Capabilities-driven strategy for defense: Asserting your right to win in an evolving market
A declining defense budget in the United States and a shift in acquisition philosophy by the Pentagon have fundamentally altered the competitive landscape for the defense industry. Defense companies can assert their “right to win” in the evolving defense market using one of a variety of strategic models — well established, relatively new, or as yet undiscovered — but this requires focusing their resources on a chosen “way to play”.
Capabilitiesdriven strategy for defense Asserting your right to win in an evolving market
DC Marty Bollinger Senior Executive Advisor +1-703-682-5750 marty.bollinger @strategyand.pwc.com
Florham Park, NJ Randy Starr Partner +1-973-410-7604 randy.starr @strategyand.pwc.com
Los Angeles Joseph Martin Partner +1-424-294-3745 joseph.martin @strategyand.pwc.com
About the authors
Marty Bollinger is a senior executive advisor with Strategy& based in Washington, D.C. He works with the world’s leading aerospace and defense companies as well as major industrial and service companies on such issues as business strategy, organizational effectiveness, and operating improvements. Randy Starr is a partner with Strategy& based in Florham Park, N.J. He specializes in developing growth strategies and strategy-based transformation for the aerospace and defense sector. Jono Anderson is a principal with Strategy& based in Los Angeles. He specializes in corporate portfolio, growth, and competitive strategies, developing and implementing innovative approaches for aerospace, defense, and transportation companies. Andrew Straus was formerly a senior associate with Strategy&.
This report was originally published by Booz & Company in 2011.
A declining defense budget in the United States and a shift in acquisition philosophy by the Pentagon — along with the emergence of nontraditional providers that are delivering less expensive or more innovative solutions that can be developed and fielded quickly — have fundamentally altered the competitive landscape for the defense industry. We see four prominent strategic models today, two well established and two relatively new. The former are program-centric exquisite systems providers, which build and integrate complex weapon systems, and process-centric scale-driven standard suppliers, which rely on operational excellence to provide lower cost products and services. The latter include product-centric agile smart customizers such as Navistar, which built a $4 billion military truck business in five years by quickly tailoring existing product lines to meet unique customer requirements, and problem-centric disruptive specialists such as General Atomics, a first mover in unmanned aerial vehicles (UAVs) that was able to scout and rapidly prototype technology solutions to fill undefined or unarticulated needs. A company can assert its “right to win” in the evolving defense market using any of these (or other, as yet undiscovered) models in its major businesses, but this requires focusing its intellectual, organizational, and operational resources on a chosen “way to play” to achieve the premiums associated with strategic coherence. This is the basis for a capabilities-driven strategy (CDS). CDS aligns a company’s differentiating capabilities with its value proposition, develops a product and service portfolio that outpaces competitors, and defines an operating model that enables the enterprise to focus on what it does best. It also provides a useful framework for management to determine which parts of the business can safely be scaled back when spending decreases, and which require continued spending even as revenues stagnate or fall. CDS creates the strategic coherence that companies need to assert their right to win in the evolving defense market.
The shift in defense
The wartime buildup has passed its peak, but the ongoing need for defense products and services that can both satisfy immediate needs and counter “near-peer” threats won’t subside. The challenge for defense contractors is to continue fulfilling this demand, but to do so more affordably, in the face of deeper cuts in military investment accounts. This challenge is compounded by a dynamic threat environment in which the resourcefulness of adversaries requires a more agile industrial base to rapidly develop and field new solutions. In the United States, the defense industry is likely to face a 30 to 40 percent reduction in total investment spending from the 2008 peak. Funding for defense equipment has already fallen more than US$50 billion between 2008 and 2012, and further cuts in investment are likely, perhaps on the order of an additional $50 billion by 2015 under some scenarios. Responding to budget pressures, U.S. Secretary of Defense Robert Gates issued new guidance in September 2010 establishing a cost-conscious acquisition system that favors “affordable” solutions. “We have a continuing responsibility to procure the critical goods and services our forces need in the years ahead, but we will not have ever-increasing budgets to pay for them,” Under Secretary of Defense for Acquisition, Technology, and Logistics Ashton Carter said in a September 14, 2010, memo announcing the new guidance. “We must … do more without more.” Although there will always be a place for highly complex, long-lead systems that push the envelope of technological sophistication, the Department of Defense is shifting spending toward less elaborate, more affordable solutions that take advantage of proven technologies, innovation capabilities, and efficient processes to control costs and get the job done quicker. Pentagon officials also plan to streamline the process for requirements definition by adopting multiple procurement tracks — near-term/urgent, midterm, and long-term — to better align acquisition processes and time lines to specific needs. This shift in procurement philosophy has further stimulated ongoing competitive challenges from nontraditional providers of defense
In the U.S., the defense industry is likely to face a 30 to 40 percent reduction in total investment spending from the 2008 peak.
products, which bring new capabilities and business models to the defense market. For example, the last two major U.S. Army tactical vehicle programs were awarded to a commercial truck manufacturer, Oshkosh Corporation. The last three military training aircraft have also been foreign designs. The Air Force MC-12W Liberty, a more affordable airborne intelligence, surveillance, and reconnaissance solution, was derived from a civil aircraft platform. And military ground forces now employ commercial-based Harris and Thales tactical radios in place of the more expensive, purpose-built systems originally envisioned. All of these programs found success in an environment that rewards affordable solutions that can be quickly developed and fielded. In contrast, longer-lead exquisite systems, which rely on long-established, traditional defense suppliers as the prime contractors, have been struggling. Some observers believe that the new acquisition philosophy will be quietly set aside after the current defense leadership is replaced. After all, there have been reductions in investment spending before, most recently when the collapse of the Soviet Union triggered across-theboard cuts. But today’s situation differs in several important ways. First, today’s military continues to face real and persistent threats that cannot be ignored, and military leaders are shifting force structure requirements in response to the “long war” against terrorists and other asymmetrical threats. In addition, nearly 10 years of war have placed considerable stress on both warfighters and weapons, demanding that priority be given to operations, and management and personnel budgets. And unlike during the 1990s, the budgetary pressure created by a deep recession, a slow recovery, and the ballooning of the national deficit limits the alternatives for any defense secretary. Even as the global economy turns around, the fundamental need for affordable programs that better meet today’s national security challenges will remain. Consequently, both traditional and nontraditional companies that compete in the defense market have already begun to reassess their operating models and market positioning in light of the Pentagon’s evolving acquisition approach. Those that take a wait-and-see stance risk being left behind.
A capabilities-driven strategy
How, then, should defense companies reassess and realign their current strategies? Our experience shows that both traditional and nontraditional competitors earn the right to win in the new market environment by pursuing coherence. They align and focus the three basic components of their corporate strategies: how they compete (their way to play); the handful of essential, distinctive, and mutually supporting capabilities that enable them to execute their strategies and prosper in the marketplace; and their differentiated product and service portfolios. The specifics of these three elements will vary among individual companies, but the elements themselves are always the same (see Exhibit 1).
Exhibit 1 The elements of a coherent strategy
Coherence Way to play (competitive archetype) How are we going to create value for our customers? The competitive approach for how a company creates value for its customers in a given market
Capability system (right to win)
What do we need to do well to deliver that value proposition? The system of capabilities consistent with this direction delivering a differentiated value proposition and ensuring the right to win
Product and service portfolio (ﬁt with capabilities)
What are we going to sell in this market and to whom? The products and services that thrive within that system to reliably and sustainably outpace competitors Source: Strategy&
In a coherent company, the right product and service portfolio naturally thrives within a capability system consciously chosen and implemented to support a deliberate way to play within a defined market (and to minimize spending in areas not deemed essential). Often, companies facing significant market changes or competition will examine only one of these elements, perhaps sharpening their internal capabilities or reevaluating their portfolios. But companies that align and focus all three elements in what we call a capabilities-driven strategy can gain a sustainable advantage over their competitors. 1. Way to play To create such a strategy, it is important for a company to assess how it creates value for its customers. At least four approaches — ways to play — have evolved in the defense market (see Exhibit 2, next page). Although there are few pure plays among companies or lines of business, these approaches basically characterize how most companies play in this market: • Exquisite systems providers: Program-centric players design, develop, build, integrate, and maintain sophisticated platforms. They create value by delivering high-quality, highly complex systems and technology — the most advanced in the world. And they often provide total life cycle support for their systems. • Scale-driven standard suppliers: Process-centric suppliers rely on operational excellence to provide off-the-shelf products and services, often applying existing products to new applications or missions, and using supply chain efficiency to drive down costs and improve margins while expanding sales to new customers. • Agile smart customizers: Product-centric companies leverage commercial or global scale and scope to respond to their customers’ needs for rapid development and fielding of products and services. They can provide tailored solutions, often based on existing product lines, to deliver mission capability in a shorter time frame. • Disruptive specialists: Problem-centric companies develop highly innovative solutions to satisfy unmet and often unarticulated needs. They seek to field disruptive products or services that satisfy a need in a different way than competitors or to provide an entirely new capability. Their innovative products may take several years to mature but can change the game by influencing force structure or concepts of operation. The inherent characteristics and capabilities of these ways to play in the defense market are all different. But regardless of their differences,
Exhibit 2 Ways to play in defense
Exquisite systems providers Program-centric Highly tuned to intricacies of defense clients and a complex acquisition system Focused on exquisite platform development and integration for well-articulated needs Deep, focused marketing in one country, targeting acquisition workforce Razor-sharp focus on affordability at low rate
Scale-driven standard suppliers Process-centric Lean, productivity-focused, centered around operational excellence Customer- and supplier-driven; incremental upgrades to stable product lines Global market reach, with standard offerings
Agile smart customizers Product-centric Commercial product-line focus and global orientation Rapid fulﬁllment of deﬁned needs through use of existing product designs Global market reach, with tailoring for national needs
Disruptive specialists Problem-centric Innovative environment; highly entrepreneurial workforce Continuous and rapid innovation to satisfy unmet or unarticulated needs Ability to access selected key decision makers in defense organizations Lean, fast, responsive business systems with low ﬁxed costs
Operational excellence for low-cost production with high schedule certainty Excellence in on-time, lowcost delivery and reliability Deep expertise in operations and logistics Attract functional practitioners; build depth for maximum leverage Minimum and ﬁt for purpose; able to scale up and down easily
Cost-effective production at moderate rates using commercial specs Product-line management focus through product and functional matrix Commercial hardware/ software integration, supplieragnostic Source best talent globally; develop breadth for maximum deployment Driven by competitive market cost pressures; global sourcing
Program & product management Knowledge
“Command and control” leadership model with program-functional matrix Deep, specialized engineering and domain expertise Hire and retain deep technical/ mission expertise; narrow sourcing base Driven by unique Defense Department requirements; very high barriers to exit
Solution-oriented focus; willingness to independently invest in and develop new solutions Highly fungible skill sets; broad awareness of defense and commercial landscape Rapid replenishment of talent through broad sources; relatively high turnover Low structural and systemic cost base; low barriers to exit
the essential goal for all companies is the same: to closely align their capability systems and their product and service portfolios with how they compete. Adopting more than one way to play in a discrete business creates conflicting goals and is very difficult to do well. The challenge for many companies is choosing a single competitive approach, either for the entire enterprise or for each major line of business (if a one-size-fits-all approach is inappropriate), and developing the capabilities needed to create value for customers and deliver a differentiated value proposition. 2. Capability system In conjunction with assessing how to create value for customers, a coherent company determines how its distinctive capability system — the most critical capabilities that set it apart from its rivals — will enable it to deliver its customer value proposition. The capabilities in the system should be difficult for competitors to replicate, and they should work together to reinforce and strengthen one another — becoming a unique source of sustainable advantage. In the defense industry, such capabilities might include deep domain knowledge of a customer’s mission requirements, achieving affordability at low production rates, innovation agility to satisfy unanticipated customer needs, and operational excellence to provide on-time, low-cost delivery of products or services. For example, Eurocopter, which primarily designs and builds commercial helicopters, exploited its capabilities in terms of scale and core platform design to customize its helicopters for military and government customers. As a result, most helicopters purchased by the U.S. Department of Homeland Security have been built by Eurocopter. And the U.S. Army’s latest light utility helicopter is also built by the company. So how does a company develop or enhance the capability system it needs to fulfill its value proposition? After identifying the select set of capabilities needed, the company should examine and align its operating model, including the tasks, processes, tools, and organizational structure that enable it to bring the capabilities to bear on the delivery of its distinctive offerings. 3. Product and service portfolio Finally, CDS requires that a company decide what to sell and to whom. Too often, companies develop (or acquire) and sell products and services that are aligned with a particular market sector, but not necessarily aligned to their ways to play or capability systems. A fundamental objective of CDS is to ensure that a company’s offerings are properly aligned with the other elements of its strategy — for
The essential goal for all companies is to closely align their capability systems and their product and service portfolios with how they compete.
example, that its capability system enables it to produce solutions that outpace competitors on a consistent and sustained basis. If offerings aren’t aligned, they may be candidates for divestment. The process of developing a capabilities-driven strategy starts with a thorough and measured look at what your company does really well, in the context of what the market is rewarding. It is not, however, a stepby-step progression. Assessing and aligning the three strategic elements is an iterative and dynamic process. Changes in one element often will impact the others, and the overall process of fine-tuning the individual elements will strengthen all three. In a coherent company, all elements work together to create value, positioning the company to take advantage of emerging market opportunities that will reward its differentiating capabilities. CDS helps a company focus on what it does best. Just as important, it helps a company understand what it should not do, facilitating clear, costsaving choices and eliminating investments that are likely to produce suboptimal returns. This yields potentially higher performance and returns — a coherence premium.
Achieving the coherence premium
Can a capabilities-driven strategy help companies achieve a coherence premium while also helping them adapt to the changing defense market? We are convinced it can. In fact, we have seen companies representing each of the major ways to play distinguish themselves with CDS-like adaptations that enabled them to deliver affordable solutions to current military requirements. Here are a few examples: Exquisite systems providers General Dynamics Electric Boat and Newport News Shipbuilding applied a cost-cutting approach — called design for affordability (DFA) — that reduced the cost of the Virginia-class SSN-774 nuclear-powered submarine from $2.4 billion to $2 billion (in 2005 dollars). The DFA approach enhanced two of the shipyards’ most important capabilities: their ability to achieve market-based affordability at a low rate of production, and their superior control processes for design and construction. By tightening the capability system and the organizational structure supporting these capabilities, the shipyards were able to identify and make changes in the design, sourcing, materials, construction, and other program elements needed to achieve the targeted savings, while maintaining the submarine’s required capabilities. This effort also enabled the Navy to increase the annual construction rate from one to two submarines. The innovative DFA approach is now being applied to other shipbuilding programs, helping to reduce costs of even the most exquisite systems. Scale-driven standard suppliers FLIR Systems provides defense customers with a standard line of thermal imaging systems that are used on a wide variety of weapons and platforms. But in recent years, the company has dramatically diversified its customer base with an expanded range of commercial applications, including camera systems and imaging devices for building diagnosis and gas detection.
Companies using each of the ways to play have made CDSlike adaptations that enabled them to deliver affordable solutions to military requirements.
Driving this expansion has been FLIR’s focus on operational excellence, including process efficiencies and global reach, both critical elements of its capability system. Sticking to what it does best — offering off-theshelf thermal imaging systems with little customization — FLIR expanded beyond the defense market and into the industrial and consumer sectors. As a result, the company was also able to serve its defense customers better, by significantly reducing the price per unit and providing a steady supply of affordable thermal imaging systems for diverse military applications. Agile smart customizers In late 2008, the Pentagon issued a request for proposal for a lightweight off-road vehicle that could protect a crew from improvised explosive devices and similar threats directly beneath the truck. A condition was that the vehicles had to be ready for production within seven months. To meet the tight deadline, Oshkosh Corporation’s defense business used modular parts from existing equipment; tested the design as it was being produced, generating new iterations frequently based on what was learned in the field in trial runs; and conducted daily meetings among a core team of about 60 members across numerous functions — design, engineering, manufacturing, procurement — aimed at ironing out problems, assessing risk, and fine-tuning the development plan. Through the smart customization of existing designs, Oshkosh won a contract valued so far at more than $2 billion for about 4,000 M-ATVs, as these vehicles are known. The company was able to align its capability system with its way to play. In particular, Oshkosh’s mutually reinforcing capabilities in commercial scale and strong product-line management expertise enabled it to rapidly fulfill the needs of defense customers. “Never since World War II has a military acquisition program gone from concept to full-scale production in less than a year,” Defense Secretary Gates told Oshkosh workers during a plant visit in November 2009. “With every vehicle you complete, you are saving American lives.” Disruptive specialists General Atomics builds UAVs that the military has used for airborne surveillance in place of manned aircraft since the 1990s. The company developed this concept ahead of an articulated customer need. But once it proved its value, it sold itself. The company’s Predator UAV, which also has an air-to-ground strike capability, was used extensively in Iraq and later in Afghanistan. The Predator changed the face of modern combat operations, often replacing manned aircraft and ground troops in surveillance and strike missions; it now plays an enduring role in the military’s concept of operations. Many companies have developed UAVs
since then, but General Atomics still retains a valuable first-mover advantage and, in true disruptive fashion, continues to proactively focus on solving problems with its electromagnetic aircraft landing systems and other leading-edge technology-driven solutions. iRobot Corp., a commercial robotics company that makes the floorcleaning Roomba, has recently been making inroads in the defense market. iRobot initially began providing defense and security customers with products used by bomb squads to investigate suspicious packages. More recently, the company has been exploring the use of robots to accompany ground combat troops in a reconnaissance or explosives disposal role. Many experts envision that armed versions of these robots could eventually accompany troops (or deploy in place of troops) in the future. And unmanned ground vehicles could eventually see the same surge in use that UAVs have seen in the last 10 years and could have an equally transformative effect on tactics and force deployment. General Atomics and iRobot aligned the way they play with their competitive advantage in at least two distinctive capabilities: They have superior knowledge of customer needs in all their markets, and they can use that knowledge to independently invest in and develop solutions even before their defense customers recognize the need for them.
iRobot Corp., which makes the Roomba, has been exploring the use of robots to accompany ground troops in a reconnaissance or explosives disposal role.
The defense market is undergoing dramatic change. The Pentagon’s emphasis on building affordable systems poses both opportunities and challenges for established industry players. Exquisite systems providers retain enormous advantages with their ability to deliver the world’s most advanced defense technology, but they must adapt their operating models to address unconventional as well as conventional threats and to deliver solutions more quickly and at lower costs. For nontraditional companies, such as the agile smart customizers and disruptive specialists, the Pentagon’s new way of doing business could play to their strengths. They likely will see more opportunities come their way, if they position themselves wisely. Regardless of the way these companies play, a CDS approach can help them. CDS is not a deterministic concept, driving toward a fixed way to succeed in the defense market. Rather, it provides a template to guide enterprise strategy development, as well as restructuring and costcutting initiatives (including addressing areas previously considered out of bounds), to generate true strategic choice. Similarly, CDS does not confine companies to the customers they have. Rather, it helps them find the customers that best fit their unique capabilities and how they compete. Most important, CDS enables companies to identify their underlying mechanism of value creation — what they do best — and the opportunities for delivering that value to market. The strategic coherence that results from these outcomes will give any company serving defense customers an essential advantage — the right to win — in the new environment.
Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities.
These are complex and high-stakes undertakings — often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you’re
charting your corporate strategy, transforming a function or business unit, or building critical capabilities, we’ll help you create the value you’re looking for with speed, confidence, and impact.
We are a member of the PwC network of firms in 157 countries with more than 184,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand.pwc.com.
This report was originally published by Booz & Company in 2011.
© 2011 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. Disclaimer: This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.