its appli-cability and utility as to make the effort almost neg-ligible and ineffective in incentivizing contractorinvestment in right-sizing and productivity improve-ments. The Commission urges DoD to reevaluatethis initiative and consider once again including pro-gram-specific initiatives to provide the greatest possi-ble incentives and broadest application of the policy.

Finally, a vital element of effective contract reform isdirectly related to reforming regulations regardingreturns on government contracts. The Commissionasks that DoD strongly consider proposing andimplementing changes to permit: increased awardfees, carryover of unearned award fees into the nextrating period, elimination of fixed price developmentcontracts, elimination of profit take backs and with-holds on Cost Plus Fixed Fee (CPFF) contracts far inexcess of requirements to protect the government,and revised profit guidelines for fee bearingIndependent Research & Development (IR&D).

7 - 1 1



Other reforms that should be considered include:

• Create a liability limitation for sales to all govern-ment agencies, as well as state, local, and commer-cial entities, to facilitate incorporation of home-land security technologies across America.

• Repeal/reform Civil False Claims Act to increasethe number of high technology suppliers to gov-ernment.

• Allow prime contractors to waive flow-down tolower-tier suppliers of unnecessary and costlyterms and conditions.

• Minimize reliance on cost data.

• Facilitate the use of common subcontractingprocesses.

• Investigate leasing as an acquisition tool.

Privatization, Competitive Sourcing, and Public-Private Partnerships. Widespread business practiceoverwhelmingly supports the economic and per-formance benefits that result when enterprises focuson the essential core competencies through which itfulfills its mission and createsvalue. Indeed the goal of everycontemporary organizationincludes an intense focus ondefining and cultivating thecore while realigning roles andresponsibilities accordingly.The Commission believes thatthere are many opportunitiesfor redefinition and prioritiza-tion of routine non-core gov-ernmental activities currentlyperformed by governmentagencies. Private sector pro-viders specializing in militarybase maintenance, facility fire-fighting services, payroll and accounting, and humanresources management can perform such services.The Commission calls for a government-wide reviewof functions and services to identify those functionsthat are not “core” to the effective execution of themission and which could best be performed by theprivate sector.

The Commission has significant philosophical reser-vations regarding public-private competition, andbelieves such competitions under current regulationsdisadvantage all parties.

Office of Management and Budget (OMB) CircularNo. A-76, “Performance of Commercial Activities,”establishes federal policy for the performance ofrecurring commercial activities, and provides guid-ance and procedures for determining whether recur-ring commercial activities should be operated undercontract with commercial sources, in-house usinggovernment facilities and personnel, or throughinter-service support agreements (ISSAs). In princi-ple, Circular A-76 is not designed to simply contractout. Rather, it is designed to: (1) balance the interestsof the parties to a make or buy cost comparison, (2)provide a level playing field between public and pri-vate offerors to a competition, and (3) encouragecompetition and choice in the management and per-formance of commercial activities.

The A-76 process was established in an era wherecost was the principal award determinant for all

competitions. Reliable cost andpast performance informationis crucial to the effective man-agement of government opera-tions and to the conduct ofcompetitions between public orprivate sector offerors.Unfortunately, this informationhas not been generally availableand/or has often been found tobe unreliable. In today’s era ofbest value procurements, whichrecognize that cost is but one ofmany important factors thatassure taxpayer interests aremost appropriately served, the

old “cost-based” decision tree is no longer valid.

The Commission believes that it is vital for govern-ment agency competition with private offerors ofgoods or services to be conducted on the basis oftruly comparable cost accounting practices, past per-formance and best value. In addition, the process

Widespread business practiceoverwhelmingly supports theeconomic and performancebenefits that result whenenterprises focus on the

essential core competenciesthrough which it fulfills its mission and creates value.

7 - 1 2



should be kept as high-level and streamlined as pos-sible, avoiding the excessively detailed, overly mech-anistic, aspects of the current A-76 procedure. TheCommission supports reform of A-76 procedures toachieve these goals.

As changes to outsourcingcompetitions are developedand implemented, theCommission believes thatdefense and aerospace indus-try must work with govern-ment organizations todevelop effective partneringrelationships. To the maxi-mum extent possible, thesepublic-private partnershipsshould be founded on bestbusiness practices and shouldfocus on enabling both gov-ernment and industry to pro-vide the products and services best suited to theirorganizational characteristics. Public-private partner-ships will be required to integrate best provider gov-ernment organizations, satisfy statutory require-ments, and provide access to unique facilities,infrastructure and technical expertise. These partner-ships will also foster a more business-like relation-ship, reduce administrative and life-cycle costs andreallocate risks, and assist in the evolution of govern-ment and industry roles and responsibilities. Recentchanges to Title 10 U.S. Code regarding “hold harm-less” will facilitate the use of conventional contrac-tual arrangements and partnerships between indus-try and government. The Commission recommendsthat both industry and government vigorously pur-sue such partnerships, and supports changes in lawor regulation that would facilitate increased use ofpublic-private partnerships.

Commercial Acquisition Practices. One of thegoals of acquisition reform is streamlining and sim-plifying the procurement process in order to reducedevelopment and production cycle times and lifecycle program costs, and to strengthen the technol-ogy and industrial base through increased access to,

and use of, advanced commercial items. The FARdeveloped a broad range of “unique” controls andrequirements for its contractors and subcontractorsover the past 50 years. The government is now

attempting to realign thesepurchasing processes to lowercosts and gain access to newtechnology by eliminating, orat least lowering, barriers thatmake government businessinefficient and unattractive tocommercial firms and inhibitgreater integration of com-mercial and military produc-tion lines. The Commissionsupports these efforts, but rec-ognizes that the governmentmust make this transforma-tion while maintaining goodfaith and stewardship of the

public dollar.

The Commission supports these enabling actions:

• Eliminate government unique contract require-ments.

• Expand use of commercial like terms and conditions.

• Establish a presumption that products and servicespurchased from predominantly commercial com-panies are commercial vs. government enablingcommercial contracting processes.

• Eliminate FAR cost principles that are administra-tively burdensome and discouraging to typicalnon-government contractors.

• Broaden available contract types under FAR (Part12) to include standard commercial-type contractvehicles.

• Accelerate implementation of e-business environment.

• Streamline all payments with electronic processingand payments.

As changes to outsourcingcompetitions are developed andimplemented, the Commission

believes that defense andaerospace industry must workwith government organizationsto develop effective partnering

relationships.

7 - 1 3



Domestic and International Business Climate:Burdensome Certain U.S. tax and trade laws and regulations thataffect a wide variety of industries weigh particularlyheavily on defense and aerospace,both in competition with domes-tic commercial entities as well asin the international markets.

The complex U.S. Tax Code doeslittle to reward or incentivize pri-vate investment in maintainingand enhancing our nation’s tech-nological edge, either military orcommercial. The Tax Code alsofails to recognize the uniquenature of defense developmentand production. In addition, a proposed resolutionto a long-standing trade dispute with the European

Union threatens to place military and aerospaceexporters at a distinct disadvantage in the globalmarketplace.

Outdated and restrictive U.S.export control laws and regula-tions do little to protect vitalnational security technologiesand, at the same time, adverselyaffect the ability of defense firmsto export military products to ourallies and friends, and negativelyimpact the ability of the govern-ment to pursue vigorously effortsto improve the military readinessand interoperability of our allies.Finally, high-tech companies are

discouraged from doing business with the U.S. government, and current contractors are unfairly


ContractReform

CompetitiveSourcing

CommercialAcquisitionPractices




•Develop and enact laws and regulations limitingcontractor liability for homeland security sales to allgovernment agencies, as well as state, local, andcommercial entities.

•Minimize use of certified cost or pricing data.•Facilitate use of common subcontracting processes.•Expand use of “other transaction authority”.•Reevaluate changes in DOD Shared Savings initiative.•Revise government profit policy to permit increasedaward fees, unearned award fee carryover, higher profitguidelines for fee-bearing IR&D.

•Eliminate fixed price development contracts, profittakebacks, and withholds on CPFF contracts in excess ofrequirements to protect the government.

•Formulate effective share-in-savings policies;reevaluate changes in efficiency savings initiative

•Conduct a government-wide study of activities andservices performed by government civilian and militarypersonnel, and develop recommendations for privatizationof non-core functions and services.

•Reform OMB Circular A-76 to provide for more equitableand effective public-private competitions

•Incentivize and expand the use of public-privatepartnerships

•Eliminate government unique contract requirements.•Continue the implementation of e-business environment.•Implement electronic processing and payments forall transactions.

•Expand use of commercial practices.•Revise FAR part 12 to include standard commercial-type contract vehicles.

•Eliminate burdensome FAR cost-based principles.•Expand commercial item definition to include all productsand services purchased from commercial companies

•Study the use of leasing as anacquisition tool.

•Repeal/reform Civil FalseClaims Act.

•Authorize prime contractors towaive flow down to lower-tiersuppliers of unnecessary and costlyterms and conditions.

•Expand multiyear contracting toleasing and procurement of goodsand services.

•Develop and implement proposalsto allow “buy to budget”.

•Enact proposals to privatizenon-core functions and services.

•Fully implement e-businesspractices.

The complex U.S. Tax Codedoes little to reward or

incentivize privateinvestment in maintainingand enhancing our nation’s

technological edge.

7 - 1 4



penalized, by the laws and regulations governingrights to inventions and technology developed undergovernment contract.

The Commission believes the government should act promptly to replace these burdensome tax lawsand outdated trade laws, as necessary, with laws andregulations that remove unnecessary administrativeburdens from industry and recognize the uniquecontribution of defense and aerospace companies toour nation’s defense and economic security. Enactingor implementing the proposals outlined belowwould remove some of the clearest impediments todefense/aerospace industry health.

Ensure FSC/ETI Resolution Maintains IndustryBenefit. As discussed in the Commission’s SecondInterim report, U.S exporters face possible sanctionstotaling up to $4 billion per year in tariffs on the saleof U.S. goods if the Foreign Sales Corporation (FSC)Repeal and Extra Territorial Income (ETI) ExclusionAct of 2000 (FSC/ETI), which was ruled an illegalexport subsidy by the World Trade Organization(WTO), is not repealed.

In Interim Report #2, the Commission recom-mended that the U.S. Trade Representative seek adelay in imposition of any sanctions on U.S. exportsto allow government and industry the time todevelop a resolution of the FSC/ETI issue. TheCommission is concerned that, while sanctions maynot be imposed in the near term, the threat of sig-nificant sanctions will negatively impact the U.S.economy and other trade issues with our Europeanallies. The Commission also reaffirms its belief thatloss of the FSC/ETI benefit would have a seriousadverse impact on the ability of U.S. defense andaerospace companies to compete in the global mar-ketplace.

The Commission therefore strongly concludes thatthe Administration, Congress, and industry engagein serious discussions to develop an equitable resolu-tion of this issue that maintains the current level ofbenefits for defense and aerospace companies. TheCommission considered several proposals that couldbenefit defense and aerospace companies, while

meeting the test of WTO compliance. The proposalsfavored by the Commission are an enhancedNational Security R&D credit, the National ForeignTrade Council (NFTC) wage credit proposal, andthe NFTC Footnote 59 changes.

Enhance the Effectiveness of the Research andExperimentation (R&E) Credit. The Commissionemphasizes the recommendations contained in itsSecond Interim report for improving the utility ofthe current research and experimentation tax creditfor defense and aerospace companies. Expanding onits earlier recommendations to make the R&E creditpermanent and increase the rates for the currentAlternative Incremental Research Credit, theCommission sees value in an additional alternativecredit that would allow defense and aerospace com-panies to enjoy the same level of benefit as otherindustries—currently a 6 percent average credit. TheCommission believes there should be a new alterna-tive tax credit of 12 percent of the excess of current-year qualified research expenditures (QRE) over 50percent of the average QRE for the prior three years,or 6 percent of current-year QRE for start-up tax-payers.

Repeal Percent of Completion (POC) TaxAccounting Method. One area of particular com-plexity in the U.S. Tax Code is the Percentage-of-Completion method under Section 460 of theInternal Revenue Code (the “POC method”) thatwas enacted in 1986 when the “Competed Contractmethod” was repealed. Under the POC method, tax-payers are required to perform a complicated set ofcalculations involving estimated costs, price, and rev-enues to derive a percentage that is used to determinethe amount of annual tax due on each contract.Many defense and aerospace contracts must be han-dled under the POC method, either because they arelong-term contracts (requiring more than 12 monthsto complete) or because the items being produced are“unique” items not normally carried in inventory.

Section 460 imposes an unfair burden on defenseand aerospace companies, as well as certain otherindustries, by requiring them to pay tax before profitis earned. In addition, complicated look-back and

7 - 1 5



other requirements impose a compliance burden ontaxpayers and a correspondingly large administrativeburden on the Internal Revenue Service to monitorand enforce compliance, for relatively little revenuegain.

The Commission welcomes theAdministration’s expression ofinterest in reviewing Section 460of the Tax Code. The Commis-sion concludes that the POCmethod should be repealed,allowing defense contractors tobe treated similarly to all otherbusinesses. At the very least, themethod should apply only to contracts involvingitems that take a very long time to manufacture, i.e.,three years vice the current one-year limit in law.

Export Control Reform. Export controls have areal and direct impact on the defense and aerospaceindustry’s ability to establish and maintain interna-tional partnerships, meet market demand and staycompetitive, and address the requirements of existingoverseas partners and customers. Current exportlicensing policies and procedures are complicatedand inefficient, and erode the competitive positionof U.S. companies in the global marketplace.

The Commission believes that protection of ournational security and technological edge in key capa-bilities must continue to be the principal focus of ourexport control laws. However, without a fundamen-

tal restructuring of the currentsystem, American companies willlose out to foreign competitionand our nations own industrialand high technology base will besignificantly undermined. Referto Chapter 6, Global Markets fora detailed consideration of theCommission’s recommendationson this critical topic.

Airline Industry Bankruptcy and User Fees. TheCommission also considered the plight of the U.S.airline industry, which is in the midst of a financialcrisis. If left unchecked, this crisis will have a seriousnegative impact on the entire American economy.The impact could become more serious very quicklyif more airlines are forced to declare bankruptcy lead-ing to payment delays or defaults on debts owed tolabor, manufacturers, and service providers. U.S. air-lines lost $7.1 billion in 2001, and, according to theAir Transport Association, will lose an estimated $9.0billion in 2002. The airline loss of revenue has beenexacerbated by the combined effects of the terrorist

Source: U.S. Tax Code via www.airlines.org

Tax/Fee

Passenger Ticket Tax*Passenger Flight Segment Tax*Passenger Security SurchargePassenger Facility ChargePassenger Facility ChargeInternational Arrival TaxINS User FeeCustoms User FeeAPHIS Passenger FeeCargo Waybill Tax*Frequent Flyer TaxAPHIS Aircraft FeeJet Fuel Tax*LUST Fuel Tax*Air Carrier Security Fee

1972

8.0%---$3.00----5.00%-----

1992

10.0%--$3.00**$6.00-$5.00$5.00$2.006.25%-$76.75-0.1¢/ga-

2002

7.5%$3.00$2.50$4.500**$13.00$13.20$7.0$5.0$3.106.25%7.5%$65.254.3¢/gal0.1¢/galTBD

R/T***

7.5%$12.00$10.00$18.00**$13.20$13.20$7.00$5.00$3.106.25%7.5%$65.254.3¢/gal0.1¢/galTBD

*Tax Applies Only to Domestic Transportation **Legislative Maximum ***Single-Connection Rountrip With $4.50 Passenger Facility Charge

Figure 7-7 Increases in Taxes and Fees Over Time Have Reduced Airline Profits

Left unchecked, the airlineindustry crisis will have a

serious negative impact onthe entire American

economy.

7 - 1 6



attacks of September 2001, the current economicslump and chronically high internal cost structure.On the manufacturing side, the surplus of commer-cial aircraft is at a record level and worldwide pro-duction continues to exceed demand. TheCommission has been told by experts that theyexpect demand to pick up with an eventual reboundin the economy. Most believe evolving market forceswill eventually lead to a major restructuring of theairline and aviation servicing industries.

The Commission finds that one cause of the currentfinancial condition of the industry relates to the fed-eral government’s over-taxation of the industry, prin-cipally in the form of aviation and security-relateduser fees. Testimony before theCommission indicated that for a$100 airline ticket, approxi-mately 40 percent of that cost isthe result of governmentimposed fees. See Figure 7-7.The Commission believes thatthe Administration andCongress should review andconsider reducing these user feeson the airlines and their cus-tomers. The government shouldalso look at how to mitigate

problems caused by the scheduling cost and lack ofavailability of terrorism insurance.

The Commission is aware of concerns that, in futurebankruptcies, airlines may be pressured to give for-eign creditors preferential treatment over domesticcreditors. The Commission urges the government toensure that all creditors are fairly and equitablytreated.

Long-Term Growth and Financial Health: InJeopardyIn order to create a stable and predictable businessclimate that enables growth and fosters the long-term financial health of the industry, government

and industry must first recognizethat the global marketplace itselfdrives this very dynamic, com-plex, and innovative businessenvironment. Challenges can nolonger be simply viewed as issuesbetween the U.S. governmentand American business. Wemust consider whether govern-ing policies and regulations sup-port or weaken good businesspractices, and whether thesesame rules support or weaken

Today’s aerospace industrydemands a dynamic, resultsoriented workforce with the

talents, multidisciplinaryknowledge, and up-to-date

skills to enhance an organization's value.


FSC / ETI

R & E Credit

Section460 Repeal / Reform

AirlineReform

TreasuryCongress

TreasuryCongress

USTRTreasuryCongressIndustry

IndustryCongressCommerceFAA

•Convene working group ofAdministration/Congress/Industry negotiations todevelop resolution that maintains benefit fordefense/aerospace industry by enacting one offour suggested alternatives.

•Propose and enact legislation making the R&Ecredit permanent, increasing the AIRC rates, andcreating a new alternative credit of 12% of taxpayers’excess QRE over 50% of the average QRE for theprior three years, or 6% for start-up taxpayers.

•Conduct a review and hearings on Section 460 ofthe Tax Code.

•Propose and enact legislation to repeal orsubstantially reform Section 460.

•Conduct study of airline user fees impact oncommercial aviation.

•Urge early Congressional action on terrorismre-insurance

•Negotiate a change in inequitableWTO rules regarding treatment ofdirect and indirect taxes that putU.S. exporters at a competitivedisadvantage.

•Periodically evaluate theeffectiveness and equity of theR&E credit in incentivizingprivate sector investment innew technology.

•Develop U.S. policy regardingairline debt payments to foreigncreditors.

7 - 1 7



the technological capabilities of the aerospace indus-trial base. A healthy, competitive, and innovativeindustry meeting defense and aerospace needs mustbe closely integrated with the global commercialmarketplace. Reduction in the uncertainty of ongo-ing business and future aerospace markets enablesgovernment and industry to make the necessaryinvestments in people, technology, and facilities, tocontinue to ensure “world class” aerospace productstoday and for the future.

Major challenges to this desired climate include theneed for dramatic personnel and training reform—how will we attract and retain necessary intellectualcapital, sustain a robust workforce for the future, andattract highly and specifically qualified individuals togovernment service; and merger and acquisition pol-icy reform—a global perspective and approach tomergers and acquisitions for aglobally driven industrialbase.

The Commission concludesthat investors and the tech-nology industry will continueto direct their focus towardthe global commercial mar-ketplace if specific reformsare not implemented in thenear term, thus depriving thegovernment and the aero-space industry of the best andbrightest personnel, innova-tive ideas and technologies, and capital investments.The Commission has outlined a desired end-statewithin each of these areas and has provided a specificframework for long-term excellence.

Personnel and Training—The Engine forChange. Today’s most successful organizations aredefining in very specific terms what they want toaccomplish and what kind of structures are necessaryfor success. They are also defining a shared vision forthe future, focusing on core values, goals, and strate-gies and communicating this shared vision clearly,constantly, and consistently. Top organizations then choose the best strategies for integrating their

organizational structures, activities, core processes,and resources to support mission accomplishments.

Aerospace-oriented organizations in both the publicand private sectors recognize that people are an orga-nization's key asset. Today’s aerospace industrydemands a dynamic, results-oriented workforce withthe talents, multidisciplinary knowledge, and up-to-date skills to enhance an organization's value to itscustomers and to ensure that it is equipped toachieve its mission. Because mission requirements,customer demands, technologies, and other environ-mental influences change rapidly, a performance-based organization must continually monitor its tal-ent needs. It must also be alert to the changingcharacteristics of the global (not just U.S.) labormarket and identify the best strategies for filling itstalent needs through recruiting and hiring, and fol-

low up with the appropriateinvestments to develop andretain the best possible work-force.

The Commission believesthat a primary barrier toaccomplishing many of theother recommendations inthis report is the lack ofunderstanding by the govern-ment and industry work-forces about the roles,responsibilities, and chal-lenges facing their counter-

parts. The Commission is also concerned aboutreported instances of government acquisition per-sonnel failing to recognize business realities, such asthe need for adequate profit margins.

Government and industry should work together todevelop and implement training and exchange pro-grams that would educate and expose their work-forces to their respective challenges and responsibili-ties. These programs should include internship andfellowship programs, cooperative training programs,and personnel exchanges to provide firsthand experi-ence for both workforces in the others’ day-to-dayactivities.

Government and industryshould work together to develop

and implement training andexchange programs that would

educate and expose theirworkforces to their respectivechallenges and responsibilities.

7 - 1 8



The Commission also concludes that governmentacquisition personnel should be required to beknowledgeable about the characteristics of the inte-grated civil contracting model, and that industryacquisition personnel be fully trained in the com-plexities of the government acquisition system. TheCommission also believes that all government offi-cials with budget and program acquisition, manage-ment, or review responsibilities, both appointed andelected, should have either a business or financialbackground or be provided access to expert advice inthese areas. The Commission urges each newPresident to take these criteria into account whenmaking selections for relevant positions. Both theexecutive and legislative branches are encouraged tocreate training programs so that personnel in relevantpositions are fully knowledgeable about businesspractices and financial issues.

The Commission also believes that investments innew, contemporary learning systems should beimmediately established to respond to the backlog ofnew policies and regulations that urgently needgreater cultural understanding and further skilldevelopment. System focus should include: emphasison the “how to” practical aspects of applying newrules and techniques, clear treatment of both culturechange and new process, maximum use of technol-ogy based learning tools, mechanisms for validatinglearning tools and measuring the effectiveness of the learning process, and incorporation of jointbuyer-seller learning scenarios in selected critical

areas. Additionally, judicious use of outsourcing toaccess private sector education and training capabil-ity, aggressive use of government-industry exchangemechanisms to best leverage each side’s knowledge,and finally, skills and sustained management atten-tion and accountability including requirement forbusiness and financial backgrounds and training forall government personnel responsible for programacquisition and financial management should beimplemented.

A Global Approach to Merger and AcquisitionPolicy. Just as the global marketplace drives ourbusiness environment, a global approach to mergersand acquisitions is fundamental. Today’s economy iscomprised of multi-national corporations, operatingacross all time zones and financial markets. No onecountry or corporation has a corner on technology,innovation, or management processes. Access toglobal best practices and markets is an absolutenecessity in today’s environment.

The Commission believes the government mustdevelop and implement a policy regarding interna-tional cooperation in defense and aerospace that rec-ognizes the global industrial base. The Commissionurges the Administration to undertake a review ofthe current policy regarding both domestic andinternational business combinations, based on ananalysis of the U.S. defense industrial base, includingthe supplier industrial base.


Personnel& TrainingReform

Merger &AcquisitionPolicyReform

Admin.DoDStateCommerce

DoDIndustryOMBCongress

Implement government/industry internship, fellowship,and exchange programs for acquisition personnel.Require training for government acquisition personnelin integrated civil contracting, and require training forindustry personnel in government acquisition processesand systems.Require all government officials with budget or programacquisition, management, or review responsibilities tohave a business or financial background or training.

Initiate/update/complete studies on U.S. defenseindustrial base.Initiate/update/complete studies on U.S. supplier base.Conduct study of U.S. policy on domestic andinternational mergers and acquisitions.

Develop and implementcontemporary learning systems torapidly disseminate informationabout new policies and regulations

Develop U.S. policy regardingglobal mergers and acquisitions.

7 - 1 9



ConclusionsThe Commission concludes that for our aerospaceindustry to be globally preeminent, now and in thefuture, it must be able to attract vitally needed cap-ital at a reasonable cost. We further conclude that thedefense and aerospace sector is viewed as a lowgrowth industry with low margins, unstable revenueand a capricious major customer, the government.Without a significant change in the business model,the future of the aerospace industry, so critical to ournational economic and homeland security, is uncer-tain and at risk.

Provide Investment Opportunities. Predictability,stability and performance are critical to the healthand growth of a robust aerospace industry. The gov-ernment must stabilize program requirements andprotect adequate long-term investment funding,enact reforms that increase the financial flexibility ofindustry and the government, and improve programmanagement stability.

Enable Industry to Attract and Retain High-Tech Partners and Suppliers. The future of theaerospace industry is intrinsically tied to the abilityof the sector to attract and retain high-tech partnersand suppliers throughout the supply chain. The gov-ernment should pursue near-term reforms to realignpurchasing processes to lower costs and gain access tonew technology by eliminating, or at least lowering,barriers that make government business inefficientand unattractive to commercial firms. DoD shouldimplement changes to permit greater profitabilityand financial flexibility of industry working on government efforts. A government-wide review of functions and services should be conducted to iden-tify those functions that are not “core” to the effective operation of government and those func-tions that could best be performed by the private sector.

Create a favorable Domestic and InternationalBusiness Climate. Certain U.S. tax and trade lawsand regulations that affect a wide variety of indus-tries weigh particularly heavily on defense and aero-space, both in competition with domestic commer-cial entities as well as in the international markets.

The government should act promptly to replace bur-densome tax laws and outdated trade laws with lawsand regulations that remove unnecessary administra-tive burdens from industry and recognize the uniquecontribution of defense and aerospace companies toour nation’s defense and economic security. In addi-tion, the Administration and Congress should reviewand consider reducing user fees on airlines and theircustomers.

Ensure Long-Term Growth and FinancialHealth. Government and industry must recognizethat a healthy, competitive, and innovative industrymeeting security and aerospace needs must be closelyintegrated with the global commercial marketplace.Major challenges to this desired climate include theneed for dramatic personnel and training reform andrecognition of the dynamic interrelated global envi-ronment. Government and industry should worktogether to develop and implement training andexchange programs that would educate and exposetheir workforces to those challenges and responsibil-ities. All government officials with budget and pro-gram acquisition, management, or review responsi-bilities, both appointed and elected, should berequired to have a business or financial backgroundor training. Finally, government must develop andimplement a policy regarding international coopera-tion in defense and aerospace that recognizes theglobal industrial base. The Administration is urgedto undertake a review of the current policy regardingboth domestic and international business combina-tions, based on an analysis of the U.S. defense indus-trial base, including the supplier industrial base.

RECOMMENDATION #7

The Commission recommends a new business

model designed to promote a healthy and grow-

ing U.S. aerospace industry. This model is driven

by increased and sustained government invest-

ment and the adoption of innovative government

and industry policies that stimulate the flow of

capital into new and established public and pri-

vate companies.

chapter 7 – business: a new model for the aerospace sector...evidenced by the decline in sector...

Documents