EDITORIAL - New, stringent regulations will govern defense contracts with Lockheed Martin, Northrop-Grumman and other defense industry companies, according to a 16 March 2007 Wall Street Journal story by Jonathan Karp. Future military contracts will be of the fixed price type, rather than the more financially elastic cost-plus variety, in which the government reimbursed contractors for cost overruns. The military’s insistence that the contractor adhere to original estimates seems fair, until one realizes that cost overruns are not always the fault of the contractor, and are often due to changes insisted upon by the military customer.

Defense contractors generate tremendous amounts of revenue by supplying our military with everything from nuclear submarines to combat boots. Abuses of the system are part of our history, from Revolutionary War profiteers selling French muskets to the Continental Congress at five times their value to the 2003 scandal in which Boeing hired an ex-Air Force acquisitions official who was involved in a Boeing aerial-tanker proposal. Ever since President Eisenhower, in his 1961 farewell address, warned of the growing power of the "military-industrial complex," Americans have viewed defense contractors with growing suspicion and mistrust.

The truth is, there is no military-industrial complex. Companies in the defense industry compete vigorously with each other to design war-fighting ships, tanks and planes. The military buys from the contractor that offers the best combination of capability, quality and price. This is, if not an adversarial relationship, at least an open and competitive free-market arrangement between the military customer and the industrial suppliers. There is no conspiracy or cabal.

There has always been friction between the military and the defense industry. In 1927, Army General Mason Patrick, outraged at the $800,000 profit earned by Consolidated Aircraft in a four-year contract to supply trainer aircraft, demanded a $300,000 rebate from company president and founder Reuben J. Fleet. Fleet had invested his company’s money and future in materials and tools with no guarantee of winning the original contract. After winning the contract, Fleet had fulfilled all obligations by supplying aircraft at the agreed price and schedule. Nonetheless, General Patrick considered Consolidated’s profit to be excessive, and demanded a give-back. As an aircraft manufacturer, Consolidated desperately needed the military contract and future business, since there were no other customers who could place such large orders. A compromise was reached in which Consolidated provided the Army with 50 extra trainers, valued at a total of $300,000, at the cost of $1 each.

The transaction illustrates a turbulent relationship that endures to this day. There are only a few large defense contractors who can design and build the advanced military systems our armed forces depend on. These contractors have only one major client–the United States military. Of course, they can also sell these systems to other nations, but only with the permission of the State and Defense Departments. And those sales only materialize if the products have first been purchased by the American military. There is little international market for a military airplane, ship or tank that has been turned down by the Pentagon. Northrop discovered this in 1982 when it invested $100 million in the F-20 fighter aircraft but, despite the plane’s impressive performance, was unable to find a foreign buyer since the fighter was never used by the U. S. military.

The military, like any customer, wants to obtain the greatest value for its money–"more bang for the buck." The defense industry, like any other, wants to realize the maximum profit. This dynamic tension is part of every free-market transaction.

High costs are caused by many factors, including some shared by all manufacturers. Certainly, mismanagement will increase the cost of any product. So will labor disputes and labor shortages, as well as rising costs of materials. Electric Boat, the submarine-building division of General Dynamics, saw material costs for its Los Angeles class nuclear subs increase 83% during the inflation-heavy years 1970-1977.

The cost of weapons systems also rises when the military customer changes contract requirements in mid-production. These requirements, known as military specifications, or MILSPECS, change constantly, abruptly, and rapidly throughout the development and production process. Sometimes, as is the current case, these changes are driven by combat experience. Our ground forces went to Iraq with unarmored Humvees, since those utility vehicles were never designed to withstand small arms, rocket or IED attack. Now that these vehicles are engaged in protracted urban warfare, the necessity for heavily armored versions, is clear. New, "up-armored" Humvees, with a ton or more of extra armor protection, obviously cost more than the original models.

In other cases, MILSPECS change to reflect projected future needs. The contract that prompted the military’s recent decision to revise its contract with Lockheed Martin and Northrop Grumman concerns the Littoral Combat Ship, whose estimated cost has risen 50%. Part of this increase is due to changes mandated by the military, including a new requirement by the Coast Guard that the ship be able to survive a nuclear detonation. Complying with this requirement is not as simple as spraying the ship with an extra coat of nuclear Scotchguard. It involves hardening every major component on board, obviously at substantial additional cost.

Since development of the more advanced systems, like warships and aircraft, can stretch over years, the military understandably wants to incorporate the most advanced features into each product. The contractor also wants to provide the most advanced product, but cannot absorb the cost of continual changes, and so the price goes up. The changes slow the production process, putting the product behind schedule as well as over budget.

This vicious circle is illustrated by the development of the B-2 bomber. Northrop Grumman originally estimated the cost of the B-2 Stealth Bomber at approximately $500 million for each of 133 aircraft. As MILSPECS changed, the cost rose, and the budget did not. Thus the order was halved, but a smaller order meant that the production cost would have to be borne by fewer aircraft, and the unit cost rose to $800 million. More changes, higher costs, reduced orders, higher unit prices–the pernicious cycle ended with only 21 B-2's built, at a price of $2 billion each.

These costs seem astronomical, but the defense industry is tasked to produce systems that are a generation ahead of anything else on earth. In the case of the B-2, the military required a long-range bomber, virtually invisible to radar, capable of delivering up to two dozen precision-guided weapons against distinct targets on the other side of the world, while evading or defeating defensive measures and bringing its crew home safely. Northrop competed against Lockheed for the contract. Both contractors had to estimate the cost of an aircraft that had no equal. They would be dealing with exotic materials, new construction techniques, technology and electronics that hadn’t been invented yet, and a performance envelope that had never been achieved by such a massive aircraft. It is impossible to accurately predict the costs involved in this, or any such unprecedented program. Balanced against the B-2's lofty price is the fact that a military aircraft conceived over a quarter of a century ago, first flown in 1989, and in active service since 1993 still has no equal or close counterpart in any nation’s air force.

Whether it’s an amphibious tank with the nautical performance of a speedboat, an advanced aircraft invisible to radar, or a communications system that contacts submerged submarines by using the Earth itself as an antenna, defense contractors are creating systems that are beyond the frontiers of modern technology. They conceive, design and fabricate systems that have previously only been dreamed of.

During the Apollo space program, a giant sign stretched across one wall of a Lockheed factory exhorted workers to "Waste Anything But Time." Military contracts, especially during a time of war, have the same mandate–our troops need and deserve the best equipment in the world, and they need it now. When American forces are engaged in combat, the quality of the weapons and equipment they use must be superior to the enemy’s. That superiority often comes at a high price.

People employed by the defense industry, from CEO’s to technicians on the production line, realize that American servicemen and women trust their lives to the ships, tanks, airplanes and weapons they produce. Defense workers are hard-working, dedicated and patriotic. They take pride in providing world-class tools for American fighting men and women.

When Americans go into battle, they know they are driving the most powerful armored fighting vehicle, flying the most sophisticated war plane, sailing aboard the most advanced warship. The high price of these systems reflects military necessity. When Congress or the Pentagon experience sticker shock on a new system that meets ever-changing requirements and the highest standards , they shouldn’t punish the companies that meet those requirements and exceed those standards. Producing the weapons and technology that ensure our troops will prevail on any battlefield is not like any other business. The demands are larger, the stakes are higher, the costs are greater. But ask any man or woman in uniform–who pays the price when weapons and equipment don’t make the grade?