Cost escalation and Technological Innovation in the Defence Sector

The problem of the affordability in military equipment acquisition is not unknown. In 1983, Norman Augustine, a CEO of U.S. defence contractor Lockheed Martin, noted that the falling of real prices associated with the electronic industry did not carry over into the defence equipment market. Augustine observed that the cost of fighter aircraft was exponentially increasing and predicted that by 2054 the U.S. defence budget would permit only the purchase of one aircraft to the exclusion of all other defence equipment (Davies et. al, 2012). Equipment acquisition has indeed become more and more affected by unsustainable cost escalation: new generations of defence equipment, such as tanks or fighter aircrafts, have shown increasing cost is well above the consumer price indices on an annualised basis (Davies et al. 2011). Cost escalation poses a substantial reduction in the buying power of the armed forces, representing a considerable problem for nations, especially the smallest ones, in most of the cases leading to military capability as well as technological gaps. Therefore, it is of primary importance for us to think about cost escalation as strictly related to technological innovation in the military industry.

What we know so far. Existing literature shows that increasing prices have been subject of concern in several countries and many scholars have been investigating what are the main driving forces of this phenomenon (Arena et al. 2008; Kirkpatrick 1997; Pugh 2007), most of them concluding that cost escalation for complex defence equipment is primarily led by the arms race between nations. Starting from the late ‘60s, Marshall and Meckling concentrate on the analysis of cost growth during the whole process of weapons procurement, and during the ‘80s and ‘90s several other studies, such as those by Deitchman (1979), Kirkpatrick (1983 and 1995), Pugh (1986, 1993 and 2007) and later by Davies et al. (2011) draw attention on cost escalation in the long-period, thus between generations of weapons systems. A particularly important insight is offered by Kirkpatrick (1995), who demonstrates how the unit cost increase between one generation of equipment and its successor is due to developments in the perceived threat, available technology and industrial productivity. Bolten et al. (2008) research the sources of cost increases tracking thirty-five mature U.S. defence procurement programmes, finding out that cost growth is generated for the 40% in the concept development phase only for the 4% in the procurement phase. Finally, Hove and Lillekvelland (2015) investigate defence investment cost escalation proposing both a clear distinction between intra- and intergenerational Investment Cost Escalation (ICE) and a revision of the estimates.

Advocating for changes. A still unanswered question is “How can we achieve the development of affordable military equipment in the future?” Despite I am not pretending to have the correct answer to this puzzle, I want to propose an interesting point of view, suggested by Amann et al. (2019) that accounts for the very moment of generation of preliminary concept for complex defence equipment: changes in the way affordability is managed in the military industry is the very first step towards curbing cost escalation. Future changes in management could allow the achievement of better strategies of development for more affordable equipment.

A closer look. Let’s dive deeper in the concept of cost escalation and consider the fundamental factors that determine any defence procurement strategy: first of all, the long-standing logic that the performance of the equipment used plays a crucial role in determining winners and losers in a conflict; second, the maximization of utility obtainable from the entire range of equipment, accounting for limited funds; and last but not least, the utility of a defence good that derives from its effect relative to equipment of adversaries – or potential ones. In short, equipment “is good or bad only in relation to what possessed by a potential/actual adversary. The benefits of improved armament are largely those of devaluing existing equipment, especially that of the adversary” (Pugh, 1986). It is clear then, that cost escalation occurs when new generation of weapon systems are purchased as a response to a changing security environment. However, this is just one of the multiple factors that contribute to magnify this phenomenon, and when trying to deal with affordability problems we have to account for many others, such as the imperfectly competitive structure of the defence market, the relative value of the military equipment – which has to be superior to those of rivals – the continuous fight for the acquisition of cutting-edge equipment, and preferential arrangements in favour of national industries.

Intergenerational cost growth. The economic theory considers defence equipment as a tournament good, and in order to maintain military superiority, it needs to be always at the cutting-edge of what is technologically possible, as well as superior to that of potential adversaries. On the basis of that, some scholars, such as Davies et al. (2012) argue that much of the cost escalation can be explained by the change in the specified characteristics of each generational platform. We define the intergenerational cost growth as the change in cost between one platform of military equipment and the next generation of a similar platform: as we can easily deduce, the latter is expected to be more technologically advanced or with improved capacity. Now, how does affordability connect to this? Affordability is generally understood as being the ability to bear the cost of something. In the defence sector, a more technical definition is proposed by Walden et al. (2009): affordability is “the balance of systems performance, cost and schedule constraints over the system life while satisfying mission needs in concert with strategic investment and organizational needs.” But for the purpose of my article, we can leave it aside and rather focus on the fundamental factors that affect affordability, namely competition, price, Whole Life Cycle Cost (WLCC) from the concept stage to disposal, budget, performance, perceived quality and technological innovation. The latter deserves particular attention when trying to explain the causes of cost escalation.

It is all about innovation. As I said, technological progress plays a crucial role both in determining defence equipment concept design and in inflating equipment real cost. The development and subsequent introduction on new technologies affects all spheres of our age, we can easily see that in our everyday life experience, where it seems to (over)simplify our daily routines. However, when it comes to the defence sector it poses the problem of the acquisition of tactical advantages that are short lived: that means relative capabilities remain approximately constant as opponents acquire rapidly similar technology. Innovation, the ability of exploiting resources in different ways and new and new combinations (Schumpeter, 2017), is what makes the real difference between winners and losers. Warfare is constantly subject to technological progress: as correctly pointed out by Dombrowski and Gholz (2009), “the ways that nation-states fight and prepare for war should change if global society undergoes a revolution in technology and organization.” As for the defence industry, the doctrine of warfare has to adapt to post-modern changes and to the emerging information society.

Military industry transformation. It is not easy to define this concept, however, a good starting point is represented by two key relationships that stand at the basis of military transformation: the first is the one between military’s demand for innovation and the defence industry, while the second is the one between the defence industrial sector and the military’s ability to transform. The debate concerning technological progress in this sector seems to emphasize the idea of network-centric warfare (NCW), as it exploits technologies to shift from the traditional platform-centric operations to more advanced network-centric operations. Advocates of the NCW believe that most of the changes are required in military communications more than in any other area of technology: a decentralized network of forces sharing information would engage targets more efficiently, with better precision and from greater distances. But what are the real benefits of NCW operations? I want to list at least four of them mentioned by Dombrowski et al. (2002): increased speed of command, self-synchronization, advanced targeting and greater tactical stability.

What incentives to innovate? Technological innovation and transformation cannot take place unless appropriate incentives are given to the defence industry: these include setting technological and programmatic priorities, coherent doctrinal and operational requirements, receiving analytic support from systems integration/technical advisory organizations, and giving contractual and financial incentives for undertaking investments in innovative programs (Dombrowski et al., 2002). Unfortunately, combining the creation of affordable concepts with the use of cutting-edge technology is not an easy task for the military industry. Among the possible solutions proposed by scholars and experts, I consider the setting of cost targets by offsetting costs in a consistently defined tradespace, starting from the concept generation process, the most promising one. Clearly, further research on the topic is needed, but the balancing of resources, technologies and systems is an initial step in our path towards affordability.

To conclude. Above average cost growth is a persisting and universal phenomenon that affects a large variety of military equipment. The problem of cost escalation in the complex defence equipment procurement and of the military capability gap among nations generated from it has long been discussed. As the concept of affordability is tightly related to that of technology innovation in and transformation of the defence industry, new solutions for balancing the two have to be found both on the economic and political level.

References

Amann, D., Kihlander I., Magnusson, M., 2019. Affordability Aspects in the Development of Defence Equipment: Case Studies of Concept Generation in the Defence Industry, Integrated Product Development, KTH Royal Institute of Technology, Stockholm, Sweden; Department of Military Studies, Swedish Defence University, Stockholm, Sweden.

Arena, M., Blickstein, I., Grammich, C. A., Younossi, O., 2006. ‘Why Has the Cost of Navy Ships Risen?: A Macroscopic Examination of the Trends in US Naval Ship Costs Over the Past Several Decades’, RAND.

Arena, M. et al., 2008. ‘Why Has the Cost of Aircraft Risen? A Macroscopic Examination of the Trends in US Aircraft Costs Over the Past Several Decades’, RAND.

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Davies, N., Eager, A., Maier, M., Penfold L., 2012. Intergenerational Equipment Cost Escalation, Defence Economics Research Paper.

Dombrowski, P., Gholz, E., 2009. Identifying Disruptive Innovation: Innovation Theory and the Defence Industry.

Dombrowski, P., Gholz, E., 2006. Buying Military Transformation: Technological Innovation and the Defence Industry, Columbia University Press.

Dombrowski, P., Gholz, E., Ross, A. L., 2002. Selling Military Transformation: the Defence Industry and Innovation, Foreign Policy Research Institute.

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Hove, K., Lillekvelland, T., 2015. Defence Investment Cost Escalation – A Refinement of Concepts and Revised Estimates, Norwegian Defence Research Establishment (FFI) rapport 2014/02318.

Kirkpatrick, D. L. I., 1995. The Rising Unit Cost of Defence Equipment — The Reasons and the Results, Defence and Peace Economics, Vol. 6(4).

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