At the Pentagon, Competition Is No Panacea : Defense: The government came up with a system of designed to cut weapons costs. Critics say it has boosted them.

Forcing some old-fashioned competition on the defense industry seemed like the perfect solution to the Pentagon’s longtime problem of weapons that cost too much and don’t work the way they’re supposed to.

But the government’s bright idea has turned into a mess. And now, top Pentagon leaders are trying to scale back competition in the defense industry, acknowledging that it’s hard to tell whether competition has saved or lost money. Many experts are convinced that the policy has wasted hundreds of millions of dollars.

Inept contractors won awards with low-ball bids and then failed to perform as required. Some quality contractors got out of the defense business, running from bidding battles that seemed sure money losers.

By mandating competition, the Pentagon pushed defense firms to expand when the industry already had too much capacity. As a result, some companies are now saddled with higher costs and are scrambling to sell assets at fire-sale prices.

Critics fear that the competition campaign has discouraged the best contractors from engaging in costly but vital research for fear that the Pentagon will turn over their secrets to other firms that can then compete with them.

“I don’t think there was a single remarkable success in competition,” said Robert Costello, a former undersecretary of defense who tried to undo the policy until he retired last year. “The policy has been a money loser.”

Although the Pentagon’s policy was called competition, it didn’t fit any traditional definition of the term. Rather, it evolved into a system known as “dual-source procurement.” Two companies competed to see which had the lowest price and, largely on that basis, the Pentagon would split the business between them.

The ultimate results were perverse: Contractors learned that they could often fare better by losing competitions.

In some programs, the winner would receive only 60% of the orders. By bidding high, some firms figured they could reap higher profits on the remaining 40%. Also, winners often must shoulder the money-losing task of developing a new weapon, only to have to share the design with a competitor.

Benefits Unclear

“I have heard many people say, ‘How do you finish second in a competition?’ because they did not want to take on the risk and the cost of developing a product,” Deputy Secretary of Defense Donald J. Atwood said. “They would rather be a follower, where all of the design is given to them. That clearly is not the way to go at all.”

Pentagon budget cuts and shrinking weapons orders make the competition policy more questionable than ever. Producing at a lower rate with the same size facilities means higher prices. Competitions that were set up at a cost of billions of dollars will have to be scrapped.

The Defense Department has never tallied--across all of the military services or even within a single service--whether its competition policy has produced a net benefit or loss to taxpayers.

“It would be hard for me to say,” Atwood said, that there has been a net benefit. “Clearly, from what I have looked at, we have used dual-sourcing to our own disadvantage--our own being both industry and the government’s disadvantage,” he said. “And we need to look at it very carefully before we continue to use it in the vein it has been used previously.”

The decision by Atwood and Defense Secretary Dick Cheney to scale back dual-source competition marks a major reversal in procurement policy and amounts to a repudiation of the system implemented by Reagan Administration appointees. Former Navy Secretary John Lehman became the most outspoken advocate of competition in the early 1980s, and in 1984 Congress mandated competition in major programs when it enacted the Competition in Contracting Act. Current law presumes that dual-sourcing is always best and requires a detailed explanation when it isn’t used.

Last month, however, Cheney and Atwood sent a legislative package to Congress that would provide for dual-sourcing to occur only on a case-by-case basis and only when justified, providing flexibility to the Secretary of Defense.

However, critics say, the turnabout comes too late--well after so much waste has occurred.

“It is locking the barn door after the horse has gotten away,” said Michael Beltramo, a defense industry consultant specializing in competition analysis. “This will not begin to undo the damage to the industrial base. It has screwed the system up to the point where recovery is a long way off.”

Excess capacity is a problem that will dog the industry for years. Once production begins, the orders are often barely enough to keep one factory operating efficiently. Running two production lines, critics contend, assures inefficiency.

The policy of competition was based on unrealistically high assumptions about future weapons purchases. The Reagan Administration projected in 1985 that defense spending would rise to $500 billion by this year; the figure turned out to be $291.4 billion.

General Dynamics, for instance, built a factory nearly the size of six football fields in Rancho Cucamonga in the mid-1980s to produce 1,000 Stinger missiles a month. But future orders are likely to require only one-third of that. Not only has the Army cut back its order, but it has split it between General Dynamics and Raytheon, which was drafted as a “competitor.”

Now, General Dynamics is scrambling to cut overhead at the plant. “I have at least twice the capacity I need,” General Dynamics Executive Vice President Ralph Hawes said in an interview last December. “I have to get into less space.”

Double Costs

Hawes argues that decreases in program budgets and cutbacks in actual weapons production have sharply reduced any theoretical payoff from dual-source procurement. “If you start cutting quantities in production, the price goes up.”

Atwood acknowledged that dual-source competition created such problems. “In too many cases, we have taken the approach that having two sources is good by definition. In cases where the total quantities hardly warrant one efficient line of operation, then, indeed, to go dual-sourcing can be very penalizing because you end up with two factories, two sets of tooling, two overheads and, obviously . . . that is all double cost. Any benefits of dual-sourcing get lost.”

But within the procurement bureaucracy, where several thousand people are employed solely to promote competition in arms purchases, the dual-sourcing policy is still revered.

In its most recent report on competition, the Navy boasted that during the past five years dual-sourcing had produced “significant cost savings.” A record 60.6% of Navy procurement dollars was awarded competitively in 1989.

Rear Adm. William Hauenstein, the Navy’s competition advocate general, said in an interview: “People ask, have we taken competition too far? Well, that is in the eye of the beholder. I believe not.”

The Navy and other services have shown cost savings on a program-by-program basis by comparing weapons prices before competition and after it. But that method often ignores the cost of setting up a second producer and other factors.

For example, once competition became widely implemented, some contractors set up separate divisions to bid on competitive programs and left other divisions to continue non-competing programs. The firms then loaded overhead, such as research and development costs, onto the non-competing divisions and unburdened the competing ones.

Although it appeared that prices had dropped at units involved in competition, the Pentagon was paying for research and development costs elsewhere. Moreover, the Pentagon was paying for overhead on two separate divisions.

Critics also argue that purported cost savings from competition are based on faulty price comparisons. Weapons prices are typically highest early in a program. That’s because, as production speeds up, fixed costs are spread over more units and firms increase efficiency as they learn how to produce an item.

Often, dual-sourcing was instituted only after the first source had been in production for a few years. So when prices dropped, it appeared that competition was working. The Defense Department’s Inspector General has argued in a series of audits since 1988 that the military services have exaggerated their savings from competition.

“The military departments have claimed in their annual reports to the Congress that dual-source competitions resulted in substantial savings to the government; however, these claims lacked credibility,” one audit asserted. “Significant dual-source investment costs were routinely excluded from such computation, and inaccurate methodologies were used to compute net cost benefits.”

Expensive Procedures

In their savings claims, military bureaucrats neglected to include $2.2 billion spent just to set up competitions in 23 major weapons programs, the audit found.

For example, the Navy claimed that it saved $339 million by having General Dynamics compete with Raytheon for Sparrow missile production contracts. But the Navy didn’t include the $338 million it spent to set up production at General Dynamics. Moreover, it based its estimated production savings on only four of 11 contracts awarded, the audit found.

“Having two sources for these things is not cheap,” Derek J. Vander Schaaf, deputy inspector general, said in an interview.

One thing military managers failed to anticipate was that competition would attract unqualified companies.

Olin Industries, the nation’s largest ammunition maker, received some rude lessons in Pentagon-style competition. The Army selected Olin in 1985 to compete against Honeywell in production of 30-millimeter ammunition.

Olin received a “technical data package” from Honeywell, describing the round. Olin decided to build most of the components itself, including the casing, propellent, primer and projectile. But it chose to subcontract the fuse, the trickiest part.

Honeywell was the only producer of 30-mm. fuses, but Olin wasn’t about to rely on its competition. So, it turned to Sooner Defense of Florida Inc., a now-defunct company in Lakeland, Fla. Sooner immediately had production problems, even though it had all of Honeywell’s data describing the fuse.

“The fuse wouldn’t work,” said Edward Geoghegan, Sooner’s chief executive, who is now in the plumbing business. “There are little, subtle things that aren’t provided to the second source.”

Wayne Coloney, a consultant to Sooner, said the problem involved manufacturing know-how that could not be transferred. “Producing a workable fuse is as much art as it is science,” Coloney said.

Sooner is liquidating itself under bankruptcy laws, and the Army says it has lost $20 million that it paid Sooner for fuses it never received.

Fewer Contractors

Olin, which also reportedly lost several million dollars, declined to answer questions about the cost of the fuses. But Coloney and others indicated that fuse costs have soared far above what Honeywell was originally charging. Meanwhile, Honeywell decided to get out of the ammunition business by spinning off its operation into a separate entity. Ford Motor, once a major ammunition firm, has liquidated its operation, and many experts say that foreign ammunition firms have targeted the U.S. market.

“Unwise second-source competition is one of the reasons that led many companies to leave the defense industry in the 1980s,” said James Blackwell, a defense expert at the Center for Strategic and International Studies in Washington. “There is a very real danger that corporate America is going to walk away from defense, and we are going to be left with a very few, very large firms that are only in defense. Then, we will be stuck with (President) Eisenhower’s military-industrial complex.”

A study by Blackwell found that of the 118,489 defense firms operating in 1982, 60%, or 80,482, had left the industry by 1987.

Not only has dual-source competition failed at the subcontractor level; it also looks like a bust at prime contractors.

The Navy decided in 1984 that it wanted a second source for its F-404 jet engine, which is used to power the F/A-18 Navy attack jet. So it took blueprints and manufacturing data created by General Electric, which designed the engine, and handed them over to GE’s archrival, Pratt & Whitney.

After funding Pratt & Whitney with an estimated $300 million, the Navy abruptly and without explanation dropped the competition last August, though it ultimately ordered about 215 of the company’s engines. Vander Schaaf, the deputy inspector general, said most of the $300 million went to just building the facilities at Pratt & Whitney to produce the F-404.

“That is the one I hold up as an example of something that did not work,” Vander Schaaf said.

The competition between GE and Pratt & Whitney created serious concerns, not the least of which was forcing GE to divulge its manufacturing processes to a key competitor.

“The whole thing was immoral,” said competition expert Beltramo. “We only have two U.S. firms that build jet engines, and they compete in the commercial marketplace. To force one firm to give its manufacturing technology to another is just crazy.”

A GE spokesman said the Navy has ordered questions about the F-404 competition to be referred to the Navy. Officials at the Naval Air Systems Command wouldn’t comment.

The transferring of technology in the F-404 program raises what may be the most troubling consequence of dual-source competition, critics say. Since the government owns the rights to the design and drawings of its weapons, it asserts the right to share that information with any manufacturer it wants.

The effect has been to penalize the firms with the best technology and reward those that are short on advanced technology. And as some firms have concentrated on being second-source production specialists, many observers worry about who will conduct the research and development necessary to be primary sources. Ultimately, the nation may be left with too many low-cost producers unable to develop new weapons.

“We must not destroy the defense industrial base or the defense technology base,” said Atwood, the deputy secretary of defense. “That is something of great concern. If we end up spreading our procurement so thin that people without the technology capability are surviving . . . we will tend to lose the kind of companies we want to keep.”

But some Pentagon critics fear that the dual-source competition frenzy has done just that at the moment when the United States does not need a lot of cheap weapons but does need the very best defense technology.

“They traded technical development capacity for a cheap-o production capacity,” Beltramo said. “But that isn’t what we need. Now, we need an ability to skip a generation of production and push development.”