Bolstering Military Strength By Downsizing the Pentagon

Secretary of Defense William Cohen is caught between a rock and a hard place. Critics from both the right and the left contend that the U.S. military cannot continue to execute its missions within its current budget. The Joint Chiefs of Staff say they face a shortfall of as much as $20 billion annually between the current procurement budget and the funding they need to recapitalize the armed forces. Recent Congressional Budget Office (CBO) figures contend that the budget shortfall may actually be even higher, reaching nearly $55 billion per year by 2004.

Two traditional solutions-throwing money at the problem or cutting back on international commitments-face insurmountable political obstacles. Fortunately, a third way exists. The Defense Department can save nearly $30 billion by aggressively reengineering the administrative and support side of the Pentagon by taking such actions such as for instance by privatizing military housing, outsourcing information technology, converting excess military bases to private use, and improving inventory management.

Secretary Cohen’s recently announced Defense Reform Initiative (DRI) takes a few small steps in this direction. But the initiative outlines a process of evolutionary change at a time when a truly revolutionary restructuring is needed. The Defense Department, our last large industrial-age bureaucracy, must undergo a transformation similar to the remarkable shakeup that has streamlined U.S. business during the past quarter century. By increasing its reliance on the private sector and emulating best business practices, the Pentagon can achieve what Cohen calls a “revolution in business affairs” and afford the advanced systems needed to ensure continued military preeminence.

Where the money is

The downsizing of the Department of Defense (DOD) during the past decade has been well publicized. Overall, spending has shrunk nearly 40 percent since 1985. What has drawn less notice is that the department’s oversized support structure has largely resisted change. As a result, the tooth-to-tail ratio-the traditional measure of combat capability to support-has become skewed, shifting from 50:50 during the Cold War to nearly 70:30 today. Spending on the support “tail” now consumes nearly $170 billion per year. Correcting this imbalance is essential if the military is to afford the modern equipment needed to carry out its missions. We should invoke the Willie Sutton principle and go where the money is: buried in the Pentagon infrastructure.

Defense “infrastructure” refers not simply to physical structures but encompasses a huge range of activities. DOD defines infrastructure as those activities that provide support services to mission programs such as combat forces and operate primarily from fixed locations. The DOD accounting system sets forth eight categories of infrastructure: installation support, central training, central medical, central logistics, force management, acquisition infrastructure, central personnel, and central command, control, and communications. Nearly half of all infrastructure spending falls in two of these categories: central logistics and installation support.

Outside of personnel costs, most spending on infrastructure occurs within the Pentagon’s operations and maintenance (O&M) accounts. O&M spending traditionally accounts for roughly one-third of the defense budget. Although it is considered the central source of funds for military readiness, O&M also supports a host of basic activities and functions that are similar to commercial practices. In fact, DOD now enrolls more than 640,000 employees in positions with direct commercial equivalents. If treated as a stand-alone company, this entity would rank No. 3 in total U.S. employment behind Wal-Mart and General Motors. Overall, only 14 percent of the 2.5 million DOD personnel are officially listed in combat positions.

Military experts can debate endlessly which areas of infrastructure spending represent “tooth” or “tail.” Despite these differences of opinion, there is wide consensus that infrastructure costs are growing at an unsustainable rate. According to CBO, total O&M spending in 1996 was 7 percent higher than it was in 1981, despite large cuts in force structure. O&M costs per soldier have been growing at a rate of roughly 3 percent per year and are not expected to decline over the next few years. At the same time, the Pentagon’s middle management layers remain heavy: DOD now supports one supervisor for every nine employees. Commercial firms average one supervisor for every fourteen employees.

These growing costs are no secret to Pentagon planners. Indeed, Secretary Cohen’s Defense Reform Initiative is designed to tackle this problem. This plan calls for four major reforms: 1) downsizing and reorganizing the Office of the Secretary of Defense, 2) authorizing two more rounds of military base closures, 3) reengineering specific business practices related to contracting, and 4) aggressive use of public-private competitions to help reduce costs for DOD’s support activities. Together, these reforms are expected to generate about $6 billion per year in savings, about half of which would come from base closings.

Although the initiative contains many good ideas, a much more aggressive path is needed to reengineer the Pentagon. The use of public-private competitions is the plan’s Achilles’ heel. Under current rules, known as the A-76 process, these competitions take two to four years to complete. First, government agencies must analyze the cost to the government of performing a particular function (say, providing janitorial services for a particular base); then it opens each job to bids from the private sector as well as the military entity involved, evaluates the bids, and awards the contracts. Since any function involving more than 10 employees is subject to competition, there is now a huge backlog of cost analyses awaiting OMB’s attention.

Because public entities do not fully account for their overhead as private competitors do, the playing field between the private and public sectors is rarely level. Moreover, the pressure to reduce costs often ends once an A-76 competition is completed. Thus competitions yield only one-time savings. A Center for Naval Analyses study of more than 2,000 public-private competitions found that although these competitions have historically yielded savings averaging 31 percent, they impose a significant administrative burden, generating additional costs of about 11 percent. Even worse, the A-76 process results in piecemeal reform rather than sweeping reorganization. Competitions have traditionally affected small operations with an average size of 35 employees. A private firm may win a contract to perform janitorial services at one installation, while public employees continue to do this job elsewhere. This prevents firms from capturing economies of scale and perpetuates the Pentagon’s cumbersome and internally inconsistent organizational structure.

Piecemeal reform must be replaced by sweeping and rapid change. In some areas, such as aircraft repair and maintenance, Congress requires public-private competitions. But in many other areas-payroll processing, central logistics, and surplus property disposal-DOD can simply opt to exit, avoiding the protracted process of public-private competitions altogether. We cannot wait four years to see whether outsourcing might work in a few target areas. We know that it works, and we can act on this knowledge today.

Learning from business

Through the use of reengineering, outsourcing, and other management tools, the U.S. private sector has become the envy of the world. This situation rebuts the conventional wisdom of the 1980s, when the rise of Japan, Inc., and a united Europe appeared to sound the death knell for U.S. industrial preeminence. In response to these competitive pressures U.S. businesses undertook a host of major reforms: Shareholders assumed a greater voice in operations, managers deployed new financial tools, and most important, companies began to shed noncore businesses to focus on their “core competencies.”

Until the 1980s, the corporate structure of choice was the pyramid, in which a host of different organizations reported up the chain of command to a single centralized leadership. Conglomerates such as Textron and Westinghouse managed businesses in many unrelated industries and maintained vertically integrated operations within each sector. Some of these firms were well managed, but in most cases, the conglomerate structure led to increased overhead costs, reduced flexibility, and misallocation of capital.

The business challenge from Japan and elsewhere shook up this sleepy world. U.S. business was forced to change. The thrust of this transformation was simple: If someone else can do a job better and cheaper, let them. Following this precept, the old conglomerates broke up. Outsourcing became the predominant management trend of the 1990s. In the area of information technology alone, corporate America outsources more than $30 billion of work each year. A recent Chief Executive magazine/Andersen Consulting Survey found that more than 90 percent of corporate CEOs expected to be involved in strategic outsourcing relationships by the year 2000.

The structure of choice in today’s business world is a web or network, in which companies rely on partnerships, cross-investments, and strategic alliances to enter new markets. Leading firms such as Microsoft and Cisco Systems no longer create new divisions in distant fields. Instead, they form strategic partnerships or form other relationships, such as Microsoft’s investment in Comcast as part of its strategy for gaining access to the cable market.

Today, the Pentagon is one of the last of the industrial pyramids. Its organizational structure is based on ways of doing business that date back to the early years of the Cold War. At that time, DOD had no choice but to develop in-house expertise or services since private sector suppliers, such as today’s Federal Express or EDS, did not exist. Contracting out these activities can improve services and save tens of millions each year, with zero impact on DOD’s core mission of military readiness.

Take the relatively simple case of payroll processing. Today, the Defense Finance and Accounting Service charges $4.58 simply to process a civilian paycheck; the private sector charges less than $2 for the same service. Or consider the Defense Reutilization and Marketing Service (DRMS), DOD’s excess property disposal agency. Operating 164 sites around the world, DRMS disposes of $24 billion worth of excess military property each year, selling it or donating it to charitable organizations. It has lost money 24 out of the last 25 years, with sales yielding 2 percent of the goods’ original price. By comparison, the General Services Administration generates 6 percent while private sector entities such as airlines often obtain 50 percent of list price for parts. Other federal agencies such as the Customs Service privatize property disposal and actually return money to the Treasury.

DOD has long recognized that this record is abysmal. In fact, the Pentagon’s inspector general has recommended that the department suspend funding for DRMS. In 1993, Vice President Gore’s first Reinventing Government report called for complete outsourcing of DRMS. More than four years and millions of dollars later, no outsourcing has occurred, and DRMS’ official position is that it is “considering privatization alternatives.”

DOD can resolve its budget dilemmas by reaching out to the private sector and emulating the best business practices. This requires a commitment to aggressive outsourcing and privatization. In business terms, the Pentagon must focus on its core business-defense-and outsource activities that are tangential to it. The goal of this effort is to cut the costs of support activity, not eliminate it. The list of candidates for change is long. Nearly every business should be considered. A rule of thumb is to check the local Yellow Pages: If a DOD function can be found there, it should be added to the list.

Health care, payroll processing, information technology services, housing construction, travel services, and utilities all jump out as ideal candidates for outsourcing. These are areas that offer the best prospects for savings and/or improved operations as well as for quick success. In addition they are far removed from combat operations and have relatively little impact on the quality of life of military personnel. These business targets have the added benefit of falling in sectors where competitive private sector firms thrive. Companies such as Federal Express, Computer Sciences Corporation, EDS, American Express, and Wells Fargo are certainly capable of serving the military as efficiently as they serve thousands of civilian customers.

Take health care, for example. Although DOD’s health care cost woes mirror those in U.S. society as a whole, DOD’s problems are compounded by factors unique to the military: lower occupancy rates in military health care facilities and a failure to cut spending in accordance with force structure reductions. In addition, when compared with civilian managed care organizations, DOD’s medical programs do little to discourage high use of services. Major savings could be generated if military health care utilization rates could be brought in line with comparable civilian rates. At the same time, many military retirees continue to use the military health care system, even though nearly 50 percent of retiree families, before they become eligible for Medicare, are covered by private insurance from employers.

Overall savings from privatization and outsourcing will be significant. According to the Defense Science Board, an aggressive campaign of business-based reforms could save nearly $30 billion per year (see chart). The biggest savings would come in logistics ($9.3 billion), base closings ($6 billion), and medical care ($4 billion). To bolster this estimate, studies of state and local governments and foreign governments (particularly Britain, where defense privatization is much more advanced) indicate that savings ranging from 15 to 50 percent are the norm when government work is outsourced. Achieving significant savings, however, requires success in the whole range of DOD’s commercial functions.

But cost savings should not be the only goal of outsourcing. Indeed, savings should always be secondary to the larger goal of providing better service. For instance, thanks to aggressive reengineering and outsourcing of Pentagon travel services, DoD employees will move from spending an average of five to seven hours of paperwork for each trip to mere minutes of administrative time under a new streamlined process. In the area of logistics, DOD takes an average of 26 days to deliver in-stock items. Leading commercial firms take 2 to 3 days. Reducing these administrative costs and hassles produces real benefits that do not always appear in an account statement.

If not now, when?

While chairing the Packard Commission on defense management reform in 1986, David Packard made an insightful point: “We all know what changes need to occur. The real question is why don’t we do it?” Packard’s query remains as relevant today as it did in the days of $600 toilet seats.

The causes of inaction come down to two factors: jobs and inertia. Cutting infrastructure costs means cutting jobs in someone’s congressional district. Thus, obtaining support on Capitol Hill for needed reforms has been a difficult task. In the mid-1980s, for instance, then-Defense Secretary Frank Carlucci argued that DOD did not need to rely on in-house security guards, since many private companies offered similar services at competitive rates. Indeed, most government agencies already contracted out this function. When Carlucci attempted to outsource this work, he was blocked by legislation that permanently barred DOD from contracting out guard and fire services. Nearly a decade later, this law remains on the books and the work remains in-house, supporting more than 22,000 government employees.

The effort to close additional military bases has followed the same path. The Senate soundly defeated this year’s request to authorize new rounds of the Defense Base Closure and Realignment Commission (BRAC), a process expected to save a minimum of $1.7 billion per year. Opponents of base closures cited a host of reasons for their votes, but their opposition was quite simply based on parochial politics. Nearly every opponent faced the prospect of a major base closure in his or her district. In fact, majority leader Trent Lott personally circulated a list of at-risk bases on the Senate floor, convincing many senators to oppose the request.

Political pressures are not the only cause of inaction. Many of today’s current problems can simply be attributed to inertia. Changing large organizations is always difficult, and it is especially hard at the world’s largest organization, the Pentagon, where special civil service rules, arcane budget and accounting practices, and unique cultural issues converge to make change difficult. For example, the use of existing federal budget-scoring rules, established to assess the impact of budget measures on the deficit, has had a perverse and unintended effect on privatization efforts. Future savings are not calculated in current procedures. As a result, privatization often appears as a spending increase because of one-time costs related to the sale or outsourcing of an asset. These rules force privatization advocates to jump two hurdles: They must convince both budget hawks and those committed to business as usual that privatization makes sense.

This inertia is reinforced by the fact that DOD’s top leaders-both military and civilian-are trained to deal with “teeth,” not “tail.” When faced with budget cutbacks, they know how to trim fighter wings or reorganize divisions but are poorly equipped to reengineer business functions such as payroll services, health care, and accounting. Moreover, since short tenures are common among top Pentagon officials, opponents within the bureaucracy often block reform through simple delay tactics. DRMS’s ability to block outsourcing for more than four years, despite the support of the vice president, top DOD leadership, and the business community, offers a compelling case in point.

Nonetheless, today the prospects for change appear more favorable than ever. Budget pressures are the primary driving factor. For nearly a decade, the U.S. military has operated under a “procurement holiday” where new weapons buys were delayed and the military survived on the backlog from heavy procurement spending during the Reagan buildup. This strategy made sense in the aftermath of the Cold War, but investments to recapitalize the force cannot be postponed for much longer. Since weapons systems now take anywhere from 16 to 20 years to complete development, today’s procurement decisions will shape the military of 2015. If present trends continue, the military of 2015 will be operating with very antiquated equipment. Under current budget plans, the average age of bombers will reach 35 years by 2010, and heavy attack helicopters will approach nearly 25 years in age. We are reaching the point where our troops will be younger than the systems they operate. These aging systems will require replacements or, at a minimum, significant new investments in repair and maintenance. At the same time, big-ticket procurement items such as F-22 and F/A-18 aircraft will consume larger portions of the total procurement budget.

The financial pressure to support current military operations, replace obsolescent systems, and buy new systems, combined with the positive lessons drawn from U.S. industry, creates a powerful force for change. We must convince Congress that inaction threatens military readiness and convey that sense of urgency to Pentagon middle managers. In addition, we must persuade businesses to support widespread reform-not just because it benefits their bottom lines, but also because it benefits our national security.

Addressing congressional concerns. Outsourcing contracts can and should include protections for employees. The laudable goal of protecting federal employees should not prevent us from our more important objective of creating an affordable and effective Pentagon. Congress recognizes that behind every outsourcing proposal is someone’s job. Reduced personnel costs create a good portion of the savings from outsourcing. We must expect that aggressive outsourcing will lead to job loss. In the private sector, job losses on the order of 10 to 15 percent generally accompany major reorganizations, due to streamlining, economies of scale, and management consolidation.

The Pentagon has limited experience with outsourcing entire operations. In its few such experiences to date, DOD has required that contractors provide special first-hire privileges to former government personnel. For example, at the newly privatized Naval Air Warfare Center in Indianapolis, most of the former government employees have been hired by Hughes, the new operator of the facility. Indeed, Hughes has even retained the government employees union that formerly represented these workers. Similarly, when military bases closed, the federal government provided significant levels of funding for base reuse, helping to trigger many local economic development success stories. Federal support for reuse helped cushion the economic impact of base closures and assisted the community in attracting new economic activity to the base. A similar transition effort will be needed to offset the effects of outsourcing so that DOD can overcome congressional and local political opposition and lay the foundation for long-term change.

Promoting management buy-in. Creating a constituency for reform requires rewards for those who reform. Past reform initiatives have foundered because line officials at DOD had little incentive to change when savings from reform were simply returned to the Treasury and future budgets reduced to reflect past savings. We should allow units to keep some of the savings from outsourcing and reengineering. For example, if a base commander saves funds by using contractors to maintain base facilities, a portion of those savings should be reserved to meet other needs at the base. More broadly, DOD needs to develop a budgetary “lockbox” that retains savings for pressing internal needs and avoids the current practice of using savings to pay for unexpected contingency operations.

Involving business. The private sector must also be convinced that outsourcing and privatization make sense. If DOD begins to do business in new ways, what will that mean for business? For one thing, it probably means creating new, long-term relationships between the public and private sectors. Relationships between buyer and seller in the private sector are based on long-term partnerships. This concept is anathema in Washington’s world of one-year budget cycles. If privatization is to succeed, government must also enter into long-term relationships with preferred suppliers. Long-term contracts allow suppliers to better amortize the costs of initial investments; if they are based on performance, rather than price, they will ultimately reduce costs for the taxpayer.

Utilities offer a useful example. Many military bases suffer from decaying and inefficient utility services, which private firms are willing to supply. Since upgrading utilities requires a significant up-front investment, private investors are reluctant to enter into short-term contracts. But if the military offered a 10- to 15- year contract for utility services, private firms would jump at this business and even pay to upgrade facilities. DOD would benefit not only from cheaper heat and electricity, it would also avoid significant new investment (now estimated to reach $20 billion) in utility upgrades.

Contracting personnel also need training to deal with this brave new world. At present, DOD is well organized to buy things, but it does not buy services very well. Yet service contractors are becoming more important to DOD. For example, Computer Sciences Corporation is now the thirteenth largest U.S. defense contractor, and many traditional defense contractors, such as Lockheed Martin, are aggressive competitors in the services business. Making effective decisions in purchasing services requires improved training about performance measures, contract design, and the like. Today, it is common to find DOD outsourcing contracts that attract no bidders because the contracts are structured in a manner that forces firms to assume all the risks without guarantees of being able to generate profits. Fairer, more flexible contracts will be needed to make outsourcing work.

Although the benefits of applying best business practices to DOD are clear, it is equally clear that the Pentagon is not a business. Unlike Fortune 500 companies, the Pentagon cannot simply decree a major downsizing; political support must be sought and won. Moreover, because taxpayer dollars remain at issue, a degree of public oversight must remain in place. Nonetheless, DOD can adapt the lessons taught by corporate America to achieve a real “revolution in business affairs.”