Where Industry and Security Intersect
What's New | Sitemap | Search
National Security Assessment of the Cartridge and Propellant Actuated Device Industry
This assessment was initiated in December 1993, at the request of the U.S. Navy's Naval Surface Weapons Center (NSWC) at Indian Head, Maryland. The Navy's request to the U.S. Department of Commerce was prompted by concern that there may be deteriorating economic conditions in the Cartridge Actuated and Propellant Actuated Device (CAD/PAD) industry as a result of major defense expenditure reductions.
The Navy's CAD/PAD Program Office (within NSWC) at Indian Head serves as the lead service for CAD/PAD items for the Department of Defense. The Commerce Department's Office of Strategic Industries and Economic Security in the Bureau of Export Administration conducted a survey of CAD/PAD producers in 1994 to obtain needed information for the assessment. The survey was authorized under Section 705 of the Defense Production Act and related Executive Order 12656.
CAD/PADs are specialized work performing components used in many modern weapon systems. The cartridges use precisely measured propellant and explosive mixtures of varying compositions and burning characteristics that perform a wide variety of jobs within the weapon systems. They range in cost from about $1 to over $10,000 and may be purchased one at a time or by the thousands. The aerospace sector is the major user of CAD/PAD items. Many are used in life saving applications under emergency conditions. Major uses include aircrew ejection seats found on high speed aircraft, chaff and flare ejectors used as countermeasures to anti-aircraft missiles, bomb rack and missile releases, and missile fuel igniters. Commercial use has increased rapidly, especially with the advent of automotive airbag initiators, which are being phased in as a mandatory Federal safety requirement. Other commercial uses have also increased. These include mining and oil field development devices, emergency cutting tools, and fire extinguisher actuators.
The total market for CAD/PAD products increased from $288 to $425 million between 1991-1995 (up 48%) as commercial shipments expanded rapidly. Commercial shipments rose from a small base of only $78 million in 1991, to $247 million in 1995, surpassing defense shipments by a substantial and growing margin. CAD/PAD defense shipments declined sharply in both total value and in overall market share for CAD/PAD products during the period. Reported defense shipments fell from $210 million in 1991 (based on incomplete data), representing 73 percent of the overall CAD/PAD market, to $178 million in 1995, only 42 percent of the market total.
Despite growth in the overall market, most CAD/PAD firms experienced hardship during this period and did not benefit from the rapidly expanding commercial markets. The industry went through a period of consolidation which saw the number of firms active in the sector drop by one-third. Three major departures from the defense market included DuPont, Dyno Nobel, and the ICI Corporations. Also, several major mergers and acquisitions resulted in the rationalization of operations.
The expansive growth of the automotive airbag market and, to a lesser extent, other commercial markets has not been shared by all firms. Most of the benefit has accrued to several larger firms. This is evidenced by increased market concentration levels of the top four firms in the industry, which rose from 54 to 64 percent of the total market over the five-year survey period (1991-1995). This share will probably continue to grow. Most smaller firms (under $5 million) and some mid-size firms (under $20 million) did not participate in the expanding commercial sector.
Smaller firms typically ship most if not all of their production into defense markets. They usually lack the resources to develop new commercial markets, which can be very risky and may take several years to yield a return. Nearly every smaller CAD/PAD firm reported their major bottleneck to increasing defense production was the subcontracting of raw materials and parts. This is related to a shrinking number of sub-vendors willing or able to supply defense parts, increasingly smaller order quantities, lack of market power, and the high relative overhead costs associated with finding alternative qualified vendors. The end results are delivery delays and higher costs for defense.
Another market trend related to reduced defense expenditures is increased foreign sourcing. Most of the foreign sourcing is for materials that go into explosive mixtures. These materials were most often imported due to a lack of a domestic source (i.e., foreign dependencies). In addition to materials, selected parts of CAD/PAD assemblies and machinery used to produce CAD/PADs were reported as imported. With a few exceptions, these items were imported because of lower cost, better quality, or quicker delivery considerations. The foreign dependencies for rare items were also cited. These items are generally made in such small quantities that the producer requires a global market to obtain least-cost production levels.
Much of the foreign dependency/sourcing is from NATO allies (UK, Germany, France, Canada) or Japan, which are considered secure sources. While foreign sourcing increases the risk of supply interruption in wartime, in peacetime it may offer an acceptable lower cost option. Some firms have increased inventories of foreign sourced items, at least in one case, for up to a three year supply. The Navy's Indian Head CAD/PAD group reported it was reestablishing capabilities to eliminate some foreign dependencies.
The actual decline in the CAD/PAD defense market is unknown. Estimates were established by reviewing aggregate procurement outlays, which began their fall in the late 1980s, and trends in procurement authorizations for aerospace vehicles. Total Defense procurement authorizations fell by two-thirds from FY1985 to FY1995 ($135-45 billion). Procurement outlays (i.e., actual spending) peaked in FY1987 ($106 billion) and then fell by almost half by FY1995 ($54 billion). Declines in aircraft, helicopters, and missiles procurement authorizations has been even more dramatic. For example, aircraft authorizations fell from 337 in 1990, to only 55 in 1995 (down over 80 percent). Helicopters dropped from 243 to 72 (down over 70 percent). And, missile authorizations were down from 24,000 to 2,500 (nearly 90 percent). These declines perhaps overstate the impact on CAD/PADs because of the ever greater sophistication of new or upgraded aerospace vehicles. The latest models use much greater numbers of CAD/PADs per air vehicle than their older, but more numerous counterparts.
Based on this aggregate data and statements from industry representatives, in the last decade the CAD/PAD defense market fell an estimated 50 percent. Most of the decline occurred following 1991, during which time overall defense outlays fell most sharply. Defense budget cuts have undoubtedly had a negative impact on the CAD/PAD industry, just as they have on other defense industries. Only three respondents to the CAD/PAD survey reported defense cuts had no adverse impact on their operations, while 26 firms (more than three-fourths of the respondents) reported a significant to major adverse impact.
While shipments rose 48 percent to $425 million, employment in the CAD/PAD sector increased 8 percent between 1991-1995, up from 3,758 to 4,040, accompanied by significant increases in sales per employee (productivity). The share of production workers to total employment increased from 53 to 61 percent. However, declines occurred in the professional occupations, although small increases were reported in 1995 over 1994 totals. Technicians and technical services personnel fell from 544 to 476, while scientists and engineers fell from 436 to 414.
Capital investment outlays averaged about 4.4 percent of sales for the five years (1991-1995). Total investment for the period was over $78 million. Investment in defense operations was only about 20 percent of total investment outlays. This amounted to only 1.7 percent of (shrinking) defense sales. In contrast, investment in expanding commercial markets was more than 7.6 cents per commercial sales dollar. Most of the investment outlays were to add new capability, upgrade technology, and improve productivity. A large portion was also used to add new capacity for producing airbag initiators.
Research and development (R&D) outlays totaled more than $70 million for the five years. Of the total, 74 percent ($52 million) was directed into defense related activities. Indian Head contributed $22 million of this total. Of the $48 million in R&D conducted by private firms (2.7 percent of sales), 47 percent was reported as financed by the Federal Government, mostly by the Department of Defense. Additional sums came from the National Aeronautics and Space Administration and Department of Energy. Defense projects represented about 62 percent of privately conducted R&D. The top 3 firms conducted 55 percent of the R&D. Ten firms conducted over $1 million in commercially related R&D.
Profitability, based on the five-year results of 25 firms, averaged an estimated 6.6 percent. This compares favorably with average profits for all manufacturing of 3.7 percent, but was exceeded by the general chemical industrial sector. Industry profits tumbled to their lowest level in 1994 at less than 2 percent, which coincided with the lowest level of defense shipments. Seven firms reported losses that year.
Several factors may be at work to reduce future profit levels. For example, several firms commented that competition in the CAD/PAD sector is sharper now that the industry has consolidated; the remaining firms are leaner and more aggressive. Also, commercial markets in general tend to be stingy. The motor vehicle companies are forcing all of their suppliers to reduce prices and improve quality. This has already affected the airbag companies by driving costs and prices down with increased production volumes. Moreover, the smaller defense market has become more competitive.
Financial analysis of the CAD/PAD sector was made difficult by incomplete data. Only 13 firms provided balance sheet items (total assets, current assets, and current liabilities) for the CAD/PAD portions of their business. For this group the 1993 current ratio (current assets/current liabilities) was 3.44 (all manufacturing was 1.4); the current to total asset ratio was .62; and the asset turnover ratio (sales/total assets) was 1.3 (all manufacturing was 1.1). These ratios indicate the CAD/PAD sector taken as a whole carries large inventories, has relatively high variable costs, and is labor-intensive. The larger CAD/PAD firms exhibit almost the opposite of these characteristics. With higher fixed costs, larger firms are more vulnerable to business fluctuations.
Competition in the CAD/PAD industry has intensified, in many cases driving prices down near or below costs. The shrinking defense market has forced some firms to terminate operations, and nearly all others to consolidate production. The wave of mergers and acquisitions that occurred in the last decade allowed the industry to both rationalize assets and position itself in emerging commercial markets. Stronger firms that acquired or merged with former competitors managed to maintain, and in several cases, actually increase market share.
While the overall number of competitors has been reduced, this is offset by the increased aggressiveness of the remaining businesses. Opportunities for market share are available to the supplier that places emphasis on increased product performance and reduced cost. More than 40 percent of the firms surveyed believe their competitive prospects will improve in the next five years. However, 31 percent are pessimistic about their future prospects.
Foreign competition is not a major problem in defense markets because of the pre-production qualification tests, transportation costs, and specialty nature of the product. As for airbag initiators and other commercial products, U.S. firms have taken the lead and currently export far more than what is imported.
In February of 1995, CAD/PAD survey participants received an information package from BXA to make them aware of export opportunities for current CAD/PAD products. A brochure was enclosed entitled "Export Programs: A Business Directory of U.S. Government Services" as well as an order form for another BXA publication entitled "Pacific Rim Diversification and Defense Market Assessment: A Comprehensive Guide for Entry into Overseas Markets" (a European guide is also available). The letter urged the survey participants to take advantage of the current Government programs designed to assist manufacturers in developing and expanding export market opportunities.
Several non-economic issues also adversely impact the CAD/PAD industry. These predominantly involve government regulations concerning the environment, worker safety, and the transport of hazardous materials, export barriers, and small business set-asides. Another issue is government competition with private industry.
Environmental and safety (OSHA) regulations: About 60 percent of the respondents cited environmental and worker safety regulations as contributing to increased operating costs. Because the market is shrinking, these CAD/PAD firms have difficulty passing on increased operating costs. The most commonly mentioned areas of concern were the disposal of hazardous waste, which now must be off-site, and prohibitions on ozone-depleting substances. As for worker safety, the biggest cost is ventilation systems that remove toxic fumes from the shop floor.
Classification of shipping: Nearly half the respondents described a lengthy and burdensome approval process to transport explosives for non-government contracts. CAD/PAD manufacturers must obtain a recommendation for classification from the American Association of Railroads, Bureau of Explosives (a private industry association), or from the Interior Department's Bureau of Mines. The recommendation is forwarded to the Department of Transportation, Office of Hazardous Materials, which issues a "letter of competent authority" to the manufacturer, who may then ship the product.
CAD/PAD firms reported the Bureau of Explosives lacks the resources to provide this service in a timely fashion. In extreme cases it has taken about a year. The Bureau of Mines typically provides the service in 1-3 months, but the fee is often excessive, ranging up to $450 to over $6,000, and the schedule unpredictable and insensitive to firm's planning. The Office of Hazardous Materials is currently issuing letters of competent authority to shippers in about one week. The Agency is also attempting to lessen the burden on industry by permitting items to be classified by grouping, worst case, or blanket classifications for like items.
Export Market Issues: Nearly half the respondents also commented on barriers to exports. CAD/PAD products are controlled under authority of the Arms Export Control Act administered by the U.S. Department of State. CAD/PAD manufacturers must register with State and apply for an export license when shipping to foreign destinations. Several CAD/PAD firms mentioned that the license review process is inordinately cumbersome and time consuming, and needs simplification. Licenses typically take 3 months to a year to obtain. Export opportunities have been lost because of delays or denials of export licenses. It was suggested that restrictions should be removed where competitors in NATO member countries can export the same product with few or no restrictions.
Export barriers also come in the form of foreign government subsidies. It was mentioned that Canadian and Israeli competitors receive subsidies on certain items from their governments enabling them to bid below U.S. producers. It was also reported that a Belgian competitor was able to eliminate international shipping expenses by utilizing government supplied military air transports.
The Small Business Set-Asides: All purchases under $25,000 are automatically set aside for small business. Contracts over $25,000 may also be set aside for small firms when two or more bids are likely to be received from responsible small businesses. In addition, section 8(a) of the Small Business Act permits small, socially and economically disadvantaged firms to receive non-competitive Federal contracts.
Problems arise when some small businesses receive a certificate of competency from the Small Business Administration without possessing sufficient capability to fulfill CAD/PAD contracts. Certification allows the firm to compete for and win CAD/PAD bids even if that company is found unqualified by DoD. The concern is greatly magnified because aircraft safety and human lives often depend on the performance of CAD/PAD products. CAD/PAD quality control must be of the highest level. Also, the taxpayer may ultimately be charged up to three times the fair value for these CAD/PAD items, while defense requirements for the items are delayed and sometimes compromised.
Several of the survey participants indicated the set-asides encourage non-competitive firms to remain in business, thereby stifling competition. Also, due to increased competition for DoD contracts, legitimate companies are forced to bid too low to provide sufficient profit margin. Many former defense suppliers are now focusing on commercial business because they can no longer afford to maintain the high quality standards and reduce profit margins in order to compete for defense contracts. The procurement regulations compel DoD to purchase CAD/PAD items on a lowest bid only basis. Several firms suggested "best value" procurement should be practiced where high quality at a fair market price are the qualifying factors.
Government competition with industry: This issue has become more contentious to the parties involved with the decline in defense requirements. Twenty-five of the 35 CAD/PAD survey respondents reported the Federal Government was competing with them in at least one of three areas. These three areas include production, product acceptance testing, and research and development. Industry claims all three areas could be accomplished faster and less expensively by private firms. Indian Head maintains that a "core" DoD CAD/PAD capability has inherent benefits to the national defense. It ensures: 1) a warm base, 2) retention of skills and the technical knowledge to produce and handle CAD/PAD items, and 3) provides insight into the production processes and technology of CAD/PADs that helps channel scarce research money to where it is needed.
The Government Accounting Office (GAO) investigated claims of unfair government competition in 1993, under Office of Management and Budget (OMB) Circular No. A-76. This circular established Federal policy regarding the performance of commercial activities by government entities. The circular also sets forth conditions where government performance of a commercial activity is authorized. These exceptions include: 1) the manufacture of mission essential items; 2) acceptance testing; 3) depot maintenance; and 4) research and development.
GAO did not find "unfair" competition by the Government. However, GAO recognized that duplication of production facilities is an added cost to the taxpayer. In view of this fact, GAO emphasized the need for ongoing evaluation of the necessity for maintaining core capabilities and the cost of facility duplication.
Between 1991 and 1995 the Government operation at Indian Head reduced CAD/PAD employment from 379 to 276 (down 27%), while production fell steadily from $2.9 million to $1.5 million. Indian Head production in 1995 accounted for less than 1 percent of total defense CAD/PAD production.
In separate conversations with OMB, BXA analysts sought to further clarify the exceptions criteria cited by GAO. An OMB representative reported Circular A-76 is a "policy statement" by the Office of the President of the United States that seeks to achieve the lowest cost for the taxpayer in government procurement. It is not a legal requirement backed by legislation. In brief, the policy refers to products uniquely for
defense that: 1) cannot be contracted to a private firm(s), or 2) that can be produced less expensively in-house by the Government than by a private firm.
The issues of environment, worker safety, small business set-asides, classification of shipping, exporting, and government competition with industry require more discussion and cooperation between various government agencies, and input from private CAD/PAD firms. Indian Head's CAD/PAD program officials have the strongest interest in the long-term health and survival of the CAD/PAD industry; they are the obvious candidate to spearhead initiatives in these areas.
Indian Head should organize regular meetings, perhaps on a quarterly or semi-annual basis, to discuss these and other issues in an open forum. The meetings could also provide an opportunity to provide the CAD/PAD industry with multi-year forecasts of defense requirements, and brief the industry on technical developments, new requirements, and other matters. Representatives from other government agencies could attend these meetings in give and take sessions to educate the industry on new matters, invite industry input, and seek ways to resolve problems.
Indian Head can also do several things unilaterally. For example, it could institute longer-term procurement commitments that would help induce cost-saving investment, streamline production, improve quality, reduce administrative overburden, and promote on-time delivery. Longer-term contacts would particularly benefit smaller CAD/PAD companies in terms of market strength to bargain with their subvendors, investment, and the retention of skilled employees.
Additionally, Indian Head should consider contracting out a greater portion of R&D to help the CAD/PAD industry retain skilled labor, and further promote dual-use technologies. Lastly, Indian Head could establish commercial transportation classification capability at Indian Head as agreed at a meeting with the Department of Transportation and Department of Interior in 1994. Indian Head already has expertise in CAD/PAD products and could reduce the lengthy process time by offering shippers an alternative testing site.
BXA's Office of Strategic Industries and Economic Security should provide the list of CAD/PAD industry subvendors to Indian Head and send the subvendors the BXA Competitive Enhancement and Defense Diversification Needs Assessment survey. To encourage defense diversification efforts, BXA is conducting a needs assessment of the defense sub-contractor base. Firms are being surveyed by BXA to determine what government services will be most useful to them in diversifying their operations. The information collected will be used to direct