What's up with the market?

Story

July 20, 2007

Perceptions, rather than reality, are adversely affecting the embedded COTS market

According to the government’s Office of Management and Budget – based
upon information provided by the Bush Administration – the DoD has had
incredible success in the Global War On Terror (GWOT). U.S. armed forces and
their allies have liberated 50 million people in Iraq and Afghanistan and trained
more than 215,000 Iraqi and 82,000 Afghan security forces – moving those
countries closer to economic and civilian security. We’ve also deployed
countless new technologies to the battlefield, from stronger and lighter body
armor, to armed UAVs and UCAVs, to dramatically improved situational awareness,
C4ISR command chain decision making, and golden hour medical advancements.

Overall, the numbers are astoundingly favorable regardless of how you look
at it. From a military materiel, technology, and lethality standpoint, technology
has indeed delivered on its promise of a force multiplier while increasing
war fighter survivability. Moreover, the DoD budget is near an all-time
high in real dollars, and FY07 should wind up at least 7 percent over FY06
to approximately $439.3 billion1 and a whopping 48 percent over 2001.

But to
those of us in the embedded industry “living and dying” on
the basis of contract awards and Science and Technology (S&T) R&D
spending, things don’t feel so good. There’s a sense that the market
is slowing and getting ready to change, despite the top-down Green Book program-by-program
numbers. As a result, big prime contractors are belaying RFQs and POs, schedules
are sliding to the right, and vendors are slowing down their own R&D efforts,
component purchasing and hiring decisions, and even advertising and trade
show spending. What the heck is going on?

1. DoD budgets – look closer. Operational
   and Maintenance (O&M) expenses are huge. President Bush did
   the right thing by raising service members’ pay by about 25 percent,
   enhancing special pays and bonuses to improve recruiting and retention, improving
   personnel housing and education benefits, and reorganizing the Army ground
   forces to improve mobility. The Air Force is using C-17s to ferry in supplies
   and fuel, reducing casualties from moving materiel by truck into Baghdad
   but doubling or tripling transport costs. We’re wearing out Cobra,
   Huey, and Apache rotor blades in the fine desert sand, overstressing HMMWV
   engines and requiring more frequent replacement, and keeping Navy and Air
   Force assets flying 24/7 to provide suppression and RECON. This burns fuel
   and increases maintenance costs. For instance, in FY07 the number of Predator
   orbits has nearly doubled to 21 to provide sustained 24-hour surveillance.
   All of these O&M expenses
   mean less money is available for nonessential program spending2, so
   we’ve
   seen F-22, F-35, DDG1000, FCS, JTRS, and countless others slide out, or smaller
   programs may go on life support. So while the topline DoD budget is up, a
   larger portion is being spent on nontechnology line items. Ergo, less money
   to spend on tech.
2. Decreased optimism. Poll after poll shows
   a majority of Americans no longer support operations in Iraq, and are becoming
   increasingly cranky about it. Additionally, the era of ENRON and Worldcom
   scandals has weighed on the buying public. According to FORTUNE magazine,
   a recent Gallup poll finds that “confidence in ‘big business’ among
   U.S. adults is very low.” The number of Americans with no health insurance
   has increased during the past five years alone, and health care costs are
   rising at 10-15 percent per year. Total government debt held by the public
   was $4.8 billion in FY06 and is forecast to peak at $5.4 billion in FY 2011,
   while the federal surplus has turned to deficit and exceeds 30 percent (public
   debt as a percentage of GDP) until 2012 per CBO. The housing boom has cooled
   and many markets have seen inventory go from hours on the
   market to months on the market; as we went to press, consumer
   30-year fixed mortgage rates hit their highest in 3 years. And though unemployment
   remains thankfully low in the near-record 4.5 percent range, in embedded
   tech the amount of offshoring to China, India, Russia, and other places
   has steadily increased. Chances are every one of us knows someone whose
   job was replaced. In short: Defense buyers, embedded tech company CEOs,
   and regular tech workers feel less optimistic about the future. Human nature
   is to withdraw and protect what you have, avoiding risk and uncertainty.
   This translates into lower R&D
   spending, fewer POs for CapEx and component inventories, and ordering “just
   enough” boards to meet customer backlog.
3. Washington political change. During
   mid-term elections last year, both houses of Congress fell under Democrat
   control. Business leaders – the same ones who drive both big and small companies
   in the DoD and embedded systems industries – are fully aware that a long-term
   change in party leadership could have serious ramifications. Companies are
   already girding for change, just in case. Investment is being funneled into
   more “green” efforts such as ethanol and energy conservation; large
   defense contractors have long been at the forefront of beating swords into
   plowshares when the defense climate changed. In 2008, if the Republicans lost
   control of the White House, DoD spending would likely (eventually) start to
   decrease. These real possibilities are also changing today’s perceptions
   of the market, artificially slowing it down and creating caution among buyers.

There are other factors, of course. Add them to these three biggies and the
top-down view of the embedded COTS market raises a caution flag. In effect,
perception might become reality.

Chris A. Ciufo, Group Editorial Director
[email protected].

1That’s base budget – Plus-ups, bridges,
riders, and supplementals make the actual number extremely variable until the
year ends.
2Essential” is anything that assists the war fighter in his or
her right-now mission. That includes urban warfare such as IED discovery, verbal
translation, or improved survivability.