Gen. Thomas S. Moorman Jr., USAF (Retired)
Vice Presidentm Booz·Allen & Hamilton Inc.m McLean, Virginia
BEFORE THE SUBCOMMITTEE ON SPACE AND AERONAUTICS OF THE HOUSE SCIENCE COMMITTEE
MAY 15, 2001
I. INTRODUCTION
I am pleased to be here and discuss the state of the US Space Industrial Base and present a few thoughts on how to sustain and foster the U.S. space
industrial base over the next two decades.
National space policy directs that the United States maintain its leadership by supporting a strong, stable and balanced national program that serves
our goals in national security, foreign policy, economic growth, environmental stewardship and scientific and technical excellence.
To these ends, the policy directs the Department of Defense and Intelligence Community to assure that critical capabilities for executing national
security space missions are maintained. This requirement includes all stages of research, development and acquisition.
Since the dawn of space age, senior policy makers across the federal government have recognized that a strong U.S. space industrial base is a critical
strategic asset. Our government has also understood the importance of the people and companies that design, develop and manufacture satellites
and launch vehicles for defense and intelligence missions.
The past decade has seen significant changes to the people and companies that comprise our space industry. New requirements, industrial
acquisitions and mergers and recent space system contract awards have altered the industrial landscape. Major manufacturers of space hardware —
General Dynamics, General Electric, McDonnell Douglas, Rockwell and Hughes — have exited the business or merged into other firms. As this
consolidation has occurred, satellite and rocket lines in New Jersey, Pennsylvania, California have been closed and many of the engineers and
technicians have moved on to other industries.
This transition is somewhat ironic, since users at all levels of the U.S. national security establishment are increasingly dependent on space-enabled
data to achieve information superiority. The reduction in players also occurs as the U.S. prepares to replace virtually all of its current constellations
of national security satellites over the next 10 to 12 years.
Another significant evolution of the past decade has been the changing environment in the commercial space sector. Despite some setbacks, the
commercial space sector is still likely to grow over the next decade. However, the bankruptcy of Iridium and well-publicized struggles of other new
space ventures have tempered some of the more exuberant projections of commercial space advocates. The most recent announcement of
ORBCOMM’s filing for Chapter 11 is just another example in this litany. While I am convinced that commercial space solutions will become an
increasingly important element of national security space activities, this evolution will be slower than many of us expected a few years ago.
There also will be increased international competition. Therefore, commercial ventures must offer world-class capabilities which are technologically
advanced and priced right to compete in global markets.
In this changing environment, two fundamental questions arise:
1. Is the current and projected U.S. space industrial base sufficient to meet national security requirements for the next 15 years?
2. Will there be adequate competition and innovation within the industry?
To help understand these questions, Dr. Jacques Gansler, the Under Secretary of Defense for Acquisition, Technology and Logistics and Mr. Keith
Hall, the Director of the National Reconnaissance Office tasked my firm, Booz Allen & Hamilton to conduct an independent assessment of the U.S.
Space Industrial Base. I was privileged to lead this study along with Jimmie Hill, the former Deputy Director of the NRO, who I am sure many of you
know.
When we began our study, Jimmie Hill and I expected that most of our efforts would focus on choke points for critical subsystems and components –
such as radiation-hardened parts, travelling wave tube amplifiers, solar cells, and space qualified atomic clocks. While we did identify and address
several component areas of concern, as the study progressed, we came to realize that the space manufacturing sector – along with the broader defense
and aerospace industrial base – faced far deeper and more profound challenges.
I believe that the results of study I led answer a significant portion of the two questions that you posed in the official letter of invitation.
1. Will trends in the space industrial base support current and emerging national security and civil space programs?
2. What tool at the government’s disposal should be used to influence trends in the commercial marketplace?
II. THE CHALLENGES
Ouir study concluded that U.S. firms still hold technical and market leadership in spacecraft production and satellite system integration. Some
indicators remain positive but the U.S. space industry faces challenge on a number of fronts. I want to concentrate on these challenges for the first
part of my talk.
I think there are four challenges that warrant your attention. The four challenges are: uncertain financial performance, production over-capacity, a
loss of independence in corporate research and development, and an impending crisis in that most precious of economic assets, human capital.
(a) Uncertain financial performance
For the next few minutes, I want to discuss some financial indicators that individually are disconcerting, but when taken as a whole are quite
troubling. Let me apologize up front by saying there is a lot of statistical data here, which after a good lunch may try your powers of concentration. I
am always mindful that sleep in a legitimate form of feedback. But I hope I can keep your attention, especially the government folks, because you
rarely hear about business metrics.
In a “macro” sense, the industrial base for national security space programs clearly exists within a larger defense and aerospace industrial base. Over
the past two decades, the defense industrial base has responded to dramatic shifts in U.S. Government spending on national defense. With the end of
the Cold War, defense spending has declined in real terms to levels that are approximately 40 percent lower than peak spending during the
mid-1980s.
The negative trend has been even more dramatic in spending for force modernization. Funding for modernization — which I would define as the
total of spending on procurement and research, development, test and evaluation – rose dramatically in the early 1980s and then entered a long and
steady decline. With the beginning of the new millennium, the modernization budget has begun to show more positive signs. In real terms, the
investment budget in 2005 is projected to be 19 percent higher than the post Cold War low, which occurred in 1998. I hope these numbers are
realized.
An even more meaningful macroeconomic indicator for U.S. space manufacturers is the Return on Sales (RoS) performance during the last two
decades. RoS is a measure of operating income divided by revenues. During the last 20 years, the performance of defense and aerospace firms
declined slightly when measured in terms of pre-tax RoS. Within this larger segment, the RoS for “space” segments initially tracked with the RoS for
the total aerospace and defense sector. The trend lines diverge in the mid 1980s and the space sectors show a decrease in Return on Sales from a
typical return of approximately 8.5 percent in the early 1980s to an average value of approximately 6.5 to 7.0 percent in the last seven years.
1999 was not a good year for space sales due to factors such as launch vehicle accidents, write-offs caused by the bankruptcies of two mobile satellite
service ventures and cancellation and delays in the construction of satellites for two Asian customers to name a few. These events have driven the
RoS figures down to new lows. 2000 should show a rebound, nevertheless the figures for this year should be around 6.5 percent. (This is being
updated with end of the year figures that we do not yet have)
The most recent drop in RoS comes in the wake of long-term erosion in asset turnover (the measure of sales divided by average identifiable assets) in
the space industry. This decline began in the late 1970s when the industrial base began to transition manufacturing from government-owned
contractor operated facilities and equipment to contractor-owned production assets. With this transition, the business risk for new and unique
facilities was transferred from the government to the contractor. Thus, the space sector became more like the broader aerospace and defense sector.Â
Like the aerospace firms, the space enterprises sustained their asset turnover in the early 1990s through consolidation of facilities.
The combination of gradually decreasing return on sales coupled with a decreasing asset turnover has led to a steadily decreasing “space” Return on
Assets (RoA). RoA is defined as operating income divided by average assets. The team’s analysis revealed that RoA for the space industry is
currently approaching the rates of return for U.S. Treasury securities, which obviously carry far less investment risk. Additionally, some space
manufacturers currently carry a BBB- bond rating, indicating that these companies must pay 11 percent interest rates on new loans.
The summary from a business perspective is the difference between “space” RoA and the cost of new money means that the corporate boards, in
representing the interests of stockholders, are having an increasingly difficult time in justifying investment in space ventures.
In addition to declining returns on assets, several companies who include key segments of the space industrial base are carrying substantial debt.Â
Much of this debt was incurred during the mid-1990s, as these companies participated in a number of acquisitions and mergers. The good news is that
while the debt is large the companies are working to reduce their total debt. The need to service this debt, combined with lower cash flow resulting
from decreasing returns on sales, has reduced interest coverage ratios (a measure of the firm’s cash flow after debt service) for several leading
aerospace firms.
This increased financial stress due to declining RoS, RoA and interest coverage ratio is reflected in the comparatively poor performance of aerospace
and defense stocks. Over the past four years, the performance of diversified aerospace and defense stocks have been relatively flat while the
NASDAQ stocks have increased five-fold. To be sure, the prices for defense stocks have improved in the last several months due to a variety of
factors not the least of which is the flight of money from the “dot.coms” to more mature companies; nevertheless, the fundamental financial issues
remain.
So, What are the bottom lines for space industry financials? There are two:
1. The prospect of flat aerospace budgets, decreasing returns, increased risk, and increased debt load make it difficult for US aerospace and defense
firms to justify investments in new space design and manufacturing capabilities.Â
2. The low rates of return also help explain the recent decisions of some firms to divest segments of their companies in favor of other business
opportunities.
(b) Production Overcapacity
The space industry has significant production overcapacity. There are a string of factors which have produced in this overcapacity. To name a few:
The result is an excess capacity today of approximately 50 percent. This excess satellite production capacity increases the overhead rates in our
spacecraft manufacturing as well as depresses the net profitability of US satellite manufacturers.
In launch, the global market for launch vehicles currently operates at approximately 35 percent excess capacity. Excess capacity will grow over the
next three years as Europe continues the transition to a new generation of larger Ariane launch vehicles and the US introduces the Evolved
Expendable Launch Vehicle. By the middle of the decade, worldwide launch capacity could be more than twice projected demand under a
conservative scenario. Using an unadjusted projected launch demand, it is estimated that overcapacity will be approximately 41 percent. When
demand is adjusted downward based on the historical actual versus projected launch percentage,– we launch an average of 75 percent of the manifest
on an annual basis — excess capacity increases to 56 percent.
So, we have a difficult business case and overcapacity. A good next question is: What is the prognosis for improved products and market
expansion? Or reworded: How are we doing on R&D?
(c) Loss of Independence in Corporate R&D
Throughout the Cold War, the national security community made extensive investments in government contracted research and development.Â
However, spending on space related, government contracted R&D began to decrease as the government was recognizing the peace dividend.
To compensate for the long-term decline in government funding and to improve their chances to win near term contracts, space prime contractors
have spent an increasing share of their own Independent Research and Development (IRAD) funds on near-term satellite development. Hoping to
score against a dwindling array of program opportunities, companies agreed to align or formally “warrant” their corporate IRAD against specific
projects. According to our survey, truly independent IRAD decreased in the years from 1996 to 2000 from 75 percent of the total IRAD to
approximately 23 percent of the total. Today, IRAD – the acronym for independent research and development, could be spelled with a small i, a little
bigger r and a capital D.
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While this switch from independent to more program specific IRAD helps individual program mangers stay within tight budgets, the diversion of
funds away from longer-term projects reduces the technical capabilities of firms over the longer term — our seed corn. This problem could become
particularly acute as the stock of innovations resulting from past research is exhausted and program managers must either rely on incremental
advances or fund dedicated technology development programs. Additionally we found that research and development funding levels have a direct
effect on our fourth macro-challenge “attracting and maintaining the best and brightest.”
(d) The Impending Crisis in Human Capital
Our discussions with the leadership of 21 space companies underscore the fact that human resources issues are the largest long-term problem the
industry faces. Even as companies continue to consolidate, the stock of human capital has been declining sharply. The industry faces significant
operating risks resulting from the lack of key program management skills at the middle management level as well as lack of interest from college
recruits because of the increasing perception of aerospace as a slow-moving industry.
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Our study concluded that the space industry is observing the leading edge indicators of a major problem in the next decade. The “graying of
aerospace” is suggested by several statistics:
Departure of key talent could be especially worrisome in 10 years, as scientists and engineers now in the 45 to 49 year-old group begin to retire from
the workforce and are replaced by a smaller pool of less experienced personnel. If present trends continue, many space primes may lack the critical
mass of talent required to design and integrate complex national security spacecraft.
The redirection of corporate R&D away from longer-term research also affects this industry’s ability to attract and retain “the best and the brightest”.
The negative perception of a “boom and bust” space industry is exacerbated by the relative lack of cutting edge information technology. Engineering
students in the “next generation” still dream of missions to Mars and starships. However, Sputnik and Apollo – galvanizing experiences for many of
us — are now subjects rushed through at the end of the course on American history.
The increasing perception of space as a “smokestack industry” is supported by the following facts:
offers to fill vacancies.
Furthermore, there is a large increase in foreign-born US science and technology degree seekers. Today, approximately 45 percent of advanced
technical degrees go to foreign nationals. While high rates of foreign diploma holders at the graduate level have been the norm for some time,
what’s more unsettling is the fact that 37 percent of undergraduate technical degrees go to foreign students.
In citing these statistics, I don’t wish to sound xenophobic. Our nation draws much of its greatness from the contributions of immigrants. However,
those women and men who elect to become Americans often cannot immediately work on many national security space programs. Moreover,
foreign born scientists and engineers are returning to their native countries in numbers greater than in the past.Â
Additionally, even the talented American students who are attracted to the industry become difficult to retain due to high demand in other sectors.
 This problem is most acute in computer science and software engineering disciplines.
While other manufacturing industries also face the challenge of competing against high technology “dot.coms” for talent, space firms also face the
more unique problem of a bi-modal distribution of scientific and engineering talent. According to company human resource managers, the
relatively small number of people with ages between 35 and 44 years reflects the departure of many mid-level engineers to other industries. This is
partly due to the fact allowable compensation on space contracts is often tied (or even government-mandated) to the calculation of an average within
the aerospace sector. The trends are not limited to the scientific and engineering workforce but are similar across all functions.
III. THE WAY AHEAD
I believe the health of the industry needs people’s attention. Fortunately, there is progress and I am glad to say that several actions are already
underway within the U.S. Government. However, there are also opportunities for both industry and government to further improve the situation.
Changes to internal DOD management practices can help stabilize funding and improve cash flow. Earlier this year, the Defense Contract
Management Agency eliminated the “paid cost” rule removing the requirement for large prime contractors to pay their subcontractors before
including the payment in their billings to the Government. This change is a very significant and useful first step. Other areas being examined such as
automation of payments and increased progress payments – would further improve the business case in the boardroom.
Changes at the accounting level are also being paralleled by changes in higher-level acquisition policy. The new versions of these “5000 series”
documents call for “full consideration” of industrial base impacts and guidance to ensure “reasonable rewards” without “undue risk” for contractors.
The revisions also instruct service and agency acquisition executives to consider the effects of specific acquisition and budget decisions on future
industrial competition.
Perhaps most importantly, the guidelines would allow firms to recover the cost of bonuses to attract and retain staff with critical technical skills.Â
Contractor “bench strength” could also be enhanced if allowable labor rates in government contracts were calculated to consider prevailing salaries
paid to engineers in the information technology sector. This would help aerospace firms in efforts to keep staff with software and systems
integration expertise.
I have talked about some things that have been set in motion. What are some additional things that government and industry can do to further
address the macro challenges?
First and foremost, there is a need for a closer partnership between the government and industry—a partnership which recognizes different
perspectives. By and large, the national security community is budget driven and organizations manage their programs by monitoring industry’s
performance against cost, schedule and capability specifications in a contract. Â Industry, by contrast, is price driven and uses a variety of metrics to
evaluate financial performance, including return on assets, return on equity and share price appreciation.
With the advent of the “New Economy” based on advanced computing and telecommunications technologies, managers of defense and aerospace
firms must first show their shareholders and directors that they can offer equal or superior value in terms of return on investment and assets. While
such bottom line considerations are now more critical than ever in shaping firm’s decisions on bids and program management, the DOD and the
Intelligence Community do not generally consider the aggregate financial health and performance of the industrial base in shaping its acquisition
policies.
Let me illustrate the gap between these two cultures with a personal example. In the 13 years I had the privilege of serving as a general officer in the
Air Force, much in space acquisition and acquisition oversight roles, I received only one briefing on general financial metrics – the language of the
boardroom and Wall Street.
Of course, program managers should continue to focus primarily on contract performance, however, the acquisition executives and legislators who
oversee defense programs must be cognizant of important corporate financial metrics. In addition to considering publicly disclosed financial
information on the overall health of firms, DOD should assess the financial health of specific defense manufacturing sectors.
I believe that the financial health of the industry mandates a closer partnership between the customer and supplier. This partnership must be based
upon improved communications, and a mutual appreciation of the challenges facing both sides. On the government side, this means developing an
understanding of the Defense marketplace and a sensitivity to market demands and pressures. I think industrial base issues must be a part of the
strategy for new acquisitions. I also think that financial or business metrics must be a more integral part of the training of our acquisition people at
the Defense Systems Management College. Government as well as industry must share in the responsibility for failure and success.
I think we also need to be mindful of the trends in IRAD. Policy changes should reverse the trend of using IRAD to buy down risk on individual
programs. While this won’t make life easier for some program managers, it would ensure that the national security space program isn’t “eating its
seed corn.” Keith Hall’s steadfast advocacy at NRO of more R&D funding is a good example of the type of leadership that’s needed throughout the
federal government.
However, we need to acknowledge that the competition for top-notch human resource talent will not let up in the near-term and could well worsen
as demand increases for computer science, systems integration and web-development skills from both dot.com startups and larger IT companies.Â
Both government and industry need to develop a better understanding of the dynamics of the human resources (HR) marketplace. Efforts in this area
could include programs to involve staff in cutting-edge technology research, greater use of internships and scholarships, and more attractive
compensation mechanisms.
I’d say that if people is your No. 1 problem, then you must include your HR executives in strategic planning and strategic decision making. You also
must demand that your HR team not be just folks who recruit and develop or just folks who can only measure their performance in terms of equal
employment opportunity goals. Those are important functions, but HR departments also must be able to describe the broad trends in qualitative
terms. It’s not enough to know that attrition with the 35-44 age group is X percent; you also need to understand the impact of this attrition in terms of
staff quality productivity and, ultimately, mission success. Our study group found significant shortcomings in these areas. Simply put, many
aerospace firms are not using best practices to become “Employees of Choice.”
This hearing is about raising consciousness. The health of the space industrial base is important to the nation. The answers aren’t simple, but it
deserves all our attention. Thank you.
