July 5, 2007
Supply Squeeze Has Pentagon, US Industry In Tough Spot
Rebecca Christie - Dow Jones Newswires

PARIS (Dow Jones)--The Pentagon has decided that mine-resistant troop transports should get top priority to tap the U.S. supply of armored steel, in what could be the first of many tough industrial decisions for U.S. defense officials as the war in Iraq drags on.

Business is booming for makers of military aircraft and armored vehicles. But the supply base hasn't grown as quickly as demand. This led Defense Secretary Robert Gates to invoke Pentagon privilege for the multibillion-dollar Mine Resistant Ambush Protected vehicle program, which now gets first access to steel plate, heavy-duty axles, military-grade tires and even skilled welders, the Defense Department said this month.

The move shows U.S. industry's exposure to a small group of key suppliers, and it raises concern that companies won't be able to get the materials they need.

This is particularly acute for defense companies because of regulations requiring U.S. content for Pentagon projects, said Jeff Pino, president of United Technologies Corp.'s (UTX) Sikorsky Aircraft Corp. unit.

"I'm really concerned about the supply chain," Pino told reporters in Paris last week. "I do think it's a problem for national defense."

When supplies run short, the Pentagon has to choose among its own programs, as well as weigh potential commercial disruptions. For now, the new mine-resistant transports, which will take time to build and ship to Iraq, will get priority over other combat vehicles that are already fielded and could be upgraded faster. This makes for tough tradeoffs, said Jeff Green, a former House Armed Services Committee staffer who now runs J.A. Green & Co., a Washington government-relations consulting firm.

"It's still a zero-sum game," Green said. "What's going to save more lives? Is it armor kits on Humvees and Strykers now, or is it rapid fielding of MRAPs?"

The Defense Department says it is working through these issues. When it gave top priority to the MRAP vehicles, it used a "DX" rating from the Defense Priorities and Allocations System, which the Pentagon and the Commerce Department use to manage critical resources, in an effort to be clear about which vehicles it wanted most.

"Armored steel production is going to be the issue," said Bill Greenwalt, the Pentagon's deputy undersecretary for industrial policy, in an interview. "We have a process in place to manage these conflicts."

For now, defense officials don't expect any commercial disruptions. The MRAP program mostly competes with other military programs for resources, not with automobiles or other civilian industries.

Titanium would be a different story, because of its importance to the U.S. aerospace market. The Defense Department hasn't so far invoked its priority for programs that depend heavily on that specialty metal, Greenwalt said. Even so, industry already faces a big test.

At last week's Paris Air Show, U.S. companies said they are already dealing with supply crunches for specialty metals and other essential materials.

Castings, forgings, bearings and other key components are in tight supply, said Richard Millman, chief executive of Textron Inc.'s (TXT) Bell Helicopter unit.

Suppliers are looking to maximize profits now, without risking a crash down the road. This translates into long waits for materials, and higher costs because even long-term contracts bring little bargaining power, he said.

"The engine guys need it, the helicopter guys need it, everybody needs castings and forgings," Millman said in an interview at last week's Paris Air Show. "The suppliers are reluctant to add capacity. They think it's a bubble."

Millman said he spent much of last week meeting with suppliers, in hopes of cementing Bell's ties to its outsourcing base. Bell is staring down a big production surge because the Pentagon plans to buy more than 1,000 of the company's helicopters and tilt-rotor aircraft in coming years.

Analysts say the Pentagon wasn't prepared to manage the industrial surge associated with long conflicts like those in Iraq and Afghanistan. By commandeering steel for the MRAP vehicles, even if they aren't now the best strategic investment, the Pentagon can atone for its initial failure to provide enough armored vehicles for ground troops, said defense analyst Daniel Goure of the Lexington Institute, a Washington-area think tank.

"This is a matter of the Pentagon running scared," Goure said. "If you're going to stay in Iraq, there's a damn good reason for doing it, and even if you're not, there's a political reason for doing it. At least you can't be blamed for anything that happens."

Foreign suppliers present another set of challenges for Pentagon and industry planners. Some countries have reciprocal agreements with the U.S. on military materials. Others don't, like France - home to Michelin (12126.FR), the world's largest tire maker and a key supplier for U.S. armored vehicle makers.

In addition, U.S. defense companies must contend with a barrage of regulations aimed at protecting the U.S. domestic supply chain. In an age of global outsourcing, this can bring unexpected headaches for U.S. firms trying to follow the rules.

The U.S. Marines said last week that rising costs for specialty metals will lead to higher-than-expected prices for the V-22 Osprey tilt-rotor, made by Bell Helicopter and Boeing Co. (BA). Other aerospace companies face an extra time crunch as well as a growing financial burden.

Boeing would like to shrink the nearly three years required to build a C-17 cargo jet, said Boeing program manager Dave Bowman in an air show interview. But the wait times for titanium and other specialty metals are, if anything, lengthening.

"That's our single biggest challenge," Bowman said.

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