By Ugurhan G. Berkok
A rule of thumb for the sustainment cost of military platforms is that the sustainment-acquisition costs ratio is in the order of two to three – more like three for land systems and then two for air and naval systems. Beyond such budgetary implications, since sustainment is as crucial an input as the equipment itself into operational capabilities, many questions arise for the acquisition of sustainment services. Is sustainment to be provided in-house by the military, by the original equipment manufacturer (OEM), or by third parties that could be domestic or foreign firms? If foreign firms provide sustainment services, should offsets be imposed?
Stepping outside the traditional concepts, sustainment can be international, such as in the cases of C-17 Globemaster, OCCAR and JSF, or whole capability can be privatized, as in some UK capabilities, thus shifting all sustainment decisions, bundled with the capability’s equipment, to the private sector.
The traditional sustainment paradigm consisted of comparing in-house capability to outsourcing, where the choice is between the original equipment manufacturer (OEM) and another private contractor. Outsourcing is typically part of offsets arrangements for countries other than OEM’s country of origin. It depends typically on four factors.
First, a necessary condition for outsourcing is the potential for cost savings. This presumes that specialized firms, domestic or OEM, can provide sustainment at a lower cost than in-house provision by exploiting scale economies, especially in the case of OEMs, which also enjoy an advantage due to their expertise on the equipment they developed and manufactured. The procuring country may negotiate further savings at this stage due to its stronger bargaining power at the time of purchase by bundling the equipment with a long-term sustainment contract.
Second, an outsourcing decision is not independent of the form of outsourcing, as most countries perceive domestic contractors as more advantageous in terms of developing industrial and technological capabilities beyond the period of the sustainment contract.
Third, on the downside, operational interruption as a risk factor is incorporated into outsourcing decisions, as only an in-house capability is fully integrated into operational capabilities.
Finally, as another risk factor, the erosion of an in-house sustainment capability upon outsourcing may also undermine the smart buyer capabilities for subsequent acquisitions.
Contractual issues in traditional sustainment
Sustainment outsourcing requires detailed long-term contracts; since investment in specific assets is inevitable, lengthier contracts will thicken the field of potential bidders. Since markets for defence equipment manufacturing and sustainment are typically thin, performance incentives must be reinforced by such proactive contractual measures as on and off ramps.
Whereas on-ramp provisions may thicken the field and bolster the competitive field, off-ramp provisions may set the stage for contract termination upon poor performance. This off-ramp incentive bites, especially towards the end of the contracting period where the contract weakens to provide performance incentives due to a shorter horizon with a smaller potential for profits, and possibly to a lack of lucrative subsequent contracts. From the firm’s perspective, if off-ramps are used repeatedly and the contract is frequently re-tendered, the risk to purchasing specialized equipment rises and generates a reverse hold-up problem. Moreover, if a firm is likely to lose at re-tendering, it may cancel repairs or delay investments.
Other major contractual challenges are related to issues of contract management such as asset specificity, hence hold-up and underinvestment. Relational contracting in long-term relationships refers to trust as a lubricant of transactions and hence as improving efficiency.
First, longer-term contracts facilitate for building trust to alleviate the asset specificity problem. Second, performance evaluation over longer periods may reduce the need for direct monitoring of contractor effort. Third, if contractor rotation is reduced, then contract management costs fall. Fourth, if good performance can be rewarded with contract extensions, the effort incentive problem can be alleviated. Finally, if cost savings are realized at the expense of reliability and punctuality, operational readiness may be jeopardized – hardly a desirable trade-off.
Experience in allied countries
Australia is spatially isolated from its major allies. Thus domestic sustainment capabilities for all equipment prove indispensable due to operational readiness requirements. This presents a problem, since they import most of their equipment and most sustainment is performed by firms that are not OEMs. They must, therefore, acquire IP rights at the time of procurement in order to service their equipment. Australian sustainment does not differ from the experience of other Western countries in NATO and elsewhere. For instance, with a wide spectrum of OEMs, France mostly performs its own sustainment, but is otherwise open to foreign OEMs for equipment France does not manufacture.
The United Kingdom stands apart in that it has been experimenting with a non-traditional capability development and equipment sustainment strategy. Four of UK’s numerous defence Private-Public Partnerships (PPPs) will be briefly described. UK’s Strategic Tanker Aircraft (Airbus A330s owned and operated privately, but leased by the military when needed.), Strategic Sealift (purpose-built transport and supply ships), Field Electrical Power Systems and Heavy Equipment Transporters are the four capabilities which introduced hitherto unknown organizational changes into the UK military.
Instead of outsourcing sustainment of capability equipment, British forces outsourced whole capabilities, personnel and equipment combined using long-term contracts. The private parties running these capabilities are consortia typically including OEMs. Compared to traditional outsourced sustainment where equipment is just plug-and-play equipment, UK’s PPPs are plug-and-play capabilities with sustainment bundled up with personnel.
JSF project and sustainment
Precursors to the JSF project are the European OCCAR and the worldwide C-17 Globemaster sustainment programs. Under OCCAR, members (Belgium, France, Germany, Italy, Spain, and the UK) and participants (Finland, Sweden, Netherlands, Luxembourg, Poland, and Turkey) cooperate in sub-groups, sustaining their equipment without necessarily collaborating as the whole group. Comparative advantage dictates the sustainment provider and the latter is typically the OEM’s country. However, for the heavy transporter A400M, sustainment is provided by the contractor winning the tender, which decides where the work is carried out. Spare parts are shared across countries. Sustainment teams from different countries receive common training. Cross-country maintenance exploits economies of scale.
Under the original Global C-17 Sustainment Partnership (GSP) between Boeing and its C-17 customers, Boeing had overall sustainment responsibility, including spares stocking and distribution, depot maintenance, performing the repairs, overseeing the supply chain and providing technical and engineering support. Later, from 2011, the United States Air Force took over the lead as an in-house sustainer, while Boeing remained part of this new program C-17 Global Integrated Sustainment Program (GISP).
In the successful spares pooling under C-17 GISP program, foreign partners did not have major design and industrial stakes in the development and production of the aircraft; moreover, their fleets are relatively small. Thus, the USAF has maintained common configuration by requiring all partners to make all of the upgrades and modifications that the USAF makes. Upon parts shortages, the USAF’s Air Mobility Command allocates scarce resources. Shirking or a partner failing to fund its share fully has not been a problem, as those fleets are small. By contrast, the F-35 partner nations have major design and industrial stakes in the development and production of the aircraft, and the disparity in fleet sizes is significantly lower than for the C-17.
The United States (for Air Force, Navy and Marines), Australia, Canada, Denmark, Italy, the Netherlands, Norway, Turkey, and the United Kingdom have been the full partners for development, manufacturing and sustainment of the F-35. In 2012, they agreed that F-35 sustainment assets (spare propulsion systems, support equipment, and all air system spares) would be pooled globally and centrally managed by the F-35 production support manager, but kept at spatially distributed maintenance, repair and overhaul (MRO) sites.
Since then, participating countries and the JSF Program Office (JPO) have developed rules governing the allocation of scarce parts, what happens when a partner cannot fully fund its share of program costs, how the program will manage divergence from a common configuration baseline and, finally, how to allow participants to opt out of the global pool and establish (and be willing to pay for) its separate stock of assets. This global pool generates savings from the need to stock fewer total spare parts than if all participants operated separately because of non-simultaneous variations in demand for spares, particularly for high-cost parts with a low failure rate.
This F-35 pool diverges from the successful C-17 version with a dominant role for the USAF; no U.S. service has primacy over spares allocation decisions, and no U.S. service dictates configuration management as in C-17 version. Thus the F-35 spares pooling arrangement may replicate problems encountered in earlier collaborative fighter efforts, such as in Tornado or Eurofighter. Thus from the U.S. perspective, three distinct risks have been identified.
First, ensuring the security of supply and prioritizing the allocation of scarce spares resources; second, configuration management and control, and managing technology innovators versus laggards; and third, managing “shirkers,” or those participants unable or unwilling to pay their agreed share to the spares pool. Whereas shirking was not a serious problem in previous programs, the first two may be difficult to avoid. Although, they were successfully avoided in the C-17 program due to the fact that the USAF played a dominant role.
Furthermore, since partners’ F-35 fleets are allowed to diverge in configuration, contract incentives for the prime sustainment contractor have to be tailored to various fleets (in terms of performance metrics and priorities) so that these fleets are serviced with the same priority as the larger U.S. fleet. Though, approximately 80 per cent of parts being identical across the three JSF versions, maintenance and logistics will be simpler overall and, of course, more economical than sustaining different classes of aircraft.
Yet the price tag for sustainment and operational costs hover around $1 trillion over the JSF project’s estimated lifetime. Underlining the difference between the Joint Strike Fighter project and its predecessors, the prime contractor, Lockheed Martin, will be responsible for global delivery of F-35 sustainment for all of the F-35 customers under a Performance Based Agreement (PBA) with JPO. This sustainment project will be managed on a global basis by Lockheed Martin but delivered locally through partners and sub-contractors under a separate Performance Based Logistics (PBL) contract with the JPO.
Any policy lessons?
The approach a country takes to sustainment must be tailored to that country’s needs and abilities. In fact, Australia’s spatial isolation and strategic environment impose high priorities for the Australian Defence Force’s operational readiness and hence for their equipment’s sustainment be performed domestically. Country-specific factors, both industrially and strategically, have been flexibly incorporated into the F-35 global sustainment design.
Moreover, given the increasing relevance of expeditionary operations, MRO sites must also be matched to front lines. In fact, MRO venues for the F-35 have already been allocated to the UK, Australia, Italy, Turkey, Holland and Norway by the JPO.
Matching Canadian F-35 subcontractors as parts manufacturers to MRO needs, an F-35 equipped Canada may win, beyond manufacturing subcontractorships, some sustainment contracts.
Ugurhan G. Berkok is Assoc. Prof. of Econ. at the Royal Military College, and Adjunct Prof. at Queen’s Univ. Econ. Dept. (BA Econ. from Bosphorus Univ., Turkey, MA Quantitative Econ. from Univ. East Anglia, UK and PhD in Economics from Queen’s Univ.) His previous positions were at Laval, McGill, Montréal, UQAM, Concordia and Sussex in the UK. His current teaching interests include defence and national security economics, and health economics. His current research interests include defence procurement, defence industrial policy (offsets, in-service support, munitions management, PPPs), defence alliances, defence force generation, intelligence agencies and coordination in intelligence.