Where Industry and Security Intersect
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The United States’ supplier base for high-performance explosives and related components -- products essential to the defense of the nation -- has been operating under increasing stress since the late-1980s. Reduced production orders and lower revenues have made it difficult for both federal government production facilities and private companies to maintain their full capabilities.
It is critical that the United States be an innovator and leader in the HPE and HPEC industries -- and it maintain a broad capability to manufacture compounds and components. To remain competitive in the field, both technologically and in manufacturing know-how, forward-looking management will be required of U.S. government agencies and of private-sector suppliers.
Manufacturers of high performance explosives (HPEs) and high performance explosive components (HPECs), whether U.S. government-owned production operations or private companies, face a number of challenges in the years ahead. Munitions R&D dollar spending been falling for the past 10 years, and will continue to fall another 50 percent by 2005, according to Defense Department projections. Munitions R&D is also falling as a percentage of the overall Defense R&D budget. In addition, some manufacturers report an aging of their workforces—a phenomenon that is found in these organizations’ research laboratories as well as in their production facilities.
For the moment, the nation does not face a supply crisis in HPE and HPECs. But if the United States is to retain sufficient explosive production capacity for the future, greater thought must be given in the next few years on how to maintain infrastructure—in terms of manufacturing facilities, trained personnel, and R&D.
This study examines these matters and other factors affecting the HPE and HPEC industries. The recent history of these industries as well as future needs are covered in the report, which looks at a range of issues, including:
The HPE and HPEC industries are small. The 33 organizations responding to BXA’s survey had combined HPE and HPEC shipments of approximately $513 million in 1998 and employed approximately 7,900 people in the United States. These organizations were located in 17 states, with the most numerous concentrations in California and Tennessee.
While U.S. manufacturers of HPECs were relatively successful from 1995 to 1999, the nation’s largest supplier of HPE was in crisis, a situation that affected both the company’s federal government and private customers. The U.S. government-owned Holston Army Ammunition Plant (HSAAP), which dominates HPE production in the United States, lost many of its customers. The reason: rising product prices attributed to high overhead expenses and reduced demand for its HPE products.
Department of Defense (DoD) weapon systems program managers reacted to these higher prices by finding cheaper foreign alternatives. As a result, HSAAP’s overhead problem grew bigger because rising costs were spread over a smaller customer base, which drove prices even higher.
In 1998, the U.S. Army solicited bids for a new supplier of HPEs. The Army selected Royal Ordnance (a part of Great Britain’s BAE Systems) as the new manager for its underutilized HSAAP facility.
Production was stopped except for a few items. The result of this “shutdown” and change of contractor was a 55 percent reduction in HPE shipments. During this time, it appears that the vast majority of the weapon system programs that left HSAAP bought their HPEs from overseas vendors located in Norway and Sweden.
Royal Ordnance, the first foreign contractor to manage HSAAP, immediately began reorganizing the government manufacturing facility’s operating structure, lowering costs, and significantly reducing prices for HPEs. Royal Ordnance is currently trying to win lost customers back as contracts expire.
In contrast, private U.S. manufacturers of HPECs experienced an upward trend during the mid-to late-1990s. Shipments from these producers, as measured in dollars, rose 12 percent from 1995 to 1999. However, all is not well for U.S. HPEC producers. As might be expected, the spending downturn at the Department of Defense over the last 15 years has reduced the HPEC sector’s capital investment. It has lagged the rest of U.S. manufacturing for over 10 years, according to Census Bureau data.
The Department of Defense munitions budget funds both the HPE and HPEC industries. The budgets for munitions procurement and for R&D have fallen substantially since the mid-1980s. According to DoD, from 1986 to 1998, procurements of munitions (the primary finished product for HPEs and HPECs) dropped 81 percent. This steep budget decline caused firms to leave the HPEC business, resulting in consolidation of the remaining suppliers. Procurement expenditures for munitions by DoD are expected to stabilize at between $4.3 and $4.6 billion a year from 2002 to 2005. This level of spending should help stabilize the remaining firms in both the U.S. HPE and HPEC industries as long as the majority of contracts are awarded within the U.S. industrial base.
R&D expenditures are an investment in the future. However, since its 20-year high in 1989, DoD spending on munitions research, development, testing, and evaluation (RDT&E) has fallen nearly 45 percent. According to current projections, RDT&E spending on munitions will plunge another 50 percent to about $820 million by 2005.
What makes this issue even more serious is that munitions RDT&E is also falling as a percentage of DoD’s overall RDT&E budget. Munitions RDT&E was between four and six percent of the overall DoD RDT&E budget from 1986 to 2000. After 2000, however, the munitions portion shrinks to about 2.4 percent of the overall defense RDT&E budget. This reduced investment in RDT&E may slow innovation and hinder the ability of the United States to field cutting-edge munitions technologies.
Reduced RDT&E spending will almost certainly degrade the ability of firms and government organizations to hire and retain scientific and technical staff. Drastic budget cuts will send a loud signal to the chemistry and physics communities that there are few opportunities in the field of high performance explosives. Scientists and engineers will simply vote with their feet—opting to “follow the money” to financially healthier areas of research.
Potentially serious employment issues with scientists, engineers, and production workers await the HPE and HPEC industries in the next decade. As the BXA survey results and anecdotal evidence suggest, a generation of HPE and HPEC workers are expected to retire in the next 10 to 15 years. It is uncertain whether this approaching loss of workforce knowledge will be avoided.
If R&D initiatives and workforce skills erode, then there will be a reduced capability of the HPE and HPEC industries to deliver to DoD effective and innovative munitions in the future. DoD and industry officials must start planning now for replacing an aging workforce.
Production of HPEs and HPECs in the United States is divided between facilities owned (and in some cases operated) by the U.S. government and facilities operated by private industry. The government-owned facilities were constructed before and during World War II and have the capacity to make very large amounts of products. These plants have been used during times of prolonged conflict (World War II, the Korean War, and the Vietnam War), but often their capacities have been underutilized or unutilized during times of peace.
Most government-owned, contractor-operated (GOCO) plants currently run at low workloads compared to their total capacities, raising the GOCOs’ expenses and increasing the cost of items produced. However, these federal production facilities are the only plants capable of replenishing the stocks of certain types of ammunition and ammunition components used by the armed forces. Department of Defense policy requires the replenishment of ammunition stocks within three years of a major conflict.
GOCOs compete at times against the smaller and sometimes more agile contractor-owned, contractor-operated facilities (COCOs). While providing similar products, frequently at a lower price, COCOs cannot manufacture items in the volume needed in time of war. These companies also lack the capacity to replenish the U.S. stockpiles of particular munitions to mandated levels within the required three years.
With greatly reduced defense spending, there are fewer orders for both GOCOs and COCOs to win. GOCOs, with their larger overhead, often find it difficult to compete against the prices offered by the smaller COCOs. COCOs often view military orders awarded to GOCOs not as contracts that are awarded because of best price but as an effort to keep GOCOs in business.
No other producer, in the United States and possibly the world, can manufacture the variety and the quantity of explosives that HSAAP can produce. Since taking over operation of the complex from the Holston Defense Corporation, the previous GOCO operator, Royal Ordnance has brought down the price of HPEs substantially. The new operator delivers bulk HPEs to the Army at a fixed price, and offers competitive contracts for HPEs to other DoD weapons systems programs.
To achieve this turnaround, Royal Ordnance has reduced overhead expenses, reconfigured the production plant, changed HSAAP’s organizational structure, and leased out space on the facility site to commercial tenants. As a result, the economic viability of HSAAP is improving.
As with HSAAP, commercial U.S. manufacturers of HPEs have been hurt by cutbacks in government orders. These private companies are very small compared to HSAAP and they focus on manufacturing HPEs for specific applications: unique military products, oil exploration, and focused research and development programs. Shipments from these producers fell almost 21 percent from 1995 to 1999, with one producer accounting for most of the drop.
Shipments of high performance explosives decreased nearly 55 percent from $78.9 million to $35.6 million from 1995 to 1999, according to the BXA survey. The primary cause of the decrease was the cutback in production and subsequent temporary closure of HSAAP. The outlook for future HPE shipments is uncertain. Royal Ordnance is challenged with winning back lost customers who turned to foreign suppliers, principally in Norway and Sweden.
Unlike HPE production in the United States, which decreased substantially between 1995 and 1999, shipments of HPECs stayed level or increased slightly with sales climbing nearly 12 percent to $441 million as compared to $394 million in 1995.
Skilled employee issues are among the most difficult challenges facing this sector. Work with HPEs is inherently dangerous, especially on the production side, where large amounts of energetic materials can be involved. The safety concerns alone call for an experienced, well-trained work force. In addition, the unique manufacturing talents of the process operator historically have influenced the quality of HPEs and HPECs.
The result of the early 1990s “peace-dividend” for many in the U.S. HPEC industry has been the lowest level of employment seen since 1963. When these munition industries downsize, they frequently retain older workers, running the risk of losing talent when a generation retires. Anecdotal evidence collected through interviews with corporate executives and government officials who work in the munitions sector suggest that some “brain drain” of scientists, engineers, and production workers has already occurred in both the HPE and HPEC communities.
Survey respondents report that some of the most troublesome bottlenecks, which prevent manufacturers from achieving full production, are labor related. If all of the labor issues (labor availability, labor training, and expertise) reported by the respondents are combined, they may constitute the industries’ most significant challenge -- and could require the greatest amount of time and money to solve.
Investment information collected by the Bureau of the Census and BXA shows a lack of new investment in the HPEC community. Census data indicate that private sector producers of HPECs are not investing in their operations on par with the rest of U.S. manufacturing.
Before recovery in 1997, HPEC industry capital expenditures had fallen 84 percent from its peak in 1988. While the rest of U.S. manufacturing has achieved capital expenditure growth from approximately $5,500 to $7,500 per employee for the period of 1988 to 1996, the HPEC industry’s capital expenditure growth was comparatively miniscule, fluctuating at approximately $1,000 to $2,000 per employee.
All of the armed services have steadily cut spending on R&D for munitions (which includes HPEs and HPECs) in recent years. DoD funding for research, development, testing, and evaluation (RDT&E) for munitions is expected to continue on a downward slope. By 2005, DoD RDT&E spending is projected to be 70 percent below 1989’s peak funding level of $2.8 billion.
The funding reductions break the historical support patterns for munitions R&D at DoD. Munitions RDT&E is falling as a percentage of DoD’s overall RDT&E budget. Munitions RDT&E averaged four to six percent of the overall DoD RDT&E budget from 1986 to 2000. By 2005, however, the munitions portion is expected to sink to about 2.4 percent of the overall Defense RDT&E budget.
R&D spending by BXA-surveyed private companies and GOCOs engaged in manufacturing HPEs and HPECs fell 12.3 percent from 1995 to 1999. Outlays for HPE and HPEC R&D by federal agencies plummeted nearly twice as much – by 23 percent. The decline in R&D has damaging effects. It not only slows the development of new materials and munitions, but it also limits the ability of firms to hire and retain scientific staff to work on R&D projects.
While overall support for R&D is falling, some private HPE and HPEC companies continue to try to leverage their limited R&D budgets. Six firms within the HPE and HPEC industries have established relationships with seven universities to undertake joint R&D projects. The majority of these projects were sponsored exclusively with company funds. Most of the firms that have collaborated with universities plan to collaborate again if a worthwhile project materializes. At least one firm has funded research at multiple universities.
HPE and HPEC producers have experienced various difficulties exporting their products. The causes for exporting delays come from both the purchasing nations and the U.S. government. Some countries require approved export licenses for proposed sales and mandate that shipments must be delivered by the purchaser’s ships rather than by carriers chosen by the U.S. producer. As a result, shipping delays can occur, which can produce cost increases and reduce cash flow for U.S. manufacturers. Other survey respondents reported that their firms have been forced to comply with defense trade offset agreements required by foreign governments, a market-distorting trade barrier that can significantly erode profits of U.S. producers and undermine their economic viability.
Munitions trade with Canada is another area of concern for the U.S. industrial base. Canada has special access to the United States’ defense market through bilateral agreements. In many cases, Canadian companies are treated like U.S. firms. Canada is even considered a part of the U.S. technological and industrial base by DoD. American HPEC companies, however, do not have the same access because of restrictive procurements by the Canadian government. In addition, U.S. companies are often penalized by having to enter into offset agreements on their sales to Canada.
HPE and HPEC producers face delays in receiving export licenses, which can prompt customers to consider foreign sources of supply. Survey respondents urged that the United States government expedite export licenses, and they requested that the Departments of State and Commerce practice more uniformity in their licensing procedures.
Many nations are capable of producing HPEs and HPECs. European manufacturers (Sweden and Norway being the most prolific suppliers) of HPEs are the strongest competitors to the United States’ primary source of HPEs -- HSAAP. Several European producers surveyed by BXA have not reduced production of HPEs as much as HSAAP – and in one case, have increased production. These firms have been able to sell more of their products in the U.S. due to the rise in HSAAP’s HPE prices starting in the mid- 1990s and its temporary closure in 1998. HSAAP’s shipments declined approximately 55 percent from 1995 to 1999 because of these two factors.
Most European manufacturers have small home markets for their products and are looking to exports as a major source of revenue. One of their main target markets is the United States. Future market penetration by foreign manufacturers of HPEs is expected to be deterred by the competitive prices now offered by HSAAP.
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.
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.
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.
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:
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.
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.
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.
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.
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.
DoD should not allow supplier acceptance of trade offset obligations to be a deciding factor in the scoring and selection of HPE suppliers.
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.
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.
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.
The U.S. Army owns significant manufacturing capacity within the HPE and HPEC sectors. A U.S. law, called The Arsenal Act, 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.
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.