Mckinsey on Government

McKinsey on Government

Number 5 4 22 44 64 Spring 2010 Lessons from An expert Stabilizing Iraq: ‘Without taboos’: around the world: view on defense A conversation with France’s new Special Issue: Benchmarking procurement Paul Brinkley defense policy Defense performance in 28 50 70 defense Mastering military Supply chain From R&D 14 maintenance transformation investment to under fire Improving 34 fighting power, US equipment 25 years later Big savings from 56 acquisition little things: A dynamic strategy Non-equipment for uncertain times procurement 1

McKinsey on Government Number 5, Spring 2010

2 44 Introduction Stabilizing Iraq: A conversation with Paul Brinkley The leader of the US effort to revitalize Iraq’s economy 4 talks about the lessons he has learned over the 4 Lessons from around the world: past three years, the relationship between economic Benchmarking performance in defense development and security, Western misconceptions 14 A first-of-its-kind benchmarking effort compares of the Middle East, and the hardest part of his job. the productivity and performance of defense ministries across the globe, helping them pinpoint 50 areas of inefficiency and identify the highest- Supply chain transformation under fire potential opportunities. Deployments to Iraq and Afghanistan exposed weaknesses in the UK Armed Forces’ supply 14 chain and provided a powerful impetus for change. Improving US equipment acquisition The resulting improvements offer valuable 34 To address the perennial problems of cost overruns and lessons for other militaries’ supply chains. lengthy delays in its major acquisition programs, the US must introduce two elements critical to lasting acquisition reform: long-range budget planning 56 and objective portfolio management. A dynamic strategy for uncertain times A world of fast-changing conditions and heightened 50 22 uncertainty demands that defense agencies act An expert view on defense procurement with speed and flexibility. They can do so by taking an In 2009, Bernard Gray, an adviser to the UK Ministry iterative, dynamic approach to strategic management. 56 of Defence, wrote a scathing review of UK equipment acquisition. In this interview, he discusses 64 the massive challenges the MOD faces—and how ‘Without taboos’: France’s new defense policy to overcome them. Olivier Debouzy, one of the authors of the French White Paper on Defence and National Security, 28 reflects on its key recommendations and the rationales Mastering military maintenance behind them. Maximizing asset availability without increasing costs will be a critical priority for armed forces in the years to come. We have found that armed forces can 70 improve both the efficiency and the effectiveness From R&D investment to fighting power, of their maintenance, repair, and overhaul (MRO) 25 years later function by as much as 60 percent, but doing Countries have been investing in defense R&D at so requires fundamental changes to organization, widely differing rates—a fact that is likely to processes, and mind-sets. lead to significant shifts in the global military balance over the next two decades. 34 Big savings from little things: Non-equipment procurement Despite constituting a substantial portion of defense budgets, non-equipment purchases tend to receive scant attention. Defense organizations can capture savings of up to 20 percent in non-equipment categories if they raise their game in several dimensions, including capability building, the use of proven purchasing tools and processes, and performance management. 2

Now, with the current economic climate placing enormous pressures on government budgets across the board, it appears that a downturn in global defense expenditures is beginning. And although there are exceptions—such as India and South Korea—the trend is clear.

Yet the world remains a dangerous place. Defense forces must still be capable of deploying and sustaining “boots on the ground.” Weapons must be maintained and upgraded. What, then, is to be done?

In this edition of McKinsey on Government, we, Introduction along with some eminent military thinkers and practitioners, look at a range of challenges facing militaries that must do more things—some of Since the end of the Cold War, and certainly in the them relatively new things—with less. post–9/11 world, military forces around the globe have been shifting from a largely static, “Lessons from around the world: Benchmarking defensive posture to one that has to support performance in defense” contends that, contrary to more expeditionary operations far from their home what is routinely argued, performance is indeed bases. This shift has led them to invest more in comparable across defense ministries wherever de- training their armed forces, acquire transport assets, fense ministries engage in the same types of and build their supply chain and logistics activities. Evidence from a first-of-its-kind bench- capabilities—all of which costs money. As the 15th marking exercise comparing 33 of the world’s century Italian military commander Gian Giacomo largest national military structures supports our Trivulzio said, “To carry out a war, three things are most fundamental claim—that countries can necessary: money, money, and yet more money.” shrink their defense budgets without losing capability.

In this regard, defense expenditure would appear to We proceed from this broad view to take on, in a be unique, in that it is driven more by threat and number of articles, a perennial challenge for all perceived threat than by affordability. The past de- militaries: acquiring and maintaining equipment cost- cade has borne this out. Since 2001, defense effectively. “Improving US equipment acquisition” spending in the United States, for example, has asserts that acquisition reform at the level of increased from about $300 billion to almost individual programs—“small a”—will fail without $700 billion for the current fiscal year. But the recent addressing “Big A,” or enterprise-level decade is not representative of the long-term issues. This candid analysis of America’s picture. Defense expenditure, appearances to the acquisition problems is followed by an contrary notwithstanding, is cyclical: it is simply equally candid discussion of the United Kingdom’s: that the cycle is much longer than in most other sec- Bernard Gray, an adviser to the UK Ministry tors, averaging some 20 years between peaks. of Defence, offers “An expert view on defense 3

procurement.” And because maintaining equipment makes a similarly robust case for change in “‘Without is fully as important as acquiring it, “Mastering taboos’: France’s new defense policy.” Debouzy military maintenance” explores the changes that discusses, among other things, the relationship defense organizations must make to maximize between defense and national security in an asset availability while keeping costs down. age of globalization, and the changing nature of activities related to “knowledge and anticipation… The next article, “Big savings from little things: without which one wastes time and money preparing Non-equipment procurement,” looks at a for the wrong kind of operations, in the wrong seemingly more modest matter. Non-equipment region, and against the wrong people.” procurement is a subject that rarely makes headlines, but it constitutes a surprising portion of Finally, “From R&D investment to fighting power, the defense budget: up to 25 percent. As such, it 25 years later” makes the intriguing claim, is a rich but typically untapped savings opportunity. based on recent research, that a country’s level of R&D spending correlates to the quality of its The next two articles deal with the on-the-ground military equipment a quarter-century later. On the realities of modern war. In “Stabilizing Iraq: A basis of this observation, the authors make conversation with Paul Brinkley,” the leader of the some provocative predictions about the defense US effort to revitalize Iraq’s economy discusses landscape a couple of decades from now: his view that “offering economic opportunity as part America maintains its dominance, but the global of protecting and helping the population is abso- balance shifts as Asia’s rising powers overtake lutely critical” in both Iraq and Afghanistan. “Supply the major European nations in military strength. chain transformation under fire” describes some of the logistical difficulties the UK Armed Forces We decided to publish an edition of McKinsey on faced in the Iraqi and Afghan conflicts, evincing the Government exclusively devoted to defense age-old truth that no army, however well equipped, because of its overwhelming importance, particularly can function without a good supply chain. at present, to governments worldwide. However, the articles in this edition are relevant across a range We close this edition with three articles that take on of institutions, both public and private. We welcome one of the biggest challenges for any large your comments on any or all of these articles at organization, the military being no exception: change. [email protected].

With the stability of the Cold War having been replaced by an altogether less predictable environment, defense agencies must shift from a traditional model of annual strategic-planning sessions to a more dynamic model attuned to a John Dowdy world in which new threats can emerge Director, McKinsey & Company overnight. “A dynamic strategy for uncertain times” presents such a model.

Olivier Debouzy, one of the authors of the French Nancy Killefer White Paper on Defence and National Security, Director, McKinsey & Company Lessons from around the world: Benchmarking performance in defense

A first-of-its-kind benchmarking effort compares the productivity and performance of defense ministries across the globe, helping them pinpoint areas of inefficiency and identify the highest-potential opportunities.

Scott Gebicke and With wars under way in several parts of the globe given that countries are in very different political Samuel Magid and many countries’ defense budgets suffering situations and have different priorities and drastic cuts, defense ministries are under military strategies. Granted, many variables affect pressure to do more without spending more. And the performance of a country’s armed forces, and most defense ministries recognize that they have it would be virtually impossible to account for all ample room to improve both the efficiency and the complexities and dynamics that come into effectiveness of their operations. Yet a typical play. Furthermore, defense ministries make defense ministry has little perspective on what deliberate trade-offs—for example, choosing to constitutes best practice in defense operations, pay more for domestically manufactured where its biggest opportunities for saving money equipment. That said, defense departments or boosting productivity lie, or how it stacks up everywhere engage in the same types of against its counterparts in other countries in the operational activities. Our firm belief is that core areas of defense. certain aspects of operational performance are indeed comparable across ministries of defense, Some would argue that comparing the and that ministries can learn from one another performance of one defense department to when it comes to delivering more defense output another’s is neither achievable nor instructive, for the same or less input. 5

In 2008 and 2009, we undertook a first-of-its kind data, but defining the inputs was reasonably benchmarking effort—one that compares the straightforward; defining and measuring outputs, performance and productivity of defense on the other hand, was a much more complex ministries worldwide. We gathered and analyzed undertaking (see sidebar, “Our methodology for data from 33 countries that account for more than calculating output,” p. 5).

Leigh Wells 90 percent of global defense spending, developing a benchmark that we believe yields valuable insights Our benchmarking results show wide variability into where and how ministries of defense can across countries in each ratio (Exhibit 1). Once a become more effective while reducing or country has selected a peer group against which to maintaining costs. In the simplest terms, the compare itself, it can use these benchmarks to help exercise involved analyzing a discrete set of pinpoint areas of inefficiency and zero in on the quantitative inputs—namely, publicly available highest-potential opportunities. data on the quantity and type of military equipment, number and general classification of For the purposes of this benchmarking exercise, we personnel, and annual defense budgets used five straightforward country categories based disaggregated into key spending categories—and on types of military strategies: global-force converting them into a set of ratios that measure projection (countries with worldwide striking outputs in three core budget areas of defense: capability), small-force projection (NATO members personnel, equipment procurement, and or countries with a fairly significant presence in maintenance. Assembling inputs presented a international missions), relevant national security significantMcKinsey on research Government challenge 2010 due to wide threat (countries under attack or threat), emerging variabilityBenchmarking in the quality and quantity of available regional powers, and non-aligned or neutral countries. Exhibit 1 of 6 Glance: Benchmarking showed wide variations in performance. Exhibit title: Stacking up

Exhibit 1 Budget area Stacking up (average % of defense budget) Key ratios Range Average Personnel (45%) • “Tooth to tail” (combat personnel as % of 16–54% 26% Benchmarking showed wide total personnel) variations in performance. • Number of deployed as % of total 1–18% 5.3% active troops • Personnel costs per active and other $800–$146,000 $44,800 personnel • Personnel costs over military equipment output1 $2,000–$218,000 $72,000

Equipment • Military equipment output1 over procurement 17–330 100 procurement (18%) and R&D spending (index) • Procurement spending over active troops $1,000–$536,000 $60,000

Maintenance (8%) • Cost of maintenance per unit of military $2,000–$104,000 $13,000 equipment output1 • Cost of maintenance over cost of equipment 8.2–446% 13% procurement

1One unit of military equipment output is approximately equivalent to one combat-ready unit (eg, a manned and maintained combat vehicle). For more, read "Our methodology for calculating output," p. 5. 6 McKinsey on Government Spring 2010

This simplified peer-group categorization was non-equipment categories; “Supply chain adequate for our initial purposes, but to generate transformation under fire,” p. 50, touches on the the most useful insights from the benchmarks, a United Kingdom’s move from a service specific defense ministry must thoughtfully and carefully supply chain to a joint supply chain.) select a peer group based on its military strategy. In this article, we highlight some of our findings One particularly interesting finding was the in each of the three budget areas we benchmarked variability among countries in the level of joint and offer perspectives on how countries might spending, which ranges from almost 70 percent to improve—or have already improved— 3 percent (Exhibit 2). Not surprisingly, we found performance in each area. that countries that share more functions across the armed services tend to be more efficient. Personnel: Tooth-to-tail and Some countries have recently moved toward deployment ratios increasing their level of joint spending, whether From most commanders’ perspectives, the true by requiring closer collaboration and coordination test of military strength lies in the front line—the among service-specific functions or establishing “tooth,” in defense industry parlance. The “tail” jointMcKinsey functions. on Government (The article 2010 “Big savings from refers to personnel who perform noncombat littleBenchmarking things: Non-equipment procurement,” p. 34, functions such as procurement, deep describesExhibit 2 of how 6 some countries have centralized maintenance, accounting, facilities management, procurementGlance: Countries of productsthat share andmore services functions in across certain the armedor servicesback-office tend toIT. perform Our benchmarking better. results show Exhibit title: Level of joint spending

Exhibit 2 Level of joint % of spending per service2 Joint Army Navy Air Force 1 spending South Africa 68 16 5 10

High Poland 67 22 3 8 Countries that share The Netherlands 58 22 10 10 more functions across the Spain 38 34 14 14 armed forces tend to derive greater efficiencies. Switzerland 32 48 0 20 Taiwan 31 19 18 32 France 30 29 20 21 South Korea 19 45 17 19 Sweden 18 32 23 27 Japan 17 37 23 24 United States 16 31 27 26 Italy 5 36 19 41 Brazil 3 49 23 25 Portugal 3 41 29 26

Low Greece 3 47 20 29

Average 27 34 17 22

McKinsey on Government 2010 Benchmarking Exhibit 3 of 6 Glance: Administrative costs can be reduced without sacriﬁcing ﬁghting power. Exhibit title: ‘Tooth to tail’ ratio

Exhibit 3 %2 Combat3 Combat support3 Other active duty3 ‘Tooth to tail’ ratio1 Norway 54 11 36 Administrative costs can Kuwait 43 37 20 be reduced without sacrificing The Netherlands 39 21 41 fighting power. Israel 38 6 56 Greece 37 6 57 Canada 34 10 55 Sweden 33 14 54 Japan 32 8 60 Taiwan 32 4 65 China 31 3 66 South Africa 29 11 59 United Kingdom 27 11 63 Saudi Arabia 27 9 64 Denmark 23 13 64 Portugal 23 10 66 Singapore 22 9 69 Spain 21 21 58 Russia 21 7 72 India 20 5 74 South Korea 19 13 68 Italy 19 8 73 Belgium 18 16 66 Germany 18 10 72 Brazil 18 5 77 Turkey 18 3 80 Poland 16 9 76 France 16 8 76 United States 16 7 77 Switzerland 7 2 91

Average 26 11 63

1We have removed the benchmark data for Australia as errors in the source data and the methodology as it applied to Australia have been identified. 2Figures may not sum to 100%, because of rounding. 3Combat troops: armor, infantry, reconnaissance, and combat aviation. Combat support: artillery, engineers, and signals. Other active duty: general and administrative functions including HR, IT, procurement, accounting, etc. Reserve personnel not included. Source: The Military Balance 2008, The International Institute of Strategic Studies; McKinsey analysis

stark differences in tooth-to-tail ratios, indicating personnel through investment in IT systems and opportunities to reduce administrative costs in outsourcing of certain noncombat operations to several countries without diminishing fighting the private sector (see “‘Without taboos’: France’s power (Exhibit 3). new defense policy,” p. 64).

Some countries are proactively trying to improve The defense ministry of a Northern European their tooth-to-tail ratio. France, for example, is nation, under pressure to increase military output aiming for a dramatic reduction of administrative in the period after the Cold War, set a goal a few 8 McKinsey on Government Spring 2010

Our methodology for calculating output

Comparing the performance of one country’s armed forces the equivalent of 3.5 submarines or 8 surface combat ships. with another’s involves both art and science, in part because This allowed us to compare armed services regardless of the data on budgets, equipment, and personnel are not always composition of their equipment portfolio. We excluded nuclear available, reliable, or reported in a comparable way. To equipment from the benchmark because it skewed results develop our benchmarks, our research departments in significantly. various countries scoured public data sources and made a number of assumptions to normalize the data. A key part of Age. Recognizing that there are variations even within the our analysis was the creation of a new metric for measuring same type of equipment—the F-35 aircraft has significant the performance of military equipment. We call our metric advantages over older fighter jets like the MiG-19, for “military equipment output,” and we used it to calculate some example—we also adjusted for age. We determined that a of the key ratios as shown in Exhibit 1 of the article. Military fifth-generation fighter like the F-22 or the F-35, for instance, equipment output is a function of four factors: volume, mix of is equivalent to 3.6 second-generation fighters. equipment, age of equipment, and overall equipment quality. Quality. We then took into account a military equipment Volume. To calculate military equipment output, we first quality (MEQ) score for each of the armed services in gathered data on several countries’ active equipment each country, based on rigorous analysis conducted by inventory—specifically, how many serviceable units of third-party consultancy Technology Futures. (For more on each type of equipment a country has in each of its armed MEQ, read “From R&D investment to fighting power, services (for example, the number of submarines in the navy, 25 years later,” p. 70.) the number of main battle tanks in the army). This exercise proved challenging because countries report inventories in By calculating military equipment output for each of the armed many different ways—for example, some include only active services—the army, the navy, and the air force—we were equipment while others include equipment for reserves or able to make comparisons across countries. Our benchmark mothballed equipment. shows, for example, that the US and Russian armies have almost equivalent output levels largely due to the size of the Mix. Then, using the average equipment mix of the United Russian tank fleet, but that the US Navy and Air Force are far Kingdom and France as our ideal target mix (because both superior to their Russian counterparts—a case of American countries have a good balance of army, navy, and air force technology trumping the sheer volume of Russia’s older equipment in all major categories and are sizeable enough platforms and aircraft. The navies of the United Kingdom and but not so large as to skew the data), we assigned a relative France are on par with South Korea’s and Japan’s, and Israel’s value to each type of equipment per armed service— air force has about twice the output levels of the air forces of determining, for example, that in the navy an aircraft carrier is France, Germany, and Brazil. Lessons from around the world: Benchmarking performance in defense 9

years ago to increase its tooth-to-tail ratio from accustomed to tools and processes of their own 40:60 to 60:40 over three years. It achieved this choosing have to be convinced—and then trained— goal by centralizing formerly duplicative support to use standardized tools and processes. functions including HR, IT, finance, media and communications, health services, and facilities To ensure the success of a centralization effort, management. By mapping the functions’ activities a defense organization must address mind-sets and resources—what exactly each function did, and behaviors. The European defense ministry who did it, and how many people did it in each mentioned earlier held seminars for the top 100 regiment—and by comparing itself with other leaders to get their buy-in and to make sure public and private-sector organizations, the they learned and embraced the new ways of defense ministry realized that centralization working. To foster collaboration, the ministry would yield savings of approximately 30 percent also established formal mechanisms; for per function. example, a joint management team, consisting of leaders of each military branch as well as of A number of countries have found that one of the the centralized functions, participated in an hardest parts in a centralization effort is annual prioritization process, ensuring that the designing the precise division of responsibilities most important needs of each branch were well and the interfaces between the centralized service understood and that the centralized service and the various military services. Political and could meet those needs. cultural sensitivities come into play as heads of regiments lose responsibility for certain positions Like corporations, defense ministries should seek and facilities. The need for coordination increases productivity improvements in administrative exponentially, particularly because of frequent functions; in these nonmilitary tasks, productivity rotations among military personnel. Individuals growth can and should offset wage growth. 10 McKinsey on Government Spring 2010

McKinsey on Government 2010 Benchmarking Exhibit 4 of 6 Glance: Combat forces are under strain in some countries. Exhibit title: Deployed forces

Exhibit 4 Deployed forces SAMPLE FROM BENCHMARK

Combat forces are under strain Deployed over Deployed over Cost per Total active Total deployable1 Deployed total active deployable troop deployed in some countries. (number of people) (number of people) (number of people) (%) (%) ($ thousands) United States 1,352,494 N/A 250,000 18.5 N/A N/A United Kingdom 185,950 74,750 34,000 18.3 45.5 N/A The Netherlands 44,636 17,724 3,896 8.7 22.0 68 Finland 10,100 6,000 840 8.3 14.0 216 Sweden 11,574 3,122 950 8.2 30.4 611 France 262,592 42,500 17,485 6.7 41.1 35 Italy 191,152 54,800 11,170 5.8 20.4 N/A Spain 77,800 39,617 3,344 4.3 8.4 195 Germany 221,185 37,275 8,946 4.0 24.0 172 Greece 135,500 22,182 1,290 1.0 5.8 83

1 Troops trained and ready to deploy. Source: European Defence Agency; The World Factbook, Central Intelligence Agency; McKinsey analysis

Increased productivity in back-office functions output and average equipment quality, which can then lead to more favorable deployment rates, naturally raises the possibility of spending large as uniformed personnel can be reassigned from sums in the pursuit of extraordinarily powerful support roles to combat roles. A country needs to weapons. US Defense Secretary Robert Gates have many more deployable service members raised this very issue last year when he than it might expect to deploy at any one time to announced his intent to “pursue greater account for periods of training and recuperation. quantities of systems that represent the ‘75 In certain countries, combat forces are stretched percent solution’ instead of smaller quantities of thin, with deployment rates exceeding 40 percent ‘99 percent’ or exquisite systems.” The United of potential (Exhibit 4). States is currently at the extreme end of the cost/ quality spectrum, delivering very high-quality These countries have the choice of either reducing equipment but at very high cost (Exhibit 5). Once deployments—which will essentially mean a loss again, variations between countries in the same of fighting power—or shifting a significant peer group can be substantial. number of personnel from administrative roles to combat roles. The latter is clearly the better In general, countries that make it a point to option. support their domestic defense industries have higher procurement costs than those that rely on Equipment procurement imports. Since this represents a narrowing of the Countries deliver substantially different levels of market being considered for purchases, this is not military output for the money they spend on a surprising result. Meanwhile, countries that equipment procurement. There is a rough procure older equipment from the global market correlation between procurement cost per unit of tend to have very capable fleets for less money. Of Lessons from around the world: Benchmarking performance in defense 11

course, one could argue that a strong domestic Germany, South Africa, Sweden, and the United defense industry is strategically critical to Kingdom—must evaluate each of their defense national defense; among other benefits, it gives a subsectors, such as secure communications, country complete control over supply, keeps it missiles, and unmanned aerial vehicles, on two from being dependent on foreign providers, and criteria: strategic criticality and commercial guarantees sovereign protection in critical areas viability. Strategic criticality is a qualitative (secure satellite systems, for example). But evaluation of the subsector’s importance to because maintaining and supporting a domestic military success, of whether there are other defense industry is an expensive proposition and countries exporting the product, and of sovereign limits financial freedom in other areas, it is importance—that is, whether a bespoke product critical that countries make sure they develop a ought to be manufactured domestically for strong rationale for their procurement choices by security reasons (as might for instance be the case way of a well-defined defense industrial strategy. with encryption software). Commercial viability is a quantitative assessment based on revenue, Countries with sizable defense industries but margins, and cost base, as well as local and global McKinseydeclining defenseon Government budgets—examples 2010 include competitiveness. Subsectors that score high on Benchmarking Exhibit 5 of 6 Glance: Governments that support their domestic defense industries tend to spend more for less output.

Exhibit 5 Exhibit title: Output versus spend Output vs spend

Governments that support Total military equipment output their domestic defense Land, air, and naval industries tend to spend more High South Korea for less output.1

Turkey India Israel Poland Japan United Kingdom Taiwan Germany France Greece Italy Saudi Arabia Brazil South Africa Norway The Netherlands To the right side of the Denmark Canada Spain diagonal line countries are Finland Sweden United Arab either in modernization Portugal Switzerland Emirates processes or have large Kuwait defense industries Low Belgium 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Equipment procurement spend $ million

1 We have removed the benchmark data for Australia, as errors in the source data and the methodology as it applied to Australia have been identified. Note: United States, Russia, and China have been excluded due to scale. 12 McKinsey on Government Spring 2010

McKinsey on Government 2010 Benchmarking Exhibit 6 of 6 Glance: Maintenance costs vary substantially, both within and among peer groups. Exhibit title: Maintenance costs Exhibit 6 Maintenance costs

Maintenance costs vary Maintenance costs over 1 substantially, both within Peer group Example Spend, military equipment output, countries % of budget index and among peer groups.

Global force projection United States 12.0 1.8

Large scale, deployable Great Britain, 11.0 1.9 internationally France

Small to medium scale, Italy, Germany, deployable internationally Netherlands 6.5 0.7

Neutral/non-aligned Switzerland 8.0 0.6

Average 9.0 1.0

1 One unit of military equipment output is approximately equivalent to one combat-ready unit (eg, a manned and maintained combat vehicle). For more, read “Our methodology for calculating output,” p. 5.

both criteria ought to be prioritized through Maintenance R&D funding and export support; subsectors that Maintenance costs vary substantially, both within rate high on only one criterion should receive and among peer groups (Exhibit 6). Although the limited government support; subsectors with low most capable forces naturally have some of the criticality and viability should be considered highest levels of expenditure, more detailed for divestiture. investigation reveals a number of drivers that help explain the wide variations that we have observed. Countries that are increasing their defense spending and looking to grow a nascent domestic Actual maintenance expenditure is driven by at industry—India and South Korea, for example— least four factors. The first driver is vintage. As should undertake a similar evaluation, but should any owner of a vintage car will immediately of course attempt to assess future commercial understand, forces that continue to operate older viability as opposed to current revenue, margins, equipment often incur much higher levels of and costs. Such an evaluation should be based on maintenance expenditure. There is therefore an comparative advantage and the ability to leverage implicit trade-off between funds to purchase new key capabilities such as engineering talent. equipment and the funds to operate and maintain older equipment. Deferring replacement This type of evaluation requires both commercial purchases often saves much less money than and analytical skills as well as military strategic- people expect, because they fail to account for the evaluation skills. Defense ministries should create high and increasing costs of maintaining the older cross-functional teams so that sound commercial equipment left in place. The second driver of and economic analysis can inform equipment- maintenance expenditure is variety. Forces that procurement decisions. operate a wide range of different platforms incur Lessons from around the world: Benchmarking performance in defense 13

greater total maintenance expenditure than those Indeed, our experience working with a number of with a narrower range, with each platform often defense organizations generally indicates a 40 requiring specialized technicians, dedicated percent to 60 percent potential for increasing the equipment, and its own spare parts and quality and productivity of the maintenance, associated supply chain. Operating several small repair, and overhaul (MRO) function, without fleets of different types of helicopter offers a good increasing costs. We have found that the best- example. The third driver of maintenance performing military MRO organizations eliminate expenditure is readiness. Some countries choose unnecessary variety, make smart use of not to maintain their equipment at high levels of outsourcing, excel at contracting, and constantly readiness, which saves money at the expense of optimize their maintenance processes. fighting power. You can leave your car in the garage and not service it, but if you need to go somewhere, you can’t always count on it to work. Of course, operations in difficult geographies can One of the cornerstones of any benchmarking also substantially increase wear and tear, and exercise is the selection of a peer group. Once a hence readiness-related maintenance costs, defense ministry has chosen its peer group, it can particularly for land equipment. Repairs for battle identify the areas in which it most needs to damage can be costly as well. The final driver of improve and implement best practices to elevate maintenance expenditure is process efficiency— its performance in those areas. The benchmarking how efficient someone is at maintaining a given results can give valuable directional insight into piece of equipment of a given vintage at the where the ministry can save money, as well as required level of readiness. We have looked at all where it can achieve maximum effectiveness of these factors to try to understand the wide without increasing costs—both critical goals in range in expenditure we have observed. today’s changed world.

This investigation uncovered massive opportunities for improvement in some countries.

Improving US equipment acquisition

To address the perennial problems of cost overruns and lengthy delays in its major acquisition programs, the United States must introduce two elements critical to lasting acquisition reform: long-range budget planning and objective portfolio management.

John Dowdy and Equipment acquisition is notoriously difficult, too carrier Admiral Gorshkov, sold to India, John Niehaus often characterized by cost growth and years- have ballooned from $700 million to more than long delays. Painfully public examples abound $2 billion. The list goes on. from around the world: in the US, the V-22 Osprey aircraft had an estimated price tag of Acquisition inefficiency in the United States is $2.5 billion in 1986, but by 2008 it had cost notably troublesome because of its scale and the US military some $27 billion, and another persistence. Interestingly, there is a large volume $27 billion is required—this for only about half of available information and history to shed the units originally planned. The United Kingdom light on the issues. In this article, we present our has had major cost overruns and delays in perspective on the root causes of the problem several of its equipment programs (see “An expert as well as recommended solutions. Although we view on defense procurement,” p. 22). The focus on the United States, the issues should European military transport aircraft Airbus sound familiar to defense ministries around the A400M is at least three years behind schedule, globe, and most of our recommendations apply as is Australia’s Wedgetail early-warning system. equally to other countries seeking higher returns Refit and modernization costs for the Russian from their national-security investments. 15

Too costly, too late, too few for—and almost certainly far fewer than required Currently, the US Department of Defense has to maintain force-structure objectives. The 96 major equipment programs—referred to as number of combat aircraft units that the US Air Major Defense Acquisition Programs, or Force procures, for instance, has declined at an MDAPs—totaling $1.6 trillion in capital commit- annual rate of approximately 5 percent over the

Neil Webb ments. MDAPs are at the center of the US’s past 50 years. The US Navy’s fleet has steadily equipment-acquisition problem. Simply put, the gotten smaller as well (especially as measured in problem is threefold: the programs are too gross tonnage). costly, both on a per-unit and aggregate basis; too late; and too few—that is, a typical program These problems are not new. Take the case of routinely yields far fewer units than planned. air-superiority fighters. In 1986 the Air Force planned to replace approximately 850 F-15s with In recent years, US taxpayers have faced a series 750 Advanced Tactical Fighters—a plan that of “capital calls” requiring an additional was never credible given that combat-aircraft $300 billion to cover cost growth alone. An costs grow at an annual rate of 4 percent examination of individual programs shows while the military aircraft budget grows at barely that on average, an MDAP experiences 50 percent 1 percent, if at all, over the long term. It was cost growth per unit. Unfortunately, many clear from the outset that the Air Force could not programs experience far greater cost growth: the possibly afford more than 400 units of what F-22 and V-22 aircraft, the Evolved Expendable became the F-22A program. It is hardly surprising Launch Vehicle (EELV), the Expeditionary Fighting that the end result has been about 200 units. Vehicle (EFV), and the DDG-1000 destroyer, among others, all cost two to three times their This type of poor planning has persisted well past baseline estimates. the end of the Cold War. The Transformation Satellite (TSAT) program is among the most recent The second problem is timing: the gestation time examples of aspiration exceeding affordability. from program start to initial operating capability Designed to serve as the backbone of the Global for major weapon systems has grown persistently. Information Grid, TSAT was clearly going to cost For example, the F-15 and the F-16 aircraft two to three times more than its predecessor, the each took 6 years to develop; 30 years later, the Advanced Extremely High Frequency (AEHF) F-22 required almost 20 years and the F-35 satellite system—which, in turn, cost a multiple of is on a similar course. In warships, three decades the Milstar system it is currently replacing. But ago the Aegis cruiser CG-47 took just over 4 years the budget for military space programs grows at to build; the DDG-51 took 6 years; the planned about the same rate as the military aircraft DDG-1000 is projected to take 17 years. budget—that is, hardly at all. So, from the beginning, TSAT was bound to fail. The third problem—not enough volume—tends to become a trade-off made in the quest for Why recent reforms are not enough maximum performance. Ever-shrinking numbers Some might say that recent legislation and DOD of ever more “exquisite” weapons, while not the policy have already addressed acquisition reform. intent, is certainly the result. The armed services Indeed, the DOD has taken some positive steps. wind up procuring far fewer units than they plan One recent study, the Defense Acquisition 16 McKinsey on Government Spring 2010

Performance Assessment, made a number of funds will be available. Detailed program recommendations, the two most important being planning and associated budgets are driven by the the recommendation to plan, to an 80 percent individual services, and trade-offs are made based probability (as opposed to the typical 50 percent), on the annual budget and the current political the development of a technical solution on situation. At times, the DOD attempts to bring a time and on budget, and the enforcement of long-term view to the process but struggles in part “time-certain” development—that is, because its approach is more conceptual than constraining time and therefore cost, forcing quantitative. The Quadrennial Defense Reviews, more technically realistic mission solutions. for example—although certainly necessary— In addition, the Weapon Systems Acquisition are insufficient because they are largely words. Reform Act of 2009 attempts to drive policy that forces more conservative and realistic The closest activity to a long-term plan is the program strategies. Future Years Defense Program (FYDP). But the FYDP is an obligatory report to Congress, These steps are helpful and important—but not not a proper plan by which the DOD and Congress enough. The focus to date has been on acquisition manage capital investments. Also, the FYDP policy at the program level, often referred to as looks ahead only five years—too short a planning “small a.” We believe it is at the enterprise level— horizon given how long it takes to develop a “Big A”—that major gaps remain, the most significant new program or capability. Perhaps glaring of which are the lack of long-term budget- most important, the FYDP is not a forcing planning strategies and effective portfolio mechanism to ensure that the armed services’ management. plans, especially acquisition programs, are collectively affordable over the long term. The armed services are perpetually seeking to develop higher-performing, and therefore more The other major problem at the “Big A” level is that costly, weapons systems, yet there is no the US government fails to manage MDAPs as a systematic approach to ensure that adequate portfolio of strategic investments. From 2000 to Improving US equipment acquisition 17

2008, the number of MDAPs increased from Develop a long-range capabilities 75 to 95, and the portfolio’s capital commitment investment plan doubled to an astounding $1.6 trillion. Did We see an opportunity to leverage the FYDP, the government consciously make this long-term among other existing budget resources, commitment? The answer is no—new MDAPs to enable the development of a long-range were assessed and committed to one at a time. capabilities investment plan (LRCIP)— a fact-based plan that takes into account realistic Toward enterprise-level assumptions and constraints, and one that acquisition reform reconciles “bottom up” estimates with “top down” The root causes of systemic failure in US equip- budgets (exhibit). ment acquisition are poor planning and an inability to make the necessary trade-offs in a Define ten-year budget plans, both top-down and world of finite budgets. In our view, there are bottom-up. We believe the DOD should extend two critical elements of lasting acquisition reform: the planning horizon of accounts within its base detailed budget planning and objective budget to ten years, in line with the time horizon portfolio analysis. Taking the following steps is of the US government’s budget. The line item for McKinseyimperative on if Governmentthe US government 2010 wants to national defense in the US budget should be the Equipmentsolve its “Big Aquisition A” issues. DOD’s top-down budget constraint. In particular, Exhibit 1 of 1 Glance: Players can develop highly detailed, fact-based plans that reconcile top-down budget constraints with bottom-up program funding. Exhibit title: Long-range capabilities investment plan1

Exhibit ILLUSTRATIVE Long-range $ billion (at constant 2013 dollar value) capabilities 200 investment plan

The LRCIP should include 1 reserves for cost growth and 150 Top-down constraint new capabilities. New programs

100 Cost-growth reserve

Smaller acquisition programs 50

Major Defense Acquisition Programs (MDAPs)

0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Fiscal year

1 DOD investment including both Procurement and RDT&E accounts. 18 McKinsey on Government Spring 2010

the DOD should estimate how much of the politically sensitive. The independent nature of national defense funding will be available for the the CAPE office may be well suited for developing research, development, testing, and evaluation a cost-growth estimate for each program, and (RDT&E) and procurement accounts over the then summing up those estimates into an ten-year period. These estimates will provide aggregate number to be included in the LRCIP. Of a clear set of top-down boundaries for investment course, higher-risk programs will have higher in new capabilities. cost-growth estimates.

The bottom-up program plans should similarly be Inevitably, and especially over a ten-year planning extended to ten years. Whereas the mechanics horizon, new programs will emerge to provide behind the FYDP enable the bottom-up summation new capabilities to war fighters. If the investment of DOD’s program portfolio, the FYDP’s plan is fully committed to existing or “known” five-year horizon is simply not long enough. The requirements, then by definition the plan is DOD should expand the mandate of the newly flawed—it has no room to accommodate innova- created Cost Assessment and Program Evaluation tions and uncertainty. Although challenging to (CAPE) directorate, which is responsible for estimate, some reasonable portion of the budget developing the FYDP, to include the formulation should be set aside for “white space” future of an LRCIP with ten-year budget projections investment needs. Again, CAPE, with input from for all approved programs. the services and war fighters, should be responsible for developing this element of the LRCIP. An extension to ten years will expose the hockey-stick effect in projected costs as programs Reconcile bottom-up with top-down budget mature from the technology research phase estimates. The bottom-up budgets, along with into the production phase. One could argue for an objective estimates for cost growth and new even longer planning horizon given recent capabilities, must then be reconciled with the development cycle times, but assuming acquisition top-down budget—the funding available for reform succeeds in driving development cycle RDT&E and procurement in the US government’s time below five years, then a ten-year horizon budget. To be clear, there is currently no should suffice. requirement for DOD to undertake any such reconciliation. Add “cost growth” and “new capabilities” as line items. Budgeting for cost growth is not, as Unquestionably, the process of reconciliation will some may think, planning for failure; it is merely be immensely challenging. It will expose being fact-based and sensible, given the track affordability issues, particularly around high-risk record of acquisition programs. But it is also MDAPs, and will compel all key stakeholders

Budgeting for cost growth is not, as some may think, planning for failure; it is merely being fact-based and sensible, given the track record of acquisition programs Improving US equipment acquisition 19

(Congress, the Office of the Secretary of Defense realm is helpful. Companies managing R&D (OSD), the armed services, and even war budgets or funds managing a large number of fighters) to debate the issues. The LRCIP should equity investments use an approach based be at the center of debate and discussions on the concept of risk versus reward. Government within DOD, and between DOD and Congress. In should apply the same principles to MDAPs. fact, the OSD—not the armed services—should lead the LRCIP dialogue with Congress. Through Ascertain risk versus reward for all MDAPs. this process, the DOD and Congress will take An assessment of an MDAP’s risk is a function of collective control over an aspect of the acquisition the confidence levels associated with the system that currently commits to far more than probability of completing the program on time it can actually afford. and on budget. CAPE should undertake the risk assessment for all MDAPs. Manage MDAPs as a portfolio The United States will invest on the order of Quantifying an MDAP’s reward—or, in $2 trillion in developing and procuring weapons commercial terms, ROI—is more challenging. The systems over the next ten years, and will do so investment is obviously the total cost to develop through thousands of programs. Centrally and procure a weapons system, but how might the managing all these programs is neither practical DOD calculate the return? nor necessary. But the government’s piecemeal approach to managing MDAPs is suboptimal at Economists speak of the value derived from a best—it systematically inhibits the elimination of good or service as utility; in military affairs low-ROI investments, at the expense of higher- the analogous concept is “military utility.” One return (and often higher-priority) programs. way to think about military utility is as a function of three variables: performance of a There are only 96 MDAPs—a reasonable number single unit (for example, one fighter or one for the government to manage as an integrated destroyer), total number of units, and devel- and finite portfolio. How might the government opment time (that is, number of years accomplish this? Looking to the commercial required to convert a concept into an operational 20 McKinsey on Government Spring 2010

A war-gaming approach allows major programs to be market-tested in a scarce budget environment, and forces them to compete against both similar and dissimilar capabilities

weapons system). The third variable is often price and availability date. If too little demand overlooked, but like money—a dollar today emerges for a future weapons system—if, say, the is worth more than the promise of a dollar in the UCCs buy only 50 percent of planned production— future—a capability fielded in 5 years is more then the MDAP scores low from an ROI perspective. valuable than the identical capability fielded in 15 years. The value of a weapons system Who should sponsor this ongoing capital- should thus decline at a compounding rate over investment war game? The OSD, supported by the the time it takes to develop and procure. An Joint Requirements Oversight Council, is the MDAP has the highest military utility when it appropriate entity. Independence and authority delivers high performance in large volumes are crucial to ensuring that the most realistic over a short period of time. scenarios and assumptions are used.

To estimate the relative returns of military utility, Create an integrated portfolio picture. Once each the DOD should look to war gaming. For MDAP is assessed for risk and reward, the next example, it can set up teams representing each step is to plot each MDAP in a risk/reward matrix, of the US’s ten Unified Combatant Commands thus allowing government to see the risk (UCCs) and give each team a finite “capital budget,” versus reward profile of the entire portfolio. Is which represents that particular UCC’s share of the portfolio rich—perhaps too rich—in the investment accounts designated for MDAPs high-risk/high-reward programs? Are there over the next ten years. Each team then “buys” enough investments in priority capabilities? equipment at the fully loaded price for each unit. Does the portfolio have a balanced mix of relatively high risk/reward and more modest risk/reward This war-gaming approach allows MDAPs to be MDAP investments? Or are there programs that market-tested in a scarce budget environment, are low-risk/high-reward, yet struggling in the and forces them to compete against both similar competition for scarce investment resources and and dissimilar capabilities. For example, a thus perhaps in need of intervention? If the warship-development program must be sufficiently portfolio includes high-risk/low-reward programs, compelling to cause UCCs to “buy” it and, in what is the justification for keeping them in the doing so, forgo the opportunity to acquire other portfolio? Why should they not be replaced with capabilities, such as additional attack submarines alternative mission solutions with more or fifth-generation tactical aircraft. Teams can attractive risk/reward profiles? also opt for off-the-shelf alternatives—for example, a readily available combat aircraft in Develop a national-security investment strategy lieu of one still in development. A key indicator is that clearly states the portfolio’s risk versus the number of units the UCCs acquire for a given reward objective. Like any investor, the DOD Improving US equipment acquisition 21

should have a clear perspective on what its discourse and debate. In steady state, the investment strategy should be, especially with the annual review should drive decision making with MDAP portfolio. It might decide, for example, an eye toward affordability, efficacy (that is, that the bulk of the portfolio should center on whether current programs adequately cover lower-risk investments that promise a more present and future capability requirements), predictable capabilities return, and that a more efficiency, and balance. limited amount of capital should be allocated to high-risk investments that aim for truly game- Some might say that long-range planning and changing capabilities. portfolio management are not worth the effort because the budget process is annual and If, on the other hand, the government opts for will remain so, and the immediate political a high-risk/high-reward MDAP portfolio strategy, interests of certain members of Congress are sure it would be sensible to hold reserves for the to trump any long-term plan. But it is this very higher level of risk (that is, by increasing the issue that fact-based dialogue about MDAPs will cost-growth account) while simultaneously be able to counter. The stakes are too high, from reducing the number of MDAPs. Failing to take both a fiscal and a national-security perspective, these steps will simply set the stage for to continue relying on the current approach. continued systemic underfunding across defense acquisition programs.

The DOD’s annual budgeting process should include a review of both the LRCIP and the MDAP portfolio strategy so that significant changes in the fact base and assumptions are surfaced and evaluated. The DOD should present both documents to Congress and engage in appropriate

An expert view on defense procurement

In 2009 Bernard Gray, an adviser to the UK Ministry of Defence, wrote a scathing review of UK equipment acquisition. In this interview, he discusses the massive challenges the MOD faces—and how to overcome them.

David Chinn and In 2008, the UK Ministry of Defence (MOD) delayed technical solution.’ Even British trains John Dowdy commissioned an independent review of the state cannot compete.” of its equipment acquisition program. The resulting report, completed after eight months of The author of the report is Bernard Gray, a former research, was made public in October 2009 and MOD adviser who had directed the Strategic immediately got the attention of the British media Defence Review of 1998. Early in his career, Gray and citizenry. “The problems, and the sums of spent almost a decade as a journalist for the money involved, have almost lost their power to Financial Times, including a stint as the news- shock, so endemic is the issue and so routine paper’s defense correspondent. He is currently the headlines,” the report said, declaring the chairman of TSL Education, a UK-based publisher MOD’s equipment program “unaffordable of materials for educators. He is continuing on any likely projection of future budgets.” to advise the MOD on acquisition reform. In Perhaps the excerpt most often quoted in December 2009, Gray spoke with McKinsey’s press articles is the following: “It seems as though David Chinn and John Dowdy in London. military equipment acquisition is vying in a technological race with the delivery of civilian McKinsey on Government: Could you quantify software systems for the title of ‘world’s most how big the UK’s defense acquisition problem is? 23

Bernard Gray: It is a huge cost problem. The Another problem in this case is that the MOD is exact size depends on what one chooses to include generating contingent output—fighting capability or exclude and what projections one might make that may or may not be used at some point in the about budgets set for the MOD, but it’s certainly in future. You’re not talking about a set of activities the billions of pounds per year and in the tens of that leads to a revenue stream tomorrow or the

Neil Webb billions of pounds in capital risk. fulfillment of a revenue stream generated yesterday. Unless one puts constraints around the In eight months one can’t do everything, so my operation of this game, it will inevitably bias report is not in any sense comprehensive, nor do toward increasing cost. I pretend it is. I tried to look at the principal drivers of time, cost, and performance overruns McKinsey on Government: But surely it’s not or underperformance. My conclusion was that inevitable that the armed services compete there is a set of incentives operating at the center themselves to oblivion. of the Ministry of Defence that causes people both to “overprogram”—that is, order more capabil- Bernard Gray: Well, a knock-on consequence ity than they have the money for—and to of having this overlarge program is that the systematically underestimate the cost of those aspiration meets an iron gate, which is the amount capabilities. There are game-theory problems of cash allocated to the department by the inside this; it’s the prisoner’s dilemma. The three treasury for this purpose every year. If, for armed services are competing for scarce example, only two-thirds of the cash resources, and unfortunately it is a stable requirement for the proposed activity is available, equilibrium that causes them all to compete there are only two choices that the system with each other rather than cooperate. can make: cancel it wholesale, which the system is very reluctant to do for a variety of political McKinsey on Government: It’s a stable reasons, or slow down the rate of cash burned on equilibrium until the MOD goes broke. each of the projects, which has terrible consequences because it’s effectively a transfer of Bernard Gray: If you have three individuals resources out of productive output and into competing for the same dollar, you might be able unproductive overhead. to get to a state of play where there is trust among the individuals and each gets 33 cents. A classic case is the construction of the new But more likely, all three are going to attempt aircraft carriers. In early 2009, the ministry to get the whole dollar, and the most stable state decided to slow the construction program is distrust among the three parties. That’s a by two years, but not to remove the people natural tendency in any government system. And working on the program in the intervening this is an important difference between the period. So they’re carrying two years’ worth of not performance of the public sector in general and just MOD people, but everybody in industry the private sector—you don’t have that same working on that program and all the capital goods revenue constraint bearing down on you all the in the shipyards. Our estimates range from time. The way incentives are set up in £700 million to £1 billion in additional cost— government causes people to behave in ways that about 20 percent of the program cost, simply are inefficient for the whole group. as a result of that two-year delay. That’s a 24 McKinsey on Government Spring 2010

particularly large, salient example, but it happens To keep the plan on track between reviews, power on every program all the time. And of course, needs to be vested in a decision maker capable of delaying a program means you don’t have the defeating the game participants. The only person equipment as soon as you want, so you’re who can effectively discharge this duty is the forced to spend additional money on maintaining permanent secretary, who is in any case formally old equipment to keep it in service. accountable for the financial performance of the department. The permanent secretary is then Another problem is that the ministry has a set of assisted by the chief of the defense staff contractual relationships with suppliers. When representing the military interest and the finance the ministry goes back to a defense company and director of the department representing says, “Can I slow down my rate of cash burn on financial rectitude. Those three people make a this program?” the company says, “Of course, but program recommendation to the defense there will be a small additional charge.” It’s very board, composed of the armed forces chiefs and difficult for the ministry to negotiate that charge. senior civil servants, and to the secretary of We’ve estimated the total annual cost of those state as the representative of the political interest. sorts of problems from roughly £900 million to If this group is given the responsibility and power £2.2 billion. I could have made higher to produce a balanced annual capital plan, which is estimates but chose to be conservative. itself subject to audit and publication, it becomes much more difficult for politicians to interfere with McKinsey on Government: How can the MOD that process. So those are two mechanisms for break out of this downward spiral? Could you constraining the size of the program. give us a broad overview on what needs to be Bernard Gray done now to help deliver equipment on time McKinsey on Government: Theoretically, the and on budget? result would be a balanced strategic plan, which is a great first step. But then the plan needs Bernard Gray: The first component is to to be put into action. You’ve identified some constrain the game. One of my proposals is to things that currently make it difficult for the have defense reviews on a regular basis. MOD to put plans into action. There has been no intrinsic mechanism that keeps the program down to size, so what Bernard Gray: There used to be a clean happens is it grows and grows, then every five or distinction between the customer community— ten years there is an ad hoc defense review the armed services—asking for things and that hacks it down to some kind of acceptable the delivery unit charged with completing the size—which is why defense reviews have acquisition process, but the lines have become associated with cuts. My proposal is to become significantly blurred. I’ve proposed a have, in the first session of any new parliament, set of measures to recreate that customer-supplier a defense review process that should be formally relationship properly inside the department and appropriately costed, and that costing so that there is an appropriate separation should be audited by either a major accounting of powers and an attribution of responsibility. firm or the National Audit Office. The treasury should then fund that plan, and it should be Another major component is the delivery unit formally reviewed every five years. itself. About three years ago, the acquisition staff An expert view on defense procurement 25

and the support staff—the people responsible McKinsey on Government: It’s ironic, isn’t it? for supporting in-service equipment—were merged into a single organization. Advanced Bernard Gray: Yes—a very expensive savings. private-sector organizations, such as airlines, The ministry can’t do a defense review because, to make decisions on a whole-life cost of a piece of save money, it sacked all the people who could equipment rather than on an initial acquisition figure out what things were going to cost. We also cost—so it’s hard to object to the idea of making found insufficient skills in engineering, project decisions about the total cost of ownership of a and program management, and general manage- project. Unfortunately, there are a number of ment. We found shortfalls in information problems in the way it’s been done. One is that systems. There was no consistency; each of the there is no financial information that allows IPTs could pick any project-management tool the delivery unit to make any such choice. Even if they chose, which made it very difficult for senior it had the capital to be able to say, “We want to management to have visibility into what was spend 20 percent more on initial acquisition in going on in individual projects. order to cut 30 percent from support costs,” it doesn’t have the data to make the choice. A second Another thing that’s happened in the past problem is that the delivery unit, through few years is that the delivery unit lost its status as historical accident, is now also responsible for an external agency with a measure of strategic communications, the joint supply independence from the Ministry of Defence. It is chain, and naval dock yards. So our first proposal now operating as a wholly owned subsidiary is that those should be hived off into separate of the ministry, which means it is under the same entities to allow the integrated project teams cash constraints as the ministry. (IPTs) to focus entirely on the acquisition and support of particular capabilities. McKinsey on Government: What’s the solution, then? What should the ministry do about the Another problem is the significant capability delivery unit? deficiencies in the IPT structures at present. In particular we found insufficient financial Bernard Gray: I recommended that the MOD skills. The costing and estimating groups had look at the options for the status of the been cut down in order to save money. delivery unit over the course of 12 months. I set 26 McKinsey on Government Spring 2010

out a range of possible alternatives, and I said my how the delivery unit is organized. Unfortunately, favorite option would be to outsource the unit— the decision that the ministry has adopted at the essentially, to invite a number of qualified major moment leaves the delivery unit stranded where it contracting organizations that do not have a is, with no real way forward. conflict of interest to run the unit as a government- owned, contractor-operated entity. This model McKinsey on Government: Your report is done, operates in quite sensitive areas of defense in both and the ministry has accepted most of your the United Kingdom and the United States. recommendations. If you had it to do again, would you do anything differently? The part of the unit responsible for acquisition has an annual running cost of about £1 billion— Bernard Gray: If we had more time, I would have that’s for roughly 9,000 people and associated looked further into support costs. We looked support costs. And they are responsible for extensively into initial acquisition costs, but we managing approximately £13 billion worth of didn’t have the time to look enough at in-service equipment acquisition and support. My support costs. Also, I would have liked to have the interest is not so much in the £1 billion but in the time and resources to do more international £13 billion. A contracting organization could benchmarking on a quantitative basis. We looked earn a significant margin by making the system qualitatively at what other countries are doing, more efficient and effective, with fewer, better but some quantitative measurement may well have people working in it. The ministry would benefit flushed out some further efficiencies. from better management of the £13 billion, which is likely to translate into higher output McKinsey on Government: I think every through more initial acquisition of equipment country in the world struggles with delivering and a higher state of readiness for existing equipment on time and on budget. Do you equipment. There has been some general research think there are some general truths here about that says most outsourcing of government how to do defense acquisition well? What can services give rise to between 30 percent and others learn by studying the UK’s successes 40 percent productivity gains. and failures?

In any case, I recommended that the MOD study Bernard Gray: I know that the critical weaknesses the options over 12 months. It has decided not I’ve talked about—misaligned incentives, lack of to do that, at least for the time being. skills—also apply in the United States, Australia, France, and other Western countries. And these McKinsey on Government: What’s your truths apply not only in defense but in other areas reaction to that? of capital-intensive government expenditures; transport systems and health care might be two Bernard Gray: I’m disappointed, because I think examples. There are inevitably some differences in the 12 months of study would have brought to the ways that countries operate, but how to light a number of issues that have to do with the constrain incentives inside the game-theory relationship between the delivery unit and the problems on the one hand, and how to get highly central customer organization, how one affords to skilled people to deliver public services on the pay for the up-skilling of the delivery unit, and other, are enduring questions. An expert view on defense procurement 27

In most areas of public service, salaries are Bernard Gray: One can do a certain amount with lower and career prospects are not as attractive as processes and procedures, as I’m trying to do, in the private sector. All Western economies face but there is also a role for leadership and will. significant fiscal pressure over the next decade. Quitting smoking and staying quit are painful What I fear will happen in most advanced decisions because the benefit lies in the long term. economies is not a productivity improvement in The benefit of having a cigarette, on the other the public sector, but an output cut. I think a hand, lies in the short term, which is the way way forward essentially involves importing human beings tend to work—optimizing their private-sector incentives into the delivery short-term benefit and blinding themselves to of public services. the long-term consequences. All armed services around the world are heavy smokers, and McKinsey on Government: In his testimony to getting them to quit is going to continue to the Senate Armed Services Committee last year, be a difficult process. Secretary of Defense Robert Gates observed that in the United States there have been nearly 130 studies on defense acquisition since the end of World War II. Why is this so hard to get right?

Mastering military maintenance

Maximizing asset availability without increasing costs will be a critical priority for armed forces in the years to come. We have found that armed forces can improve both the efficiency and the effectiveness of their maintenance, repair, and overhaul (MRO) function by as much as 60 percent, but doing so requires fundamental changes to organization, processes, and mind-sets.

Colin Shaw As militaries around the globe strive to do more productivity of their maintenance processes by without increasing their costs, one critical between 40 percent and 60 percent, and they can area for improving performance is equipment increase the consistent availability of critical maintenance, repair, and overhaul (MRO). assets to more than 95 percent. Delivering these Performance in MRO has an important effect on kinds of improvements requires armed services the availability of equipment: in many to take three fundamental steps. First, they must armed forces, one-third to half of the total do maintenance work only when needed, capability of key asset classes is out of eliminating unnecessary work by reevaluating action for maintenance at any time. Furthermore, MRO protocols. Second, they must do it where in a typical armed service, MRO accounts it counts—that is, they must ensure that their MRO for more than 10 percent of the total defense infrastructure meets the requirements of current budget and as much as 70 percent of all operations. Third, they must do it as efficiently as aircraft-related costs. possible, which often means adopting best- practice techniques for productivity improvement— Our experience, based on our work with defense techniques pioneered by the manufacturing organizations across the globe, shows that armed industry but equally applicable in MRO services can typically improve the quality and environments. 29

By taking these steps, armed services can aircraft while keeping engine reliability under maximize availability without having to make any close scrutiny. trade-offs; the improvements come about even as MRO costs remain the same. In this article, we In the United States, one armed service replaced examine these steps in greater detail and discuss conservative, time-based maintenance intervals

Leigh Wells three elements vital to sustaining productivity and specified by manufacturers with a reliability- quality in MRO processes: smart labor planning, centered approach, thereby extending the time effective information management, and strong between major overhauls of some large assets operations management. from 5 years to 15. Key to the success of this approach has been the development of a Do it only when needed comprehensive evidence base that covers the In recent years, companies in various industries— performance of equipment in service. including oil and gas, automotive, and Detailed recording of incidents of equipment commercial aviation—have reduced maintenance failure allows MRO staff to perform work to the minimum possible level, whether maintenance only when needed; parts that by switching from time-based to condition-based do not wear out in normal service remain maintenance scheduling, implementing untouched during overhaul. in-service equipment monitoring, or building a detailed understanding of the root causes of Do it where it counts equipment failure. In so doing, companies not Many military MRO organizations were designed only cut maintenance costs and increase in an environment very different from that in equipment availability but also reduce the which they operate today. In Europe, for example, significant risk of introducing new problems many armed services established their current during maintenance procedures. MRO infrastructure during the Cold War, when the next conflict was expected to take place at Leading armed services are using some of the same or near home and MRO structures needed to be approaches. Typically, they begin with a critical robust in the event of a direct attack. Changing look at current MRO protocols: were the protocols military doctrine brings these structures into designed for operating conditions that have since question. Are multiple MRO facilities at home changed? Could a simpler inspection or diagnostic necessary when the expeditionary force needs test replace a costly and time-consuming critical capability thousands of miles away? intervention? Is the MRO requirement of a few Should resources be reallocated from the main- critical parts dictating a larger overhaul? One tenance of tanks to aircraft, given that aircraft of the world’s ten largest air forces, for example, sees much higher levels of utilization in theater? undertook a review that revealed that the By better matching their MRO organizations to manufacturer requirement for a major overhaul of current need—that is, collapsing processes onto one aircraft type every 200 flying hours was strategic locations and making common driven by the likelihood of failure in a few key MRO services available closer to the front line— engine components. By separating engine and armed forces can reduce redundancy, minimize airframe maintenance schedules, the air force transportation requirements, was able to dramatically increase the time maximize economies of scale, and improve between interventions for the majority of the asset availability. 30 McKinsey on Government Spring 2010

In the United Kingdom, maintenance work on More open-minded leaders of MRO units have Harrier vertical takeoff fighter aircraft took delivered dramatic quality and productivity place at two separate bases, each with engine- improvements by emulating the processes of overhaul facilities located nearby. Consolidating modern production facilities. One UK army these facilities into one site has produced unit, for instance, halved the man-hours required annual savings of £250 million and allowed the to refurbish each armored vehicle by moving introduction of more efficient and flexible from a fixed-station approach—in which one team maintenance processes. In Australia, a program is worked on a single vehicle from beginning to under way to consolidate submarine maintenance end—to a flow-line approach (long used in mass at a single base, with key suppliers located adjacent production but only recently proven valuable to the repair docks. (We note that consolidation in military MRO) in which vehicles move through of facilities makes sense only for nations without the facility from station to station, with a team an immediate threat from a neighboring country.) at each station focused on a specific task. Teams have thus developed deep expertise in their Moves like these can be challenging to implement. particular tasks, performing them faster and Military commanders tend to be reluctant to more effectively. The flow-line approach has close facilities that have received substantial delivered other benefits as well: a reduced need investment, and loss or movement of large for duplicated tools and equipment, and fewer numbers of jobs is obviously politically sensitive. training requirements because individuals have to To be successful in these kinds of efforts, armed develop proficiency in only a few tasks. forces must convincingly demonstrate both the operational and financial case for consolidation. The same unit also changed its approach to shorter- cycle maintenance processes for bringing vehicles Do it as efficiently as possible back into full operational order between missions. Maintenance personnel take pride in their It used a pit-stop approach inspired by motor- flexibility and ability to cope with unexpected sport processes—that is, rather than working on “emergent” work discovered during main- each vehicle when it arrives, teams do as much tenance activities. While these skills are preparatory work as possible before a vehicle important in MRO, they are often accompanied comes in from the field, ensuring they have the by a failure to recognize that the majority of right parts, tools, and people in place to work on maintenance work is highly predictable and damage reported by crews. The pit-stop approach therefore likely to benefit from the same has enabled the unit to do repairs in the field that productivity-improvement techniques that have would previously have required vehicles to be sent transformed the efficiency of manufacturing to a dedicated maintenance facility. Damaged industries around the world. These best-practice vehicles are often made ready for use again during techniques eliminate waste and root out the same mission—something that had been rare unnecessarily nonstandard work practices, under the previous system. Since adopting the unbalanced maintenance loads, and highly approach, the unit has reduced by 67 percent the variable team structures that have hampered time taken to complete work on each vehicle. efficient and effective delivery, and that many defense personnel have traditionally—and Some MRO staff fear that the rigor inherent in mistakenly—viewed as unavoidable. standardized best-practice techniques will Mastering military maintenance 31

Labor planners and schedulers must strike the right balance between maximizing the availability of individual assets and increasing the efficiency of the system as a whole

hamper their ability to “flex” capacity in response training activities or are keen to spend the time to spikes in demand. However, MRO personnel with their families. Even if they are theoretically often find that these techniques actually improve available for work, other aspects of military life flexibility—both by reducing the time required to can limit their actual working hours to as little as complete common tasks and by making it easier 20 percent of the available time. to allocate tasks across available labor resources. If MRO organizations are effectively paying five Achieving continuous improvement times their standard hourly rate for military Once they have designed and implemented personnel, it may be more cost-effective to employ efficient MRO processes, military organizations civilian staff for MRO roles. Australia, for must adhere to those processes and seek to example, has outsourced maintenance work on improve them in the face of emerging knowledge military transport aircraft to the technical and changing demand. To do this, they must have organization of Qantas Airways, thus freeing up excellent capabilities in labor planning, infor- key military personnel for other tasks. mation management, and operations management. Furthermore, the civilian personnel have applied sophisticated approaches developed for airliner Labor planning maintenance and thus achieved higher produc- Leading manufacturing companies use production tivity than their military counterparts. leveling—a technique that aims to keep the volume and mix of work as constant as possible— Outsourcing maintenance activities is not without to achieve extremely high efficiency. Similarly, risks, however. If civilian contractors are required labor planners and schedulers must strike the in theater, the cost and complexity of providing right balance between maximizing the avail- appropriate protection can be significant. Also, ability of individual assets and increasing the the loss of MRO skills among military personnel efficiency of the system as a whole. It may be could threaten a service’s ability to keep key better, for example, to bring forward the scheduled equipment operational in the field; some services overhaul of a vessel if dock capacity is available have minimized this risk by rotating military than to ensure it completes all its operating hours. personnel into contractor work teams.

Planning for labor availability can make a big Information management difference in MRO performance. It is common for Effective management of information is equally crews to be assigned to maintenance activities important to sustaining high performance. when their vessels or vehicles are not in service, For example, to optimize scheduling and work but pressure on this time is particularly intense, allocation, planners need accurate data on as personnel are often required to participate in how long MRO tasks take. In one military facility, 32 McKinsey on Government Spring 2010

the shortest time allocated to any task was four a job card for each maintenance task. Once hours, even though many tasks took considerably they complete the tasks, they are required to sign less time. The result: long MRO cycles and an off on the cards and in both logs. underutilized workforce. MRO organizations can overcome this simply by monitoring how long MRO organizations must implement information- it takes for experienced staff to complete certain management processes and systems that allow tasks over a few MRO cycles, making these data relevant personnel to enter, access, and analyze easy to record and access, and using them as data easily and in real time. In one air force, benchmarks for planning and work allocation. pilots key details of incidents into a computer terminal when their mission is complete, enabling In other military MRO activities, tedious record- automatic creation of work orders and real-time keeping places a burden on staff. Excessive review of the frequency of incidents by all paperwork, in fact, is one factor that eats into relevant personnel. This system allows the service “wrench time”—the working hours that to constantly refine its maintenance policies. maintenance staff spend on their assigned tasks (exhibit). Some armed services, for example, Operations management require pilots to keep handwritten records of One might think that introducing operational aircraftMcKinsey defects on Government in a log kept 2010 in each aircraft. changes is relatively straightforward in the TheirMRO notes are then copied into a duplicate log military environment, since presumably it can be keptExhibit at the1 of base, 1 and MRO personnel create done by order and maintained as a function of Glance: When “wrench time” is low, there is a major opportunity for productivity improvement. Exhibit title: Time for tasks

Exhibit Time for tasks Average hours (based on standard hours for Monday through Thursday) 0.67 0.33 When “wrench time” is low, there is a major opportunity for 0.67 0.16 productivity improvement. 0.50 1.00 0.50 9.15 1.00 0.50

2.00 20% 1.82

Total shift Lunch Breaks Break Shift Obtaining Obtaining Obtaining Waiting Waiting Paper Time time overruns brieﬁng and and and for for and spent on waiting waiting waiting other skills inspection computer maintenance for tools for parts for (eg, other work and auxiliary trades, external equipment authorized agencies person)

Source: On-site observations and interviews with maintainers and supervisors at a European military facility Mastering military maintenance 33

military discipline. The reality is that the internal components under great strain and management of MRO is at least as challenging frequently resulted in damage. MRO managers in the military as in civilian life—but the must ensure that they train their staff to challenges can be overcome with smart engage in root-cause problem solving rather than operations management. going for quick fixes.

One challenge is that while military operations can A third management challenge in military MRO is produce pockets of extremely good practice, capturing the “hearts and minds” of personnel. these practices are far from universal. Aircraft- After all, few military personnel envisage working maintenance personnel, for example, are in a factory environment when they embark on trained to avoid the risk of foreign-object damage their careers; furthermore, the connection between in part by ensuring that tools are returned to improved shop-floor productivity and battlefield their allocated place after each use; a byproduct success is not obvious. Emphasizing that link of these excellent tool-control practices is that an through frequent and careful communication can aircraft-maintenance staff never wastes time become a vital motivator. The leaders of one air searching for tools. Yet ground-vehicle MRO units force MRO facility, for example, explained to rarely adopt these practices. The most effective personnel that savings achieved on the overhaul of MRO leaders establish mechanisms for best- an existing aircraft fleet would allow the force to practice sharing and learning. acquire an additional squadron of new-generation fighter aircraft. Another challenge is that best practices in operations can run counter to good practices in other military activities. For instance, many military personnel excel at finding fast and creative As with any transformation program, the support solutions to problems on the line. One air force and commitment of top management is vital to suffered frequent failures of the hydraulic power the sustainability of MRO improvement efforts. units used to support aircraft on the ground, and The explicit and implicit signals that leaders instead of investigating the cause of the failures send their subordinates have a direct effect on right away, MRO staff quickly became adept at how well new techniques “stick.” Leaders repairing the units. Only much later, when use must persist even when MRO staff initially appear was studied in the field, did it become clear resistant to new ways of doing things. Our that operators were circumventing the unit’s experience has shown that once military personnel time-consuming shutdown procedure by see the benefits of best-practice approaches, they activating the emergency stop, which placed typically become extremely enthusiastic adopters.

Big savings from little things: Non-equipment procurement

Despite constituting a substantial portion of defense budgets, non-equipment purchases tend to receive scant attention. Defense organizations can capture savings of up to 20 percent in non-equipment categories if they raise their game in several dimensions, including capability building, the use of proven purchasing tools and processes, and performance management.

Hans Arnum, While costly equipment, such as ships or aircraft, more than the GDP of countries such as Singapore Christian Husted, understandably receives much of the attention or Israel (Exhibit 1). Frank Klausen, when it comes to defense spending, non-equipment and Yaron Savoray procurement—the recurring purchase of items Non-equipment procurement in defense shares related to daily operations—makes up a substantial many of the challenges common to public-sector portion of the defense budget. Our analysis procurement, such as the lack of a consolidated indicates that many large militaries spend as view of spending, limitations imposed by complex much on non-equipment purchases as they procurement laws, and issues with basic do on equipment—that is, up to 25 percent of the performance.1 These challenges are aggravated by defense budget. Non-equipment purchases the lack of scrutiny given to non-equipment include civilian-type categories (for example, food purchases; decision makers are understandably and office supplies), military commodities such most concerned about equipment procurement, 1 See Christian Husted and Nicolas Reinecke, as simple munitions and helmets, and spare parts which represents the “core business” and for which “Improving public-sector for vehicles and aircraft. Non-equipment spend the risks associated with failure are much purchasing,” McKinsey on Government, Summer 2009. in the 15 largest militaries exceeds $200 billion, greater. Furthermore, few people in a typical 35

defense organization have commercial capabilities it warrants, opportunities to achieve savings in non-equipment procurement. As a result, often go unnoticed. And these opportunities are even basic approaches for obtaining items at significant: a number of studies suggest that lower prices, managing demand, and challenging defense organizations can attain savings of up to specificationsMcKinsey on Government are not always 2010 applied. 20 percent, enabling them to redirect 2 percent Leigh Wells Nonequipment Procurement to 3 percent of the defense budget to better uses— BecauseExhibit 1 non-equipment of 4 procurement typically without any reductions in personnel or military doesGlance: not Annual receive non-equipment the senior-management procurement of attention the world’s 15capacity largest militaries (Exhibit represents 2). more than $200 billion. Exhibit title: Big spenders

Exhibit 1 Big spenders Estimated annual non-equipment Annual defense spend (2007) procurement spend $ billion $ billion Annual non-equipment procurement of the world’s United States 552.6 110.5 15 largest militaries represents United Kingdom 63.3 12.7 more than $200 billion. France 60.7 12.1 China 46.2 9.2 Germany 42.1 8.4 Japan 41.0 8.2 Italy 37.8 7.6 Saudi Arabia 35.4 7.1 Russia 32.2 6.4 South Korea 26.6 5.3 India 26.5 5.3 Brazil 20.6 4.1 Canada 18.5 3.7 Spain 17.5 3.5 Turkey 13.6 2.7 McKinsey on Government 2010 Total 1,035 206.9 Nonequipment Procurement

Exhibit Source: The 2 ofMilitary 4 Balance 2009, International Institute of Strategic Studies; McKinsey estimates Glance: Indirect defense procurement typically saves 10%–15%. Exhibit title: Savings potential

Exhibit 2 Savings potential Examples of specific category savings identified Overall non-equipment savings identified in defense in recent defense procurement projects, % procurement projects, %

Non-equipment savings Country A Country B Country C 15–20 can be as high as 20% in Public transportation 12–16 10–18 some categories. Vehicles (civilian) 8–12 9–14 Food and catering 8–12 20 14–25 8–15 Uniforms and clothing 5–10 10–15 Fuel 5–8 3–5 3–5 Simple ammunition 9–15 10–20 Country A Country B Country C 36 McKinsey on Government Spring 2010

Our work with several military organizations opportunities in all four performance dimensions reveals substantial opportunities to better covered in the survey: strategic alignment and manage non-equipment expenditures. We used a orientation, capabilities and culture, category proprietary tool, the Global Purchasing management and execution, and structures Excellence (GPE) survey, to help military and systems. In this article, we describe the organizations assess the performance of challenges as well as potential solutions in their purchasing organizations. The survey results each of these four dimensions. indicate that non-equipment procurement is McKinseyundermanaged on Government relative to 2010 a benchmark of more Strategic alignment Nonequipmentthan 300 companies: Procurement the military average and orientation Exhibitfalls near 3 of or 4 below the bottom 20th percentile in Countries use one of three organizational Glanceall but: Defenseone of the procurement ten survey spend subcategories is typically undermanaged models in comparison for defense to benchmarks. procurement (Exhibit 4). Exhibit(Exhibit title: 3). WeImpr foundovement substantial opportunities improvement Each model has advantages and disadvantages.

Exhibit 3 Procurement managers’ evaluation of their organizations’ Average for all industries Improvement procurement practices, on a scale of 1 to 5, where 5 is best Defense average opportunities 80% of companies in all industries Strategic alignment Defense procurement spend and posture is typically undermanaged in comparison to benchmarks.

Strategic alignment and posture Capabilites Knowledge and and culture information 5 Mind-sets and management aspirations 4

3 Performance Talent 2 management management 1 Structure and systems

Cross-functional Category value- collaboration creation strategies

Organizational Category purchasing structure processes Strategic value- chain impact

Category management and execution Big savings from little things: Non-equipment procurement 37

McKinsey on Government 2010 Nonequipment Procurement Exhibit 4 of 4 Glance: There are three options for organizing a non-equipment procurement department. Exhibit title: Sound structure

Exhibit 4 Organizational Model 1 Model 2 Model 3 models Department Department Department of Defense of Defense of Defense There are three options for organizing a non-equipment procurement department. Non-equipment Equipment Joint procurement procurement procurement

Air Air Air Army Navy Army Navy Army Navy force force force

Procure- ... ment

Description Non-equipment procurement is a Non-equipment procurement is Service-speciﬁc procurement shared service but separate a shared service, integrated with function, often integrated from equipment procurement equipment procurement with equipment procurement

Examples • Germany • United Kingdom • France (certain categories) • France (certain categories) • Israel • United States • Canada

In one model, non-equipment procurement is of this model is that it tends to result in separate from equipment procurement and is a inadequate attention to non-equipment purchases. shared service across all military branches. This model allows the organization to pay adequate In the third model, each branch has its own attention to non-equipment procurement, hire procurement organization. This setup increases civilian personnel with extensive purchasing speed and flexibility in meeting users’ needs experience, and capture economies of scale. but often results in unnecessary duplication But in this model, the demanding functions or and missed opportunities to capture scale “customers”—the military branches—are benefits. It also impedes an organization’s ability separate from the procuring functions, increasing to get an accurate picture of total spend per the risk that purchasers will lack a good category and total spend with specific suppliers— understanding of users’ needs. Also, the procuring both critical data points for developing a function focuses solely on execution and has sound sourcing strategy and facilitating limited ability to create value by influencing the effective procurement. procurement strategy, challenging product specifications, or managing demand. Some countries—including Canada, Germany, Israel, and Sweden—appoint civilian leadership The same holds true in the second model, in which for the procurement organization. Other a single organization is responsible for both countries, such as Denmark, France, and the equipment and non-equipment procurement for United States, appoint military leadership. all military branches. An additional disadvantage While civilian leaders typically have more 38 McKinsey on Government Spring 2010

Israel: A case study

The Israel Defense Forces (IDF) and Ministry of Defense (MOD) The IDF and MOD are piloting several initiatives to address purchase more than $3 billion per year—approximately these inefficiencies in four non-equipment categories. 2 percent of GDP—in products and services to support For each category, they are creating an integrated category- defense operations. The defense establishment, in fact, management team including personnel from both is the single largest customer of many Israeli industries. organizations. The team will be accountable for cost, quality, and on-time delivery, and it will have authority over the For the past 60 years, there has been a clear separation end-to-end process. The civilian team members from the between the demand organization (the IDF) and the MOD will be responsible for negotiating with and procurement organization (the MOD). The IDF defined the purchasing from vendors, thereby maintaining the existing need, specified the product and service, and allocated a prohibition on commercial activities by military personnel. budget, while the MOD negotiated a price for and purchased However, the civilian personnel will also work with military the items requested. The separation ensured that military team members to develop specifications for the items officers did not have responsibility for the commercial aspects requested. The MOD is preserving the independence of of defense operations. civilian operations by maintaining existing reporting lines. A function within the MOD’s budget department will oversee In 2009, the MOD conducted a diagnostic to assess the and challenge the performance of the integrated teams. quality of procurement processes, organizational structures, and outputs in Israel’s defense establishment. The The organizations are also establishing performance metrics diagnostic also assessed the value received for expenditures and targets for savings and customer satisfaction. They and the scale of the opportunity for achieving efficiencies. are improving the relevant skills of personnel involved in Detailed analyses of six categories covering approximately purchasing and category management through on-the-job one-third of non-equipment purchasing identified the training and the hiring of experienced civilian personnel. To potential for annual savings of 8 percent to 10 percent. capture economies of scale, they will make greater use of multiyear budgets and consolidated categories. The diagnostic homed in on three root causes of inefficiencies. First, the defense establishment lacked a single point of To enable implementation of these changes, the IDF and accountability for each category. No function or individual MOD are revising purchasing regulations and standards, in the organization had visibility into the cost implications conducting a major overhaul of the budgeting process, and of decisions made at each step of the process. Second, the redesigning the purchasing organization by appointing a absence of performance metrics resulted in an insufficient “lead purchaser” to manage each generic category. The focus on cost efficiency. Third, a series of organizational, government has set a savings target of $250 million per year. process, and budgetary barriers impeded efforts to capture scale benefits. For example, the budgeting and ordering processes for some items were on a monthly cycle, limiting the benefits attainable through purchasing larger quantities over the longer term. Big savings from little things: Non-equipment procurement 39

sophisticated commercial capabilities, they may Second, defense organizations can appoint a sole lack credibility with regard to understanding category “regulator” or “lead purchaser”—that military needs, which can hinder their success in is, a unit within the procurement function that challenging specifications. sets standards for purchases within the category. One defense organization had been Because the organizational model is dictated by purchasing 11 types of headsets for the issues much broader than procurement efficiency, military branches, with varying specifications addressing procurement challenges through on cable length, speak/listen functionality, large-scale organizational redesign is typically not ear-shell design, and electrical impedance. By the first option to pursue. Defense departments appointing a category regulator to determine can instead focus on two elements to drive a combination of variants that would meet the effectiveness in non-equipment procurement, needs of all users, the organization was able regardless of their organizational model. to set specifications for a single, standardized headset—thereby achieving a savings of First, they can establish a cross-functional team, 25 percent for the category. While each defense including people from both the military and ministry will make different decisions about procurement sides, to oversee each product which product categories to purchase on a branch- category. These joint teams would be accountable specific basis, there are certain categories (for for setting and challenging specifications as example, food and fuel) that in all cases should be well as procuring items. Defense ministries have centrally managed because the scale benefits found ways to establish joint working teams clearly outweigh the need to satisfy different without compromising the separation of military preferences among the branches. and civilian responsibilities (see sidebar, “Israel: A case study,” p. 38). For example, they Capabilities and culture require that only civilian team members Procurement capabilities in defense organizations directly interact with vendors, and they maintain are seldom commensurate with the scale and separate reporting lines between the complexity of non-equipment purchasing. Military demanding and the procuring functions. Such personnel typically lack a commercial background teams should be relatively small—a dozen and, because officers tend to have short rotations people at most—to remain effective. in the procurement department, few develop deep 40 McKinsey on Government Spring 2010

expertise in the area. Moreover, because military coaching and workshops, the experts trained staff personnel do not view non-equipment members in procurement skills—for example, procurement as an attractive career path, it is equipping buyers with the techniques as well as difficult to attract and retain the best people. the confidence to negotiate aggressively with As to culture, defense organizations are primarily suppliers—thus helping the organization make concerned about operational preparedness and improvements in category management even getting the equipment “right here, right now”—a after the external experts departed. To embed mind-set that leads to overspecification and capability building into the culture of the lack of standardization. organization, some procurement functions have set up a daily reinforcement and skill-building Building capabilities should be an integral part of system, with talented “champions” within all procurement programs. Defense organizations the function serving as coaches. should strengthen capabilities in four critical areas: process knowledge (for example, skills in Hiring civilian talent with extensive procurement negotiating and contracting); analytical skills; experience can also play a critical role in commodity expertise (that is, for specific capability building. In many cases, the defense items, an in-depth understanding of value drivers, organization is among the largest purchasers savings levers, and internal demand-management in the country, which can make it an attractive levers); and execution abilities (including defining employer for procurement professionals. and tracking performance metrics). Such efforts These experienced civilians can help train should emphasize on-the-job training, with military personnel and instill a more classroom instruction kept to a minimum. commercial mind-set throughout the organization.

One European defense organization paired To attract and retain talent, defense organizations external experts with motivated internal talent. should establish a well-defined career path Through a combination of one-on-one within non-equipment procurement and offer Big savings from little things: Non-equipment procurement 41

Organizations should apply a total-cost-of-ownership approach, calculating costs throughout the life cycle of items. In the case of vehicles, this would include garage, fuel, and maintenance costs in addition to the purchase price

opportunities for moving into and out of the needed to create a complete picture of spend will function to build related skills. Detailed probably not be readily available in the job descriptions for each procurement position, organization’s IT systems; many procurement including the job’s purpose, major accountabilities, systems in defense organizations contain and key performance indicators (KPIs), are only an aggregated view for budget purposes also essential to track performance and ensure a (that is, the types of products and services continuous career-development path. Someone purchased) and item-by-item records of purchases. who starts as a local transactional buyer, for Procurement personnel will therefore have to instance, should see a clear path toward becoming estimate the size and composition of these a regional buyer or category manager, and the categories by gathering data from a variety steps for getting to those positions should be of sources, including invoices, department explicitly integrated into his or her professional budgets, and current suppliers. development plan. Organizations should apply a total-cost-of- Category management and execution ownership (TCO) approach—that is, they should There are two main challenges in category calculate costs throughout the life cycle of items. management and execution. First, personnel often In the case of vehicles, for example, this would have limited visibility into the true costs of include garage, fuel, and maintenance costs in items—with regard to both total spend and total addition to the purchase price. Because non- cost of ownership—particularly across military equipment procurement includes spare parts for branches, thus limiting the organization’s ability big-ticket items, the function can play a critical to realize benefits of scale and take advantage role in managing life-cycle costs for the entire of price differences. Second, public-sector defense establishment. constraints, such as strict tender rules, reduce the willingness of personnel to apply the full set of Once they have the data, procurement leaders procurement levers. For example, to avoid violating should then develop a category-management an equal-opportunity rule, personnel might not strategy that includes a sourcing strategy, attend supplier workshops despite the valuable identification of demand-management levers, knowledge that they could gain. and the process for vendor negotiations. They should create clear protocols for supplier To gain better visibility into costs, organizations interaction (including requests for information should get a consolidated view of the overall and supplier workshops) so as not to spend per category. Such an effort will not be unnecessarily restrict the use of procurement straightforward, given that the information tools and methods. And they should streamline 42 McKinsey on Government Spring 2010

Defense organizations should establish a performance- management system that makes clear to all personnel what they and the department as a whole must achieve, beginning with aspirational savings targets for each category

procurement processes—for example, by setting one country, for example, the delivery time for standards for periodic review of contracts and bid requested items was the sole performance solicitations. One European country captured metric for procurement. The lack of KPIs and significant savings by expanding the number of targets for individuals or for the department vendors in the tendering process. The often results in limited collaboration among procurement staff created detailed specifications military branches, despite the fact that for uniforms and bid out the supply contract many defense organizations have established a rather than use its traditional vendor. The resulting shared service for procurement. contract with a new vendor cut the cost of uniforms by up to 40 percent. Some countries outsource non-equipment procurement in an effort to get better prices. We recommend that organizations first pilot new However, because third parties are typically approaches in categories for which changes will compensated based on a percentage of the cost of be easiest to implement and that hold significant goods purchased, they have little or no incentive savings potential. These will typically be the to manage demand or challenge specifications. In more generic categories in which the military the absence of adequate systems for managing branches are least resistant to change. One the vendor relationship, the defense organization European country started its transformation loses the benefits of these two valuable levers effort in four categories: telephony, canteen for reducing costs. food supplies, facilities maintenance, and IT support. For each category, it identified the Defense organizations should establish a relevant improvement levers, including performance-management system that makes product standardization, supplier consolidation, clear to all personnel what they and the demand management, solicitation of bids department as a whole must achieve, beginning throughout the European Union instead of just with aspirational savings targets for each domestically, and standardized agreements. category. Procurement leaders can set these The total savings ranged from 15 percent to targets by first making top-down estimates 25 percent in the four categories, and the based on external benchmarks and then government is now extending the program confirming these estimates through a detailed, to all categories. bottom-up analysis of specific categories. In one defense organization, bottom-up analysis of Structures and systems the clothing category identified savings in the Performance-management systems are often range of 18 percent to 26 percent, comfortably absent or inadequate in procurement functions. In exceeding the benchmark range of 10 percent to Big savings from little things: Non-equipment procurement 43

15 percent. Clean-sheet cost analysis suggested to manage demand and challenge specifications. that the organization was paying a premium of up For example, the contract could set targets in each to 50 percent for a polyester garrison uniform category for the vendor to fulfill orders with shirt, for example. private-label brands. The contract could also require the vendor to quantify the savings The organization should define a broad set of KPIs potential for changes in demand-management for cost savings, quality, and service. Such KPIs policies, such as guidelines for travel expenses might include TCO savings per category, annual (for example, how much the organization and three-year savings, percentage of spend could save if staff used videoconferencing in place addressed, frequency of using preferred suppliers, of single-day travel). advance notice of orders, and internal customer satisfaction, as well as other metrics for demand and supplier management. To hold personnel accountable for achieving these targets, senior In our experience, it is best to begin the process management can use tools such as KPI of improving non-equipment procurement by first dashboards to track the variance from targets. addressing a few specific product categories, Consequence management is also critical; because quick realization of savings in these the organization should give monetary or categories will help establish credibility within nonmonetary rewards for good performance the organization. Early successes will build and impose negative consequences for momentum for addressing more complex issues underperformance. relating to the organizational structure. Organizational redesign should not, as some Whenever non-equipment procurement is believe, be the starting point for procurement outsourced, the vendor contract should set clear transformation, but rather should be addressed guidelines and offer incentives for the vendor over time.

Hans Arnum and Christian Husted are principals in McKinsey’s Copenhagen office, whereFrank Klausen is an associate principal. Yaron Savoray is an associate principal in the Tel Aviv office. Copyright © 2010 McKinsey & Company. All rights reserved. 44

Stabilizing Iraq: A conversation with Paul Brinkley

The leader of the US effort to revitalize Iraq’s economy talks about the lessons he has learned over the past three years, the relationship between economic development and security, Western misconceptions of the Middle East, and the hardest part of his job.

John Dowdy When the US Department of Defense (DOD) people, and that doing so would help stabilize the sought to modernize its business practices, country. In June 2006, largely through Brinkley’s it turned to a Silicon Valley executive with a efforts, the DOD established the Task Force proven track record in streamlining operations. for Business and Stability Operations (TFBSO), Paul Brinkley had been the chief information dedicated to revitalizing Iraq’s economy and officer and a senior vice president at the technology creating jobs for Iraqis. TFBSO placed civilians company JDS Uniphase, as well as a licensed with expertise in industrial operations and industrial engineer with four US patents to his factory management on the ground in Iraq— name, when he joined the DOD in 2004. skills previously absent from the American Brinkley promptly went to work improving the presence there. department’s processes and systems. But two years later, in a turn of events he did not anticipate, Under Brinkley’s leadership, the task force began he was spending half of every month in Iraq. on-site assessments of idled Iraqi factories and worked with Iraqi businesspeople to reopen An eye-opening first visit to Iraq in 2006 them— providing training for employees, convinced Brinkley that the DOD could do more upgrading equipment, and preparing the factories to improve economic conditions for the Iraqi for large-scale private investment. The task force 45

also engaged leaders from the United States and Westerners have an impression of an entire people international corporations to support Iraqi that is extremely unfavorable and not at all industries, hosting more than 130 private investors representative of that world. I wish every American and senior executives in Iraq and facilitating could get to know the Iraqi people. They have several joint ventures. In addition, TFBSO has the same hopes, dreams, and aspirations as people

Brian Stauffer deployed more than 400 US business leaders, in every other country. They aspire to a good engineers, accountants, and academics across life, a job, advancement, an education for their Iraq’s provinces. For example, faculty and staff kids. I think so much of what we’re exposed from American universities have worked on farms to in the media dehumanizes Iraqis and makes in central, northern, and western Iraq, helping the problems in Iraq just seem insurmountable. Iraqi farmers increase production levels and learn American businesspeople think, “How could you modern farming techniques. To date, TFBSO has possibly do business in a place where the people helped restart production at more than 60 Iraqi are so different?” But they’re not so different. That factories, facilitated contracts worth more than has been a lesson learned for me, and it’s a $1 billion between foreign private investors and challenge we really need to confront in the West. Iraq’s state-owned enterprises, and helped How we currently view the Middle East provide jobs for 250,000 Iraqis. definitely damages our ability to be effective there.

In October 2009, Brinkley spoke with McKinsey McKinsey on Government: Most people director John Dowdy in Washington, DC, wouldn’t think of economic revitalization as a about his work in Iraq and what lies ahead. core defense function. How did you end up Excerpts from the interview follow. doing this in the Department of Defense?

McKinsey on Government: Before 2005 you Paul Brinkley: To answer that question, I’d had never even been to Iraq; now you are like to point out a lesson—and I am calling it a there every two weeks. What surprised you most lesson because I think what I’m about to say is when you went to Iraq for the first time? now a widely accepted proposition in Washington among the people who think about what the Paul Brinkley: In my private-sector career I had government is and should be. The lesson is that we been to East Asia and India, but never the need the ability to use economic improvements Middle East. My image of the Middle East had as instruments of foreign policy. been formed by what we see on television and the mass media. I probably wasn’t atypical of an Until today, the US government has institutionally American businessperson in that I expected had two instruments of foreign policy: diplomacy to see desert, camels, palm trees, oil. I never went and force. Yet what the world sees—via mass media, into Iraq expecting to find a skilled workforce the Internet, mass communications—and what and an industrial economy. That was completely the world wants access to is economic prosperity. surprising to me. America is the predominant actor in terms of projecting economic prosperity. But we’ve seen in I think the West has a notion of the Middle East places like Iraq and Afghanistan a synchronous and the Muslim world that is colored by the linkage of violence and economic deprivation. We sensational events that dominate the media. Many need to look proactively for ways to uplift the 46 McKinsey on Government Spring 2010

economic prospects of a society to help stabilize it. we’ve had, and there are a lot of statistics we can We don’t have that institutionally in the cite about the effects we’ve had across Iraq. government; the US government is not designed Those successes are heartwarming, but I’m to assist in that capacity. proudest of our team’s ability to be nimble and adjust to circumstances, particularly in a But the Department of Defense is doing it today. government structure that makes adaptability And it is doing it for a couple of reasons. One is very hard, especially in civilian-type work. that the DOD is in harm’s way. It is facing the most immediate consequences of the problems, McKinsey on Government: The conventional and it is bearing the brunt of the pain and loss— wisdom is that there has to be security wounded soldiers and casualties of war. before economic development can begin. You The other reason is that the DOD is itself a huge have a different view—that economic business operation. It is the world’s largest development actually helps establish security. industrial enterprise by a factor of about three, much larger than the world’s largest corporation, Paul Brinkley: It can sound like a cliché, but we so it has people who understand business. have to address the fundamental structural It can draw on its business expertise. That’s how brokenness in places where violence has taken we initially engaged in Iraq. hold. What causes people—not just random actors, because you can have random violent Institutionally, there’s a debate under way about actors in any society—but people in general how the government should approach this. Should to reach a point where they sympathize with [business and stability operations] be in the violent actors, and violence takes hold and Paul Brinkley department long term? Should they be in some becomes part of daily life? People without hope— other part of the government? For the time people with no prospects—will act out. being, the DOD has been able to marshal the resources to address this problem. There I look at our own experience in the midst of this have been challenges in doing it as part of the economic downturn and the decisions we DOD, and there have been benefits. We’ll see have made in the West that even two years ago how the structures play out over the longer term. may have seemed shocking. We’ve made certain decisions regarding our banking industry McKinsey on Government: In the more than and our automotive sector. Why have we three years since TFBSO was formed, what made these decisions? Because we don’t want are you proudest of? What do you think has been social unrest; we don’t want to create an the task force’s biggest accomplishment? environment where society begins to degrade—so why would it be any different for anyone else in Paul Brinkley: I’m proud of the way that we as a any other part of the world? I think we have lost team have been able to adapt. When [TFBSO] our perspective because of our long-term started working in Iraq in 2006, the situation prosperity. We have lost a sense of understanding there had deteriorated to a level of violence of how hopelessness can cause one to act out that no one had predicted, and no one had a plan in ways that someone in a prosperous situation at that time for how to deal with that violence. wouldn’t. And now you see our troops dealing Obviously I’m proud of all the successes with the results of that—our young men and Stabilizing Iraq: A conversation with Paul Brinkley 47

women are trying to secure areas where the about people’s lives and livelihoods, we unemployment rate is 50 percent, where people compromise quickly on those things. By the way, I have no hope and no prospects, and where think it is reasonable that we compromise; it the sympathy with violence is so great. In my view, doesn’t mean that we’re becoming socialists or it is fundamentally unacceptable to send troops that we’ve given up on the free market, but it into harm’s way like that. is an acknowledgment of the fact that government has a responsibility to act in the best interest of I don’t think it’s an either/or, and I don’t think citizens. An ideologically driven mind-set on either security necessarily creates economic side is not the right one to have. If we’ve learned development or vice versa, but to say there’s anything in Iraq, it’s that you have to take the no relationship between economics and ideology but then apply some pragmatism to it. security is, I believe, very naïve. We all agree—and the Iraqis agree—that the end McKinsey on Government: It’s interesting to state in Iraq should be a free-market economy. No hear you talk about the decisions the US one is arguing for socialism in Iraq. The question government has made in the financial and is, how are we going to get there? We’re seeing automotive sectors. You came under evidence that the approach we’ve taken is more heavy criticism for helping to revitalize state- sound, much less disruptive to society, and owned enterprises in Iraq. Could you results in much less violence. comment on how you see the role of state versus private investment in economic stabilization? McKinsey on Government: The counterinsurgency doctrine says you must protect and Paul Brinkley: Our efforts to reverse the policy help the people in order to win. It sounds regarding state-owned industry in Iraq— like you’re suggesting that “help” is at least as that is, to get state-owned enterprises up and important as “protect.” running and then transitionally privatize, as opposed to the economic “shock therapy” Paul Brinkley: I’m not crazy about the word approaches that were taken early on—were “help” because it implies charity; it implies only one aspect of our total efforts in Iraq, but yes, showering people with our largesse. What we they did attract a lot of attention. I think it is mean by “help” is assisting people to build interesting and ironic—and, I hope, for the West a their own capability to live a good life, have little discomforting—that we project such a upward mobility, feed and educate their sense of certainty about our own economic model, children, live in a safe neighborhood, and and yet when confronted with difficult decisions eventually protect themselves. That to me 48 McKinsey on Government Spring 2010

is what counterinsurgency means, and you can’t especially around the election cycle, is a do that without an economic capability as recurrence of very large, spectacular, desperate part of that “help” equation. acts by a shrinking pool of violent actors— people who are desperate to make one last effort McKinsey on Government: How would you to demonstrate that security is not restored. describe the nature of the opportunity today for I was talking to someone recently who had spent a private investors in Iraq? lot of time in Northern Ireland during the Troubles, and he said that the closer they got to a Paul Brinkley: I would describe Iraq today as a peace agreement, the more spectacular the high-risk, high-return opportunity. It’s not for events became and the more desperate the last widows’ and orphans’ money. I would not put an remaining hard-core insurgents were to try entire 401(k) into an Iraqi fund—but certainly to reverse course. So I suspect that we will see the percentage of the 401(k) that is allocated to those kinds of spectacular acts that will attract higher-risk and higher-return investments. a lot of attention. For investors, these acts will keep I honestly believe Iraq is one of the last great the ground floor open a little longer. “ground floors” we will ever have in the world. China in the late 1980s and early 1990s It’s also interesting that these acts are centered in was a ground floor—if you got in at that time, Baghdad. Iraq, of course, is far broader than just you did very well. India followed. Iraq today is a Baghdad. It is a country with many cities—Basra, ground floor. It doesn’t have the population of Najaf, Karbala, Ramadi, and in the North, China or India, but it has a huge amount of mineral Kirkuk, Mosul, and so on—so events in Baghdad wealth, oil wealth, and agricultural wealth. do not necessarily reflect the security situation Geographically, it is positioned to become one of in the entire country. the most prosperous countries in the world. And I don’t think that ground floor is going to stay McKinsey on Government: All eyes are now on open for too much longer. I think we have a Afghanistan. Do you think the approach that few more months, and then the acceleration of you used in Iraq could be productively applied in investment in Iraq will take place. I expect Afghanistan? that to happen during 2010. Paul Brinkley: Offering economic opportunity McKinsey on Government: There has been as part of protecting and helping the population is a lot of press recently about renewed violence absolutely critical in Afghanistan. What gets in Baghdad. Do you think that is scaring done tactically is going to be very, very different investors off? Should it? than what we did in Iraq. It’s a different culture, it’s different people, and Afghanistan has advantages Paul Brinkley: If you look at the statistics and disadvantages when compared with Iraq—for on Baghdad, the violence has not increased. The example, with respect to educational levels or number of events in Baghdad has actually pre-existing infrastructure to support business. continued to decline. The performance of the But the general approach—the acknowledgment Iraqi army and the Iraqi police after our that there must be a strong tactical economic and troops have pulled back has actually been quite private-sector business-development effort in strong. I think that what we have seen, Afghanistan—is absolutely essential. Stabilizing Iraq: A conversation with Paul Brinkley 49

We have already been impressed by the caliber happens on its own. But if you look at the of the business community that we’ve engaged in history of the United States or the United just the short time we’ve been working there. Kingdom or other countries, that’s not the way The more we learn, the more we’ll see how we can it happened. Interstate highways were built, help, but I am optimistic that the approach infrastructure was laid down, industries were at the broadest level is absolutely appropriate created. These were things that the govern- for Afghanistan. ment did; they did not happen spontaneously. Much of our industrial capability here in the McKinsey on Government: You have now spent United States came about in the middle of the three years flying back and forth to the Middle 20th century as a result of massive East, initially in a very dangerous situation and military spending. certainly in a very complicated one. By all accounts, your job is extremely difficult and Yet we’ve grown so accustomed to the success of challenging. What has been the hardest our free-market model that we’ve lost sight part about doing it? of the fact that, for a country coming out of violence or engaged in violence, this alchemy Paul Brinkley: On the personal side, the hardest isn’t natural. So the hardest part of my job has part of my job is having to be away from my been to confront the deeply embedded belief family so often. Professionally, the institutional among people in the government that what we’re and structural challenges we face in our doing in Iraq isn’t necessary, or even that Western governments have been the hardest part. what we’re doing is wrong, and this has led to Our economies have evolved to a level of tremendous bureaucratic barriers being maturity such that it has created a mind-set— thrown up at every stage of the process. That’s one that is now so deeply ingrained at all been our most difficult hurdle. But I think levels of our bureaucracy—that the economy just we’ve overcome it.

Supply chain transformation under fire

Deployments to Iraq and Afghanistan exposed weaknesses in the UK Armed Forces’ supply chain and provided a powerful impetus for change. The resulting improvements offer valuable lessons for other militaries’ supply chains.

Air Vice-Marshal The idea that “[l]ogistics are fundamental to the United Kingdom, the supply chain involves Matt Wiles CBE generation and maintenance of fighting power 11,000 destinations (including air bases, ships, and David Chinn in every environment”1 is not new—it has been and garrisons at home and abroad), more true in all major combat from Alexander’s than 200 million orders a year, dozens of internal Macedonian army until today. For commanders of organizations, hundreds of suppliers, and the UK Armed Forces, however, near-continuous billions of pounds in spending. overseas operations since the early 1990s have brought the importance of logistics to the fore. In some ways a military supply chain resembles a commercial one, and the UK Armed Forces has One of the most critical areas of military logistics at times considered adopting the best practices is the supply chain: the set of processes, of companies such as Amazon or FedEx. However, infrastructure, equipment, and personnel that commercial practices are far from adequate in moves a force to the theater of operations and meeting all the challenges a military force faces sustains it by maintaining stocks and transporting when engaged in a theater of operations. For 1 Joint Warfare Publication 4-00: Logistics for Joint additional goods and people. The supply chain example, while commercial logistics operations Operations, Joint Doctrine & also must meet day-to-day needs at a country’s and militaries are both prone to massive Concepts Centre, UK Ministry of Defence (2003). military bases throughout the world. For the peaks in demand, in the commercial world those 51

peaks are often predictable (such as product resided in each branch of the military to create launches or holidays) whereas the military cannot a Joint Supply Chain (JSC). In this article, we predict where or when peaks will occur. In the share some of the most effective changes made as military, most of the “points of sale” (such as army part of the creation of the JSC, the successes units, ships, and air bases) are mobile and achieved, and lessons learned.

Neil Webb move several times a day, and the range of items they need to stock and supply—including spare Supply chain challenges exposed parts of vehicles and aircraft, heavy industrial The buildup to the second Gulf War required equipment, and hospital supplies—is more a massive movement of equipment and personnel diverse than that of most commercial businesses. from their bases in the United Kingdom and In addition, the military has much more at Germany within only ten weeks (exhibit). To put stake: while commercial operators need to keep a this in perspective, it was roughly the equivalent close eye on competitors, the Armed Forces of moving the entire population of Canterbury, needs to watch out for enemies who can kill drivers, England; Arles, France; or Biloxi, Mississippi, more blow up depots, or threaten suppliers. While in than 4,000 kilometers (2,485 miles). the commercial world, stockouts can lead to loss of profits, in the military world stockouts of Sustaining this force was demanding as well, certain items—ammunition, fuel, blood—can lead especially considering the hundreds of different to loss of life. pieces of equipment in use, the complexity of the technology, and the harshness of the Nobody notices the supply chain when it works environment. To give an idea of how many spare well, but it quickly becomes a focus of attention— parts were needed in steady supply, a single even among the general public—when it does aircraft may consist of more than 100,000 parts; not meet expectations. This was the case during in this operation, seven different types of the UK forces’ extremely demanding deployment aircraft were used. For the troops, the supply to Iraq in 2003. Shortcomings in the supply chain McKinsey on Government 2010 chain had to ensure the constant flow of became very clear and provided a powerful food and water that met UK hygiene standards UK Supply Chain impetus to make improvements. An important and tastes, mail and other connections, and Exhibit 1 of 1 enablerGlance: ofThe these 2003 improvements deployment of the was UK the military involved rapidlymedical preparing supplies, equipment as well and as personnel.a means of transport integration of the supply chains that previously home for leave and at the end of a tour of duty. Exhibit title: Buildup for Iraq

Exhibit Buildup to Iraq Transporting ...... required 46,000 personnel The 2003 deployment of the ~15,000 vehicles 15,000 metric tons of ammunition 9,000 containers UK military involved rapidly 115 ﬁxed-wing aircraft 1,002 military and civilian transport ﬂights preparing equipment and ~100 helicopters 113 surface-vessel sailings personnel. 19 warships 14 Royal Fleet Auxiliary vessels

Source: UK Ministry of Defence 52 McKinsey on Government Spring 2010

When we measured the supply chain’s performance when the logistical challenges were less complex at the end of the ten-week period, we found and time-constrained. shortages of many critical items. A common assumption among the front line was, “If Improvements to supply chain planning started I don’t have it with me, it will never arrive.” slowly; many initiatives launched in Iraq had Additionally, the large volumes and tight not yet been fully delivered by the time the United timelines exposed shortcomings in information Kingdom deployed to Southern Afghanistan systems, particularly with regard to the ability in 2006 as the lead of the International Security to track items moving through the supply chain. Assistance Force (ISAF). We therefore decided These shortcomings led units to hoard stocks to pilot some new processes in Afghanistan. While and over-order. For their part, supply personnel there was certainly a need for information focused on expediting urgent deliveries rather systems and decision-support tools, we started than ensuring that everything arrived on time. with a very low-tech solution to help achieve early results. The planning group developed a Successful improvement initiatives simple simulation of the supply chain, using Based on this experience, we set about improving different-colored poker chips to represent different the supply chain’s performance through the types of supplies (for example, fuel and food) Defence Logistics Transformation Programme, and a long table to show the layout of facilities in a comprehensive program to increase the United Kingdom and Afghanistan; we used the effectiveness of logistics support to the simple computer models to calculate volumes. This UK Armed Forces. We identified three visual approach enabled us to test different areas that needed close attention: supply chain scenarios quickly and understand their impli- planning, performance management, and cations and risks. It also made it easy to supply processes. Here, we discuss some of the involve and communicate with a broad range most successful and easily replicable initiatives of stakeholders. in each of these areas. Once the approach was proven to work, it Planning was relatively easy to build computerized tools The responsibilities of supply chain planners that could conduct the simulations and include identifying supply routes and air- calculations for future operations in Afghanistan, and seaports, estimating volumes, establishing Iraq, and other theaters of operation. The new warehouses, and negotiating contracts with supply chain planning process and tools were a suppliers. In a multinational force, decisions about success. The United Kingdom successfully each country’s force and its specific tasks deployed more than 4,500 military personnel in often are finalized very late, leaving supply chain the right order and with the right equipment planners very little time to deliver and execute and associated support, despite unreliable land on plans. This became a significant challenge for and air communication lines and a very planners in the UK Armed Forces, in part hostile operating environment. because they were using outdated tools, lacked coherent planning approaches, and relied The UK Armed Forces has continued to develop heavily on their judgment and experience— the planning tools since 2006. The tools are now experience gained during the Cold War, capable of integrating updated data on actual Supply chain transformation under fire 53

We had to change the management culture from one focused on expediting and fire fighting to one focused on effectiveness and measurable results

consumption and delivery times, and then supply chain. The picture that emerged was creating simulations, testing multiple courses of not encouraging: low delivery reliability and long action, and assessing risks based on those data. (sometimes very long) wait times. These tools are recognized as tools of the trade for supply chain planning and are fully integrated Once we had data, we had to change the into the standard training for planners. management culture from one focused on expediting and fire fighting to one focused Performance management on effectiveness and measurable results. We Once a plan is in place, performance management— formed a supply chain performance- generating, interpreting, and acting on management board, which convened all the performance data—comes into play. Here our individuals involved in the supply chain starting point was very weak, largely because on a monthly basis to develop tools and review data on supply chain performance resided in and improve performance. multiple legacy IT systems. Getting a complete picture of performance was a tedious and time- An early success was a pilot conducted in Iraq. consuming task. Data showed that items were taking roughly one week to reach units after arriving in the The first step was to agree on what measures we country even though no British unit was would use. We selected delivery reliability more than a four-hour drive from the air- and (how often the supply chain met targets for seaports. The pilot team implemented—in the delivery time) and customer wait time space of two weeks—a very simple performance- (CWT—how long customers had to wait between management system using colored stickers: ordering something and receiving it). For every package sent to Iraq had a colored sticker example, if the delivery target was 5 days and the attached, on which everyone in the supply supply chain met that target 70 percent of the chain wrote the time and date that they handled time, the average CWT might be 7 days or 20 days, the package. When packages arrived at their depending on how delayed the other 30 percent final destination, the units sent the stickers back of items were. to the performance-management team in the United Kingdom. The data were tabulated, then The only sources of data on delivery reliability and circulated to all involved on a weekly basis. CWT were the handwritten order books that (We had high-tech devices that could read every unit maintains. We manually entered the barcodes and electronic tags on packages, data into a database, extracted from multiple but because of the lack of data integration and IT systems the records for each item that the units limited communications in Iraq, we could ordered, and then linked all the records to not use these devices to make quick understand how items progressed through the improvements. We also knew that visual- 54 McKinsey on Government Spring 2010

management tools—which make performance and how they contribute to overall performance, data highly visible and easy to grasp—have been and there is a shared set of development very effective in industrial settings, and we goals to maintain continuous improvement. suspected they would also have impact in Iraq.) Supply processes After four weeks, we held a workshop to redesign Among the process changes we made, the one that the supply processes, implementing simple touched the largest number of units was a changes such as removing double handling, change in the way units receive equipment prior coordinating delivery timetables, and to deployment. Traditionally, each unit would making deliveries directly from aircraft to combat have 30 days of stores on its shelves so it could unit. We also set a new target: next-day deploy and sustain itself while waiting for the delivery. The results were immediate and supply chain to operate at full capacity. Many sustained. When threat levels increased, units did not know where and for what type the target was lengthened to two days to account of mission they would be deploying, and therefore for added logistical challenges—a target the stored items that they probably would not need in supply chain continued to meet. the near term, resulting in constant shortages—a significant problem in an organization with Based on our experience in this and other pilots, constrained budgets and suppliers that often need we created a permanent performance-management long lead times. When deployments were cell—a small team that gathered data and announced, units quickly tried to stock up on ensured that improvements were implemented— what they did not have, thus creating a and replaced the ad hoc and largely manual massive strain on the supply chain. Furthermore, collection of performance data with an automated all units were holding stores when only a few data warehouse. Performance data has become were ever deployed, and each unit designed its own the main input for the supply chain staff’s weekly stores holdings; there was no established videoconferences and planning sessions. The methodology, and there were limited guidelines. impact has been impressive: specific successes include a reduction in delivery times to bases in Today, units no longer maintain their own stores. the United Kingdom and Germany from 30 days Instead, the supply chain stores both standard to 7 days and, thanks to an improved ability to and destination-specific “priming equipment packs” detect the root causes of delays and intervene (PEPs), designed based on usage data, expert accordingly, a more-than-15-day reduction in engineering analysis, and the judgment of CWT in Iraq and Afghanistan. Using a new experienced quartermasters. PEPs are designed “effectiveness” performance metric, we have been to maximize the ability of the unit to sustain itself. able to determine that the supply chain has They have been tested in live, high-readiness given commanders in Afghanistan the operational operations, and they work well. The increase in flexibility they require—a major achievement. self-sufficiency substantially reduces the strain on the supply chain in the early days of an Most impressive, however, has been the cultural operation, when staff is often overloaded and change. The supply chain is managed by the the infrastructure is not fully in place. The concept numbers, all involved have a clear view of how also allows for gradual withdrawal of stock they are performing relative to their targets from units as they gain confidence that what they Supply chain transformation under fire 55

need will be available from the depot transparent. Otherwise, you are navigating when required. without a map or compass. An important starting point is to get consensus on which performance In addition, the supply chain has captured cost measures really matter. Once all stakeholders are savings by ensuring that all the items a unit in agreement, start measuring right away. needs for a deployment can be ready at the time they are needed. For example, units being deployed • The best data available—no matter how within days have everything packed and ready to imperfect—are better than no data. One critical load, while units that have a warning time of leadership challenge is to ensure that the team is months have protected inventories in central focused on studying and improving warehouses and contracts with suppliers that performance, rather than on debating the data guarantee they will meet the readiness timeline. and coming up with reasons for why the numbers must be wrong. Lessons learned The progress we have achieved since 2003 has been • Process change, management tools, and cultural massive. We may not be able to stop delays change have to develop in parallel. Otherwise of freight at the Pakistan-Afghanistan border due change will not be sustainable. Leaders can use a to customs checks or poor weather, but we “blueprint”—a vision of the desired future now can anticipate such delays, plan for them, state—as a tool to achieve alignment and drive and mitigate their impact through close and the improvement process forward. sustained management.

With the benefit of hindsight, we can share a few lessons for anyone else embarking on a Since our early work, we have completed a major similar journey: program to provide full consignment tracking visibility across the extended supply chain, • A good supply chain plan is the basis for success. started to roll out a single inventory-management Make planning as scientific and quantified system across all the armed services, and as possible, even though there will always be developed techniques to balance inventory across unknown factors. Also, make it easy to operational theaters. We are managing the supply test new approaches and adjust course—military chain’s performance in increasingly sophisticated operations have a habit of changing direction ways, and we are now able to properly cost and at short notice. benchmark its performance. That said, continual attention to performance management is • Focus on performance. Be clear about the supply essential, especially given the ever increasing chain’s objectives and measures, and gather demands of combat operations in Afghanistan. the best data available to make performance Our journey is ongoing.

Air Vice-Marshal Matt Wiles CBE RAF is Director, Joint Support Chain, for the UK Ministry of Defence, Defence Equipment and Support. David Chinn is a principal in McKinsey’s Tel Aviv office. Copyright © 2010 McKinsey & Company. All rights reserved. 56

A dynamic strategy for uncertain times

A world of fast-changing conditions and heightened uncertainty demands that defense agencies act with speed and flexibility. They can do so by taking an iterative, dynamic approach to strategic management.

Lowell Bryan, Richard In this era of unprecedented global uncertainty, will be familiar to agency leaders, and indeed, Elder, Becca O’Brien, defense agencies—ministries and departments as agencies already conduct many of the activities we and Scott Rutherford well as armed services and their major branches— describe. We have found, however, that the must rethink how they develop and manage their majority of agencies treat these three stages as strategies.1 While some aspects of strategic discrete tasks, rather than as related parts 1 A defense agency’s strategy is the overall plan meant to planning (such as procurement decisions for of an integrated and dynamic process for making guide major strategic next-generation equipment) require long the right choices at the right times. Rarely do decisions regarding personnel, technology, readiness, lead times, fast-changing conditions—ranging agencies iterate through all three stages and ensure equipment, and infrastructure from evolving situations in war zones to civil that they feed into each other. In our experience, in support of the country’s national security objectives. unrest due to governmental destabilization or the agencies also fall prey to common pitfalls that This strategy should encompass several different global economic crisis—require fast action. hinder rapid, confident decision making, time horizons (that is, 1–3, such as failing to take a broad enough view of the 5–10, 10–20, and 20+ year views). A defense agency’s In this article, we propose an approach to context, developing a static strategy that does strategy is distinct from on- strategic management that involves three basic not take into account trade-off decisions, creating the-ground military strategy (that is, how to invade or stages: understanding the context, making a strategy document that lists broad principles defend) and political military strategic decisions and weighing risks, and rather than specific initiatives and pays only strategy (for example, whether to deploy units). executing amid uncertainty. These stages cursory attention to strategic risk, and adding 57

initiatives and programs to the strategy without outside entities (such as private-sector industrial stopping and eliminating those that have and technology companies) that provide become nonessential. in-depth support or intelligence.

Our proposed approach to strategic management Assessing the external environment

Dieter Braun focuses on iterative, interconnected decision Most defense leaders studiously observe the making and incorporates familiar tools as well as external environment and identify the trends that several that may be new to some defense could affect the defense and national-security agencies. The approach shares some insights with landscape in the near term. However, in part other literature and thinking on military strategy. because of annual budgetary cycles, leaders For example, in the 1970s, Colonel John Boyd of tend to give less thought to contextual trends the US Air Force proposed the concept of the that will develop over the longer term (say, “OODA loop,” the repeated process of observing, ten years), such as demographic shifts, economic orienting, deciding, and acting. Boyd hypothesized regionalization, and technological discontinuities. that executing on this loop faster and better Here, we offer some questions to consider— than the enemy is the key to winning in warfare. some rather obvious, others less so—that have The first stage of our approach (understanding been helpful to agencies as they ponder what the context) corresponds to “observing” and the future might hold in three general areas: global aspects of “orienting,” the second stage (making trends, the competitive landscape (including decisions and weighing risks) corresponds to trends in technology, equipment, and other aspects of “orienting” and to “deciding,” and the personnel structure of other agencies and the the third stage (executing amid uncertainty) private sector), and stakeholder perspectives. corresponds to “acting.” Our emphasis, however, is on what it takes for a defense agency to Determine the impact of global trends observe and orient thoroughly, decide dynamically, • What threats and adversaries, whether military and act quickly. or nonmilitary, are expected to emerge? What new weapons, tactics, and areas of operation will Understanding the context come into play? The US military’s 2010 With varying degrees of formality and frequency, Quadrennial Defense Review, for instance, agencies collect data about the external acknowledges climate change and its environment and the agency’s internal operations consequences—including rising sea levels and to help them understand their context, resolve resource scarcity—as important factors in ambiguity where possible, and identify remaining planning for future operations. uncertainties. Many agencies purchase external reports on global trends, administer • What is the emerging geopolitical context? internal surveys that gauge staff’s attitudes Who are the foreign and domestic influencers? or satisfaction, and engage in other information- Which scenarios and cultural mind-sets might gathering efforts. To supplement these efforts drive future conflicts or produce pressure to and gain a fuller perspective, agencies could build avoid them? For example, how might conflict and a repository of proprietary data—for example, unrest in Africa—in some cases related to the data and trends on personnel, equipment, power struggle over vital raw materials such as oil suppliers, and materials—and collaborate with or water—affect the rest of the world? 58 McKinsey on Government Spring 2010

• How will the global and domestic economy shape intragovernmental partners (such as the security context? What trends will develop intelligence and diplomatic agencies)? Of allied with regard to domestic budget deficits, nations and their armed forces? productivity, and prices for raw materials? • What are the principal priorities of key • What technological trends will shape the security nongovernmental groups, interest groups, and context? To what degree will cybersecurity and related businesses? What is their current other technologies be game changing? Protection and expected level of influence? from improvised explosive devices (IEDs) was a priority for US and coalition governments in the • What trends will affect the agency’s major 2000s, but what technological innovations suppliers, and how will their perspectives will be most needed in the next decade? likely evolve?

• What demographic trends will affect the agency? Assessing the internal environment The obesity trend in some countries and aging Getting an objective perspective of its internal populations in others, for instance, could environment can be difficult for any significantly reduce the armed services’ talent pool. organization, in large part because organizations tend to have a culture of unexamined Analyze the competitive landscape (that is, adherence to “how we have always done things.” the agency’s position in the market for An additional challenge in the defense context essential resources) is that many agencies have very rapid turnover in • How will the agency be positioned to compete senior positions. An assessment of the for human capital? What is the expected impact following four areas can help an agency establish of employment rates and economic growth on a baseline of its current performance and recruiting and retention? What will be the identify performance gaps: cultural drivers of propensity to serve? • How well does the agency execute strategic • How will the agency be positioned to compete for initiatives? What have been the drivers technology and raw materials? of its successes and shortfalls? Here, an objective performance review—usually Understand stakeholders’ perspectives and conducted by a third party—is crucial, because their likely evolution bias is likely to taint any self-assessment. • What are the emerging policy priorities of national leaders? Of major parties and key committees? • What is the agency’s financial situation? What are the assumptions behind the agency’s • How does the public regard the agency’s brand forecasts of appropriations revenue, budgeting, and value proposition? How much public and spending? What factors could cause support is there for the country’s defense and those assumptions to change? How predisposed security policies? is the organization to actively seeking out efficiencies? Is the agency’s financial planning • What are the current and emerging priorities of process free from institutional biases and other domestic armed services and justification of sunk costs? For example, is there A dynamic strategy for uncertain times 59

a process that would allow the agency to prices and supply but also the longer-term changes scrap a new IT system that does not meet that the organization should begin preparing operational requirements? for today. Once an agency has cataloged its assumptions according to their relative • What are the positive and negative aspects of uncertainty and potential impact, it can put in the agency’s culture (values and mind-sets)? place appropriate mitigation or monitoring How strong are the agency’s capabilities (skills programs. Frequent updates to this “assumptions at all levels of the organization? What is catalog” ensure that agency leaders are basing inhibiting improvement? For example, given their decisions on the best information available. that most military cultures are hierarchical and The assumptions catalog becomes an important rely on strong leaders, does the agency have input to scenario development during the decision- mechanisms to foster bottom-up innovation? making process described in the next section.

• How healthy are the agency’s leadership Making strategic decisions dynamics? What are the leaders’ capabilities, and weighing risks and how will those change over time? To what Even agencies that religiously gather data degree are leaders aligned with one another? and generate insights about the internal and Senior leaders in defense agencies must have external context are not always disciplined exceptional collaboration and communication about feeding these insights into their strategic- skills, for example, yet few agencies focus on management processes. A failure to incorporate building such skills among senior personnel. contextual insights into strategic decisions can move an organization in the wrong direction. Cataloguing assumptions Among the key aspects of dynamic management, Because the contextual analysis will almost always therefore, are setting a vision with measurable have to rely on imperfect and incomplete data, an goals and then translating those goals into agency must be aware of its most significant initiatives that take into account the uncertainties unknowns and how much risk lies behind them. identified in the contextual assessment. For example, to understand how the price and availability of oil might affect its operations, an Setting and adhering to a vision agency can list all the assumptions it is making and measurable goals about oil prices and availability, and then segment Most defense agencies have common elements to those assumptions based on how much supporting their mission. The US Army’s mission, for data exists (for example, none, partial, or almost example, is “to protect our nation from our complete). The agency could then conduct a sensi- enemies, defend our vital national interests, tivity analysis on each assumption: what is the and provide support to civil authorities in response anticipated impact of being wrong slightly to domestic emergencies.” Singapore’s armed (5 percent to 10 percent if quantifiable), moderately forces have a similar mission: “to enhance (approximately 20 percent), or dramatically Singapore’s peace and security through deterrence (30 percent or more)? and diplomacy, and should these fail, to secure a swift and decisive victory over the aggressor.” This exercise is critical to understanding not only But these two countries face different the near-term impact of fluctuations in oil environments and challenges. 60 McKinsey on Government Spring 2010

McKinsey on Government 2010 Defense Strategy Exhibit 2 of 5 Glance: The United Kingdom’s Ministry of Defence and Air Force have a deﬁned vision and goals. Exhibit title: Setting its sights

Exhibit 1 This demands the Setting their sights UK Ministry of Defence vision Royal Air Force vision Royal Air Force should:

The United Kingdom’s Ministry An agile, adaptable, and capable Air Force that, person for person, of Defence and Air Force have a • Generate air power (comprising is second to none and makes equipment and trained personnel, defined vision and goals. a decisive air power contribution at readiness) to achieve precise • Defend the United Kingdom and in support of the UK Defence Mission campaign effects across the spectrum its interests • Agile of conflict whenever and wherever • Strengthen international peace Our ability to create rapid effect they are required and stability across the full spectrum of • Develop air power to face the • Be a force for good in the world operations in a range of environments challenges of the future, providing and circumstances a decisive contribution to the security We achieve this aim by working • Adaptable of the United Kingdom and supporting together on our core task Our ability to react in an appropriate its role as a force for good to produce battle-winning people time scale to new challenges • Be modern and flexible, and proud and equipment that are: and to seize new opportunities of its heritage • Fit for the challenge of today • Capable • Foster professionalism and team • Ready for the tasks of tomorrow Having the right equipment and spirit founded on good leadership, • Capable of building for the future doctrine, together with commitment, and self-discipline sufficient, motivated, and capable • Offer opportunity to all, a rewarding people to deliver precise and enjoyable career, and skills for life campaign effects successfully, at range, in time

Source: UK Ministry of Defence, Defence Plan 2009-2013; UK Royal Air Force Strategy 2006 (still current in 2010)

To guide day-to-day decision making in support of linked strategic initiatives, defense leaders of the mission, a defense agency needs a clear vision can use a range of familiar analytical tools, such as of what success looks like within a specific strategic scenario planning. Once they have identified key time frame, as well as a set of metrics that will tell areas of uncertainty as part of the contextual the agency whether it has achieved that vision. The assessment, leaders can engage in a disciplined vision must be easily understood, inspirational, exploration of potential scenarios, including rare and—most important—actionable. Disaggregating a but catastrophic outcomes. Some of the vision into a handful of strategic goals, each with its key uncertainties—for example, the impact of the own simple set of metrics, allows everyone in the recent global economic crisis—may be organization to see the opportunity for individual nonmilitary variables. An agency can also use other and collective contribution. analytical tools (such as decision trees, war gaming, or probabilistic modeling) to develop For example, the vision and goals of the Royal Air scenarios. The next steps involve weighing Force (RAF) build off the United Kingdom Ministry the likelihood of the various scenarios, identifying of Defence’s vision (Exhibit 1). Taking the example any gaps they expose in the agency’s strategic goals, further, the RAF might link its first goal—which has and developing initiatives to fill those gaps while to do with readiness of personnel and equipment— allowing for a comfortable level of risk. to metrics such as the availability of people by skill type and unit, the adequacy of training, and The idea of accepting a certain amount of risk equipment levels. can conflict with a prevalent bias in military psychology. Militaries feel the need to always Developing and prioritizing initiatives be prepared; the natural inclination within To translate an agency’s vision and goals into a set any defense organization is to try to fill every A dynamic strategy for uncertain times 61

gap completely and eliminate, or at least reduce, The agency can then explore the resulting all risks—a laudable but unachievable aim. questions of risk and trade-offs using a portfolio of Part of managing risk dynamically is making initiatives (Exhibit 3). The most thoughtful defense informed decisions about which gaps to leaders prioritize initiatives and make trade-off address and to what extent, and which gaps to decisions based in part on a realistic accounting of tolerate, if only temporarily. the resources required across the entire portfolio. So as not to impose new burdens on an already As it determines what to do, what not to do, and the stretched organization, they make well-considered appropriate degrees of risk to absorb, an agency choices about what the agency will not do or will may find two tools very helpful: a strategic play- stop doing, and then communicate these choices book and a portfolio of initiatives (POI). A strategic unambiguously to the organization. Almost always, playbook shows both an initiative’s absolute value these decisions are difficult and require exceptional and its value under different scenarios (Exhibit 2). levels of clarity and fact-based conversation among The agency can thus identify its no-regrets moves senior and mid-level leaders. (those for which it can quickly allocate resources and assign responsibility), its best bets (strategic Executing amid uncertainty choices based on advantaged information) and real Institutional flexibility is critical to an agency’s McKinseyoptions (the on next-bestGovernment choice 2010 when the best bet ability to respond to material changes in the Defenseinvolves Strategy too much risk or more resources than are environment and adjust levels of investment. Exhibitavailable), 3 of and5 its contingency plans (those that Building this flexibility into an organization will, Glance:would Usingbecome lenses favorable of uncertainty if a “trigger” and value, event a set of initiativesin manycan be cases,translated require the introduction of new intohappens). a strategic Each playbook. type of initiative requires a differ- processes. Some of the most important include Exhibitent level title: of resources By the book and monitoring. the following:

Exhibit 2 By the book Best bets and real options: • Using lenses of uncertainty and No-regrets initiatives: Create pre-positioning equipment-maintenance triage centers in strategic locations worldwide value, a set of initiatives can • Manage life-cycle gates of • Investigate major outsourcing options of equipment be translated into a strategic qualified personnel Very significant to higher-demand skill “swap-out” programs playbook. areas and units • Launch new “lean” process improvements to reduce training waste (idle time) and optimize flow Significant

Value of the potential initiative Value Contingency planning: • Investigate and build alternative placement models (eg, career civilians to military positions, external lateral hiring at ofﬁcer level)

Moderate • Create common technology protocols for all systems to link into a common database

Positive in all scenarios Positive in likely scenarios Positive in unlikely scenarios Value of initiative in different scenarios

Source: McKinsey proprietary framework and analysis 62 McKinsey on Government Spring 2010

McKinsey on Government 2010 Defense Strategy Exhibit 4 of 5 Glance: A “portfolio” approach balances risk against short- and long-term opportunities and makes resource trade-offs explicit. Exhibit title: In the mix

Exhibit 3 Portfolio of initiatives (readiness examples) In the mix Smaller impact Moderate impact Highest impact A “portfolio” approach balances Familiarity risk against short- and long- Improve provision of people to operational Familiar term opportunities and makes Best portfolio balance forces, avoid inventory imbalances resource trade-offs explicit. • Knowledge exists of familiarity and impact internally or A1 Manage life-cycle gates of qualified personnel is easily acquired to higher-demand skill areas and units A2 Investigate and build alternative placement • Involves execution risk models (eg, career civilians to military positions) Increase trained population Unfamiliar B1 Institute new training doctrine to tier critical • Knowledge is limited skill training to better reflect 2010 needs • Results may B2 Launch process improvements to reduce be unpredictable idle time Increase equipment preparedness Uncertain C1 Create pre-positioning equipment maintenance • Possibility of success triage centers in strategic locations worldwide is difficult to estimate C2 Increase use of “just-in-time” parts supply • Can be overcome with process to improve equipment uptime passage of time McKinsey on Government 2010 Leverage technology advancement Defense Strategy 1–2 years 2–4 years 4+ years D1 Improve precision of personnel-management system with new architecture design Exhibit 5 of 5 Time to impact D2 Create common technology protocols for all Glance: To confront uncertainty, organizations will have to change gears. systems to link into a common database Exhibit title: Attitude adjustment Source: McKinsey proprietary framework and analysis

Exhibit 4 Attitude adjustment From a mind-set of … To a mind-set of … • Expecting stability and downplaying variability and • Knowing that uncertainty and change are the norm and that To confront uncertainty, making “reasonable” assumptions the real risks are in the assumptions organizations will have to • Delegating decisions downward to reduce complexity • Collaborating on critical decisions and making sure the right change gears. people are involved to make the best possible choices • Meeting deadlines at almost any cost • Individually and collectively making decisions in the best interest of the organization • Maximizing investments by fully committing resources • Deliberately accumulating resource reserves and committing them only when risk-adjusted returns are clearly attractive • Making decisions at the scheduled time • Making decisions when the timing is right, with the right amount of staff work • Believing that good leaders inspire conﬁdence by making • Understanding that good leaders are navigators who visionary statements and sticking to a single course of action conﬁdently adjust course as conditions change

An iterative—rather than annual—management gathering updates on the most crucial indicators; cycle. Recurring forums for bringing leadership monitoring thoughtfully selected information together—whether for 30 minutes per week, triggers (on an hourly or daily basis for imminent three hours a month, one day per quarter, or some threats, quarterly for slower-moving trends); and other regular interval—are more conducive to coming up with contingency plans for potential dynamic management than an annual planning game-changing events. cycle. Such forums should include formal mechanisms for evaluating the POI regularly; An integrative resource-allocation process. A repeating the full environmental scan and comprehensive look at the POI should factor into A dynamic strategy for uncertain times 63

the agency’s process for allocating resources (in- implications for other initiatives, the leaders of each cluding capital, manpower, and leadership over- initiative should have appropriate exposure to one sight), with careful regard for legislative constraints another. Initiatives that focus on personnel readiness, imposed by appropriations and authorizing for instance, might each have different leaders and processes. End products could include a rolling timetables for completion and impact, making 18-month budget or multiple financial plans that collaboration and coordination critical to success. reflect different scenarios and are updated quarterly. The goal is to allocate resources “just in Processes such as these can help an agency support time” through a stage-gating process in which and monitor its strategy while simultaneously leadership checks in at specific milestones to decide creating mechanisms for adaptability. For many whether to continue, abandon, or redirect an agencies, the introduction of new processes, or even initiative, thus allowing the agency to change its the refinement of old ones, will require a change in investment level in each initiative as the mind-sets (Exhibit 4). environment evolves.

Performance-management systems that drive accountability and foster understanding. Clear Most defense agencies have implemented at least metrics and regular performance reviews consistent some of the elements outlined in this article. with agency and military command structure are However, to fully embrace a dynamic approach to fundamental enablers of dynamic management. strategic management, an agency will need to start These reviews might include strategic “performance by building a baseline of the internal and external dialogues” throughout the organization. A context, and the organization’s vision and goals. performance dialogue convenes senior leaders, key From there, it can begin the kind of iterative strategic commanders, and owners of initiatives to discuss decision-making cycle we have described. Initially, progress against metrics, diagnose the root causes the agency could focus on one component of the of problems, and develop potential solutions. Such strategy (such as personnel) and its impact on the dialogues are helpful for communicating why other components, or it could focus on a single issue agency leaders have chosen a certain direction or that cuts across all components (such as deployment taken certain actions and for giving individuals a readiness). A singular focus will allow the agency to sense of their role in realizing the agency’s vision. become more comfortable with the approach and develop the requisite strategic skills, after which it A process for collaboration across initiatives. The can expand the scope of the effort. Agencies that agency’s governance model should enable mid- and engage in dynamic management will be able to adjust project-level leadership to resolve conflicts and course confidently as the context changes and ensure share ideas but ensure that a single person is that everyone in the organization quickly and ultimately accountable for the success of an effectively executes any shift in course that leaders initiative. Because most initiatives will have deem necessary.

Lowell Bryan is a director in McKinsey’s New York office.Richard Elder is a director in the Washington, DC, office, where Becca O’Brien is a consultant and Scott Rutherford is a principal. Copyright © 2010 McKinsey & Company. All rights reserved. 64

‘Without taboos’: France’s new defense policy

Olivier Debouzy, one of the authors of the French White Paper on Defence and National Security, reflects on its key recommendations and the rationales behind them.

Philippe Cothier Soon after taking office in May 2007, French external experts. Among those appointed to President Nicolas Sarkozy established a the White Paper Commission was Olivier Debouzy, commission to take a hard look at France’s a lawyer and a former diplomat. Debouzy held defense and national security policy. In various posts in the French diplomatic service, June 2008, this commission published the specializing in nuclear military affairs and French White Paper on Defence and strategy, from 1985 to 1991. In 1993 he became an National Security, the first official statement attorney and two years later cofounded the of French defense policy since 1994. In the full-service law firm August & Debouzy, which paper, the commission says it was given “full now has more than 130 lawyers. latitude to fulfill its task, without any taboos.” The French government has begun incorporating In November 2009, McKinsey partner Philippe the White Paper’s recommendations into its Cothier interviewed Debouzy in Paris about planning and spending decisions. the highlights of the White Paper. Excerpts of the conversation follow. In a departure from prior commissions, the 2007–08 White Paper Commission consisted McKinsey on Government: It is rather unusual not only of government officials but also of in France to have lawyers participating in academics, industry representatives, and other national security debates. To my knowledge, the 65

2007–08 Defence and National Security White innovation is reflected in the scope of the White Paper Commission was the first to include Paper Commission’s mission. Previous White lawyers—two of them, actually, of which you are Papers had been exclusively about defense, but one. Why do you think President Sarkozy this one is about defense and national security. appointed you? What does that mean? In the 20 years since the

Dieter Braun fall of the Berlin Wall, defense and national Olivier Debouzy: I do not claim to know security have been integrated into a continuum. President Sarkozy’s motivations, but I have been In the age of globalization, there are few active in defense and national security debates threats that are exclusively external or internal. for the past 28 years, first in the government For instance, terrorism, which used to be and then outside it. More generally, I think linked much more closely to the local stakes of a President Sarkozy wanted to have a diverse array given territory (think ETA in the Spanish of minds thinking about the issues we are Basque region or the IRA in Northern Ireland), is confronting, which is why he chose to appoint to now global, in large part due to the increasing the White Paper Commission military and civil mobility of populations and the massive presence servants as well as outside experts such as myself. of minorities in Western societies. Another reason for this continuum is the evolution of McKinsey on Government: How would you technology and the globalization of the describe the commission’s purpose? unofficial arms trade, which have resulted in highly destructive means being available to Olivier Debouzy: Without betraying the terrorist groups which, 20 years ago, would have confidentiality of the White Paper Commission’s been able to obtain such means only if they deliberations, I can say that when we first were backed by states. met with President Sarkozy in August 2007, he was very clear: he said to us that the French At the same time, the post–Cold War world is a defense and national security policy should be world where the United States, the United analyzed without regard to any taboos or Kingdom, France, Italy, and even Germany are preconceptions, and that our recommendations waging wars. We have not seen that since 1945. should be as bold as we thought necessary. Nuclear deterrence is no longer enough; the need I think we fulfilled that mission. We certainly for more robust, better-equipped, better-trained, had debates up to the very end of the drafting and better-serviced conventional forces has never of the White Paper. The chairman of the been so pressing. White Paper Commission, Jean-Claude Mallet, kept President Sarkozy apprised of our work All this led the White Paper Commission to on a regular basis, and he never limited our reconsider the fundamental paradigms of French freedom of thought and of proposition. defense and national security policy and to establish five priorities, the first of which is McKinsey on Government: What do you think knowledge and anticipation. In the days are the main innovations of the White Paper? of the Cold War, we knew who the enemy was. Intelligence was mostly about discovering Olivier Debouzy: I shall try to be concise, but things that the Soviet Union wanted to hide from this is obviously a big question. The first us. Today and in the foreseeable future, 66 McKinsey on Government Spring 2010

the scope of knowledge and anticipation will looking to mobilize intelligent people to achieve expand to cover who our enemies are, what better security at home and abroad. they are planning, and where and how they will attack us. The technical aspect of McKinsey on Government: What does this intelligence served us well during the Cold War, mean with regard to technological investments in but we now have to add a strengthened such areas as space observation, early human intelligence component. detection, unmanned aerial vehicles, cyber intelligence, and so on? In addition, the nature of knowledge- and anticipation-related activities has changed. In the Olivier Debouzy: The LPM [Loi de age of the Internet, most of the intelligence is Programmation Militaire, the 2009–14 defense available on the Web. Secret intelligence covers a equipment bill], which the French Parliament much-reduced if still crucial scope. Intelligence recently passed, reinforces the priority of such in the form of “weak signals” out in the open needs technological investments, consistent with to be analyzed carefully, as it might be the recommendations of the White Paper predictive of threats on which secret intelligence Commission. More than ever, we need both will then have to focus. Similarly, cultural, technical and human intelligence. religious, and linguistic knowledge may prove decisive in understanding diplomatic moves The second priority is protection. The need to and future or emerging threats and in adequately organize protection is based on a concept that our preparing diplomatic initiatives, internal British friends have developed and formalized— security policies, or military moves. that of resilience. Our societies are complex, and their architecture is only as solid as their Knowledge and anticipation are force multipliers. weakest part. In addition to the strengthening Without them, one wastes time and money of the internal intelligence agency, the White preparing for the wrong kind of operations, in the Paper recommends—through energetic action of wrong region, and against the wrong people. public authorities and the development of a We’re not looking only for intelligence; we’re special kind of public-private partnerships, so to ‘Without taboos’: France’s new defense policy 67

speak—better organization of the capacity of choices have to be made. Intervention now is French society to withstand systemic shocks. And directed toward a strategic axis going from Rabat these shocks include not only terrorism but also [Morocco] to Dhâkâ [Bangladesh], or, if you pandemics and industrial catastrophes, since the prefer, from Dakar [Senegal] to Peshawar [Pakistan]. means required to treat them are largely similar. This strategic axis is that of the “arc of crisis” The fulfillment of this objective requires not so where most conflicts can directly threaten much more money, but rather a different way Western interests. to spend it and a reorganization of the way the state works, both internally and with the Because of the technological evolutions we private sector (for example, telecommunications spoke of a moment ago, the nature of conventional operators, utilities, food supply logistics, war is changing. The American experience in and so on). Iraq was watched and analyzed closely by our military. Similarly, the Afghan war is teaching One should be careful to avoid restricting civil the French very useful lessons about the wars of liberties in efforts to provide better protection to the future and the equipment needed to fight the people. The White Paper Commission was them. Joint forces operations; generic equipment particularly conscious of this and organized several easily adaptable to a variety of environments; hearings with foreign experts. Obviously, you giving up gold-plating in favor of robustness and don’t want to impinge on people’s freedoms and on simplicity of use; intelligent exploitation of their ability to live normal lives; protecting available civil technologies; emphasis on training, them at that cost is just not worth it. A delicate maintenance, and readiness—these are the balance has to be struck. priorities that should be implemented to be able to effectively intervene abroad, in a world The third priority is deterrence, which remains characterized by growing instability. a fundamental dimension of the French security paradigm. Its implementation, however, Last, the White Paper Commission put the may differ from what it has been in the past. For emphasis on prevention by recommending a instance, as President Sarkozy has said, restructuring of French bases abroad, the antiballistic missile (ABM) defenses can—and, in updating of existing defense agreements, and the all likelihood, will—play a useful role as a signing of new ones. The first result of this complement and reinforcement to our offensive reorientation of policy was the status-of-forces deterrent capabilities. At the same time, no agreement signed between France and the effort and money will be spared to ensure that United Arab Emirates in 2009. the capability of our weapons to penetrate other countries’ ABM defenses remains intact McKinsey on Government: A few years ago you and even improves. published an article in the Revue de Défense Nationale that called on France to make some hard The fourth priority is intervention. The French, choices. Would you say that the 2008 White like the British and the Americans, have Paper makes those choices at last? kept alive a strong tradition of intervention abroad during the past 40 years. But they Olivier Debouzy: Indeed, the White Paper cannot intervene anywhere and everywhere; Commission made some very difficult choices and 68 McKinsey on Government Spring 2010

recommendations on several issues: the definition forces, but I am confident that it can be of strategic priorities; the reorganization of the implemented, if only because there is little choice. Ministry of Defence and the improvement of pro- Also, the LPM that I mentioned earlier curement, training, and support; the represents a major breakthrough in the French reorganization of the internal intelligence agencies; budgetary tradition in that for the first time, the basing of French forces abroad and in the Ministry of Defence benefits from the econ- overseas territories; and the reorganization of the omies it achieves—savings will be 100 percent French defense industry. These are being reinvested in equipment and training. Quite an implemented as we speak, albeit some more incentive, don’t you agree? slowly than others. McKinsey on Government: Indeed. What does McKinsey on Government: Let’s talk about one the White Paper recommend with regard to of the issues you just mentioned—the improving the efficiency of defense acquisition? reorganization of the Ministry of Defence. What do you think the White Paper’s impact will Olivier Debouzy: The second area of focus be on that? addresses this point: rationalizing weapons procurement by making a clear distinction Olivier Debouzy: The White Paper exercise was between what is strategic and what is not. The conducted in parallel with the Revue générale consolida-tion of the European defense industry des politiques publiques (RGPP), which aims to is rationalize the ways in which the state is ongoing, at a painfully slow pace. It is a fact of life. managed. How do the two converge? I think three Therefore the French have to distinguish Olivier Debouzy areas of focus are worth noting. between fields and weapons for which they absolutely need to keep French suppliers The first is improving the tooth-to-tail ratio of the (what I call vital competences), fields and weapons French armed forces. Today, many in the for which they can cooperate with suppliers armed forces are the “tail”—that is, they are based in other EU member states (what I call employed in logistical and support tasks strategic competences), and fields and that could be, except in theaters of operations, weapons that can be bought off-the-shelf in outsourced to the private sector, which is the world market. Once this is done, the more efficient, less costly, and strongly motivated restructuring of the French defense industry, to provide good service. The armed forces which has been hampered by political should be doing what they do best, which is prejudice and confusion, will be much easier. fighting, and preparing to fight as well as they can. So in the coming years, there will be a The third area of focus is creating an analytical trimming down of ancillary functions. cost-accounting system allowing, in Two evolutions will help in this regard: first, particular, the calculation of the total cost of investment in information systems that ownership of weapons systems. At present, are now readily available, and second, systematic the armed forces do not precisely know how they outsourcing of noncombat functions and are spending their money: what proportion equipment used outside theaters of operations. on purchase, what proportion on maintenance, This requires a cultural change in the armed repair, training, and so on. The White Paper ‘Without taboos’: France’s new defense policy 69

Commission recommended that the existing a public stance that at times was virulently cost-accounting system, which is painfully anti-American with the reality of cooperation inadequate, be transformed into a proper one where it mattered? Let us not be blind to and applied to a wider scope of activities the facts: France is a Western country. We are part and investments. of Western Europe, subject to the same threats and the same demographic, economic, diplomatic, McKinsey on Government: One final question: religious, and cultural challenges. Second, France has rejoined the integrated military militarily: the absence of coordination between organization of NATO after 40 years of absence. France and the rest of NATO generated The White Paper clearly advocated it. What multiple problems of interoperability and of consequences will it have? coordination where it mattered most— that is, on the battlefield—and limited the Olivier Debouzy: First, it should be noted that the exposure of French officers and soldiers NATO-integrated military organization that we to foreign modes of reasoning, experiences are rejoining is not the one we left in 1969. It is not abroad, the exchange of ideas, and the integrated any more, hardly a military confrontations of strategic and operational modes organization anymore (only the United States, the that being part of a coalition entails. United Kingdom, Canada, and France are significant military contributors), and the re- Another advantage of rejoining NATO is that, on thinking of its strategic concept and revamping issues such as ballistic-missile defense, there of its structures are going to be the major is a debate going on within NATO in which France tasks of the coming years. will be an important participant, if only because it faces the Mediterranean. On this issue and on After 1969, France’s military cooperation with many procurement questions, being within the NATO and the United States was discreet integrated military structure may allow France and but nonetheless real. France always remained part other Europeans to think together, to caucus, of the NATO Air Command and Control System and hopefully to be able to have discussions with (ACCS); it always retained the pipelines supplying the United States in a more organized manner. the Central Front troops with oil from its harbors Ultimately—and this is ironic—it may be through in the Nantes region; and it had uninterrupted NATO that the Europeans will be able to ex- changes with its military partners in NATO— answer Kissinger’s question: “Who do I call if I more specifically, with the United States. Even at want to call Europe?” the times of the worst possible diplomatic tension, the military link between France and the United States was never broken.

In fact, this “cooperation in hiding” was becoming increasingly untenable on a number of levels. First, diplomatically: how could France reconcile

From R&D investment to fighting power, 25 years later

Countries have been investing in defense R&D at widely differing rates—a fact that is likely to lead to significant shifts in the global military balance over the next two decades.

Steven Bowns and In today’s constrained budgetary environments, and the quality of a military’s equipment Scott Gebicke nations are investing in defense research 25 years later. The regression model uses a and development at wildly different rates. Some 25-year time lag for R&D to “pull through” into countries are trimming, if not slashing, their equipment deployed in the field, which is budgets, whereas others are boosting their R&D realistic judging from the development cycle times spend, trusting that their investments will of combat technologies launched in the past pay off down the road. Yet it has never been easy few decades. to link defense R&D investment to victory on the battlefield, simply because of the slow pace We have now used this model to study the evolution of testing and adoption of substantial new of R&D investment from eight major nations combat technologies. Generally, the process of and project these nations’ military equipment moving from lab to field takes decades. quality (MEQ) out to the 2030s. What emerges are a number of important shifts that Detailed regression analysis conducted in recent governments and industry players will years, however, shows a statistically valid need to factor into their long-range strategic correlation between the levels of R&D investment planning. Namely, while the United States 71

will maintain its MEQ dominance, the same correlation between MEQ scores and R&D cannot be said of Russia. The major European investment 25 years prior came out to be 0.9— nations’ MEQ will stagnate. The rising military a very strong indication that, over time, powers of Asia—including China, India, and governments got what they paid for. South Korea—will develop much stronger capabil-

Brian Stauffer ities over the next 20 years, eclipsing Western MEQ alone, however, does not guarantee European countries in military might. military victory. Troop quality, doctrine, leadership, morale, and other factors play important roles As a result of these trends, governments will need in combat. In addition, the changing nature of to make dramatic changes in international modern warfare—in which counterinsurgency policies with regard to the proliferation of military efforts and special-forces teams are as prominent technology. They will also see a greater need to as traditional tanks and artillery—would seem to forge force-projection alliances in this increasingly complicate the value of MEQ as an indicator. multipolar world. European countries will While we acknowledge the difficulty of analyzing need to collaborate more closely with one another. current conflicts, we nevertheless believe that And the defense industry, which today is MEQ, if coupled with a measure of troop quality, predominantly Western, will have to contend with could well predict the outcome of future wars. both new competitors and restrictive regulations in the very markets that offer the The shifting military balance most growth potential. In today’s world, substantial shifts in military R&D investment are occurring—shifts that have MEQ: Our key metric serious implications for the global defense Our insights stand atop important work done in landscape. We applied the MEQ function to recent 2006 for the UK Ministry of Defence. Using R&D spending data drawn from eight countries: regression analysis, co-author Steven Bowns Europe’s three largest R&D spenders, the United generated a historical conversion function Kingdom, France, and Germany; rising Asian of R&D investment into a quantified metric, MEQ, powers China, India, and South Korea; and the which compares one aspect of the fighting long-time R&D spending champions, the power of one military with the same aspect of the United States and Russia, as benchmarks. Our fighting power of another. The analysis analysis sheds light on an important military involved using conjoint techniques to assess 69 technology question: when, if ever, will Asian categories of military equipment across ten nations overtake the Western powers? We countries and five time periods dating back to studied R&D investment levels through 2006 to 1971, generating like-for-like comparisons derive future MEQ scores until 2031 (Exhibit 1). of the equipment’s fitness for purpose. This work produced expert ratings on the overall Our model obviously cannot account for quality of 5,500 pieces of military equipment— exogenous disruptions such as technological a statistical robustness that gives MEQ innovations or economic turmoil—thus the much greater reliability than any other published imperfect 0.9 correlation. With this limitation in measure of defense output to date. These mind, what does this forecasting exercise ratings were then mapped against R&D spending tell us about the military equipment landscape data from 25 years before. The overall in the 2030s? 72 McKinsey on Government Spring 2010

McKinsey on Government 2010 Defense R&D Exhibit 1 of 3 Glance: China, India, and South Korea are rapidly emerging. Exhibit title: Military equipment quality

Exhibit 1 Military equipment 105 United States 100 Russia quality India 95 France The US will stay dominant; China 90 Asian powers will achieve parity United Kingdom with Europe. 85 South Korea Germany 80

65 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 Year Source: Technology Futures

American edge endures, Russia struggles The East rises The Cold War spending boom and bust still drive R&D investment trends across Asia over the past a large share of equipment quality, even decade have led us to believe that China, South decades later. The United States remains the Korea, and India will see dramatic surges in MEQ dominant force, and perhaps the most over the next ten years. We see these Asian striking feature of American MEQ supremacy is powers overtaking European countries during the that even by 2031, no nation has significantly next two decades. closed the gap with—let alone overtaken—the United States. The steady rise in the US’s MEQ Our model may be exaggerating the effect of this results from the increases in military R&D growth, as there are certain line items baked spending in the late 1980s under the Reagan into Asian countries’ defense budgets that make administration. Spending declined in the true comparisons difficult. (For example, the 1990s, but climbed again following the attacks defense budget data for India include program- of September 11, 2001. specific surges.) South Korea is a special case, in that it has historically been a preferred The rise and subsequent fall in Russia’s MEQ recipient of US technology transfer, so result directly from the large increase in Russian predicting that country’s future MEQ based solely R&D spending in response to the Reagan on indigenous R&D spending could under- defense buildup, then the sharp drop-off after the estimate its ranking. In any case, the strong growth collapse of the Soviet Union. Whether we will see in these Asian nations’ R&D investments is likely an effective conversion of Gorbachev-era R&D into to continue for the foreseeable future (Exhibit 2). real equipment in service remains to be seen; the Russian machinery for pulling through military Europe risks falling behind R&D to the field may well be broken. If that turns Unlike the roaring tigers of Asia, Europe can out to be the case, the expected near-term upsurge expect its MEQ rankings to plateau—or in Russian MEQ might not materialize and the even decline—based on recent reductions in R&D falloff after 2015 might be much more dramatic. investment. The UK decline stems from From R&D investment to fighting power, 25 years later 73

progressive cuts in R&D starting in the mid- dividend in the 1990s and has since seen 1990s as the United Kingdom took a some increases in R&D spending. Even so, India large post–Cold War peace dividend. Further cuts is still likely to overtake France in the continue, with some coming as recently mid-2020s (Exhibit 3). Germany, a nation that McKinseyas September on G 2009,overnment when 2010 the UK Ministry of tends to spend comparatively small sums on DefenseDefence R&Dannounced a 25 percent cut in military R&D, will fall behind India by 2012 Exhibitits research 2 of 3 budget. France is in a slightly and behind the other Asian powers Glancedifferent: There position, is strong as growth it took in a Asian smaller nations’ peace investments . soon thereafter. Exhibit title: Global defense spending

Exhibit 2 2008 Defense equipment 2015 spending Country Total defense equipment budget $ billion Share of global spend %

There is strong growth in Asian United States 125 49 115 35 nations’ investments. 16 6 China 29 9 10 4 France 15 4

9 4 United Kingdom 14 4

India 9 3 17 5

8 3 Japan 12 4 8 3 South Korea 13 4

Saudi Arabia 7 3 11 3

3 Australia 7 12 4

6 2 Russia 11 3

Source: The Military Balance 2009, International Institute for Strategic Studies 74 McKinsey on Government Spring 2010

What remains unclear is whether further technology to countries in Asia, Africa, and References consolidation among Europe’s indigenous defense the Middle East, and if China produces Andrew Middleton, Steven industries will occur. Such consolidation may innovations that radically improve its military Bowns, Keith Hartley, improve European countries’ ability to pull R&D hardware, the results could include widespread and James Reid, “The investment through to the field. proliferation and an unexpected MEQ catch-up effect of defence R&D on effect for a variety of developing nations. military equipment quality,” Implications for defense ministries Defence and Peace and industry While American MEQ dominance looks Economics, April 2006, These conclusions, some less surprising than reasonably secure, the United States will need to Volume 17, Number 2, others, have complex implications for how decide whether to keep high-tech weapons pp. 117–39. governments and players in the defense industry proliferation on the diplomatic docket, particularly Keith Crane, Roger Cliff, ought to plan for the future. Assuming MEQ as the United States and China do not currently Evan S. Medeiros, is indeed a dominant predictor of behavior, four see eye-to-eye on the topic. Proliferation could James C. Mulvenon, main implications emerge. become a more important factor in and William H. Overholt, Sino-American relations in the future. The “Forecasting China’s Policy changes in response to outcome of such talks could also affect military spending through increased regionality military sales and technology transfer decisions in 2025,” Rand research The rising Asian powers may focus their other regions, such as Africa or Latin America, brief, 2005. investments on equipment that will which may then require additional policy shifts Keith Crane, Roger Cliff, allow them to project military force far from among the major powers. Evan S. Medeiros, James their shores. An example of this might C. Mulvenon, and William be the transition of China’s navy to more of a Need for pan-European collaboration H. Overholt, “Modernizing “blue-water” orientation. China already has As Europe’s individual member states continue to China’s military,” Rand aircraft carriers, amphibious assault ships, and reduce their military R&D spending, the monograph, 2005. fleet train vessels in its acquisition pipeline; region as a whole stands to see its edge in MEQ its possession of such platforms could lead to an erode dramatically. This prediction, however, Keith Hartley, “Defence increased propensity to intervene in regional reflects the current industry structure, which R&D data issues,” Defence conflicts. This risk is especially acute in areas of features only nascent collaboration among and Peace Economics, June 2006, Volume 17, resource disputes such as those around the European governments. Number 3, pp. 169–75. Pacific Rim and the Indian Ocean, which were previously beyond China’s reach because Increased collaboration among governments Evan S. Medeiros et al., of a lack of long-range force-projection equipment. and further consolidation in the European “Pacific currents: The China’s ownership of such equipment will also defense industry could help Europe maintain some responses of US allies and raise the cost of intervention for powers advantage over the Asian powers. Given the security partners in East from outside the region. Governments must plan success of existing multinational European Asia to China’s rise,” Rand, for this increased regionality and multipolar ventures, such as missile developer MBDA, 2009. force projection—a mammoth strategic task. and the region’s common currency, pan-European SIPRI Yearbook Series, collaboration appears to be a promising route. Stockholm International Evolving proliferation policies But there seems to be little political will emerging Peace Research Institute, The ultimate direction of weapons proliferation in to carry this through. Will the increasing threats Oxford University Press. Asia will be shaped by Chinese policy decisions. posed by the catch-up of the rising East supply If China continues to export advanced combat this political will? It seems unlikely at present. From R&D investment to fighting power, 25 years later 75

McKinsey on Government 2010 Defense R&D Exhibit 2 of 3 Glance: Asian powers are poised to overtake Western countries in the next 20 years. Exhibit title: Realizing advantage

Exhibit 3 2010 to 2020 2020 to 2030 Realizing advantage India overtakes Germany and United Kingdom India overtakes France Asian powers are poised to overtake Western countries in China overtakes Germany China overtakes United Kingdom the next 20 years. France overtakes United Kingdom South Korea overtakes Germany

Discontinuity in the defense industry significant MEQ advantage, intervention in Many Western original equipment manufacturers conflicts in other parts of the globe is (OEMs) have already established a presence in likely to become much riskier, even for a Asian markets. However, this dynamic is fragile, superpower. Unless Europe brings as emerging markets tend to be far more together its R&D efforts into a more unified demanding today than they were in the past when construct, it will risk falling behind Asia— it comes to technology transfer and local and could thus become highly reluctant or even production. Strict regulations and the rise of unable to intervene in any conflict without former partners turned competitors mean being part of a coalition led by the United States. Western OEMs risk becoming obsolete in Asia’s In light of these trends, governments and the growth markets—a risk further exacerbated defense industry must become more flexible and by Western governments’ tighter export control resilient so as to meet the coming challenges laws. This trend has played out in adjacent and respond to changing market dynamics. industries—shipbuilding and high-tech assembly, for example—with dramatic restructuring effects. The defense industry will need to find ways to manage this discontinuity.

The military balance of the 2030s is unlikely to resemble today’s. We see the rising Eastern powers resorting more often to regional conflicts, in the knowledge that a dispute could be fought out to a conclusion without US intervention. And while the United States should retain a

Steven Bowns is director of Technology Futures Ltd. and an associate fellow at Chatham House. Scott Gebicke is an associate principal in McKinsey’s San Francisco office. Copyright © 2010 McKinsey & Company. All rights reserved. 76 McKinsey on Government Spring 2010