U.S. Government Procurement - Fragmented Operations, Policies

Factors besides competition affect the HPE and HPEC sectors. One of the most important is the federal government. The U.S. government is the customer, partner, competitor, and regulator in these industries. Firms have to comply with follow regulations developed by the Departments of Defense, State, Commerce, and Transportation; the Environmental Protection Agency; and others.

Environmental Regulations - Loose Rules Overseas May Skew Competition

The production and use of HPES and HPECS creates hazardous wastes. In many cases, the HPES themselves are hazardous materials, capable of contaminating the environment. Environmental regulations over the past 30 years have become stricter for U.S. companies and this trend will most likely continue. Compliance adds to the cost of production, making it more difficult for firms to compete internationally in the HPE and HPEC markets with nations that may not have the same level of regulation.

Operating costs for some U.S. HPE and HPEC operations may escalate in the future as companies have to bear the cost of cleaning up contamination at their sites. The energetic materials sector, including HPE and HPEC manufacturers and particularly the government-owned and/or operated facilities, does not have a strong record of environmental stewardship. This potential for incurring higher cost is affirmed in the Energetic Materials Environmental Study published by DoD's Strategic Environmental Research and Development Office. The study found that government facilities were slower to address environmental issues than the private sector.

A key policy question that DoD top management and munitions procurement officials must consider is whether it is appropriate for the department to buy HPES from foreign suppliers that may have environmentally "dirtier" manufacturing operations and as a result of those operations gain a cost advantage over U.S. firms.

Future of the Industries - Prospects Mirror Curve of Declining Demand

Respondents were neutral to optimistic about their own future, but pessimistic about the future of their industries. Many HPE and HPEC producers stated that their individual prospects in the next five years would remain the same or improve somewhat. When the respondents spoke of the future of their industries as a whole, however, they used descriptions such as "bleak" or "very poor" because of the declining demand for their products and reduced R&D spending.

Several survey respondents predict that more consolidation will occur within the HPEC industry in the future. To some extent, this activity is healthy to the extent that it brings stability to DoD's supplier base. Three recent mergers, in fact, are viewed by some industry executives as having increased the capability of the suppliers to provide more complete product solutions to the U.S. military.

Recommendations

Issue 1. - Research and Development

Research and development spending has been falling in the HPE and HPEC industries, according to DoD and BXA data. Since 1989, RDT&E spending has fallen 45 percent. According to current projections, DoD support for munitions R&D will plunge another 50 percent to about $820 million by 2005. This decline represents a historical shift in support for munitions R&D. The munitions RDT&E budget is falling from approximately four to six percent of the total DoD RDT&E budget (1986-2000) to about 2.4 percent by 2005.

Anecdotal and survey evidence collected by BXA suggests that the HPE and HPEC industries could suffer a major loss of engineering and scientific talent in the next 10 to 15 years due to declining defense funding and a graying workforce. BXA recommends that DoD take the following steps to reverse this trend:

Recommendation A

DoD should restore munitions funding to its 14-year average of between four to six percent of overall RDT&E spending. This level of spending would come much closer to providing the resources required for maintaining a culture of innovation within federal and private research facilities. Higher funding levels are essential if DoD is to retain existing professional staff and is to develop new technical talent.

Recommendation B

DoD should establish a $10 million-a-year, competitive research grant program that would be open to U.S. industry and U.S. government research organizations. Both organizations can enlist U.S. research universities in their research program, when it is deemed necessary. This program should be designed to bolster basic and early-applied research capabilities with the goal of developing new and improved energetic materials to meet national security needs.

The scope of the R&D program should be determined by a multi-service panel, which includes at least two representatives of the U.S. HPE industry and two members affiliated with top research universities. Research grants can be for one, two, or three years, depending on need. An expert peer-review panel should award these grants on a competitive basis. This funding should be used to supplement (not replace) funds normally spent by industry and government on munitions related R&D. The R&D grant program should target specific engineering and scientific challenges identified by the multi-service panel at the outset of the program.

Recommendation C

There should be an expansion of R&D efforts funded under DoD's ManTech Program to support the munitions community's pursuit of process improvements that promise product performance gains, safe process and materials handling, methods for reducing manufacturing costs, and ways to lessen manufacturing-related environmental impacts.

Issue 2. - Purchasing of HPEs from Non-U.S. Sources

In the 1990s, DoD procurement officials increasingly purchased their HPES from cheaper foreign sources instead of U.S. suppliers, principally HSAAP. The procurement decisions reduced production volumes at HSAAP -- and drove HSAAP's overhead costs and product prices for HPEs even higher. Consequently, even more defense procurements were shifted away from HSAAP.

While DoD procurement officers are supposed to consider "best value" factors in making their purchasing decisions, their deliberations appear weighted in favor of product pricing. Potentially less restrictive environmental rules in some countries may give foreign suppliers a pricing edge in procurements. U.S. suppliers may also be disadvantaged by temporary swings in financial markets, which elevates the dollar relative to other currencies to unusually high levels.

Recommendation A

Procurement officers within DoD should comply with requirements that they consider economic, trade, industrial base, and environmental factors affecting U.S. suppliers of HPEs in making price-based decisions in awarding supply contracts to foreign vendors.

Recommendation B

DoD should not allow supplier acceptance of trade offset obligations to be a deciding factor in the scoring and selection of HPE suppliers.

Recommendation C

DoD should investigate whether a "Buy America" provision is needed for HPEs to ensure a responsive U.S. manufacturing base. The department should consider establishing a minimum tonnage threshold for annual purchases for U.S. HPE suppliers. A technical advisory panel should determine the level of domestic production that is adequate to maintain the economic and technical health of the U.S. HPE manufacturing sector-and to guarantee that national security requirements can be met.

The "Buy America" provision would only activate when annual purchases dropped below this threshold and would be deactivated when DoD purchases exceeded the threshold by 5 percent. DoD would be free to buy HPEs from foreign suppliers except when domestic manufacturers' volumes drop below the threshold level. In no instance

should DoD be prevented from buying from foreign suppliers those explosive materials and compounds that are not available from domestic manufacturers.

Issue 3. - Recycling of HPES (Opportunity and Challenges)

One third of the respondents to the BXA survey expressed interest in the concept of recycling HPEs. The recycling of HPES is consistent with the intentions of the September 1998 Executive Order 13101, which mandates greater use of recycled material in all government operations, including munitions.

Currently, several firms are developing processes to remove HPEs from warheads and rocket motors. Many technical issues, however, need to be resolved before recycled HPEs can be used in military applications. In addition, recycled HPES could adversely affect the economics of producing virgin HPE material at HSAAP by reducing production volume to less than acceptable levels.

Recommendation

The Department of Defense should form an industry/government panel consisting of engineering and manufacturing experts to investigate the utility of recycled HPEs in defense applications. This panel should examine and report on the technical challenges, economic opportunities and impacts, environmental liabilities, and related safety issues associated with recycling HPEs. This panel should deliver a final report to DoD within 18 months.

Issue Role of U.S. Government-Owned Manufacturing Capacity

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The U.S. Army owns significant manufacturing capacity within the HPE and HPEC sectors. A U.S. law, called The Arsenal Act10, requires that the Army manufacture its supplies (including HPES and HPECs) in government-owned factories -- presuming the plants can manufacture the item on an economical basis. In 1998, the U.S. Army published what appears to be a contradictory instruction, the Industrial Base Policy Letter 98-1. It states that the Army should rely on the private sector for its ammunition needs and transfer government manufacturing assets to the private sector "to the maximum extent feasible." The goals of the Army's 1998 policy letter do not appear to be fully compatible with federal law.

Recommendation

The U.S. Army should either amend or eliminate its Industrial Base Policy Letter 98-1 to produce consistency with the Arsenal Act; or it should seek legislative action by the U.S. Congress to amend or eliminate the Arsenal Act.