‘Can we actually build it?’ Defense CEOs and other leaders look ahead to uncertain 2023

SIMI VALLEY, California—With Pentagon budgets headed for a new record, defense officials and industry executives wonder: Can contractors fulfill all the outstanding weapons orders?

Defense spending could rise 10 percent in 2023, though relatively few U.S. troops are deployed in conflict zones around the world. A good chunk of the increase is meant to rush weapons to Ukrainian forces fighting off the Russian invasion and replenish the U.S. missiles, artillery, and other weapons donated to Kyiv.

But it’s not clear whether defense companies—and more importantly, the thousands of small businesses that supply them—can meet the demand, due to a confluence of worker shortages, record-high inflation, and supply-chain disruptions that have been exacerbated by a years-long pandemic and an uncertain economic outlook.

On top of that, executives say the Pentagon has been slow to award contracts to rebuild weapon stockpiles. Those that were awarded quickly were fast-tracked by top-level Biden administration officials.

This all comes as Congress is positioned to approve tens of billions of dollars more in defense spending for fiscal 2023 for new weapons for the U.S. military and Ukraine.

“The real question is, can we actually build it?” Raytheon Technologies CEO Greg Hayes said in an interview. “They can appropriate all the money, but...if we take months and months and months to get on contract, that's months and months of delay.”

Many defense firms will enter 2023 short of the workers needed to fulfill anticipated Pentagon orders to replace weapons sent to Ukraine, and to design and build new-generation weapons to counter China.

High inflation rates are pinching small suppliers, and Pentagon officials have so far been hesitant to renegotiate fixed-price contracts that are advantageous to taxpayers. On Capitol Hill, a split Congress—where Democrats control the Senate and Republicans the House—is expected to once again make defense spending a bargaining chip, as it has been over the past decade.

Nearly three months into the new fiscal year, Congress has yet to pass a 2023 budget, something that has become the new normal. That means spending is frozen at 2022 budget levels.

“The whole system has adjusted in an unhealthy way to expect that,” said Mackenzie Eaglen, a senior fellow at the American Enterprise Institute. “What you see are program officers holding cash and awards for contracts  … then there's the bulging spending at the end of the fiscal year in the last six months—and sometimes it's not spent well, because it's in a hurry.”

Lawmakers have signaled a willingness to approve more money for the Pentagon, particularly to make up for lost purchasing power that comes with inflation. Congress is poised to pass a National Defense Authorization Act OKing $45 billion more than the Biden administration requested for 2023. But until lawmakers approve an appropriations measure, that additional cash will not be there to spend.

And while the supply chain issues that companies have experienced over the past three years appear to be stabilizing, companies are still having challenges in other areas.

“The supply chain is not getting worse,” Hayes said. The company’s biggest supply chain problem is getting rocket motors, but he said the chip “supply is coming online.”

Inflation is the more pressing issue, especially among smaller suppliers who have fixed-price contracts with larger defense companies. 

“I have talked to some people in industry who are interested in equitable adjustments,” Air Force Secretary Frank Kendall said in an interview. “Most of our contracts were written in an era of pretty much stable money. So we are going to manage our way through this. I don't think it's going to be free of impact on either industry or the government. As we build budgets and as we adjust, [we'll] work Congress to try to take inflation into account and use whatever knowledge we have as it progresses.”

Raytheon entered the year anticipating increased inflation would cost the company $200 million, but that has since doubled, Hayes said. The majority of that inflationary pressure, he said, is on defense programs.

“It is so product dependent,” he said. “There's labor inflation, there's raw material inflation, there's parts shortages, … [and] it's a lot worse down in the supply chain. They're paying more for chips, they're paying more to expedite things.”

The microelectronics supply "continues to be an area of focus for us," BAE Systems Inc. CEO Tom Arseneault said in an interview. "I think that'll be a little time yet before that's back where we'd like it to be," he said.

Companies across the defense sector "have been forced to learn a lot more about our supply chains, and where the vulnerabilities are, and where the risks are," Arseneault said. 

At BAE, company officials have adapted to supply chain disruptions by shifting "the sequence in which production is done in order to allow for some of the delays we can anticipate," Arseneault said.

Energy inflation, especially in Europe, has also raised prices, Hayes said.

While defense companies have experienced similar labor trends for jobs spanning multiple sectors nationwide, aerospace and defense firms have had issues attracting workers for high-tech positions as well as skilled laborers.

"We've seen attrition start to stabilize a bit, I think the economy has probably had some impact there," Arseneault said. "I think some of the steps we've taken in order to ensure  that we're attracting [talent] and we have a culture that people want to be a part of is helping. But we'll see where things go from here. But I think things are stabilizing."

Pentagon officials have been urging companies to expand factories and hire workers in anticipation of new contracts—on their own dime.

During an early November meeting with Deputy Defense Secretary Kathleen Hicks, CEOs encouraged the Pentagon to sign multi-year contracts for the weapons, especially munitions. Bill LaPlante, the Pentagon’s acquisition chief, put his support behind the multiyear munition deals in September.

“It'll be less expensive and a lot more efficient going through the factories, and we can do it faster,” Hayes said. “The problem at DOD, I don't mean to be critical, is there's a big bureaucracy out there, and it just takes time.”

Pentagon officials say they have awarded about $6 billion in deals to re-supply weapons given to Ukraine. Army Secretary Christine Wormuth repeated that figure during a panel discussion. By comparison, the U.S. alone has pledged nearly $20 billion in weapons to Kyiv, according to the Forum on the Arms Trade.

Hayes said the main reason the Pentagon was able to quickly award Raytheon contracts for its highly effective NASAMS missile interceptors was the personal involvement by Doug Bush, a Biden administration appointee who is the Army’s top acquisition official.

“If the quantities are high enough, and you're certain enough in the production run, then I'm in favor of multi-years, whenever the economics are adequate to justify them,” Kendall said.

But even if Pentagon officials end up proposing multi-year weapon contracts, lawmakers must still bless the deals. 

Raytheon might be among the first to get one of those contracts, a five-year deal for its shoulder-fired Stinger missiles. The U.S. has sent 13 years worth of Stinger production and five years worth of Javelin production to Ukraine, Hayes said during a panel discussion at the Reagan National Defense Forum here.

Seeing the demand for Stingers, Raytheon is “going to take a little bit of a gamble” because it seems NATO and other U.S. allies want to buy the easy-to-use weapons in the coming years as well. 

“We want to be prepared to meet the demand that's out there,” Hayes said in the interview. “I wish I could snap my fingers and then all of a sudden miraculously, throw a building up and train 500 people [to build them], but it just takes time.”

Kendall, who was the Pentagon’s top weapons buyer during the Obama administration, said that the Defense Department’s stockpiles are not a “significant risk” yet, but it could be down the road. 

“I think we need to give more attention to the potential for longer conflicts, and what the consequences [are] of that and how we prepare for that,” Kendall said. “So that's a combination of stockage and manufacturing capacity that needs to be factored into our planning, more than may have been in the past.”

One possible way the U.S. could accelerate the resupplying of NATO allies is by standing up factories in Europe, to produce weapons closer to the front lines. 

“[W]e're going to need more help if we're going to really be able to divert more systems into Ukraine,” Hayes said. “This is not just a US [defense industrial base] issue. This is a NATO and U.S. [issue]—and I would go so far as to include Japan and Australia in terms of working with co-production arrangements.”

Producing weapons in multiple locations or multiple continents also creates a backup if another factory experiences problems. 

“Having allies produce some of these weapons in theaters, where they're likely to be needed, means that we can set up redundant supply chains that are trusted and secure,” Stacie Pettyjohn, director of the defense program at the Center for a New American Security, said during a panel discussion during Defense One Outlook 2023.

Both Kendall and Pettyjohn referenced Australia planning to bulk up its munition stockpiles. Hayes pointed to Raytheon standing up Patriot missile factories in Germany and Poland for interceptors bound for each of those countries. 

“This isn't all about the U.S. defense industrial base,” Hayes said. “Frankly, we need all the help we can get.”

Stateside, a Raytheon factory in Massachusetts builds about one Patriot battery per month. While the company can slightly increase the assembly time at that factory, it could use manufacturing help elsewhere.

“I think if we begin to actually try to break down a lot of the barriers that exist, and do what the [National Defense Strategy[ says is so important, where allies and partners are a center of gravity, co-production could be a really useful way to help everyone,” Pettyjohn said.

There are also benefits to standing up additional suppliers in the United States, Kendall said.

“We used to do that routinely in the Cold War,” he said. “As we get back into an era of major competitors, now we need to think about that again.”

That also means having multiple suppliers throughout the entire supply chain.

“It's not just the prime that's going to do the final assembly, it's everybody that's involved,” Kendall said. “It's multiple sources of multiple levels, potentially. We have tools to do this now. But it's working together with the primes to ensure that that supply chain is as reliable as you can be.”