NDIA head David Norquist on Pentagon communications and handling inflation

WASHINGTON — The defense industry finds itself in a confusing situation as fall nears. On the one hand, there is broad agreement that the defense budget for the upcoming fiscal year will be record-setting, and there is strong demand signal globally for American weapons in the wake of Russia’s invasion of Ukraine. On the other hand, a giant spike in inflation, compounded by already existing component and workforce shortages means real challenges for c-suite executives.

David Norquist served as the Pentagon comptroller from June 2017 to July 2019, when he was sworn in as the Deputy Secretary of Defense, the department’s No. 2 civilian. After leaving the Pentagon in February 2021, he took over as the head of the National Defense Industrial Association in May, making him one of the point people for communicating between DoD and industry at this chaotic moment.

He sat down with Breaking Defense in late July to discuss how both sides need to communicate more clearly, and how he sees the impact of inflation on defense programs. The following interview has been condensed and edited lightly for clarity.

We know the inflation situation is the highest in years. Where are you starting to see that pop up?

There’s three places it shows up, in no particular order. The first one you saw is the debate over the [budget] topline. And the realization is, if you’re not covering inflation, then that is a sizable hit to the Defense Department in order to get the same buying power. The fact that there was bipartisan support in the HASC and the SASC to begin to address that was very valuable. If you don’t have that, then you’re signaling a challenge in the future that you’re actually going to have negative growth, because you’re not going to keep up with inflation. And then no one knows who that’s going to affect — but everybody starts to determine maybe it’s gonna affect me, right? And maybe it’s gonna affect everybody

The second hit that you saw, and this came very quick, was the effect on readiness. [Deputy Secretary of Defense Kathleen Hicks’] comment was “for me, it’s not a ’23 problem. It started in ’22.” She’s got fuel pricing, challenges to flying hours, training time, all of the maintenance, those types of accounts. They’re the ones seeing the pressure now, and so they’ve been doing reprogramming and things to address that. But there’s some very near-term challenges.

I think the third one is contracts. Somebody has a multiyear firm fixed-price contract and all of a sudden the costs look nothing like what it was at the time they assumed. You have a multiyear contract with option periods. The flat rate was 2%. For more than a decade, that was fine. Now I think the most recent news was like 9%. That changes everything. And the problem is for defense, there’s thousands of contracts, right? So you can’t easily have everybody negotiate individual pieces in finding their way through it. It affects them all somewhat differently, like labor costs, raw material, fuels. If it was 3%, plus or minus, I mean, we’ve been off plus or minus one in the past. People can manage that. The number now is different with what DoD was planning on when it came in and so therefore, they are in a very different place in terms of being able to execute their vision than what they thought they were asking for.

And so I know they’re working hard to try and get their hands around this. I know the Hill is working hard to try and get the right number, but figuring a mechanism by which the department can adjust its contracts, perhaps on a more centralized basis, for anything that’s not an anomaly, say, “Okay, here’s what we’re going to generically do.” Those are the sorts of things that I think are worth looking at as a way of facilitating how the department gets through this without a very labor intensive line by line type of effort.

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So how does that work? Is there a mechanism that you can do that with?

You can create one. You might need legislative authority, or you might be able to do a directive that says, “We will make the following adjustments to all of these certain types of contracts, and you can vary them by that.” And then you could signal if somebody thinks that that’s an inappropriate match, they can raise it by exception. But for most people, this may be close enough, right? Those are the sorts of things you could work through.

Ok, let’s lay out an example, just as a hypothetical. Say the assumption on fuel costs was $1, now we see it’s going to be more like $5. Could you make a blanket rule that the assumption going forward will be $5?

You could go to [industry] and say, if this was a significant part of your price, we will adjust for that, and we’ll use this number instead. So you could work through types of contracts or sets of problems, come up with a more across the board rule that says this is the adjustment we will make. And if it’s close enough for most people, then you save yourself a lot of the labor time trying to sort pieces out.

Because otherwise the risk is everyone starts coming back and saying I need to renegotiate my deal. And you’ve got thousands of contracts and all of a sudden all they all need —

All need to be renegotiated, people not willing to take up their options because the price is no longer realistic. So then somebody has to [renegotiate] — and the ones most unable to ride it out will be the small businesses. And then whatever you do has to affect the subcontractors, right? It’s got to cascade down from the primes through to the subcontractors.

That idea that you just brought up, is this something you’re talking to DoD about?

It’s something — part of our job is to talk to the Hill, the industry, private sector and say what types of solutions could work, and those are the communities we’re going to work with on these issues going forward. But one of my priorities going through this year is all the different places where I said inflation shows up, [to ask] how can I help in each of those areas? And find a good way forward.

Let’s talk Ukraine. Where are you finding the challenges of that conflict for industry playing out?

The first one actually sort of predates it, which is the problem with computer chips. You mentioned the Javelin, I think the number’s 200 or more chips in it. And that was a problem before we hit our most recent COVID/Ukraine challenges.

The second thing is the same problem that we’ve run into in the past which is, it’s a tough budget choice for inventory of munitions, and the quantity that you need them. One is, it’s never sure which is the munition of the day, and the munitions in one conflict are not the munitions needed in the other. The second is if I want somebody to have a capacity to produce more, I have to pay them more than just the cost of the missile. I have to pay them for that extra capacity or have to pay to hold extra inventory. [With] tight budgets, people tend not to do as much of that, which means when you turn around and say, “Can you ramp up?” The answer is, “I wasn’t set up for that” in some cases, or you’re trying to do the extended production when it’s something where you stopped [production] so the supply chain isn’t there.

And so that’s one of the ones that you have to keep coming back to because it frequently revolves around munitions — munitions and often spare parts, those are the two where you’ll see the question of, did we buy enough and if I bought enough did I buy the right ones? Did I think this part was gonna fail, did I think this was gonna run short, and now someone’s gonna get mad at me because I have this warehouse full of stuff I’m not using and then that one’s empty.

So those are some of the strategic challenges and I think as you point out, we have European countries now willing to put significantly more into their capabilities. Munitions are likely to be one of those shortages to start with. If they were one of the countries shipping their existing supplies to Ukraine to be helpful, their gaps [are] going to be even larger. It puts a premium on accelerating and facilitating FMS sales, right? Let’s help get everybody on to the newer systems to get them standardized and to be able to be interoperable.

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From an industrial standpoint, what messaging are you giving to your members post-Ukraine? Because to your point, we don’t even know necessarily what’s going to be needed in the future fight or how long it will go.

You have to follow the department’s signal. And the department has to be clear about its signal. I credit the leadership — inside the department they understand the importance of trying to do this. Strategically, this National Defense Strategy has a great deal in common with the previous National Defense Strategy, which had strong bipartisan support. You have a world where everyone agrees that China is the larger pacing challenge, the one who’s got the most serious capabilities and the one who’s more patient. And on the other side, you have Russia who is impatient and knows their clock is running out and is therefore more dangerous.

These are people who are thinking and coming to the same set of conclusions. So there’s a clear signal. These are the technologies that both parties — new leadership, different players — all reach the same conclusion about what is important. So that is a very helpful message I use to highlight to industry, which is, you are getting a very stable signal at the strategic level, from different administrations over different periods of time about where the department is heading.

The actual individual buys are where you also have to be able to be clear. If somebody is told that there’s a need for Javelins and they start ramping up, are you still gonna believe that in two years? Use the example of the masks for COVID. There was a big effort in the previous administration — I was part of it — to try and get companies to produce more masks. And one of the [industry executives] was very clear. He said, “I will build the factory. I will build the capacity. I will turn out enormous quantities of masks. And in 12 months, you’ll tell everybody it’s over, and they will go back to buying from foreign suppliers and my entire business will go under — not just what I expanded, everything I used to have will go under with it. Why would I do this?” And that was his experience from watching before, where you have this demand, you ramp up you meet it, crisis has gone, everything falls.

Here you’ve got a similar thing, which is how do you work with industry so that they’re not exposed to the risk that this becomes yesterday’s news story, and they’re holding the buck on the production. That’s where the government, the consistency of the signal, the wise choice on the acquisition tools to say we are going to try and to get to this quantity of production or this inventory, [can show] you can count on that.

Do you think that communication is successfully going out? And do you think the members believe what they’re being told? Using Javelin as an example, that’s a weapon that wasn’t a focus for years and years, and the government signaled that — and now it’s a massive priority.

Again I know [that communication] is being worked on. I don’t know if people believe the level of clarity but I also think the department has to decide — some of these [systems] you aren’t actually going to replace that weapon, right? You draw down an inventory of something from before, you may replace it with something different, either the next generation or an alternative tool. And that’s okay. You just have to help signal to everybody, this is the direction we’re headed. That’s where the POMs [Pentagon budget requests] come in, that’s where the budget comes in.

Just reading between what you’re saying a little bit, it sounds like in your mind, Pentagon leaders have a good plan for communicating, they have an understanding of all this, but maybe it hasn’t filtered out clearly enough to industry.

It is often surprising in government how often you think you’ve gotten the message out. I was talking to someone who was at a conference and the person said, “When did China get to become such an issue?” And my thought was, I thought we had been hitting this message all the time. So there is part of it where you think you have said it, and you don’t realize how many voices speak and how many times you have to say it to be heard.

NDIA plays an interlocutor role between DoD and industry. So what questions are you hearing from industry on this?

One of the questions is, sort of, who should we look to as the voice? There’s a lot of people who speak, and so there’s a simple question of, who would you like us to look to as the voice on it. And again, the answer may change by subject. But sometimes it’s knowing who is speaking with authority, and who is answering questions.