The Role of Defense Companies in Fighting Inflation

Aerospace and Defense Review | Tuesday, January 10, 2023

Cost increases may ultimately limit the US Department of Defense's (DOD's) purchasing power.

FREMONT, CA: Producer price indexes (PPI) measure the prices US businesses receive for their output. In the past year, the producer price index has increased by 12.2 percent for goodsand 6.8 percent for services. There has been an increase of 10.0 percent inindustrial chemicals, 17.8 percent in warehousing and transportation, and 25.9percent in energy costs for standard defense products and services.If the economy returns to high inflation and the defense budget is limited to nominal top-line increases, similar to what happened in the 1970s, the agency could lose more than $100 billion in purchasing power within five years. By doing so, the Department of Defense would have limited funds to modernize military equipment, especially since mandatory requirements still require the department to increase military pay. In addition to reduced demand, defense companies would also face higher input costs.

Defense contracts and their inherent vulnerability to inflation: There are several subtypes of commercial contracts at defense companies and disclosure contracts. It is often necessary to select the agreement based on the nature of the good or service covered, and the exact terms may differ. Purchasing requirements and contract terms may be determined partly by federal contract regulations.

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Differences for product and service suppliers: Contractor types vary in their frequency of fixed-price contracts. There was 84 percent of product contracts in 2021 involved FFP contracts, but only 4 percent included EPA clauses. A service contract accounts for 62 percent of the contract value, making it less susceptible to inflation than a product contract.

FFPs are used differently for different types of products within the same category. On the other hand, Ships are not commonly used for medical and dental supplies. Groups with a higher proportion of cost-reimbursable contracts will be less exposed to suppliers. There are also variations within service groups regarding the use of FFPs. For professional services, most contracts are in the cost-reimbursable category. Those who achieve the most value from FFP contracts are at the most significant risk.

Difficulties fighting inflation within the defense industry: It is important to note that while defense leaders have effectively dealt with many challenges throughout their careers—changing strategic priorities, slowing top-line growth, and the COVID-19 pandemic, they have not experienced severe inflation. Neither have they considered the profound effects of inflation on the DOD's ability to maintain a strong military.

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