Companies See Bright Spots in Bleak Market

http://www.nationaldefensemagazine.org/archive/2013/November/Pages/CompaniesSeeBrightSpotsinBleakMarket.aspx

Military contractors were recently warned by a senior official that they are about to be “punched in the face” as the defense market takes a beating over the next several years.

That statement comes as no surprise. Sequestration and gridlock will be taking a huge toll on Pentagon spending. Budgets for new weapons will be plummeting by at least 20 percent. And Pentagon buyers will be hesitant to spend what they have, as they are still scarred by a decade of procurement flops.

Remarkably, there are still companies that have the stomach to invest in defense. Some actually view these tough times as an opportunity to win new business.

Textron just unveiled a new light-attack surveillance aircraft that can carry spy sensors and is based on a commercial Cessna business jet. The aircraft, named Scorpion, is a private investment by Textron and a partnership of 22 vendors.

But in today’s bleak market, how long can a company wait for a Pentagon order before investors lose their patience?

Textron executive Edward Hackett says the company is not expecting to “drive decisions” within the Defense Department. But he hopes that products such as Scorpion will help open the debate on the “value” that industry can bring to the Defense Department.

The company decided to take the plunge in response to what it has been hearing from Deputy Defense Secretary Ashton Carter and Undersecretary for Acquisition, Technology and Logistics Frank Kendall: Industry, keep investing, please. Bring us solutions.

The business model is rather simple: Build an aircraft at a fraction of the cost of a government-developed system, mostly by using commercial components from the Cessna line.

It remains to be seen whether industry-funded hardware such as Scorpion sparks interest within the Defense Department. Some industry insiders appear impressed by the idea. Maybe the Pentagon is not ready to buy a commercial jet to replace F-16 fighters, but other countries that have less money might consider it. All Textron needs is one customer that is willing to be the first to buy one of these airplanes. Then, others probably will follow, or so some business leaders believe.

Another company that sees the downturn in a positive light is Saab North America, which spends 8 to 9 percent of its approximately $4 billion in revenues on research and development.

That’s at least two to three times what top prime contractors spend, on average, on corporate R&D.

Saab executives will admit that investors do not always like to see so much money poured into research ventures. “It takes a lot of leadership to do it,” says Vice President Brian Lawrence.

But that is the only way the company believes it can compete with the bigger primes. Saab’s story is a cautionary tale for defense companies that primarily rely on government funding to develop new products. In the 1980s, 90 percent of Saab’s revenues were from sales to the Swedish government. After the end of the Cold War, it faced a sink-or-swim moment. It decided to start funding its own product development and branched into the global market. Now 50 percent of Saab’s business is outside Sweden.

Non-U.S. defense firms understand the politics of jobs and the industrial base and have no problem pouring funds into domestic production, licensing or codevelopment, if they are reasonably sure that the U.S. government intends to buy the product.

That philosophy is guiding new investments by MBDA Inc., the U.S. subsidiary of Europe’s largest missile manufacturer. It is actively marketing its Brimstone air-to-ground missile — whose development was funded by the United Kingdom — to the U.S. Air Force, Navy and Army. This might seem overly ambitious, as the market is owned by Lockheed Martin’s Hellfire. But the company believes it can beat incumbent suppliers if given a chance to compete.

Some industry CEOs remain skeptical that the Defense Department can be trusted to commit to buy products that it did not design or develop in house. This is often known as the “not invented here” syndrome.

The government is asking industry to invest in new technology, but for some corporations, that is too big a gamble. David Melcher, CEO of Exelis Inc., a supplier of high-tech military equipment, says he expects most industry investments will be based on “requirements” set by the Defense Department.

As the downturn loomed, Defense Department leaders assumed that they would have to slash R&D spending and industry would pick up the slack. Melcher cautions about overblown expectations that industry will deliver products at high technology readiness levels not knowing whether the Pentagon will buy them. “At the end of the day, our board and our shareholders will not want us to keep investing in something that doesn’t have a return on the invested capital,” he says.

Melcher might have a point. A new study by the Center for a New American Security contends that the U.S. military “strongly resists serious investments in technologies that may threaten perceived ‘core’ weapons platforms and traditional concepts for their employment.”

Risk aversion is a “deeply rooted facet of Pentagon culture,” the CNAS study says.
Government buyers eventually will have to decide whether their desire for innovation will trump entrenched thinking. They will need to keep in mind that the modernization of the military largely will be made possible by advances in commercial technology. “The commercial sector now catalyzes far more technological innovation than the military industrial base,” says the study.

This is good news, CNAS analysts note, because a healthy commercial industry will generate innovative technologies that can be applied across the entire U.S. economy while also allowing the military to benefit from private investments.

The Pentagon, however, will always need technologies that are not available in the civilian world, and will have to make sure it invests in those areas. And if it wants defense contractors to put more skin in the game, it will also need to do a better job informing companies about its needs. The Pentagon is asking industry to invest in technology not only because it is cash strapped but also because it is in danger of losing its technological edge.

Lawrence notes that one of the biggest hurdles his company encounters in its defense business is the way the Pentagon articulates its requirements.

“The defining of requirements for new weapon systems in the U.S. needs a complete overhaul,” he says. “I think a lot of people would agree with this.” Military buyers often write requirements that are too restrictive or too difficult to achieve, he said. “That is why we have so many programs that are over budget and behind schedule.”

Compromised By Design? Securing the Defense Electronics Supply Chain

http://www.brookings.edu/research/papers/2013/11/4-securing-electronics-supply-chain-against-intentionally-compromised-hardware-villasenor

Executive Summary:

Electronic “chips” are found everywhere—not just in critical defense systems, but also in the broader infrastructure for power, finance, communications, and transportation. All of these systems function effectively only when the electronic circuits at their heart can be trusted to operate as intended.
Unfortunately, ensuring trust has become much more difficult in recent years. Concern over the growth of counterfeit electronics (parts that have been harvested from discarded systems, relabeled, and sold as new to unsuspecting buyers) has grown in recent years. These parts can fail prematurely, with potentially disastrous consequences. Thanks to recent congressional attention, improved detection methods, and heightened screening requirements for parts destined for defense systems, however, the threat of counterfeits is being actively addressed.
Yet the supply chain is almost completely unprotected against a threat that may turn out to be more significant in the long term: Chips could be intentionally compromised during the design process, before they are even manufactured. If placed into the design with sufficient skill, these built-in vulnerabilities would be extremely difficult to detect during testing. And, they could be exploited months or years later to disrupt—or exfiltrate data from—a system containing the compromised chip.
As chips have gotten more complex and design teams have grown larger and more globalized, the opportunities to insert hidden malicious functionality have increased. If the history of cybersecurity has taught us anything, it is that these opportunities will be exploited. The prudent question, therefore, is not “will intentionally compromised hardware will end up in the defense electronics supply chain?” but “how do we maintain security when it inevitably does?” This paper aims to help frame the discussion regarding how best to respond to this important and underappreciated aspect of cybersecurity.

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U.S. Manufacturing Expands At Best Pace In 2½ Years

http://www.manufacturing.net/news/2013/11/us-manufacturing-expands-at-best-pace-in-2%C2%BD-years-0?et_cid=3574502&et_rid=490548696&linkid=http%3a%2f%2fwww.manufacturing.net%2fnews%2f2013%2f11%2fus-manufacturing-expands-at-best-pace-in-2%25C2%25BD-years-0

WASHINGTON (AP) -- U.S. factory activity expanded in October at the fastest pace in 2½ years, suggesting that the 16-day partial shutdown of the government had little effect on manufacturers.
Instead, overseas demand and healthy U.S. auto sales appear to be supporting factory output. The housing recovery is also lifting the furniture and wood products industry despite a recent slowing in home sales.
"We've become accustomed to the way Washington operates in the past couple of years and assume that it will get resolved eventually, however painfully," said Bradley Holcomb, head of the survey committee of the Institute for Supply Management, a trade group of purchasing managers that on Friday reported a solid manufacturing figure for October.
The ISM's manufacturing index rose to 56.4 from 56.2 in September. A reading above 50 indicates growth.
Factories also expanded in Europe this month, though at a slightly slower pace, according to surveys in that region. Manufacturing indexes have all picked up in China, Japan, and South Korea.
The overseas strength is boosting demand for U.S. factories. A measure of export orders jumped to its highest level in nearly a year and a half in October, the ISM report said.
"The outlook for manufacturing looks far more constructive now than it did over the past several months, in light of the improving global backdrop," said Michael Dolega, an economist at TD Economics.
U.S. factory activity has now risen at an increasingly fast pace for five straight months, according to the ISM's index. In October, a measure of new orders rose slightly. And a gauge of production fell but remained at a high level. Factories added jobs, though more slowly than in September.
The shutdown did depress activity at some companies that make metal products and electrical equipment. And while the survey's findings suggest stronger output in coming months, the most recent measures of factory production remain tepid.
"The strength of this hasn't yet been reflected in actual manufacturing output," said Amna Asaf, an economist at Capital Economics.
On Monday, the Federal Reserve said factories barely increased their output in September. Automakers produced more. But that gain was offset by declines at companies that make computers, furniture and appliances.
Companies reduced demand for long-lasting factory goods in September, the government said last week. Orders for industrial machinery, electrical equipment and other core capital goods fell. And August's figures were revised down.
Economists pay particular attention to core capital goods, which exclude aircraft and defense-related goods, because they reflect business confidence.
Analysts were also encouraged by a survey of companies in the Chicago region, released Thursday. It found that the companies expanded at their fastest pace in more than two years in October. New orders jumped, and hiring also rose.
Still, economists don't expect manufacturing to boost economic growth in the coming months. Growth likely fell to a weak annual rate between 1.5 percent and 2 percent in the July-September quarter from a 2.5 percent pace in the April-June period.
Most economists expect similarly slow growth in the final three months of the year.

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Cliff Waldman, senior economist for the Manufacturers Alliance for Productivity and Innovation (MAPI), offered the following analysis:
“The October report on U.S. manufacturing activity from the Institute for Supply Management (ISM) contributes to growing evidence that modest improvements in global financial stability and growth are benefiting U.S. factories. The Purchasing Managers’ Index rose slightly from 56.2 in September to 56.4 in October, the highest level for this closely watched leading indicator of factory sector performance since April 2011.
“The demand components of the index were notably positive, with the new orders component remaining above the strong 60 percent level and the backlog of orders, a measure of the pressure on the factory production schedule, increasing nicely from contraction territory in September to growth territory in October,” Waldman continued. “Neither the data nor the respondent comments in October suggest any measurable impact from the government shutdown, although reports for coming months need to be interpreted carefully for any distorting influence of Washington difficulties.

“In recent months, the survey-based data from the ISM have painted a more optimistic picture of manufacturing performance than the industrial production reports from the Federal Reserve,” Waldman concluded. “Federal Reserve data show that the third quarter rebound from the modest contraction of manufacturing output in the spring was a disappointing 1.3 percent. Fed data also show that the slowdown in the U.S. housing recovery is impacting overall manufacturing performance. Taken together, the ISM data and the industrial production data suggest positive but muted near-term performance for U.S. factories, as the beneficial impacts of an improved global growth picture are at least somewhat neutralized by uncertainties about the sustainability of the rebound in key parts of the world and the potentially harmful effects of historic policy uncertainty in Washington.”