The Gathering Storm

1. The Gathering Storm Michael J. Bayer January 20, 2010 1

2. 2009 AUSA Exhibit Floor 2

3. U.S. Investment In DoD Compared to Defense Spending of Other Industrial Nations 2008 Defense Spending -- Billions $650 2008 Defense Spending as a % of Country’s GDP $600 The U.S. invested more in Defense in 2008 than the combined national defense investments of China, France, the UK, Russia, Saudi Arabia, Germany, Japan, & Australia. $320.3 $200 (Excluding US) 2008 Defense Spending (Billion $) $150 Germany Italy Canada 1.3% $100 (Excluding US) $50 SouthKorea2.3% 5.0% 10.0% 15.0% 30.0% 40.0% 3 % of Country’s GDP * FY08 Total National Defense Outlays (includes Non-DoD defense), October 2009 Source: Defense Intelligence Agency; The Military Balance 2009

4. SECRETARY GATES, “Even as we consider the future, I am prepared to respond to urgent needs and will keep pushing to get troops the equipment they need.” (October 2009 AUSA Speech)GENERAL MCCHRYSTAL – When asked whether he would support scaling back the American military presence in Afghanistan: “The short answer is: no.” (London interview, 2009)Government Accountability Office: Iraq withdrawal would be a "massive and expensive effort" that would likely increase war costs by billions. Estimated an additional $12 billion to $13 billion a year for two years following the withdrawal needed for maintenance, repairs,and replacement of returned equipment. Defense Spending Predictions 4

5. Defense Spending Changes from FY2009 to FY 2010 Total % Change • DoD Top Line $534 billion +4.0% • Procurement $107.4 billion +5.6% • Uniform Headcount* 2.249 million +2.0% • MilCon $21.0 billion -4.1% 5

6. Gathering Storm?? 6

7. Briefing Agenda • Long term trends in defense spending • Erosion from within the DoD budget • Pressure from competing demands • Concluding thoughts 7

8. DoD Budget Top Line Trends 8

9. Base Budget Position Non-War Supplemental War Funding Position War Funding Department of Defense Topline ForecastFY 2001 – FY 2015 (Current Dollars in Billions) 36%Real Growth 73% Growth 316 Base Budget Base Topline in FY 2009 Constant Dollars Note: FY 2010 – 2015 reflects the FY 2010 President’s Request, May 2009; FY 2009 Non-War Supplemental is appropriated through American Recovery and Reinvestment Act of 2009 Source: Defense Appropriation Acts FY 2001 – 2010; OMB Historical Tables FY 2009 Numbers may not add due to rounding

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11. Cyclicality of DoD Budget Source: DoD FY2010 Greenbook 11

12. DoD’s Approach to Building Budgets: $300,000 RDT&E Procurement Korea $250,000 Reagan Buildup Bush Transformation Vietnam Drawdown Procurement Holiday $200,000 Billions FY07$ $150,000 $100,000 $50,000 $- 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 12 Source: DoD, Jane’s Analysis John Kenkel – Gersen Lerman Group

13. Budget Cuts by Secretary Gates • Generation Guided Missile Cruiser – CG(X) was deferred beyond the FYDP • Future Combat System (FCS) Manned Ground Vehicle (MGV) – terminated • FCS Non-Line of Sight - Cannon (NLOS-C) – terminated • FCS basic program – restructured • Kinetic Energy Interceptor (KEI) – terminated • Airborne Laser (ABL) aircraft – truncated to one aircraft • Combat Search and Rescue (CSAR-X) helicopter – terminated • VH-71 presidential helicopter program – terminated • Transformational Satellite Communications (TSAT) – terminated • F-22 was ended, not terminated – reached the inventory objective of 187 aircraft • DDG-1000 was truncated from 7 ships to 3 ships • Ground Based Interceptor (GBI) stopped buying additional interceptors for deployment in Alaska • FCS - Class IV unmanned aircraft system program and two variants of the Multifunction Utility/Logistics and Equipment unmanned ground vehicle program terminated 13

14. Erosion from Inside the Budget 14

15. The Growing Cost of Hardware

16. Major Defense Acquisition Program Portfolio1978 - 2007 (2007 Constant Dollars in Billions) 2007 Year $ (B) Annual Growth Rates* ‘79-’86 ‘00-’07 3% 13% 21% – Recent Buildup – 7% Program Cost Changes 13% 5% Total 14% 8% Reagan Buildup Baseline Changes** Program Baseline 1979-1986: 245%Spending Growth Overall 30 year MDAP Growth Rate*: 4% 2000-2007: 170% Spending Growth Recent buildup is characterized by fewer new programs, increases in existing baseline budgets, and increases in engineering and estimating costs * Figures reflect Compound Annual Growth Rates (CAGRs) ** Includes all changes between a program’s initial ‘baseline estimate’ and its current ‘baseline estimate’ (as of 2Q 2007 SAR); BMDS engineering cost changes were reclassified as ‘baseline changes’ due to unique program budgeting process 16 Numbers may not add due to rounding Source: OUSD(C) Study, DoD Selected Acquisition Reports,1978 – 2007 (2nd Quarter)

17. Major Defense Acquisition Program Portfolio Cost Growth by Program 2000 - 2007 (Dollars in Billions) SSN 774 Attack Submarine$27.3 Joint Strike Fighter (F-35)$66.8 Chemical Demilitarization**$23.4 Program Cost Growth $401B Future Combat Systems$69.7 Evolved Expendable Launch Vehicle (EELV)$18.5 91 Additional MDAPs ($195B) Baseline Changes* $328B • Including: • C-17A ($17.6B) • EFV ($7.2B) • DDG 51 ($6.9B) • C-5 RERP ($6.4B) • SBIRS ($5.8B) $190B New Programs $401B Cost growth in Only Five Programs accounted for $206B or 51% of the total * Includes all changes between a program’s initial ‘baseline estimate’ and its current ‘baseline estimate’ (as of 2Q 2007 SAR); BMDS engineering cost changes were reclassified as ‘baseline changes’ due to unique program budgeting process: ** Combines 3 Chemical Demilitarization programs into 1 to match earlier SARs 17 Source: DoD Selected Acquisition Reports, 2000 – 2007 (2nd Quarter) Numbers may not add due to rounding

18. Generational Cost Growth in MajorWeapons Programs“In the year 2054, the entire defensebudget will purchase just one aircraft. Thisaircraft will have to be shared by the AirForce and Navy 3-1/2 days each per weekexcept for leap year, when it will be madeavailable to the Marines for the extra day.”Norman Augustine 18 18

19. The Growing Cost of People

20. NDAA Authorized End Strength Levels for Active Components(FYs 2004-2010) *ARMY FY10 level based on July 09 SecDef Memo ARMY authorized 592,400 for FY11-FY12 Source: OUSD/P&R/MPP 20 20

21. DoD Labor Costs are Substantial… * Source: OSD(PA&E), OUSD(C) and WHS, excludes costs not on the DoD budget (e.g., VA) ** Source: WHS, which categorizes contracts as Procurement, RDT&E, or Services *** Retirement, DHP, Family Housing 21

22. Projected Growth through FY 2015 in the DoD Unified Medical Budget(No GWOT) Increase over FY2000 $46.7B 168% $12.1B – 26% $2.5B – 5% $5.2B – 11% ($M) $9.0B – 19% $18.0B – 39% ___________ 100% FY2000 Baseline $17.4B * Increase over FY2000 is $46.7B and ultimately 12% of the DoD budget 22 Source: OUSD/Health Affairs--Chart does not reflect DoD’s unfunded liability for TRICARE-for-Life

23. $22.8B $21.3B $20.0B $18.9B $17.4B $16.0B $12.7B $8.9B $0.3B Congressional Actions Shape the Compensation Bill Billions $ 23

24. Generational Cost Growth of Uniformed Personnel“In the year 2054, the entire defensebudget will be able to afford just one war fighter. Thiswar fighter will have to be shared by the Army, AirForce and Navy 2 days each per week, only available to the Marines on Sunday.”Michael Bayer 24 24

25. The Costs from the Economic Crisis 25

26. Trends in Federal SpendingFY1980 – 2019Outlays in billions of current dollars Source: Historical data from Historical Tables, Budget of the United States Government, Fiscal Year 2010 (February 2009) and projections from Mid-Session Review, Budget of the United States Government, Fiscal Year 2010 (August 2009).

27. Federal Government Mandatory vs. Discretionary Spending Over Time NOTE: Graph shows the ever increasing percentage of mandatory spending (including interest on the debt)—another leading indicator of a declining Federal addressable market. 27

28. Low rates have helped keep debt service costs in check

29. 2009 Federal BudgetNet Interest – 3.347% Int Rate: 3.347% DebtNet Int 2009 12,867,455 339,830

30. Administration forecasts anticipate significant increases in debt

31. Gross Federal Debt (as of October 2009)

32. Interest Bearing Debt Source: US Dept. of Treasury Average Rate September 2009 3.347% Average Rate 1993 – 2009 5.899%

33. Projected Net Interest on the Gross Federal Debt • Int Rate: 5.8997% • DebtNet Int • 2009 12,867,455 598,941.49 • 17,440,160 811,787.21 • 2017 20,990,000 977,021.63 2009: 3.347%

34. Comparison of Current Net Interest vs Projected Net Interest

35. What Does it all Mean? 35

36. THE HARD REALITIES • Growing people related expenses are the heart of the purchasing power challenge • Acquisition accounts are always the first source of funds to fill the gaps • The service of the growing mountain of debt will soon eat away at Defense • A real recovery will only accelerate this 36

37. LEADERSHIP • Nine straight years of defense budget increases • Few “flag officers” were “flags” at the $340 billion pre-9/11 defense budget • Four or five rotations of staff officers since • Systems and processes that worked poorly in up budgets are worse in flat or down budgets • The skills needed for up budgets are distinct from those in flat or down budgets 37

38. BOTTOM LINES • The “bad guys” are just getting started • Thus, Gates' transformation will outlive him • US defense budget is under real pressure • “Big” is no longer an inherent advantage • Advantage will be to the lean, smart, and fast • High value people will matter most 38

39. It’s Already Been Said: “If the Department of Defense can’t figure out a way to defend the United States on a budget of more than half a trillion dollars a year, then our problems are much bigger than anything that can be cured by buying a few more ships and planes.” -- Secretary of Defense Robert Gates 39

40. Questions? 40

41. Backups

42. NDAA Authorized End Strength Levels for Active Components(FYs 2004-2010) Actual end strength as of 30 Sept 09: Air Force = 333,408 Navy = 329,044 Source: OUSD/P&R/MPP 42 42

43. USAF Strategic Choices Resources • Active Duty end strength down 7%, but Personnel spending up 16% • AF inventory down 10%, but O&M spending up 19% • Approx 40,000 personnel deployed Strategic Challenges • Current conflicts • Nuclear proliferation by state and • non-state actors New Technologies • Cyber • Unmanned aircraft Personnel Costs vs End Strength O&M Costs vsInventory These forces are driving us to change—status quo is not an option

44. Base Budget Request Non-War Supplementals War Funding Request War Funding Department of Defense ToplineFY 2001 – FY 2010 (Dollars in Billions) 38%Real Growth 80% Growth 316 Base Budget Base Topline in FY 2009 Constant Dollars Note: FY 2009 Non-War Supplemental is appropriated through American Recovery and Reinvestment Act of 2009 Source: Defense Appropriation Acts FY 2001 – 2010; OMB Historical Tables FY 2009 Numbers may not add due to rounding

45. FY 2010 Base Budget(Enacted) (Dollars in Billions) Military Personnel: $135.0 Procurement: $104.8 RDT&E: $80.1 Military Construction: $21.0 Operation & Maintenance: $184.5 Family Housing: $2.3 Revolving Funds: $3.1 $530.7B Numbers may not add due to rounding

46. FY 2010 Overseas Contingency Operations(Enacted) (Dollars in Billions) Continuing the Fight: $109.9B Force Protection: $8.7 Operations $70.9 MRAP: $11.3 IED Defeat: $1.8 Military Intelligence: $4.7 Non-DoD Classified: $4.2B Afghan National Security Forces: $6.6 Coalition Support: $1.9 CERP: $1.2 Military Construction: $1.4 Temporary Army End Strength: $1.0 Navy IAs: $0.4 $129.6B Numbers may not add due to rounding 46

47. Entitlements Squeezing Out Defense Spending% Distribution of Total Federal Outlays: FY1962 – FY 2014 Share of spending in 2014 Net Interest, 11% • Entitlements, 58% • Income Security • Medicaid • Medicare • Social Security Discretionary, 15% National Defense, 16% Source: Historical data and projections from Historical Tables, Budget of the United States Government, Fiscal Year 2010 (February 2009).

48. Source: DoD FY2010 Budget Request, USD (Comptroller), May 2009

49. Estimated Net Interest Payment Calculations

50. Fiscal Year 2009 Budget by Category Source: Office of Management and Budget 50