i

DEFENSE ACQUISITION UNIVERSITY

FROM CHAOS TO CLARITY:

How Current Cost-Based

Strategies Are Undermining

the Department of Defense

Report of the

Military Research Fellows

DSMC 2000–2001

Lieutenant Colonel Warren M. Anderson, USAF

Lieutenant Colonel John J. McGuiness, USA

Commander John S. Spicer, SC, USN

September 2001

PUBLISHED BY THE

DEFENSE ACQUISITION UNIVERSITY PRESS

FORT BELVOIR, VIRGINIA 22060-5565

For sale by the U.S. Government Printing Office

Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328
ii

DISCLAIMER

This book was produced in the Department of Defense (DoD) school

environment in the interest of academic freedom and the advancement

of national defense-related concepts. The views expressed in this book

are those of the authors and do not reflect the official position or policy

of the DoD or those of the United States Government.

NOTICE

The content of this report was created as a work of the U.S. Government

and is not subject to U.S. copyright. However, because of certain parts

of this report are copyrighted, no part of this report can be reproduced in

part or in whole without permission from the Defense Acquisition

University Press.

Cartoons and pictures are copyrighted as noted and used with permission

for the printed version of this publication only, including the photo of

“Broadway from Maiden Lane – Wire Congestion” on the front cover.

Property of AT&T Archives. Reprinted with permission of AT&T.

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DEFENSE ACQUISITION UNIVERSITY

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ISBN 1-893833-04-6
iii

TABLE OF CONTENTS

Page

Preface ................................................................................................................................. vii

Executive Summary ............................................................................................................ ix

Acknowledgments ............................................................................................................... xv

Defense Acquisition University Military Research Fellows Program ............................ xvii

Introduction ..................................................................................................................... I-1

Effectiveness, Efficiency, and Business Strategy ........................................................ I-1

Purpose of the Study .................................................................................................... I-3

Department of Defense Business Perspective ............................................................. I-4

Budgetary Pressure and the Drive to Reduce Cost .................................................... I-5

Execution of Public Policy and the Establishment of Strategic Boundaries............. I-5

Resource Allocation ...................................................................................................... I-7

Strategy Drives Structure ............................................................................................. I-7

Overview of the Report................................................................................................ I-7

Objective of this Study ................................................................................................ I-8

Chapter 1 – Business and Government in the Twenty-First Century........................ 1-1

Introduction ................................................................................................................... 1-1

Global Transition and Challenges ................................................................................. 1-2

End of the Cold War ...................................................................................................... 1-3

The Impact of Downsizing on the Defense Industry ..................................................... 1-5

The Post-Consolidation Defense Industry..................................................................... 1-8

Impact on Equity Markets ............................................................................................. 1-9

Debt Markets ................................................................................................................. 1-10

Trends and Opportunities in the New Global Economy................................................ 1-11

Recurring Technological Revolution ............................................................................. 1-13

The Revolution Continues ............................................................................................. 1-15

The Information Economy ............................................................................................ 1-15

From Make and Sell to Sense and Respond .................................................................. 1-18

Impact on the Organization ........................................................................................... 1-18

Potential for this New Technology for DoD.................................................................. 1-20

Summary ....................................................................................................................... 1-20
iv

Chapter 2 – Key Terms, Concepts, and Definitions..................................................... 2-1

Introduction ................................................................................................................... 2-1

Outsourcing — An Outcome of Strategy ...................................................................... 2-1

What Then Is Strategy? ................................................................................................. 2-6

A Resource-Based View of Corporate Strategy ............................................................ 2-9

Tools of the Trade .......................................................................................................... 2-14

Five Forces Analysis...................................................................................................... 2-14

Value Chain Analysis .................................................................................................... 2-17

The Value Net ................................................................................................................ 2-19

Levers of Control........................................................................................................... 2-19

Game Theory ................................................................................................................. 2-24

Summary ....................................................................................................................... 2-26

Chapter 3 – Business Approaches to Strategy, Integration, and Outsourcing .......... 3-1

Introduction ................................................................................................................... 3-1

Limits to the Size of the Firm........................................................................................ 3-2

Analysis of Vertical Integration ..................................................................................... 3-7

Creating and Capturing Value ....................................................................................... 3-10

Strategy Drives Structure .............................................................................................. 3-12

Differentiation ............................................................................................................... 3-13

Brand Image .................................................................................................................. 3-13

Integrating and Outsourcing .......................................................................................... 3-14

Cost Leadership ............................................................................................................. 3-14

Market Analysis............................................................................................................. 3-14

Strategic Implications .................................................................................................... 3-15

Other Considerations ..................................................................................................... 3-16

Vulnerability of Cost Strategies to Disruption .............................................................. 3-16

Strategic Cost Analysis.................................................................................................. 3-17

Focus ............................................................................................................................. 3-18

Integration and Outsourcing .......................................................................................... 3-18

Differentiation Focus ..................................................................................................... 3-19

Cost Focus ..................................................................................................................... 3-19

Integration and Outsourcing .......................................................................................... 3-20

Stuck in the Middle ....................................................................................................... 3-20

Moving Out of the Middle ............................................................................................ 3-20

Drifting into the Middle ................................................................................................ 3-22

Strategy and Outsourcing .............................................................................................. 3-24

Case Study: Successful Outsourcing ............................................................................. 3-24

Case Study: Unsuccessful Outsourcing......................................................................... 3-25

Summary ....................................................................................................................... 3-27

Chapter 4 – The Department of Defense’s Business Strategy

and Competitive Sourcing Program ........................................................ 4-1

Introduction ................................................................................................................... 4-1

Strategy Development ................................................................................................... 4-2
v

A Look at Alignment ..................................................................................................... 4-3

Historical Background of DoD Sourcing ...................................................................... 4-12

Defense Reform Initiative ............................................................................................. 4-12

Defense Reform Initiative Directive 20 Report ............................................................. 4-15

Federal Activities Inventory Reform Act ....................................................................... 4-16

OMB Circular A-76 ....................................................................................................... 4-18

Strategic Sourcing ......................................................................................................... 4-21

Results to Date .............................................................................................................. 4-23

Factors that Influence Savings ...................................................................................... 4-24

Study Initiation and the Performance Work Statement ................................................. 4-25

Baseline Cost Estimates ................................................................................................ 4-26

Unrecognized Costs of the Competition ....................................................................... 4-26

Tracking Costs ............................................................................................................... 4-28

Initiating and Completing Studies ................................................................................. 4-29

Summary ....................................................................................................................... 4-31

Chapter 5 – Why Results Have Been Marginal ........................................................... 5-1

Introduction ................................................................................................................... 5-1

A Strategic Framework for the Department of Defense ................................................ 5-1

Belief Systems ............................................................................................................... 5-2

Vision ............................................................................................................................ 5-6

Mission .......................................................................................................................... 5-7

From DoD Beliefs, Vision, and Mission, to DoD Strategy ........................................... 5-8

Implementing Strategy through Levers of Control........................................................ 5-11

Boundary Systems ......................................................................................................... 5-11

Diagnostic Control Systems .......................................................................................... 5-13

Interactive Control Systems .......................................................................................... 5-15

Compliance and Execution Incentives .......................................................................... 5-15

Spans of Accountability and the Profit Motive ............................................................. 5-16

Cost Center Accountability ........................................................................................... 5-16

Impetus to Generate Savings ......................................................................................... 5-17

Strategy or Execution Failure? ...................................................................................... 5-18

Transformation Urgency................................................................................................ 5-18

Summary ....................................................................................................................... 5-19

Chapter 6 – DoD Corporate Strategy and Outsourcing ............................................. 6-1

Introduction ................................................................................................................... 6-1

DoD Corporate Strategy ................................................................................................ 6-2

Five Forces Analysis...................................................................................................... 6-2

Suppliers ........................................................................................................................ 6-2

Buyers and Customers ................................................................................................... 6-4

Potential Entrants to the Market .................................................................................... 6-4

Substitute Products or Services ..................................................................................... 6-5

Rivalry among Existing Competitors ............................................................................ 6-5

Formulating a DoD Corporate Strategy ........................................................................ 6-7
vi

DoD Corporate Strategy Execution and Outsourcing ................................................... 6-10

Aligning DoD to the Differentiation Strategy ............................................................... 6-11

Controlling Strategy Implementation through Levers of Control ................................. 6-13

Belief Systems ............................................................................................................... 6-13

Boundary Systems ......................................................................................................... 6-14

Diagnostic Control Systems .......................................................................................... 6-15

Interactive Control Systems .......................................................................................... 6-16

Is the New Approach Achievable?................................................................................. 6-16

Summary ....................................................................................................................... 6-18

Chapter 7 – Conclusions and Recommendations ........................................................ 7-1

Conclusions ................................................................................................................... 7-1

Recommendations ......................................................................................................... 7-4

Epilogue ................................................................................................................ Epilogue-1

APPENDICES

Appendix A Circular A-76 .............................................................................................. A-1

Appendix B Federal Activities Inventory Reform Act of 1998 ...................................... B-1

Appendix C Department of Defense Appropriation Accounts........................................ C-1

Appendix D Outsourcing Survey .................................................................................... D-1

Appendix E Contacts ...................................................................................................... E-1

Appendix F Selected Bibliography ................................................................................ F-1

Appendix G Acronyms ................................................................................................... G-1

Appendix H About the Authors ...................................................................................... H-1
vii

PREFACE

For each of us this has been an enlightening year of study and research. Being selected for the

Defense Acquisition University (DAU) research fellowship program was both an honor and a

wonderful opportunity. DAU sponsored our application and enrolment in the Harvard Business

School Program for Management Development (PMD). This ten-week executive education

program brings together a diverse group of business leaders from over 30 countries to learn stateof-the-art management techniques and the technologies necessary for success in the global

marketplace. The program is designed so that the 160 participants learn as much from the individual

experiences and insights of their classmates as they do from Harvard professors and classroom

study. It surpassed all of our expectations.

Before departing for Harvard, we were provided a broad topic for study. It was then left to us to

refine that topic into a more narrow focus suitable for an eleven-month research effort. The topic

provided to us was “Effectiveness of DoD’s Implementation of Outsourcing, Privatization, and

Commercial Acquisition Practices.” The topic was broad indeed. In the weeks before PMD, we

considered several narrow areas for concentration. However, while in the program, we were exposed

to numerous case studies and related literature on the formulation and execution of business

strategies. The more we studied this topic, the more we were intrigued and the more parallels we

were able to draw between the corporate world and business functions within the Department. In

our minds, we felt that this was a valuable perspective by which to examine the broad topic

assigned to us. We also felt the application of business strategy methodologies represented a

valuable analytical tool with which DoD could examine some of the problems it now faces.

Throughout this fellowship, we have been mindful of the investment DoD has made in us, the

privilege that was ours to attend such a prestigious program, and what we owe in return. In her

article, Leading the Change Adept Organization, Rosabeth Moss Kanter wonders, “...why

companies pay as much as they do to send managers to executive education programs but then

fail to require that they teach others what they have learned.” Taking this as a charge, we have

attempted to do just that. In this report, we rely extensively on materials we were able to review at

the Harvard Business School. These include class lectures, case studies, and texts. Resources also

include one-on-one discussions with faculty members and the many hours of discourse, dialogue,

and debate we engaged in with the other program participants.

In addition to examination of current business literature, we developed and administered a survey

to a limited sample of DoD personnel. This was done in order to gauge attitudes and impressions

of current outsourcing initiatives. We did this because we could find no indication that anyone
viii

had attempted to gather such feedback on a Department-wide basis. The results are quite striking

and are included in this report.

We are convinced that support activities within DoD, as well as in other government agencies,

can learn much from techniques businesses use to develop and implement strategy. We are also

convinced that there is a need to rely on interactive feedback as any business strategy is implemented. We hope that we can convey what we think is a compelling case for reassessing DoD

business strategies in order to bring them in balance with the basic tenets of the Defense

Department’s mission.
ix

EXECUTIVE SUMMARY

Cost-driven outsourcing strategies are undermining the Department of Defense (DoD). This is

the inescapable conclusion we have reached in the course of our research. The effort put into

Office of Management and Budget (OMB) Circular A-76 (A-76) and related initiatives is great

yet the savings are at best marginal. Moreover, there is evidence these initiatives are degrading

mission performance.

Why is this so? First, cost-based initiatives do not align with DoD business strategy. The Defense

Department has historically followed a generic strategy of differentiation, not cost leadership.

The Department of Defense’s beliefs, values, and mission are aligned to support this generic

strategy. A-76 and related initiatives, with their focus on cost, are not well suited for an organization

such as DoD, which competes on quality, not cost.

This misalignment of strategy and outsourcing policy has generated a great deal of concern within

DoD. This is especially true of base and installation commanders who must implement A-76 and

related measures. Installation commanders, more so than any other group we surveyed, place

mission performance and personnel ahead of cost. This is at odds with current outsourcing policies

that place cost ahead of performance and personnel.

Second, as measured by savings goals, the A-76 process has not generated anything near the

results expected. These goals are set unrealistically high and as a consequence, motivation to

meet them is low. Additionally, any incentive to attain cost saving is secondary to impact on

mission performance and personnel. These latter two are central to DoD’s differentiation strategy

and are strongly reflected in the Department’s belief system. Furthermore, mission performance

and responsibility toward subordinates are the basic tenets of diagnostic control systems at the

unit level, where A-76 must be executed. Cost savings, on the other hand, are the driving metric

at the headquarters and staff level. This is the part of the hierarchy that creates but does not

implement outsourcing strategy in its current form.

More important, A-76 has not generated the business process improvements needed to transform

DoD from an old to a new business model. A-76, by its nature, is a mechanism to make the old

model as economical as possible. It is not a process designed to engender more effective business

structures.

Under A-76, DoD has the same model with the same vulnerabilities both before and after

outsourcing initiatives. Further, while the model may be slightly less expensive, it is not more
x

effective. In fact, our survey data indicate that mission performance may be suffering as a result

of pursuing A-76 and related measures developed by the individual Services.

As long as the outsourcing strategy is cost driven, it will be at odds with DoD’s generic business

strategy. One of two things can happen to rectify this conflict. Either DoD can modify outsourcing

policies, or it can take measures to adopt a new strategy of cost leadership. We recommend the

former.

For this and other reasons, we recommend that DoD suspend cost-based outsourcing initiatives.

By emphasizing cost, DoD risks losing sight of its primary mission: to fight and win our nation’s

wars. Given this mission, cost will always be a secondary consideration, not a primary focus. By

vastly expanding the number of positions studied under A-76 in order to achieve an unattainable

savings target, the Department loses perspective and risks a great deal.

Instead of focusing on core warfighting areas that properly lie within DoD’s strategic domain, the

Department is instead focused on activities that do not benefit operational forces. Pursuit of costbased outsourcing is diluting the ability of leadership to concentrate attention on mission

effectiveness. This, in turn, impacts mission performance. Resources — especially leadership

resources — directed to an ever-expanding number of cost studies are resources that are not

directed to the support of operational forces and the development of warfighting skills.

Complicating matters are the current limitations of DoD’s accounting systems and the way in

which accounts are fragmented and compartmentalized. Savings at one activity or in one account

do not necessarily garner savings throughout DoD. Expanding cost analysis beyond the individual

activity may in fact show an overall cost increase to the Department.

There is also an impact on organizational learning and growth. What is the consequence of costbased outsourcing on a culture that has traditionally emphasized product and service quality? For

personnel performing functions that bring DoD a competitive advantage, what message is sent

when they are told that quality of performance is secondary to cost? Given the vitality of the

private economy, how does DoD attract and retain quality personnel in an environment where

cost is apparently valued above talent and ability? “Better, faster, cheaper” is often used as a

mantra for streamlining initiatives. Unfortunately, under cost-based outsourcing, the mantra

becomes “cheaper, cheaper, cheaper.”

Our Report

It is often stated that DoD can derive many lessons from business practices in the private sector.

Such statements are an acknowledgment of the fact that, while DoD is involved in operations that

have no business parallel, there are large segments of the Department involved in day-to-day

business-like functions. Some estimate that this business segment represents 70 percent of the

vast personnel and material resources that compose DoD.

Typically, this push to adopt business practices has focused on areas such as accounting, information

technology management, and acquisition processes. However, very little emphasis has been given
xi

to applying business practices in the areas of business strategy and strategy development. Our

report was written to address this shortfall.

This report analyzes DoD business activities using a strategic framework. We use this framework

as a means to address issues DoD is facing with regard to current outsourcing policies, and as a

means to outline strategic alternatives that may prove more effective to the Department than the

cost-focused measures now being pursued.

The Department can, in fact, derive many lessons from business. In addition to imitating best

business practices in such disciplines as accounting and operations, it would be helpful to study

DoD business operations using corporate strategy as an analytical framework. This framework is

a useful reference for discussing some of the issues above as well as DoD’s outsourcing initiatives.

Instead of a cost-centric approach that yields only marginal savings, a more fundamental solution

is mandated.

Our hypothesis is that ongoing outsourcing initiatives will not result in the necessary performance

improvements and changes required to transform DoD to meet the challenges of the 21st century

because these efforts are focused on doing things right versus doing the right thing.

Further, Department personnel see cost-based outsourcing as a budgetary manpower drill to be

performed with little regard to mission effectiveness. An examination of these programs in practice

tends to validate this position. No cost is assessed to the disruption caused by A-76 studies or to

the resources that must be applied to execute them. Nor are there any diagnostic measures applied

in order to gauge customer satisfaction or organizational effectiveness before, during, or after the

studies. When asked to respond to the statement, “Outsourcing has improved my mission

performance,” 59 of the 75 installation commanders who responded (79 percent) said “no.”

Unfortunately, cost-based outsourcing relies only on efficiency measures. There are no effectiveness

measures applied to the process. The sole driving metric is cost to perform the function.

In our report, we will test this hypothesis by answering the following questions:

• Does a transformation urgency exist?

• Do DoD outsourcing initiatives align with DoD business strategy?

• Has the A-76 process generated the results expected?

• Has Strategic Sourcing generated the results expected?

• Have shortfalls resulted from execution problems or are they strategy-related?

• What are the benefits of a new corporate strategy approach?

• Can such an approach be implemented?
xii

The Department needs to look upon itself not through the overused core competency magnifying

glass, but from a new, resource-based view. Under this examination, DoD derives its competitive

advantage not from a set of core competencies, but rather from a collection of unique resources.

The choice of strategy is constrained by the current available resources and the speed at which

new resources can be acquired. Formulating a strategy that integrates sound processes and smart

business decisions will enable DoD to succeed in transforming and driving the right outsourcing

solutions.

We provide an analytical framework for examining DoD from a resource-based corporate

perspective and develop an approach to outsourcing consistent with this corporate strategy. The

goal of this report is twofold. First, we seek to use this framework to analyze DoD business

activities in terms of seeking a competitive advantage. As we will show, this framework provides

a unique perspective on how to make DoD more effective and, in so doing, will create the desired

efficiencies. Second, because of the size and nature of the organization, processes must be developed

that will drive the desired outcomes. No amount of restructuring will reduce DoD to the point

where change can be dictated from the top. Instead, realignment can best be achieved through the

decentralization of certain decision rights. We carefully explore mechanisms to effect a corporate

business strategy using measurement and control systems.

Current Department of Defense Business Perspective

In the course of our research, we have noted that DoD focuses almost exclusively on efficiency

when conducting business operations. Almost no emphasis is given to devising effective business

strategies or examining efficiencies in terms of a value proposition. Giving precedence to efficiency

is largely a reaction to the following:

• unrelenting budgetary pressures;

• execution of public policy; and

• resource allocation processes.

This drive to the “bottom line,” however, assumes that DoD already has an effective strategy and

merely needs to fine-tune the operation. This is a poor assumption on three counts. First, without

conducting a strategic business analysis, DoD cannot be certain it has an effective strategy. Second,

DoD should seek best value and not lowest cost. In other words, DoD should garner the most

performance for every dollar spent rather than spending the least amount of dollars. Finally, in

complex integrated systems, aggregate and not isolated efficiencies must be the focus. In ignoring

these, there is an inherent risk that tactical pursuit of cost reductions at the business unit level will

drive adverse strategic outcomes.

In the post-Cold War era, defense planners have been subjected to a great deal of budgetary and

political pressure to find areas of potential savings in DoD. This focus on savings stems from the

notion that streamlining the Department will free up dollars to reinvest into weapon system upgrades

and other modernization initiatives. This defines the operating vision. The Department will use
xiii

the savings within existing accounts rather than increased budgetary authority to fund various

procurement programs. Anticipating these savings, a budgetary shortfall or wedge was incorporated

into procurement and operating accounts. This wedge assumed projected savings would be realized

in full and then applied to correct for these shortfalls.

This focus on trimming accounts and infrastructure is a tactical and not a strategic move. The

focus is on efficiency. Squeezing accounts never addresses the question of strategy — are we

doing the right things in the first place?

The Need for Strategy and Strategic Boundaries

The basic tenet behind A-76 is that the Government should not compete with its citizens.

Government, therefore, should rely on commercial sources and perform in-house only functions

that are inherently governmental in nature. If this policy dates back to 1955, how then did DoD

get to the point where it finds itself today with over 150,000 full-time positions that are commercial

in nature and are subject to A-76 studies? The inescapable answer is that this policy has been

largely ignored.

The Department must firmly establish strategic boundaries around a well-defined strategic domain.

This would preclude many of the costly and difficult to reverse integration decisions that have led

the Department to the point where resources applied to infrastructure vastly overshadow resources

directed to core mission performance.

However, even if DoD had relied on a simple check of the Yellow Pages to see if the activity was

available commercially before integrating activities over the past 45 years, the Department would

likely still find itself over-integrated. It does not take a great deal of rationalization to justify any

activity as being inherently governmental if the qualifying characteristic is that the function is,

“so intimately related to the public interest as to mandate performance by Government employees.”

We hold that the concept of “inherently governmental” should be abandoned when addressing

DoD business strategy. Instead, the integration decision should revolve around whether or not

integrating the activity provides the Department with a competitive advantage (or conversely,

whether integrating the activity will generate a strategic disadvantage). More to the point, if an

organization can do a few things well or many things poorly, what are the few things DoD should

do to be effective in the performance of its mission?

Such an approach will yield a much different answer than cost-based restructuring. Our report

goes beyond the mere slogan that DoD should operate more like a business. We offer a new

perspective to demonstrate what operating like a business actually means. It means much more

than business efficiency. It entails a focus on the productive use of resources, processes, and

culture to gain a competitive advantage. Operating like a business begins with an effective strategy.

We submit that a primary focus on effectiveness entails a critical shift in perspective that is much

needed within DoD. We believe this discussion is worthwhile and provides a framework for

understanding some of the vexing issues DoD currently faces and better strategies for dealing

with them.
xiv
xv

ACKNOWLEDGMENTS

As with any publication, this book represents far more than the work of the individuals cited on

the cover. We owe debts of gratitude to many people, a few of whom we’d like to name here.

First of all, we would like to recognize our instructors and colleagues at the Harvard Business

School. Professors Steven Bradley, Michael Beer, David Bell, Cynthia Montgomery, Richard

Nolan, Thomas Piper, Louis Wells, and Michael Yoshino provided us a well structured and

masterfully presented set of case studies and related materials that focused and refined our

understanding of the business community. We are also grateful to the other 157 participants in the

Program for Management Development for their insights, expertise, discussion, and understanding.

We would like to thank the faculty and staff at the Defense Acquisition University for their

professionalism and support during this research effort. Particular thanks go to Alberta Ladymon,

Maryellen Tipper, and Greg Caruth. Our every need was met so that we could concentrate on

researching and assembling this report.

Additionally, we are grateful to the Department of Defense and to our individual Services for the

opportunity to perform this research and for the educational opportunities afforded to each of us

throughout our careers. While at Harvard, many people from the United States and countries

around the world were much impressed that the military would invest so highly in education. We

hope that we acted as good ambassadors for the U.S. military and that we can provide our country

a sound return on the resources it has invested in us.

Finally, we would like to thank our families for giving us the time to go away for a ten-week

program at Harvard. Separations are a fact of life in the military but, as we have learned, something

that should never be taken for granted. We thank our families for their support, their encouragement,

proofreading, criticism, but most of all for the pride they show in us.

Warren Anderson

John McGuiness

John Spicer
xvi
xvii

DEFENSE ACQUISITION

UNIVERSITY

MILITARY RESEARCH

FELLOWS PROGRAM

The Military Research Fellowship Program provides professional military education to selected

Fellows and develops new and innovative concepts for systems acquisition management. It was

chartered by the Under Secretary of Defense (Acquisition) in 1987 to enhance the capabilities of

the then Defense Systems Management College (DSMC), and today the Defense Acquisition

University (DAU). This joint fellowship program is a unique opportunity for these selected Fellows

to supplement DAU research goals and to impact the defense acquisition process. The program

begins in August each year and continues through June of the following year. Part of the program

includes an opportunity for education at the Harvard University School of Business. If accepted,

selected Fellows attend the ten-week Program for Management Development at Harvard. The

remainder of the program is held at DAU.

Every year, each of the Services selects one candidate to attend the DAU Fellowship Program. All

Fellows must have at least a master’s degree in a discipline associated with acquisition management,

have achieved the rank of O-5 or GS/GM-14 for Army civilians, and have documented experience

and performance in positions that develop understanding and expertise in acquisition management.

Once selected, the Fellows work together as a research team to develop and produce research

findings that illuminate an aspect of systems acquisition management. Research Reports are

published upon program completion.

Short summaries of Military Research Fellows Reports are available to view online. For information

on obtaining hard copies of the Reports please refer to the following web address: http://

www.dsmc.dsm.mil/pubs/mfrpts/mrflist.htm

Additionally, DAU has full digital reports available for Military Research Fellow Reports dated

from 1994 to the present. Hard copies may be available from DAU at FAX (703) 805-3726.
xviii
I-1

INTRODUCTION

“The Americans will always do the right thing...

after they’ve exhausted all the alternatives.”

— Winston Churchill Sr.

Effectiveness, Efficiency, and

Business Strategy

The mission of the Department of Defense

(DoD) is to support and defend the Constitution of the United States; to provide for the

common defense of the nation, its citizens, and

its allies; and to protect and advance U.S. interests around the world.1

 To support this mission, DoD conducts operations involving over

$1 trillion in assets, budget authority of about

$310 billion annually, and about 3 million military and civilian employees.2

 By any standard,

this represents the employment of assets on a

vast scale. Using Fortune 500 companies as a

benchmark, one can see that the magnitude of

this enterprise easily eclipses the giants of

global commerce. Table I-1 provides a quick

comparison.

While DoD is involved in operations that have

no business parallel, there are large segments

of the department involved in business-like

functions. For this reason, there have been

many calls for DoD to operate in a more business-like manner.3

 Calls for sound business

practices within DoD have invariably focused

on the need for increased accountability of

Fortune Operating

500 Company Revenue Expenses Assets Employees

Rank ($M) ($M) ($M)

DoD $310,000 $1,000,000 3,000,000

1 Exxon Mobil $210,392 $192,672 $ 149,000 106,000

2 Wal-Mart $193,295 $187,000 $ 77,895 1,140,000

3 General Motors $184,632 $180,180 $ 303,100 106,000

4 Ford Motor $180,598 $177,310 $ 284,421 364,550

5 General Electric $129,853 $117,118 $ 437,006 340,000

Source: Retrieved from World Wide Web 26 April 2001: http://www.fortune.com/indexw.jhtml?_DARGS=%Z

Ffragments%2Flist2Ffrg_list_rank_f500.jhtml.

Table I-1. Comparison of Fortune 500 Companies and the Department of Defense
I-2

assets and reduced operating costs. While the

companies listed in Table I-1 — like all successful companies — are concerned with assets

and expenses, they are more concerned with

developing a business strategy that will provide them with a competitive advantage,

profitable earnings, and a high return on

shareholders’ equity.

To this end, successful companies begin with

a basic business strategy that will provide them

with a competitive edge. To do this, companies determine where they want to position their

business and what approach they will take to

gain market share. This analysis is not done in

isolation. Firms not only look at their target

market but also take into account the environment in which they operate. Successful firms

examine competitors within their industry, the

threat of potential entrants, their supplier base,

the threat of possible substitutes, and, to an increasing degree, the impact of governmental

oversight, regulation, and public scrutiny.4

 This

analysis is critical to crafting an effective business strategy. Furthermore, it is not a one-time

event. Companies must continuously adapt to

changes in the business environment by modifying their strategies. Without this business

discipline, companies cannot become successful or sustain their success in a competitive

environment.

In their book Cost and Effect, Robert Kaplan

and Robin Cooper make the distinction between doing things right and doing the right

things.5

 This subtle twist of a phrase brings

about a critical shift in perspective. An effective business strategy begins with doing the

right things. Firms must decide not only what

products or services they will produce but also

how to craft an operating structure, what activities they will integrate into these operations,

and what activities they will not. Firms must

decide what processes they will employ, devise effective marketing strategies, map out

distribution channels, and determine what approach they will use to differentiate themselves

from their competitors. They must focus on

those key resources that build upon the business

strategy to create value. All this must be done in

the context of a structured industry analysis that

takes into account the elements described in

the previous paragraph. Doing the right things

is about effectiveness and effective strategies.

Conversely, doing things right is about efficiencies and business tactics that will yield efficiencies. When discussing efficiencies, the

underlying premise is that an organization

is already aligned to be effective. If an entity is not effective, focusing on efficiencies

becomes a wasted exercise. Furthermore, in our

view, efficiency is not a cost proposition. It

is inherently a value proposition. To focus on

cost without taking the output and trade-offs

into consideration is a recipe for probable disappointment or potential disaster.

By way of example, Henry Ford had an extremely efficient business operation producing

the Model T. His product policy was to produce that one car and to keep cutting the cost.

Ford was able to do this through standardization of his product and a relentless pursuit of

manufacturing efficiencies. The Model T had

no options. The only color offered in the U.S.

was black and one car looked exactly like another. To reduce production costs, Ford built

the vast River Rouge Plant and integrated

operations. River Rouge was a model of efficiency. Ford controlled a vast vertically integrated structure that included foundries and

machine shops in addition to the assembly

line. Through a centralized structure, Ford controlled all essential resources used to produce

a Model T, right down to the black paint. Ford’s

drive to be efficient was successful. The 1908

Model T sold for $850. In 1920 the price was

$440. Finally, by 1925, a Model T could be

purchased for $290.6
I-3

By contrast, Alfred P. Sloan Jr., as head of

General Motors (GM), adapted to the changing

business landscape. He devised a business strategy that recognized, among other things, that

the car market was becoming a trade in business and that automobile ownership was becoming a reflection of both social status and

personal taste. In response, Sloan crafted a business strategy that recognized and exploited the

forces of the market. Acquiring a series of auto

manufacturers, he created brands that would

appeal to various market segments. Customers

could start with a Chevrolet and move up to a

Cadillac as their level of income rose. Within

each of these brands, Sloan offered options that

would allow for differentiation within the

brands. No longer would customers have to

settle for black.

Sloan is also credited with instituting process

and control systems that made it possible for

this strategy to be effected. While Ford centralized control, Sloan was keenly aware that GM

was far too large an organization to effectively

centralize decision-making. GM decentralized

decision-making, allowing its divisions to operate autonomously within a strict set of strategic boundaries while adhering to a well understood structure of operating rules. In this way,

Sloan was able to craft the strategy and set processes in place to implement it successfully.7

GM’s strategy of a car for every purpose and

purse, along with the systems in place to effect

it, drove Ford from a 56 percent market share

in 1921, to 40 percent in 1925 and finally down

to a 21 percent share in 1937. By contrast, GM’s

market share in 1937 had risen to 42 percent.

In second place was the Chrysler Corporation

with a 25 percent market share. Had it not been

for the fear of attracting the attention of antitrust authorities, Sloan could likely have driven

Ford completely out of business. Instead, Sloan

intentionally held GM to less than 45 percent

of the domestic market share.8

This illustration demonstrates the power of an

effective strategy and the precedence effectiveness must take over efficiency. Not until Sloan

was able to execute his strategy did he implement the statistical controls and other efficiency

mechanisms that bolstered GM’s profit margin and added to the success of the company.9

It is also noteworthy to point out that after years

of successful and profitable operations, GM,

like Ford, did not adapt its strategy to reflect

changes in the business environment. The

1980s saw GM lose market share to foreign

auto manufacturers (primarily Japanese). These

new entrants understood that consumers were

coming to value quality and reduced fuel consumption.10 Because of this, they were able to

enter a market dominated by established players and quickly pull the rug out from under

them. This is a compelling reminder that all

companies, even those at the top of their game,

must maintain constant vigilance, adapt as the

world changes, or suffer the consequences.

Purpose of the Study

DoD can derive many lessons from business.

In addition to imitating best business practices

in such disciplines as accounting and operations, it would be helpful to study DoD business operations using corporate strategy as an

analytical framework. This framework is a useful reference for discussing some of the issues

above as well as the DoD’s outsourcing initiatives. However, DoD outsourcing efforts to date

have been wanting. The picture that comes to

mind is that of the chaotic telephone systems

of Wall Street at the turn of the century — no

coherent strategy and too many players. The

result (depicted on the cover of this book) is a

problem that does not lend itself to an A-76

type solution — finding a source that can string

the wire at the lowest cost. Like the rationalization of the telephone industry, a more basic

solution is mandated.
I-4

Our hypothesis is that ongoing outsourcing

initiatives will not result in the necessary performance improvements and changes required

to transform DoD to meet the challenges of

the 21st Century because these efforts are

focused on doing things right versus doing the

right thing. We will test this hypothesis by

answering the following questions:

• Does a transformation urgency exist?

• Do DoD outsourcing initiatives align with

the DoD business strategy?

• Has the A-76 process generated the results

expected?

• Has Strategic Outsourcing generated the

results expected?

• Have shortfalls resulted from execution

problems or are they strategy-related?

• What are the benefits of a new corporate

strategy approach?

• Can such an approach be implemented?

DoD needs to look upon itself not through the

overused core competency magnifying glass,

but from a new, resource-based view. Under

this examination, DoD derives its competitive

advantage not from a set of core competencies,

but rather from a collection of unique resources.

The choice of strategy is constrained by the

current available resources and the speed at

which new resources can be acquired.11 Formulating a strategy that integrates sound processes and smart business decisions will enable

DoD to succeed in transforming and driving

the right outsourcing solutions.

We will provide an analytical framework for

examining DoD from a resource-based corporate perspective and develop an approach to

outsourcing consistent with this corporate strategy. The goal of this report is twofold. First we

seek to use this framework to analyze DoD

business activities in terms of seeking a competitive advantage. As we will show, this framework provides a unique perspective on how to

make DoD more effective and in so doing to

create the desired efficiencies. Second, because

of the size and nature of the organization,

processes must be developed that will drive the

desired outcomes. No amount of restructuring

will reduce DoD to the point where change can

be dictated from the top. Instead, realignment

can best be achieved through the decentralization of certain decision rights. We will carefully explore mechanisms to effect a corporate

business strategy using measurement and

control systems.

Department of Defense

Business Perspective

In the course of our research, we have noted

that DoD focuses almost exclusively on efficiency (doing things right) when conducting

business operations. Almost no emphasis is

given to devising effective business strategies

or examining efficiencies in terms of a value

proposition. Giving precedence to efficiency

is largely a reaction to the following:

• unrelenting budgetary pressures;

• execution of public policy; and

• resource allocation processes.

This drive to the bottom line, however, assumes

DoD already has an effective strategy and

merely needs to fine-tune the operation. This

is a poor assumption on three counts. First,

without conducting a strategic business analysis, DoD cannot be certain it has an effective

strategy. Second, DoD should seek best value

and not lowest cost. In other words, DoD should
I-5

garner the most performance for every dollar

spent rather than spend the least amount of

dollars. Finally, in complex integrated systems,

aggregate and not isolated efficiencies must be

the focus. By ignoring these, there is an inherent risk that tactical pursuit of cost reductions

at the business unit level will drive adverse

strategic outcomes.

Budgetary Pressure and

the Drive to Reduce Cost

In the post-Cold War era, defense planners have

been subjected to a great deal of budgetary and

political pressure to find areas of potential savings in DoD.12 This focus on savings stems from

the notion that streamlining the Department

will free up dollars that can be reinvested in

weapon system upgrades and other modernization initiatives.13 This defined the operating

vision. The Department would use the savings

within existing accounts rather than increased

budgetary authority to fund various procurement programs. Anticipating these savings, a

budgetary shortfall or wedge was incorporated

into procurement and operating accounts. This

wedge assumed projected savings would be

realized in full and then applied to correct for

these shortfalls.14

In addition to squeezing procurement and operating accounts, rounds of base closures were

authorized as a mechanism used to reduce infrastructure and free up dollars. While the Base

Realignment and Closure (BRAC) process did

close down excess infrastructure, it fell short

on three counts. First, for political reasons, the

process stalled before it could close the infrastructure targeted. During the 1995 BRAC

round, the Clinton Administration privatized

two bases rather than close them down. This

action was widely viewed as partisan, forfeiting Congressional support for the process. Second, BRAC required a degree of environmental remediation that was unanticipated and

costly. For BRAC rounds completed thus far,

clean up costs are likely to exceed $11 billion.15

Finally, BRAC planners projected significant

revenues from land sales, but the number of

acres sold and the amount of proceeds were

far less than anticipated. For example, in 1990,

DoD estimated that the sale of property on

military bases closed by BRAC 1988 could

raise about $2.4 billion in revenues. In fact,

DoD only received about $65.7 million in revenue from land sales on those bases between

1990 and 1995. This is because, by statute,

these properties must be offered to other government agencies before they are offered for

public sale.16

It is important to note that this focus on trimming accounts and infrastructure was a tactical and not a strategic move. The focus was on

efficiency. Squeezing accounts and BRAC

never addressed the question of strategy — are

we doing the right things? DoD was performing the same functions both pre- and postBRAC, albeit on a smaller scale.

Execution of Public Policy and the

Establishment of Strategic Boundaries

Office of Management and Budget (OMB)

Circular A-76 lays out policy that addresses the

role of government but in our opinion, relies

on a flawed process for implementation. The

Circular states that the government will rely

on the private sector to provide commercial

products and services unless the government

can perform those products or services more

economically (Appendix A contains the latest

revision of the Circular).17 While this is a global statement, execution of this policy has been

delegated to individual commands and activities within DoD. We feel that this is an incorrect approach. Inherent in the development of

a sound corporate strategy is the determination

of a firm and unambiguous set of strategic

boundaries. These boundaries are not strictly a
I-6

function of cost and they are not decentralized

decisions. Such decisions are of the select few

to be made by top management and dictated to

the firm.

Like DoD, business strategists are mindful that

they have limited resources and numerous

opportunities. Unfortunately for DoD, this is

often where the similarity stops. For the business strategist, success hinges on making the

best use of available resources, not wasting

them on initiatives that do not support the business strategy. To this end, a sound business

strategy must include specific boundaries

beyond which the organization will not go.

These strategic boundaries are essential to

defining the scale, scope, and positioning of

the business.18

Limits to scale and scope are critical. While

there are advantages and economies to horizontal and vertical integration, there are also

costs that must be addressed.19 Among the most

quantifiable are the costs of maintaining fixed

assets (i.e., infrastructure) and the costs of governance (i.e., the administrative hierarchy).

While, in the long run, fixed assets can be reduced incrementally in proportion to the level

of operations, governance costs typically do not

vary proportionally with operational cost.20

Production facilities and the related infrastructure may often be reduced, but home office

staffing remains the same or, in some instances,

increases. This trend exists in both the public

and private sector. However, in the public sector, this trend is often exacerbated by incentive

structures unique to government.21 This also

applies to DoD. One need take only a cursory

glance around DoD to observe administrative

commands staffed with individuals who are

tasked with controlling the functions of integrated systems. While the production structure

has decreased, the policy structure has not kept

pace. During the draw down of the 1990s, the

number of soldiers, sailors, airmen, and marines

declined by one-third while the number employed by headquarters fell by just 18 percent.22

Often there is a compelling business rationale

for vertical and horizontal integration; and often there is not. Absent a compelling reason,

when the costs of the bureaucracy exceed the

economic benefits, DoD does not create value

— it removes it.

There are other costs of integration that are

more difficult to measure but nonetheless

worthy of consideration. While these will be

explored extensively in Chapter Three, there

is one metric that — while difficult to quantify — should be at the forefront of any discussion of strategy. That metric is Return on

Management (ROM) defined as:

Amount of productive

organizational energy

Return released23

on = _______________________

Management

Amount of management

time and attention

invested

By diversifying into many activities, ROM is

diluted. Putting processes in place that require

installation commanders to undergo numerous

A-76 competitions increases the denominator

of this equation without a commensurate increase in the numerator. By not dictating clear

strategic boundaries and the systems to enforce

them, DoD ensures it will not leverage its management talent — this most scarce of all resources.24 Perhaps Michael Porter stated it best:

“Being all things to all people is a recipe for

strategic mediocrity and below-average performance, because it means that a firm has no

competitive advantage at all.”25

We are fully cognizant of the political difficulties inherent in setting strategic boundaries, or

more to the point, deciding what functions to
I-7

do in house and what functions to outsource.

However, the issue goes beyond outsourcing

decisions. Those decisions are made after the

fact. In other words, present outsourcing decisions are a direct result of past integration

decisions. In the course of our research, we have

noted that DoD’s overwhelming predilection

is to perform new functions internally rather

than to look first to the market. The Department activities are standing up functions on a

routine basis while at the same time they are

undertaking A-76 type studies. Unless a defined

and enforced set of strategic boundaries is

instituted, we see this trend continuing.

Resource Allocation

In addition to the pressures of falling budgets

and execution of OMB Circular A-76, resource

allocation within DoD drives behavior that

makes implementation of any integrated strategy difficult. By running elements within the

Department as cost centers rather than profit

centers, the government fosters behavior that

concentrates on acquiring resources rather than

creating a return on assets, especially capital.

Add to this a year-to-year budget cycle that

rewards the use of resources rather than their

conservation, we have before us a system driving behavior that should come as a surprise to

no one.

As stated earlier, we fully understand political

realities and the difficulties involved with

changing government resource allocation policies. However, it is worthwhile to discuss the

behavior these policies drive and the outcomes

and limitations they suggest. In the context of

a sound analytical framework, one can discuss

not only better strategies for DoD but also the

confines inherent in the current structure of the

Department.

Strategy Drives Structure

Building on themes of strategy development

and implementation, we will show that strategy drives structure and related outsourcing

decisions. A sound corporate strategy that

yields competitive advantage will dictate what

functions should be performed internally and

what functions should be performed by activities outside the firm. As stated earlier, this is in

stark contrast to A-76 and other cost/efficiencydriven approaches. Structure should not drive

strategy. Strategy should drive structure. This

is what we mean by doing the right things.

Overview of the Report

Chapter One explores the geo-political landscape and business environment confronting DoD

at the dawn of the 21st century. We explore the

evolution of DoD and the private sector through

various historical events as well as the opportunities available in the information age. In the

past fifteen years the power of information

technology has transformed whole industries,

moving them from monolithic vertical structures

to more responsive, disaggregated, horizontal

structures to virtual organizations that blur traditional organizational boundaries.26 We believe

this technology offers many opportunities for

similar transformations within DoD.

Chapter Two defines the terms outsourcing and

corporate strategy. We examine the evolution

of private sector outsourcing over the past ten

years. In addition, we describe methodologies

firms use to develop successful corporate strategies. We will focus particularly on company

resources and how they are leveraged to create value. This chapter draws extensively on

current literature on corporate strategy and cites

several examples of firms that have used these

approaches to carve out dominant market

positions.
I-8

Chapter Three examines how industry makes

outsourcing decisions in light of the business

strategies that they have developed and how,

once those decisions are made, they are implemented. Additionally, we examine how the

value chain is tied together once the structure

is defined. This includes a detailed description

of market structure and internal governance

mechanisms. In particular, this highlights how

strategy affects structure and related outsourcing decisions as well as the systems and processes used to achieve goals and strategy. This

is significant because, no matter how efficiently

information flows, large organizations cannot

be effectively run on a centralized command

and control system. Instead, systems must be

put in place that drive the organization to effect strategy successfully while allowing for

the decentralization of decision rights.

By contrast, Chapter Four is a detailed look at

DoD cost-focused approaches to outsourcing.

We carefully examine OMB Circular A-76 and

variants of this approach to outsourcing, along

with the legislative impact of the Federal

Activites Inventory Reform Act (FAIR) and the

Government Performance Results Act (GPRA)

(both acts are contained in Appendix B). This

discussion includes A-76 implementation and

its subsequent impact. Particular attention is

given to the financial goals and assumptions

that drive aggressive A-76 studies.

Chapter Five addresses why the results of A76 outsourcing initiatives have fallen short of

expectations and why further pursuit of this

strategy will generate only marginal results.

More important, we examine how this focus

on efficiency may bring about adverse consequences, eroding business advantages that DoD

has long held and removing value. In this chapter we cite survey data to address not only the

indicators (demonstrating that A-76 is a flawed

business strategy) but also the underlying causes.

These causes include a review of systems,

processes, and culture that must be addressed

before implementing any strategy.

Chapter Six describes how to build effective

strategies around the tenets of the Department,

and processes that will drive the outcomes DoD

is seeking. This chapter draws on the previous

chapters in order to show how the new framework can be used to evaluate the business functions in DoD and formulate strategies that will

leverage critical resources to the Department’s

advantage. This includes the construction of a

strategic decision model and the mechanisms

that can be applied to effect the desired outcomes. Chapter Six also addresses how to

implement strategy once it is formulated. The

most effective strategies are of little use if they

are never successfully implemented. Unlike a

corporation (which has relatively wide latitude

to implement policies and relatively few stakeholders to challenge them), DoD exists in an

environment that makes change especially

difficult. Here we suggest methods by which

corporate strategic decisions can be implemented in ways that are politically viable and

self-reinforcing.

Finally, Chapter Seven draws conclusions and

recommendations as well as areas for further

research. We hope these will be acted upon.

Objective of this Study

It is our sincere hope that this publication

fosters much needed discussion among those

who are involved in DoD business operations,

especially those individuals responsible for

developing policies and leading change. By

stepping back and examining an issue from a

new perspective, people may see opportunities

that might not have been evident before.

“The real voyage of discovery is not in seeking new lands but in seeing with new eyes.”

— Marcel Proust
1-1

1

BUSINESS AND GOVERNMENT

IN THE

TWENTY-FIRST CENTURY

“The times they are a-changing.”

Bob Dylan

Introduction

This report begins with an examination of the

political, business, and technological landscape. We do this because, just as evolution

tends to reward species that successfully adapt

to the environment and punish with extinction

others that do not, businesses too are rewarded

for successful strategic adaptations. Conversely,

companies that do not have sound strategies or

fail to successfully adapt to the changing

environment are likely to go the way of the

dinosaur.

In this chapter, we cover three areas. First addressed are the changes that have taken place

in the political and economic landscape. These

changes have had a significant impact on the

structure and health of the defense industry. The

vitality of this industry is of strategic interest

to the Department of Defense (DoD) and given

DoD’s monopsonistic position in the market,

its actions have direct consequences on these

critical suppliers.

Next we explore the technological revolutions

taking place and the impact of emerging technologies on the business environment. This

examination is done using comparisons with

historic innovations that transformed the economic landscape. In retrospect it is easy to see

the impact of technological forces, but often

the power of these forces weren’t understood

in their day. That is much the case for today’s

advances in information technology (IT).

Finally we examine modern business models

that can help organizations take advantage of

these advances. Through information flow,

companies are now able to respond nearly

instantaneously to the needs of individual

customers and to run business enterprises that

extend well beyond the physical limits of company assets. These models are redefining how

business is transacted in much the same way

that gunpowder redefined warfare.
1-2

Global Transition and Challenges

The past 15 years have been marked by dramatic changes in the political, economic, and

business landscape. This period brought us the

end of the Cold War, the rise of the information economy, and a transformation of business

processes. Fifteen years ago, the North American Free Trade Agreement (NAFTA) and the

World Trade Organization (WTO) did not exist, there was no common European currency,

and companies with names like Digital Equipment Corporation (DEC) graced the top of the

Fortune 500 list.1

 Today NAFTA, WTO, and

the European Union (EU) are accelerating the

globalization of business. DEC fell from supremacy and was subsequently acquired by

Compaq, a company that was incorporated in

1982 when DEC reigned supreme.2

 In the past

15 years, the Dow-Jones Industrial average has

risen at a faster rate than during any other period

in history and business structures are rapidly

changing from centralized hierarchical frameworks to virtual organizations where information technology is rapidly diminishing the

importance of organizational boundaries.

Fifteen years ago, containing the Soviet Union

held sway over U.S. military doctrine. A wall

separated East and West Berlin and the Warsaw Pact was a very real threat to Europe. Fifteen years ago, few Americans had heard of

Tiananmen Square. Hong Kong was a British

possession, and China, with its communist

economy, was not widely viewed as a potential economic powerhouse. Fifteen years ago,

North Korea did not have a ballistic missile

program, Iraq was viewed as a bulwark against

an aggressive Iranian regime, and the U.S. had

a sizeable presence in Panama.

Today the Soviet Union is found only in history books, East and West Germany are united,

and Poland is a member of the North Atlantic

Treaty Organization (NATO) along with

Hungary and the Czech Republic (a country

that did not come into existence until 1993).

Americans now cite the military crackdown

at Tiananmen Square when discussing SinoAmerican Relations. Hong Kong is no longer

under British rule, and an increasingly capitalist China is rapidly growing into an economic

powerhouse. Today North Korea and Iran are

classified as rogue nations with ballistic missile capabilities, the U.S. views Iraq as the

principle threat to Middle East peace, and

Panama (using a Chinese company) operates

the Panama Canal and exercises sovereignty

over the Canal Zone.

Just as the political climate has changed, so too

has the business and economic landscape. Fifteen years ago, the Internet was a small global

network, its use limited to scientists and the

military.3 Companies like Netscape, America

Online (AOL) and Yahoo! did not exist. Apple

Computer was dominant in the home computer

market, California’s prosperity was largely

driven by the Aerospace Industry, and Silicon

Valley was synonymous with research, not

economic power.4

Today of course, access to the Internet is widespread. Netscape, Yahoo!, Amazon.com, AOL,

and dozens of other Internet-related companies

are household names, and companies like

Toshiba, Dell, and Compaq have eclipsed

Apple.5

 Aerospace and Defense Industry restructuring and relocation have eliminated

nearly 200,000 jobs, mostly in Southern California.6

 Despite this, the Silicon Valley has

fueled California’s economic rise to become

the sixth largest economy in the world.7

This chapter provides an overview of some of

these changes, their impact on DoD, and their

potential impact on DoD business functions.

We provide this insight because understanding the business environment is a critical

element to constructing an effective strategy.
1-3

Businesses do not exist in a vacuum. When performing strategic analysis, it is essential to understand the dynamics of the marketplace. This

applies not only to private firms but also to

public entities like DoD. Second, in order to

position a business effectively in the marketplace, it is important for a firm to understand

the impact and the potential of technological

change. Throughout this chapter, we will highlight some companies that understood these

verities and successfully adapted; we will also

provide examples of companies that did not

adapt and paid the price.

End of the Cold War

In 1988 President Bush endorsed President

Reagan’s military buildup and pledged to support modernization of the U.S. Armed Forces.

The U.S. was on track to continue its Cold War

posture. But then something welcome and unexpected happened. In November of 1989 the

Berlin Wall fell. Over the next two years, the

Soviet Block dissolved. By the end of the third

year of the Bush Presidency, the Soviet Union

itself disintegrated.9

 In what seemed like the

blink of an eye, the geo-political landscape had

been transformed. The Cold War was over.

Victory in the Cold War was a vexing event.

While war with the Soviet Bloc was a horrific

prospect, this potential conflict had provided

defense planners with a fixed adversary and a

stable focused doctrine. Envisioned was the

potential of a vast global conflict and a defense

structure designed to wage a vast war of attrition. This model necessitated stockpiles of

material and the maintenance of large standing forces ever on alert to engage the enemy

on a global battlefield.

Support and infrastructure assembled for this

conflict (that fortunately never came) is daunting in retrospect. Consider the following: in

1992, DoD stocked about 2.2 million different

items valued at $100 billion.10 This material

would be used to support and sustain the wartime requirements of 27 active and 11 reserve

Army and Marine Corps divisions, 53 active

and reserve air wings (Navy, Marine Corps and

Air Force), 324 heavy bombers, and 546 combat ships. In just a few years these figures —

material equipment and manpower — would

be trimmed by 40 percent.11

As the Cold War wound down, however, the

U.S. would soon discover the world was not

necessarily without conflict or unrest. In August

of 1990, Iraq invaded Kuwait and threatened

Saudi Arabia. The U.S., along with a multinational coalition, assembled a force that first

contained Iraqi forces, then drove them from

Kuwait. Operation Desert Shield/Desert Storm

was arguably the high point of American military might in the postmodern era. The U.S. had

mustered assets for global war on a regional

battlefield and Allied forces attained a striking

victory. The war also showcased what to the

general public were new concepts in warfare

— stealth technology, precision munitions, and

missile defense among others. Like the geopolitical landscape, warfare itself was changing. The advent of smart weapons and other

new technological capabilities meant that war

could be waged more precisely. However, these

new weapon systems and capabilities came

with acquisition costs that would rapidly

become unsustainable.

In this and other ways, the end of the Cold War

and the allied victory in Desert Storm marked

the end of one era and the beginning of another. Military planning shifted from waging

global war to engagement in regional conflicts.12 Defense structure was revised accordingly. The 1993 Bottom-up Review and 1997

Quadrennial Defense Review (QDR) set targets

to reflect a smaller force. Table 1-1 illustrates

the change in defense structure.
1-4

The downsized military reflected what was

needed to cope with new global realities. After

40 years of living with the threat of World War

III, and in the face of looming budget deficits,

the U.S. was ready to reduce its defense structure. Envisioned in these reductions was a commensurate reduction in defense budgets.

Planned budget reductions would sustain the

new force structure and support authorized

procurement and modernization programs.

However, faced with soaring deficits, the context of defense budgeting soon changed from a

discussion of funds needed to sustain the base

force to a discussion of what would be DoD’s

contribution to deficit reduction. Figure 1-1

shows the dynamic of rising deficits during this

period. This came to a head during the 1992

presidential election and guaranteed that

U.S. Defense Draw-down 1999-2000

Cold War QDR

Item (1990) 2000 Target

Military Personnel (1,000):

Active 2,069 1,385 1,363

Selected Reserve 1,128 865 835

Army Divisions:

Active 24 10 10

Reserve 10 8 8

Air Force:

Fighter Wing

Active 24 13 12

Reserve 10 8 8

Heavy Bombers 324 90 92

Navy:

Aircraft Carriers

Active 15 11 11

Training 1 1 1

Air Wings

Active 13 10 10

Reserve 2 1 1

Battle Force Ships 546 314 306

Marine Corps:

Divisions

Active 3 3 3

Reserve 1 1 1

Air Wings

Active 3 3 3

Reserve 1 1 1

Source: U.S. Census Bureau, Statistical Abstract of the United States: 1999.

Table 1-1. The Post Cold War Defense Structure
1-5

defense budget reduction would expand beyond

what would be needed to sustain the revised

military structure.13

This meant that budgets would be squeezed

beyond the amounts planned to sustain structure and operations. However, while funds were

being reduced, operational commitments began to rise. Over the ten-year period from 1990

to 1999, the DoD budget was reduced by 27

percent, manpower was cut by over one-third,

and bases were reduced by 10 percent. In this

same period, however, deployments and operations increased. Army deployments rose by 300

percent. From 1993 to 1999 Navy deployments

increased by 52 percent. Since 1986, Air Force

deployments have quadrupled. For the Army,

this increased operations tempo was executed

with 40 percent fewer people (military and

civilian). The Navy has 30 percent fewer ships

and the Air Force has lost a third of its people.14

With no compensating increase in defense budgets (specifically operations and maintenance

accounts), these operations were largely funded

out of hide (i.e., tapping into other accounts).

As we will see, modernization accounts, which

includes weapon system procurement, bore the

brunt of the impact. This was to amplify the

impact of the new defense structure on the

Defense Industry. (Appendix C lists DoD

account data by major appropriation.)

The Impact of Downsizing

on the Defense Industry

The downsizing of the military and the increasing pressures on the defense budget had implications not only for DoD but also for the

defense industrial base. Recognizing this, in

1993, Defense Secretary William Perry summoned America’s main defense contractors to

a meeting that has gone down in legend as “The

Figure 1-1. Federal Budget Deficits (1985-2001)

Source: Retrieved 13 March 2001 from Internet: http://ibert.org/deficit.html
1-6

Figure 1-2. Consolidation of the Defense Industry

Source: American Institute of Aeronautics and Astronautics (AIAA), Defense Reform 2001: A Blueprint for Action Final Report, Feb

Washington, DC, p. 4.
1-7

Last Supper.” With the end of the Cold War,

the military procurement budget was being cut

in half; the administration made it clear that

there was not enough business to sustain the

current industrial structure. The result was that

32 defense companies consolidated into nine

and then to seven.15 Figure 1-2 illustrates the

magnitude of this restructuring.

This structure reflected the realities of the new

business environment and a strategic realignment of the industry. The primary goal of consolidation was to remove excess capacity so

that the remaining players could take full advantage of economies of scale and scope.16 For

those that chose to stay in the defense industry, the strategy was to acquire and integrate.

Other firms made decisions to divest and reposition their firms. These were critical strategic

decisions. Over the past decade, virtually every

tier of the industry from major prime contractors to suppliers has consolidated through a

series of mergers and acquisitions that have led

to far fewer but larger and more vertically integrated companies.17 The environment had

changed and industry adapted accordingly.

This of course changed the economic and competitive landscape. The decreased number of

suppliers has led to increasingly oligopolistic

competition among the remaining firms. As

competition moves from several to a relatively

few firms, there are two critical fall-outs. First,

as competition narrows, the power to set price

is increasingly in the hands of the supplier.

Offsetting this is the power of Government as

the sole (monopsonistic) buyer. To exercise this

power, the Government relies on law and regulation to limit the price that contractors can

charge (e.g., Cost Accounting Standards, the

Federal Acquisition Regulation (FAR),

Weighted Guidelines, etc.). Enforcement of

these governance mechanisms represents a cost

to both the supplier and the buyer. This is an

example of strategic behavior between buyer

and seller. Often these strategies lead to situations in which the two players are worse off

than if an alternative strategy were used, such

as eliminating governance structures and sharing the benefits (see Figure 1-3, Prisoner’s

Dilemma).

The second fall-out is that sellers behave strategically. This is because, in oligopolies, the

actions of individual players affect the profits

and welfare of all the players. This drives behaviors that are designed to avoid a worst case

risk but are not optimal for the sellers, the buyer,

The Prisoner’s Dilemma describes a situation where two players each have a dominant strategy, but

playing this pair of strategies leads to an outcome in which both sides are worse off than they would be

if they cooperated and played alternative strategies. Imperfect information or a lack of information

causes the dilemma.18 For example, imagine two persons accused of a crime (which they have committed) and separately interrogated. If neither confess, they will be convicted of a lesser crime that is

easily proven giving them each a one-year sentence. If one confesses and the other stays quiet, the

confessing prisoner will go free and the one who stayed quiet will receive a ten-year sentence. If both

confess, each prisoner will receive a five-year sentence. Clearly, both are collectively better off if they

stay quiet, but lacking information, each is likely to confess to avoid ten years of imprisonment.

Source: M. Katz and H. Rosen, Microeconomics 2nd edition (Burr Ridge, IL: Irwin Press, 1994), p. 557.

Figure 1-3. Prisoner’s Dilemma
1-8

or the players as a whole. In Chapter Two we

will introduce Game Theory and in Chapter

Three we will apply this discipline to further

explore these behaviors and discuss strategies

to attain optimal outcomes for all players.

The Post-Consolidation Defense Industry

Declining defense budgets and inconsistent

acquisition policies have had an adverse impact on the Defense Industry.19 The Department’s procurement spending is down significantly. In constant fiscal year (FY) 2000 dollars these accounts are down from $96.7 billion

in 1990 to $53 billion in 2000.20 Figure 1-4

illustrates this decline across major defense

budget categories during the 1990s.

Perhaps more important, the nature of the Defense Department’s budgetary process and the

political environment in which DoD operates

has provided an unstable landscape for industry

players to operate in. Consider these excerpts

taken from recent press reports:

[Greg Schneider; Thomas E. Ricks,

“Fighter Jet Faces New Scrutiny; Budget Crunch, Changing World Threaten

Figure 1-4. Spending Across Major DoD Budget Categories (1960-2000)

Source: Retrieved 20 March 2001 from World Wide Web: http://www.afa.org/magazine/0400def.html.
1-9

$200 Billion Project,” Washington

Post, Dec 28, 2000, p. E.1] Pentagon

insiders say that Marine aviation is so

troubled that the Marines may not have

either the energy or standing to complain about changes in the JSF program. In addition to the Harriers, the

Marines are having high-profile

trouble with their V-22 Ospreys, hybrid aircraft that take off and land like

helicopters but can fly like airplanes

by tilting their rotors forward. Two of

the Ospreys have crashed this year,

killing a total of 23 Marines. If the Joint

Strike Fighter program were altered,

Pentagon insiders predict, the Marines

would grumble but ultimately just limp

along with the frequently grounded

Harriers as best they could, and maybe

fill whatever gaps developed by buying additional copies of the F/A-18 E/

F. The Air Force would rejoice and buy

more F-22s. And the Navy would

shrug and happily increase its purchases of the F/A-18 E/ F. Of course,

shifting defense dollars away from the

Joint Strike Fighter to other programs

would not necessarily disrupt the nearterm bottom lines of contractors.

Lockheed Martin could sell upgraded

F-16s for a few more years; Boeing

would sell a few more F/A-18s; and

Raytheon Co. and Northrop Grumman

Corp. could equip those planes with

the electronics gear they are currently

developing for the Joint Strike Fighter.

[Mark Thompson, “Another downed

Osprey has Marines defensive,” Time,

25 December 2000 – 1 January 2001,

p. 44] The accident couldn’t have come

at a worse time; it led to the fleet’s

grounding and compelled the Pentagon

to postpone a decision on beginning

full scale Osprey production. Within

hours of the crash, Defense Secretary

William Cohen and Congress announced probes of the program. As if

that wasn’t enough trouble, the incoming Vice President is Dick Cheney, who

tried to kill the program a decade ago

when he ran the Pentagon.

[Sig Christenson, “Lackland Contract

Under Fire Way Pact Awarded Drawing Attention,” San Antonio ExpressNews, December 19, 2000, p. A1] The

Pentagon was poised late Monday to

launch a probe into the way the Air

Force awarded a $336 million, five and

a half year support services contract at

Lackland Air Force Base. A Defense

Department spokesman vowed Monday to “satisfy outstanding concerns

of six Texas lawmakers about the deal.”

Such reports hardly inspire confidence in the

affected firms, the industry, or the investment

community. For this and other reasons we will

explore, DoD is far from an ideal customer and

the Defense Industry far from an ideal target

market. This conclusion is driving market

behaviors that have a direct and discernable

impact on DoD. In the following section, we

will examine these market behaviors and

illustrate their systematic impact.

Impact on Equity Markets

A lack of profit or predictability are two of the

reasons that defense contractors have seen their

market capitalization evaporate. For a company

like General Dynamics or Lockheed Martin

(LM), DoD might be their major customer, but

for shareholders in these companies, this isn’t

the only place for their investments.21 Figure

1-5 compares the three-year stock performance

of AOL with that of Lockheed Martin.
1-10

LM is the nation’s largest defense contractor

with $25.3 billion in annual revenue, about 60

percent of it from military sales. Recently, after a dismal five-year performance, its shares

have surged 72 percent to a recent high of $37.

Part of the stock’s strength lately is traceable

to the company’s announcement that earnings

are expected to grow 25 percent to 30 percent

in 2001. At the time of writing, shares were

trading at 26 times those expected earnings.22

This may seem like good news, but the performance pales in comparison to new economy

giants like AOL.

The simple fact is that other opportunities in

the equity markets make the Defense Industry

relatively unattractive. Inevitably, this has

driven investment capital to other more lucrative market opportunities. While some readers

might be inclined to think that the ability of

defense contractors to attract investors is not a

DoD problem, such issues have a real strategic

impact on DoD. The ability to attract financial

resources in the equity markets is a critical factor for companies that wish to remain robust

and competitive. It can also be argued that an

enfeebled Defense Industry has a potentially

negative impact on the nation’s ability to

mobilize rapidly in the event of war.

Debt Markets

Absent the ability to attract capital through

equity, firms must turn to debt markets to finance operations. However, the debt markets

are equally unforgiving of low or inconsistent

performance. As a result, bond ratings for the

industry are sliding. With this comes an increase in the cost to borrow. Figure 1-6 shows

the erosion of bond ratings for each of the top

five defense firms.

Equally distressing, the debt loads of these

companies have risen dramatically. This is depicted in Figure 1-7.

Rising debt levels and lowered credit ratings

increase the cost of capital and the return investors expect for their investments. Absent

high returns, more equity is driven from the

industry. The effect of all this is that market

risks are increasingly born by DoD. This translates into higher prices for weapon systems.

Higher prices mean these systems are less affordable; therefore, fewer will be procured.

Overhead costs are then allocated over a smaller

number of sales, further driving up price in a

vicious circle.

Figure 1-5. Stock Performance of Lockheed Martin and America Online

Source: Retrieved 20 March 2001 from World Wide Web:

http://www.quicken.com/investments/charts/?symbol=aol+lmt.
1-11

For this and other reasons, reforming profit

polices was a top goal for the Clinton Administration during its final year in office. In the

wake of a mid-1999 drop in Defense Industry

stock prices, DoD officials feared that many

leading firms on which the nation depends

for its needs were ripe for break up. The price

collapse at the time was driven by poor performance at such leading firms as LM and

Raytheon, which have been working to return

to financial health. Recommendations for new

policies were contained in a Defense Science

Board (DSB) study completed in April 2000.23

Trends and Opportunities

in the New Global Economy

As defense industries and manufacturing in

general were becoming unattractive investments over the past fifteen years, new hightech elements of the global economy are on

the rise. This shift is driven by underlying

Figure 1-6. Bond Ratings

Source: AIAA Defense Reform 2001, p. 6.

Top Five Aerospace and

Defense Contractors

Corporate Debt Ratings

(20-Year Note)
1-12

changes, specifically computer and information technologies. This in turn has revolutionized the ability of businesses to transact and

share information. Understanding the power of

the enabling technologies and their impact on

the economic landscape is the key to understanding the transformation taking place in business

today and the potential impact of these changes

into the future. To aid in this understanding,

we offer a brief historical examination of

technological change and how those changes

affected business and the economy.

Just as the Industrial Revolution changed the

world economy, the current technological revolution is echoing and amplifying the original

impact that industrial mechanization had on the

business, political, and social environment.

Indeed, some have theorized that industrial

revolution is not a singular event but rather a

Figure 1-7. Defense Industry Debt Load

Top Five Aerospace and Defense Contractors

Long-Term Debt Burden

Source: AIAA Defense Reform 2001, p. 6.
1-13

recurring theme.24 Understanding this theme is

fundamental to understanding the power of the

revolutionary changes that are impacting

today’s business environment. Furthermore,

understanding this environment is essential to

formulating an effective business strategy.

Additionally, just as revolutions in technology

recur, the refinement of that technology continues over time. Strategists must not see only

the capacity of any given new technology, but

they must also grasp the potential of the technology in order to lead their organizations in

directions where they can move quickly when

technological potential is realized. Business

strategists must also define and position their

businesses in light of the impact of technological change. As Theodore Levitt advised in

“Marketing Myopia,” U.S. railroad companies

defined their business too narrowly. They

thought they were in the railroad business when

they should have realized they were really in

the transport business.”25 Railroads, of course,

suffered from this narrow definition. Similarly,

Curtiss-Wright thought they were in the radial

engine business when they were in fact in the

aircraft engine business. The result — CurtissWright never made significant investments in

jet engine technology. By contrast, Pratt and

Whitney, another radial engine manufacturer,

understood they were in the aircraft engine

business and that under this definition they

needed to embrace and invest in jet engine

technology. This change in technology and the

ability to define and position a business also

allowed General Electric (GE) to enter the market successfully. By examining the parallels

between the power generation turbines it was

producing and how this technology was applied

in jet engines, GE understood that the turbine

business, by definition, encompassed the jet

engine business. Today, GE and Pratt dominate

the aircraft engine market.26

Recurring Technological Revolution

The First Industrial Revolution was characterized by automation that replaced labor with

capital. No longer did items have to be produced by hand. Now they could be produced

rapidly by machines. This was a revolution in

the ability to transform material from raw inputs to finished goods. The next revolutionary

change came with the advent of the steam engine and the locomotive. Now these goods

could be rapidly moved by machine. This was

a revolution in the ability to transport. Today,

enabled by the advent of the computer network,

we are in the midst of an equally powerful

transformation — a revolution in the ability to

Since the seventeenth century, the standard weapon for the infantryman was the smooth bore musket

(and later the rifle). Prior to the Industrial Revolution, these weapons were handcrafted and parts were

not interchangeable. As tooling improved, this changed. In the United States, the Springfield Armory

is credited with being the first arms manufacturer to produce to a sufficient standard where muskets

could be disassembled, their parts mixed and then reassembled into functioning weapons. This represented a giant step forward and was quickly imitated. Now the presence of a few spare parts could

quickly put a musket back into service where before the weapon would be rendered useless.27

Source: J. McPhereson, The Battle Cry of Freedom (Oxford, UK: Oxford University Press, 1988), pp.15-16.

Figure 1-8. Standardized Production and the U.S. Military
1-14

transact. In the following paragraphs we will

explore the impact and consequences of

changes in the ability to transform, transport,

and transact.

The impact of this First Industrial Revolution

propelled manufacturing economies forward in

ways that were then unimaginable. Shops that

could produce a small quantity of hand-crafted

goods were displaced by factories that could

produce large quantities of standardized items.

The Industrial Revolution made possible the

mass reproduction of objects and, in a virtuous

cycle, produced the wealth needed to purchase

them.28 Whole industries were changed including arms manufacturing (see Figure 1-8, Standardized Production and the U.S. Military). By

the mid-nineteenth century the impact of

mechanization was in full swing.

Still, this great expansion of production capacity remained isolated to specific geographic

areas with sufficient populations that would

provide a market for these goods. With no way

to economically transport large quantities of

material except by direct water routes, the Industrial Revolution was predominately a localized event. Regional economies and regional

markets predominated.

This changed with the advent of rail transportation. New, heretofore unreachable markets

were opened, accelerating the economy and the

economic motivation to produce. In this country, with the completion of the Transcontinental Railroad, goods could travel from coast to

coast in a matter of days instead of months. So

too could people, a fact that was not lost on military planners (see Figure 1-9, The Transcontinental Railroad and U.S. Military Strategy).

Rapid, effective, and economic transportation

reduced freight transportation costs and made

the price of consumer goods and industrial

goods more affordable, further accelerating a

growing economy.

Rail transportation also accelerated the concentration of manufacturing in what has been referred to as the Second Industrial Revolution.30

By the 1890s, firms seeking to exploit economies of scale were consolidating operations.

This is the era of the “Robber Barons” and the

emergence of manufacturing powerhouses like

Ford and DuPont. The period was also characterized by the emergence of national economies that replaced local economies. No longer

were consumer goods produced in close proximity to the consumer. Now, they could be produced across the country and delivered locally.

The United States Army was quick to see the potential that railroad transportation offered, especially

in the western territories. Prior to the building of a railroad network, the Army had planned to build and

outfit an extensive fort system, each post having responsibility for a defined geographic area. This, of

course required investments in materials and manpower both of which the post Civil War Army had

very little. General William T. Sherman saw that the railroad could move soldiers and supplies rapidly

over a wide geographic range, eliminating the need for an extensive system of forts. With this in mind,

Sherman did all he could to support the construction of the Transcontinental Railroad, visiting the

Union Pacific work site several times a year and keeping in close correspondence with Grenville

Dodge (Chief Engineer of the Union Pacific).29

Source: S. Ambrose, Nothing Like It in the World (New York, NY: Simon and Schuster. 2000), p. 215.

Figure 1-9. The Transcontinental Railroad and U.S. Military Strategy
1-15

This business model powered the American

economy throughout most of the 20th century.31

The Revolution Continues

We are now in the midst of a Third Industrial

Revolution.32 This revolution is enabled in large

part by information technology and the impact

it is having on the ability to transact business

across geographic and political boundaries.

This coupled with the reduction of tariff barriers has accelerated the expansion of a global

economy that is rapidly diminishing the importance of and replacing individual national

economies, as it expands (see Figure 1-10, The

Fall of Tariff Barriers). Just as railroads reduced

transportation costs and opened up markets, the

accelerating power and connectivity of computers is reducing the cost of business transactions from firm to firm and from firm to

consumer. This, in turn, has given rise to the

Information Economy.

The Information Economy

Just as rail transportation enabled the Second

Industrial Revolution to take root, the Third

Industrial Revolution grew from the rich environment of information technology. Railroads

made countries and continents smaller places;

lines that transmit large amounts of data at the

speed of light are quickly transforming the

world into a global community. The needs of

customers at just about any place on earth can

be rapidly communicated anywhere else. However, unlike the relatively slow expansion of

railroad service, access to information is expanding at a greater pace than anything ever

previously seen.

In their day, railroads, driven by powerful economic forces, grew at a dizzying pace, more

than doubling the amount of track laid each

decade.35 Today, equally powerful economic

forces are driving the growth of the Internet

(see Figure 1-11, Moore’s Law). In 1993 there

were 130 sites on the World Wide Web

(WWW). By the year 2000, that number had

grown to over 22 million.36 The Internet

economy surged 63 percent in 1999 to nearly

$524 billion, up from $322 billion in 1998. Jobs

related to the Internet increased by 650,000 in

1999 to more than 2.4 million today.37 The

world is going electronic, but why?

Several other factors of course have made globalization possible. Most notably, tariff barriers have

dropped, causing a rapid increase in cross-border trade, integrating world economies. In 1960, American Imports and Exports stood at 9 percent of GNP. Today, they stand at more than 25 percent.33 The

expansion of trade has placed economic pressure on American industry. In order to compete globally,

American businesses have moved many functions to areas of the world that contribute to their competitive advantage. Operations may be relocated to take advantage of lower labor costs, less stringent

environmental regulation, or to better serve a local market. This has resulted in a significant realignment of U. S. Industry. For example, today there are no televisions manufactured in the United States

despite the fact that this country produced and perfected the technology. This trend is not specific to

the United States. Currently, electronics firms in Japan are moving television manufacturing operations to Mexico and Malaysia.34

Source: T. McCraw, American Business, 1920-2000: How It Worked (Wheeling, IL: Harlan Davidson Inc. 2000),

pp. 144 and 161.

Figure 1-10. The Fall of Tariff Barriers
1-16

Figure 1-11. Moore’s Law

In 1965, Gordon Moore was preparing a speech and made a memorable observation. When he started

to graph data about the growth in memory chip performance, he realized there was a striking trend.

Each new chip contained roughly twice as much capacity as its predecessor, and each chip was

released within 18-24 months of the previous chip. If this trend continued, he reasoned, computing

power would rise exponentially over relatively brief periods of time.

Moore’s observation, now known as Moore’s Law, described a trend that has continued and is still

remarkably accurate. It is the basis for many planners’ performance forecasts. In 26 years the number

of transistors on a chip has increased more than 3,200 times, from 2,300 on the 4004 in 1971 to 7.5

million on the Pentium II processor.38

Moore’s Law:

Every 18 Months, Processing Power Doubles While Costs Hold Constant

The corollary to this exponential increase in the capacity of microchips and the commensurate increase in computing power has been an exponential decrease in the cost of computing. By the 1980s,

mainframe computers that cost $10 million in the 1960s could be bought for less than $3,000. Today

that same computing power costs less than $5.39

1,000,000,000

100,000,000

10,000,000

1,000,000

100,000

10,000

1,000

1970 1995 2020

Transistors

per Chip
1-17

Just as the ability to transform and transport

more efficiently had real and lasting impact on

the business models or their day, so too does

the rise of technologies that allow for more

efficient business transactions. This enhanced

ability to process and disseminate information

means that the preferences of customers can

now be rapidly accessed, organized, and transmitted to all elements of the value chain. This

will continue to have a profound impact on

the business model and the organizational

structures that support them.

Prior to the advent of these technologies, firms

used a make-and-sell model.40 Under this model,

businesses would use generic aggregate data

to decide what items to design, build, and sell

to a customer base. Cycle times were long,

product runs steady, and information was processed through hierarchical organizational

structures. In this model, resources were tightly

controlled via an annual budget process, and

bureaucratic governance structures ensured that

activities were efficiently coordinated. A small

cadre of corporate officers resided at the top of

this structure. Information flowed up to them

through the organization and decisions based

on this information flowed back down. At the

bottom were individual workers who performed

tasks assigned to them.

This business model followed a classic structure used by military organizations and adopted

by industry. For most of the 20th century, this

command and control structure worked quite

well, propelling American industry and the

American economy to unprecedented levels of

prosperity. But this model has obvious drawbacks. Cycle times are slow, deviations from

planned production are costly, and the sheer

size and momentum of such an organization

impose limits on its responsiveness. Like a lumbering supertanker, it takes a great deal of time

to change the direction of the organization after

the rudder order is given.

“Make and Sell” “Sense and Respond”

Annual budget resource allocation Dynamic, real-time resource allocation

is the “heartbeat” is the “heartbeat”

Glacial change Real-time change

Design, build, sell Sell, build, redesign

Plan Act

Market share Mind share

Build to inventory Build to customer

Build reliable, complex products Create unimaginably complex products

and services and services

Source: R. Kaplan and D. Norton, The Balanced Scorecard (Boston, MA: Harvard Business School Press, 1996),

p. 117.

Table 1-2.

Contrasts Between the Make-and-Sell and the Sense-and-Respond Business Models
1-18

From Make and Sell

to Sense and Respond

Today successful businesses are transforming

into responsive and agile organizations. The

power of networked computer systems and

their ability to format and move data are dramatically shifting the business model from

“make and sell” to “sense and respond.”41 In

their book by the same name, Sense and Respond: Capturing Value in the Network Era,

Steven Bradley and Richard Nolan show some

of the important contrasts between these two

models. These are displayed in Table 1-2.

The sense and respond model offers several

advantages over the old make-and-sell model.

Cycle times are reduced and there is less need

for the long, inefficient production runs, the

build-up of inventory, and much of the infrastructure required to get the product or service

to the customer under make and sell. Under

sense and respond, by contrast, the supply chain

is far more efficient and responsive, reducing

inventories and freeing up resources. This

model also diminishes the need for resource

governance and control structures. By sharing

information from business to business, the flow

of materials can be orchestrated long in advance

of the requirement, thereby shortening the

ordering period and eliminating the need to

import materials in bulk from firm to firm. Information availability within the firm eases

scheduling and improves process flow, eliminating waste and dead time (see Figure 1-12,

Manufacturing Cycle Effectiveness).

Impact on the Organization

Perhaps most important, this model is deemphasizing the importance of organizational

barriers and allowing firms to cross those barriers freely, making, in effect, ad hoc virtual

firms. Put another way, firms can outsource

functions and retain the same (or in some cases,

enhanced) oversight and responsiveness that

Figure 1-12. Manufacturing Cycle Effectiveness

Processing time

 MCE =

 Throughput time

Where Throughput Time =

Processing Time + Inspection Time + Movement Time + Waiting/Storage Time42

Understanding MCE is the key to understanding the power of an efficient supply chain. When material

just sits without being processed, throughput time increases while processing time remains constant.

Storage lowers MCE as do unnecessary movement, waiting periods, or any other activity that does

not add value. Information technologies shorten transaction time and improve MCE. Customer orders

can be instantaneously transmitted via computer, products can be designed and tested rapidly using

powerful software programs, and materials can be ordered on line to specification. These actions

drive MCE toward a one-to-one ratio.

This also applies to services. By investigating MCE, some lending institutions have moved mortgage

approval processes from weeks to minutes. Approving mortgages in 15 minutes would obviously be of

value to a customer and provide a competitive advantage over a bank that takes weeks to process the

same application.43
1-19

they experienced when those same functions

were performed in house. Companies like Cisco

Systems, known for making the switching routers that are the backbone of the Internet, actually manufacture only a small percentage of

those routers.44 Most manufacturing and assembly is outsourced. Cisco, by controlling the flow

of information and not the production process,

has risen to be an industry giant.

Similarly, callers to the Kraft General Foods’

consumer hotline might think that they are talking to an employee of the company. However,

American Transtech (a subsidiary of AT&T)

performs this service. This company is designed specifically to support telephone-intensive business processes.45 Networking technology allows American Transtech to perform an

important customer service activity and allows

Kraft to concentrate on its core business. To

the consumer, the transaction is absolutely invisible. In fact, because American Transtech

specializes in and is scored on call center service, customer satisfaction is likely better than

if Kraft performed this function in house. Both

Cisco and Kraft have identified a strategic

position in the marketplace, made outsourcing decisions accordingly, and used the power

of this transactional revolution to make that

structure seamless to the customer.

The increasing use of outsourcing is clearly

being driven by the expanding demands of the

evolving information economy. According to

the most recent Dun & Bradstreet Barometer

of Global Outsourcing report, outsourcing expenditures were anticipated to surpass the $1

trillion mark at the end of 2000, becoming “one

of the few business activities to ever reach this

level of annual expenditure.”46 In fact, global

outsourcing has nearly doubled in the past three

years, growing at an average of 25 percent a

year (see Figure 1-13). Moreover, companies

are expanding outsourcing beyond traditional

activities such as information technology and

manufacturing to areas that directly touch

their most important asset — the customer.47

Through media services, outsourcing has also

Figure 1-13. Global Outsourcing Growth

Source: Retrieved 28 February 2001 from World Wide Web: http://www.dnbcollections.com/outsourcing/bar2.htm
1-20

played a roll in the evolution of the information economy (see Figure 1-14). We will explore the evolution in outsourcing more in the

next chapter.

Potential for this

New Technology for DoD

Listening to net radio through the computer as

we write this, we can, with the click of a mouse,

purchase a compact disc (CD) recording of the

song that was just played and have the product

delivered to the door in a few days or pay a

little extra for overnight delivery. Not long ago,

such a purchase would have meant a trip to a

music store. The savings — at least an hour of

time, a retail structure that need not be built,

distribution infrastructure that need not be carried as a fixed cost, and a governance and control structure (marketing, etc.) that need not be

staffed. So the CD will cost less than if we had

made the purchase at a traditional music store.

Furthermore, we can make the purchase at any

time of the day or night without regard to

traditional retail hours.

Going beyond the CD to the content it contains,

we could have the music instantaneously by

downloading it (this may happen when the

music industry defines itself to be in the music

business rather than the CD business). This

would further reduce the price we pay by eliminating manufacturing, packaging, and shipping costs from the equation. This capability

might open up a whole range of unrealized

opportunities for the music business as it has

for other industries (see Figure 1-15, Threats

or Opportunities).

Expanding on this business model, we could

purchase a music file containing songs sequenced to our individual tastes. What is more,

Figure 1-14. Growth in Outsourcing Linked to Information Economy

The evolution toward the information society and its relationship with outsourcing is obvious in the

growth of “new media services.” With planned expenditures growing at 18 percent per year, new media

services is one of the fastest growing outsourcing areas for the fourth consecutive year. Dominated by

electronic commerce and Internet support services and experiencing constant change, virtually the

only way to secure access to current best practices and the latest software is through outsourcing to

those that keep up with change.48

Figure 1-15. Threats or Opportunities?

When videocassette recorders began to be sold in great numbers, some in the movie industry saw

this as a threat. With movies to play at home, people might not go to theaters. To defend against this,

the studios charged high prices for videocassettes, effectively limiting their availability. To their surprise, however, the studios soon found out that movies on video had a complementary effect. People

could see upcoming attractions on the tapes and make plans to see a new feature in a theatre. Those

that enjoyed seeing a movie might rent the tape or recommend it to their friends. Some would enjoy

movies so much they might buy a tape to have permanently. Realizing this, studios reduced the prices

they charged for the tapes.49
1-21

the business on the other end of this transaction would have access to information showing our individual musical preferences, buying habits, and the timing of our purchases. This

would allow them to target not just market

segments, but individual customers and generate additional business by forwarding concert

information, upcoming recording releases, song

previews, etc. No longer is the game aggregate

market segmentation. Rather, it is leveraging

individual relationships, dramatically extending

the value delivered to the customer.

This model also minimizes the importance of

investment in infrastructure. The computer

screen becomes the store front. The back office

is centered on the transmission of data. Demand

can be aggregated over a global population.

Distribution is not reliant on geographic networks and (in the case of digital products) inventory is nonexistent. This is why Internet

providers with ability to create and collect value

can provide a high return on invested capital,

and why investors are showing interest in these

new companies.

This is the power of the Information Economy.

Today a computer printer can monitor its ink

or toner levels and communicate over the computer it is connected with to companies that

will ship replacement cartridges to arrive just

before the old ones run out. A supplier can

gather and aggregate data about the rate at

which ink or toner is used, streamlining the

supply chain. This reduces the need for retail

outlets and a distribution network, lowers inventory costs, and eases production scheduling. Furthermore, the supplier need not internally develop this capability. It can outsource

to a specialist business, paying it a fixed price

or (saving time and investment) collaborate

with the IT provider providing payment based

on a percentage of sales.

Today commuters can drive through tollbooths

without stopping. The toll payment transaction

is measured electronically using a device affixed to the vehicle and read by a machine on

the tollbooth, eliminating the need for a booth

operator and allowing the turnpike authority

to more accurately measure highway usage,

even down to individual driving habits. It is

conceivable that in the future, this information

could be used to transmit to the individual

driver highway conditions tailored to the route

he or she normally takes, offering suggestions

for avoiding peak hours, alerting the driver to

road conditions, offering alternative routes, etc.

Are these examples so far removed from DoD

business functions and their support of deployed operational units? The same technology can be used to create virtual agencies that

are a mix of public organizations and private

firms existing in symbiotic partnerships. Field

maintenance equipment can be checked and

diagnosed remotely, reducing manpower requirements. Questions about the characteristics of equipment can be answered correctly

and instantaneously via links back to the original manufacturer, improving maintenance. The

performance of individual equipment by serial

number can be tracked, eliminating bad players and improving reliability. A fault diagnosis

can be forwarded to a repair facility in advance

of the physical arrival of a component, allowing the facility to order materials and schedule the repair, thus reducing turnaround times.

And requirements can be identified and shipped

in advance of the need reducing order and

shipping times.

Such is the potential that exists today. Successful businesses have grasped these concepts and

are adapting accordingly. Business functions

within DoD can also take advantage of these

capabilities in order to formulate strategies that

allow them to more effectively perform the
1-22

Department’s mission. Just as General Sherman

realized the potential of the railroads to solve

vexing problems of his day, DoD must see and

act on the potential of today’s rapidly evolving

technology.

Summary

In this chapter we provided a quick snapshot

of the political, business, and technological

environment facing DoD at the dawn of the 21st

century. The Cold War has been fought and

won, Europe has freed itself from communist

oppression, and the world is fast becoming a

global community. Strategies well suited to the

past are not well suited to the present. Not long

ago, DoD set the technological standard and

industry followed. Not long ago, military industrial processes were looked upon with envy.

What other organization could field complex

systems such as the Polaris Submarine in just

two years?

But today it is commercial industry that has

taken the lead. Advanced technologies are

found in home computers as well as in military hardware. Complex consumer products are

developed and go to market often in less than a

year — contrast this with weapon system development which can take ten to fifteen years

from concept development to fielding. Quality

standards are higher, accounting processes

more accurate, and responsiveness to customer

is far superior. These business models have set

a new standard that leaves DoD lacking in

comparison. The need to transform is urgent.

The good news is that several models for transformation have already been applied and tested.

In the next chapter we will begin to illustrate

the techniques the business community uses to

evaluate the changing environment and to craft

strategies that have transformed hierarchical

command and control structures into effective,

responsive, and profitable entities. We hold that

these techniques and lessons can be absorbed

and applied to DoD business functions.
1-23

ENDNOTES

16. American Institute of Aeronautics and Astronautics

(AIAA), Defense Reform 2001: A Blueprint for

Action Final Report, February 14-15 2001,

Washington, DC, p. 5.

17. Vago Muradian and Frank Wolfe, “Aldridge Seen

As Frontrunner For Top DoD Acquisition Job,”

Defense Daily, February 8, 2001, p. 8.

18. M. Katz and H. Rosen, Microeconomics 2nd edition

(Burr Ridge, IL: Irwin Press, 1994), p. 557.

19. L. Thompson, “Defense Industry’s Real Problem:

Capricious Pentagon,” Aviation Week and Space

Technology, 13 March 2000, p. 66.

20. Retrieved 20 March 2001 from World Wide Web:

http://www.dtic.mil/execsec/adr 1999/apdx_b.html.

21. Thompson, p. 66.

22. Erin E. Arvedlund, “Taming The Pentagon Starship

Troopers New Weaponry Will Shake up the Defense

Industry — and Investors,” Barron’s, 12 February

2001, pp. 23-26.

23. Thompson, p. 66.

24. Harvard Business School Case No. 9-796-161,

Confronting the Third Industrial Revolution, April

1996, pp. 1-4.

25. Quoted in C. Markides, A Guide to Crafting Breakthrough Strategy (Boston, MA: Harvard Business

School Press), p. 40.

26. L. Eltscher and E. Young, Curtis-Wright: Greatness

and Decline (New York, NY: Twayne Publishers,

1998), pp. 143-155.

27. J. McPhereson, The Battle Cry of Freedom (Oxford,

UK: Oxford University Press, 1988), pp.15-16.

28. Michael J. Lewis “When the Craftsman Met the

Machine,” Wall Street Journal, January 29, 2001,

p. A24.

29. S. Ambrose, Nothing Like It in the World (New York,

NY: Simon and Schuster. 2000), p. 215.

1. Fortune, Vol. 113 No. 9, 28 April 1986, pp. 174-

232.

2. Retrieved from the World Wide Web on 26 April

2000 http://www.netadvantage.standardpoor.com/

sphome.html.

3. M. Iansiti and A. MacCormack, Sense and Respond

(Boston, MA: Harvard Business School Press,

1998), p. 175.

4. Harvard Business School Case No. 9-198-020, The

Worldwide Web and Internet Technology, November 1998, p. 2.

5. Iansiti and MacCormack, p. 176.

6. Steven Hayward, “California Boomin’” The World

and I, Vol. 15, Issue 12, December 2000, pp. 48-53.

7. Jon Hilsenrath and Rhonda L. Rundle, “Will

Economy Feel California’s Tremors?” Wall Street

Journal; January 8, 2001, p. A1.

8. M. Porter, Competitive Strategy: Techniques for

Analyzing Industries and Competitors (New York,

NY, The Free Press, 1980), p. 3.

9. D. Ippolito, Blunting the Sword (Washington, DC:

National Defense University Press, 1994), p. 39.

10. General Accounting Office, Defense Inventory

Management, United States General Accounting

Office High Risk Series, (Washington, DC:

Government Printing Office, December, 1992),

p. 8.

11. Defense Inventory Management, p. 8.

12. Ippolito, pp. 85-107.

13. Ippolito, p. 75.

14. Retrieved 13 March 2001 from World Wide Web:

http://www.defenselink.mil/pubs/dod101/.

15. The Economist (Volume 356, Issue 8183), London:

August 12, 2000: Anonymous. pp. 61-62.
1-24

30. Harvard Business School Case No. 9-796-161,

Confronting the Third Industrial Revolution, April

1996, pp. 1-4.

31. Ibid.

32. Ibid.

33. T. McCraw, American Business, 1920-2000: How

It Worked (Wheeling, IL: Harlan Davidson Inc.

2000), p. 161.

34. McCraw, p. 144.

35. S. Ambrose, Nothing Like It in the World (New York,

Simon and Schuster. 2000), p.35.

36. Retrieved 21 March 2001 from World Wide Web:

http://info.isoc.org/guest/zakon/Internet/History/

HIT.html43 University of Texas Report, “Measuring the Internet Economy” January 2001, pp. 1-9.

37. Retrieved 21 March 2001 from World Wide Web:

http://www.intel.com/intel/museum/25anniv/hof/

moore.htm.

38. S. Bradley and R. Nolan, Sense and Respond (Boston, MA: Harvard Business School Press, 1998),

p. 8.

39. Bradley and Nolan, p. 4.

40. Ibid.

41. Ibid., p.6.

42. Kaplan and Norton, p. 118.

43. Retrieved 15 March 2001 from World Wide Web:

http://www.cisco.com/warp/public/750/

johnchambers/facts/fact_vmfg.html.

44. Bradley and Nolan, p. 11.

45. Retrieved 28 February 2001 from World Wide Web:

http://www.dnbcollections.com/outsourcing.

46. Retrieved 28 February 2001 from World Wide Web:

http://www.dnbcollections.com/outsourcing/

bar2.htm.

47. Retrieved 14 March 2001 from World Wide Web:

http://www.dnbcollections.com/outsourcing/

bar1.htm.

48. A. Brandenburger and B. Nalebuff, Co-opetition

(New York, NY: Doubleday, 1996), p. 29.
2-1

2

KEY TERMS, CONCEPTS,

AND DEFINITIONS

“What underlies the malaise of so many large and successful organizations

worldwide is that their theory of business no longer works.”

— Peter F. Drucker

Introduction

In this chapter, we establish common reference

points in the treatment of outsourcing, strategy, and the analytical tools used by the private sector in formulating and implementing

effective strategies. Industry’s experiences to

date with outsourcing have been more successful than those of the Department of Defense

(DoD), perhaps suggesting that DoD take a

different stance to outsourcing implementation.

In addition, business strategy is conceptually

different from military strategy and so we

present a brief overview of business and corporate strategy. Finally, we provide a brief

tutorial on five preferred tools in use today for

formulating and implementing effective strategies. Later, in Chapter Three, we will illustrate

how these are used in the private sector.

Outsourcing — An Outcome of Strategy

Famed management expert Peter Drucker once

wrote in regard to what he terms the theory of

the business:

The assumptions on which the organization has been built and is being run

no longer fit reality. These are the

assumptions that shape any organization’s behavior, dictate its decisions

about what to do and what not to do,

and define what the organization

considers meaningful results.1

Such is the case in DoD today. The Department’s assumptions concerning outsourcing

and privatization, a type of outsourcing, are no

longer valid (see Figure 2-1 for definitions of

these terms).

The Department has experimented with

outsourcing efforts under the guidance of the

Office of Management and Budget (OMB) Circular A-76, and each of the Services (Air Force,

Army, and Navy) has tried its own approach,

such as competitive sourcing and strategic

sourcing (see Figure 2-2 for definitions).

While there is remarkable consistency among

these definitions used throughout DoD, the fact
2-2

Outsourcing

• Defense Science Board (DSB) – Transfer of a support function previously performed

in house to an outside provider.2

• Air Force (AF) – The sourcing of a new requirement or transfer of an activity that has

been performed in house to an outside provider. The Air Force retains full control and

responsibility (through service contracts) of the recurring services or functions, which

are outsourced.3

• Army – Outsource...implies that current in-house workload will be contracted out after

a study is completed.4

• Navy – The transfer of a function previously performed in house to an outside

provider.5

Privatization

• DoD – Privatization is the process of changing a public entity or enterprise to private

control and ownership. It does not include determinations as to whether a support

service should be obtained through public or private resources when the government

retains full responsibility and control over the delivery of those services.6

• DSB – A type of outsourcing involving the transfer of government assets, to the private

sector.7

• AF – The transfer of ownership of function(s), business assets or both (e.g.,

government-owned plant and equipment) from the public to the private sector.8

• Army – Privatization occurs when the government relinquishes ownership and control

of an operation by divesting itself of the commercial activity, including the associated

real property, and becomes a customer that purchases goods and services from a

commercial source.9

• Navy – A process of changing a public entity or enterprise to private control and

ownership.10

Figure 2-1. Outsourcing and Privatization Definitions

that each Service has elected to define these

terms separately is bothersome. In fact to date

these initiatives have not realized the full

potential of outsourcing (Figure 2-3 illustrates

the gamut of outsourcing options) while, on

the other hand, the private sector has reaped

significant benefits through outsourcing

initiatives.

The private sector has realized that the question is not about how to do things more efficiently. Outsourcing is not a management

technique designed to do things differently, but

instead it has become a powerful management

tool that forces one to reconsider what to do.

Clearly the private sector’s experience with

outsourcing over the past ten years has shown

that it has evolved to the point that it can

fundamentally redefine a business.

In the primer, Ten Years of Outsourcing

Practice: Tactical, Strategic, and Transformational, Michael F. Corbett & Associates, Ltd.,

define three distinct phases in the evolution of
2-3

outsourcing. The changes are not calendardriven but rather are tied to the advances in

value proposition resulting from the growth in

the use of outsourcing over the past decade.14

In the infancy of outsourcing, firms were seeking fixes to specific problems. Often a company

was looking for a means to address limited

resources or a desire to reduce headcount. Tactical relationships were forged to create immediate savings, eliminate the need for future investments, realize a positive cash flow from the

sale of assets, or relieve the burden of staffing.

When successful, the value of using outside

Figure 2-2. Competitive and Strategic Sourcing Definitions

Competitive Sourcing

• Army – Competitive sourcing more accurately describes the process that identifies the

most efficient provider of a service.11

Strategic Sourcing

• Air Force – Overall, strategic sourcing seeks to balance military effectiveness (the

ability to fight and win) with the incorporation, where possible, of increased efficiencies

from best business practices. The selection of the optimum source and process is

central to strategic sourcing and should result in improved performance, efficiency,

quality, cost effectiveness, and savings for modernization, quality of life, or other Air

Force priorities....12

• Navy – The Navy approach to reducing the total cost of providing infrastructure by

conducting a comprehensive review of a business unit or units considering a wide

range of options including consolidation, restructuring, privatization, make or buy

decisions, adopting better management practices, development of joint venture with

the private sector, asset sale, and the terminiation of obsolete services or programs.13

Figure 2-3. The Outsourcing Spectrum

GOCO: Government-Owned/Contractor-Operated

PIP: Privatization in Place

Note: Position is relative to each type of outsourcing; where an item appears on the scale of “Totally Public” to

“Totally Private” is dependent of the specifics of that item.

Source: Adapted from “Torpedo Outsourcing”, a study conducted by the Program Executive Officer for Undersea

Warfare, June 1996.
2-4

providers was clear: better service for less investment of capital and management time.15

Seeking even more value from the outsourcing

relationship, the goals of these relationships

expanded.

Executives realized that they were better able

to direct their attention to the more critical aspects of their jobs. Outsourcing changed from

being a tactical tool to becoming a strategic

tool by virtue of the dollar value of the relationships, the integrated scope of services, and

the length of the new relationships.16 Most important, the relationships matured into longterm business partnerships. Strategic outsourcing relationships are about creating long-term

value, as illustrated with the landmark KodakIBM information technology outsourcing deal

of 1989.

In that year Kodak signed a ten-year outsourcing deal with IBM Corporation, Digital Equipment Corporation, and Businessland Inc. for

$250 million.17 Kodak was not in trouble — at

the time it was a “top 20 U.S. corporation” with

annual revenues of $18.4 billion.18 The issue

facing Katherine Hudson, then Kodak Chief

Information Officer, was whether to invest $90

million in capital expenditures on a computer

center that had nothing to do with imaging.

At the time many other business leaders had

begun to ask the question, “what are we really

in business to do?” Hudson concluded, “our

mission doesn’t say ‘be the world leader in

computing’.”20 Her decision to outsource was

not about fixing a problem. The Kodak-IBM

deal was about partnering with a provider to

deliver a non-core function while focusing the

firm’s resources on its vision — “...be the

World Leader in Imaging.”21 The decision to

outsource was very much strategic, and the role

the provider (IBM) took on was critical, or as

Michael Corbett defines strategic outsourcing,

“the redefinition of the corporation around its

core competencies and strategic, long-term,

results-oriented relationships with service providers.”22 Partnership, whether between private

companies or between public and private entities, is an example of strategic outsourcing, but

one can take such an alliance even further.

If the first phase of outsourcing was about doing the work within existing rules, then the second phase was about using outsourcing as the

corporation is being redefined. The third phase

takes outsourcing a step further to transform

the business — open new markets, deliver new

customers, and create new products.23 Outsourcing is leverage. It is paving the way to

growth through partnerships. Where once firms

kept outsourcing relationships hidden, firms

now co-brand products and services and openly

advertise their outsourcing providers. Figure

2-4 illustrates just such a relationship between

the United States Postal Service (USPS) and

Targeted Marketing Solutions, Incorporated

(TMSI). TMSI and its advertisers pay for all

costs associated with the MoversNetTM Internet

Figure 2-4. Co-Brand Illustration

Source: Adapted from Web site; retrieved 20 February 2001 from World Wide Web: http://www.usps.gov/

moversnet/.
2-5

service and the Mover’s GuideTM, which are designed to offer increased help to consumers

before, during, and after they relocate. This

cooperative effort between the private sector

and USPS reduces postal operating costs while

providing products like change of address

forms previously paid from USPS revenues.24

Transformation outsourcing is about actively

creating interdependencies that add value to

both partners in the relationship. This new

transformational outsourcing recognizes that

the real power of outsourcing is in the innovations that outside specialists bring to their customers’ businesses. No longer are outsourcing

service providers simply viewed as tools for

getting more efficient or better focused; they

are seen as powerful forces for change.25

Outsourcing enables a firm to redefine its

theory of the business — what its business is,

what its objectives are, how it defines results,

who its customers are, and what the customers

value and pay for.26

The decision on which outsourcing strategy to

pursue is dependent on the firm’s vision of

where it wants to be positioned in the future

(see Figure 2-5). Whether you seek efficiencies, more focus onto the core business, or

whether you want to change the business altogether will dictate the strategy chosen. Hence,

the Outsourcing Spectrum depicted in Figure

2-3 is inadequate since it doesn’t reflect the

true potential of outsourcing on the theory of

the business. One should not look at

outsourcing in terms of cost savings, how to

do it, or who should do it, but rather in terms

of “what is our vision?” Figure 2-6 reflects this

 Strategy Objective

Tactical Seeking efficiency

Strategic Seeking focus

Transformation Seeking change

Outsourcing

Figure 2-5. Outsourcing Objectives

Figure 2-6. The New Outsourcing Spectrum
2-6

new spectrum and depicts where DoD and the

private sector lie with respect to transforming

the business. The Department is still entrenched

in looking for efficiencies and focus rather than

moving forward with the type of transformational vision required to make the changes

dictated by emerging threats and opportunities.

That vision of where you want the business to

be is captured within a corporate strategy that

seizes upon the unique resources from which a

corporation obtains and retains its competitive

advantage. According to Peter Drucker, strategy converts the firm’s theory of the business

into performance.27

What Then Is Strategy?

One can find the definition in Webster’s (see

Figure 2-7) but in the context of this treatise

this definition is simply not sufficient.

We might turn to economic models, where the

firm is defined by the answer to four essential

questions.28

• What should the firm produce?

• How should the firm produce its output?

• Whom should the firm sell to and at what

price?

• How should the firm promote its product?

To an economist, these four questions might

represent the essence of strategy. However, as

powerful as these questions are, they do not

reflect the environment the firm operates in,

the values of its management and employees,

the tools at the firm’s disposal, and the other

players whose actions are constantly shifting

the competitive landscape. In the business context we need something to motivate employees to do the right thing and manage scarce

resources in today’s ever changing environment. Strategy is the vital framework for overcoming conventional wisdom, reducing uncertainty, and integrating the firm toward one

purpose.29

Strategy also has many different meanings depending on the context; for example, in the

military, we make the distinction between national security strategy and military strategy.

Within the context of this research, an important distinction is the one between business

strategy and corporate strategy. Business strategy is focused on how a firm attains competitive advantage within an industry, or what

Michael Porter termed competitive strategy.

30

Corporate strategy is concerned with where

corporate resources are invested, seeking to

maximize the value of these resources.31 Just

as national security strategy and military strategy are interrelated, so too are corporate

strategy and business strategy, as illustrated in

Figure 2-8. Business strategy is about creating

value in one discernable market, whereas

Figure 2-7. A Strategy Definition

Strategy:

a) A careful plan or method: a clever stratagem

b) The art of devising or employing plans or stratagems toward a goal

Source: Merriam-Webster’s Collegiate Dictionary, retrieved 1 March 2001 from

http://www.m-w.com/cgi-bin/dictionary.
2-7

corporate strategy is concerned with a diversified firm. Within DoD, the Office of the Secretary of Defense (OSD) is the corporation that

would set an overarching corporate strategy,

and the Services and agencies within DoD are

the business units that set business strategies

consistent with that corporate strategy.

E. P. Learned, C. Roland Christensen, and

Kenneth Andrews are quoted by David Collis

and Cynthia Montgomery as stating that strategy fulfills two vital functions.32 First, strategy

allows a firm to position itself, externally,

relative to its competitors within a market. In

gathering a thorough understanding of this

competitive environment, a firm can match its

strengths and weaknesses to market threats and

opportunities and formulate an effective strategy. Five Forces Analysis, which we describe

later in this chapter, is an essential tool for this

undertaking. The ultimate reward is a competitive advantage. Second, according to Porter,

strategy must align internal activities and investments. The key is to establish consistency

among the various elements and activities and

in the investment choices, thereby ensuring a

process of creating competitive advantage.

According to Robert Simons, the formal processes for formulating and implementing strategy is captured in a cascading hierarchy (see

Figure 2-9).

The left-hand column describes the elements

critical to building a successful firm. Elements

flow from top to bottom in order of precedence,

which is critical. Note in particular that strategy follows a firm’s beliefs, vision, and mission; and structure follows strategy. Also note

that while decision making flows down, systems must be in place to allow feedback to flow

back up. Just as an individual listens to an internal voice when engaged in a self-evaluation,

voices and signals within the organization will

alert the firm as to adjustments that must be

made to the elements within the organization.

Clearly, the elements, or systems, must be in

alignment to attain success.

Figure 2-8. Corporate and Business Strategy Relationship

Corporate Strategy

Products and Services

to Create Value in

Product-Market A

Business

Strategy

Business

Strategy

Business

Strategy

Business

Strategy

Products and Services

to Create Value in

Product-Market B

Products and Services

to Create Value in

Product-Market C

Products and Services

to Create Value in

Product-Market D

Source: R. Simons, Performance Measurement & Control Systems for Implementing Strategy (Upper Saddle

River, NJ: Prentice-Hall, 2000), p.17.
2-8

The middle column illustrates the demarcation

between the need to do the right things (effectiveness) and the need to do things right (efficiency). The slanted line indicates that this demarcation line is not fixed, but the transition

point is certainly somewhere within the organizational and control structures established by

a firm. This also shows why questions of efficiency can only be addressed once a framework is established to ensure the firm is doing

the right things in the first place. This will become increasingly evident as we describe what

is meant by the elements to achieve strategy.

Finally, the column on the far right illustrates

where these decisions should be made. Certain

decisions must be made centrally and apply to

the entire firm. These include establishment of

a set of beliefs, the strategic boundaries of the

firm, the designation of the vision, and the strategy to attain the vision. Flowing down past this

point, decisions are increasingly the realm of

the individual business units. A slanted line

indicates that decision rights are established at

the business-unit level that have the best visibility over the pertinent information and are

in the best vantage point to act upon this information. This ability to act is essential to any

incentive system. In business, the operative

assumption is that the individual manager

shouldering this accountability is in charge of

a profit center, reaping the rewards of success

Beliefs

Vision

Mission

Strategy

Structure

Organizational

Control

Critical Performance Variables

Performance Measure

Profit Planning Process

Operating Plan

Financial Plan

Performance Evaluation

Objective vs. Subjective

Controllable/Non-Controllable

Strategic Profitability Analysis

Rewards, Incentives, Punishments

Source: Adapted from summary class notes. T. Piper, Corporate Financial Management, Program for Management Development (PMD75), Harvard Business School.

Figure 2-9. Hierarchy of Strategy

Relationship of Strategy Effectiveness Where Decision

to Other Elements vs. Efficiency Rights Reside

Doing the Right Things Strategic (Corporate)

Decisions

Doing Things Right Tactical (Business Unit)

Decisions
2-9

garnered and accountable for any negative

outcomes resulting from his or her decisions.

Strategy is the overarching plan that brings all

these elements together, ensuring they operate

as one system. We found the analysis of corporate strategy developed by David Collis and

Cynthia Montgomery brings the discussion of

strategy and the essential elements of a firm to

a coherent whole.

A Resource-Based View

of Corporate Strategy33

Corporate strategy is the way a company creates

value through the configuration and coordination of its multi-market activities.34 There are

three essential aspects of this definition: creation, configuration, and coordination. Value

creation is the ultimate purpose of a corporate

strategy. The second aspect of note is the

attention to the corporate configuration, which

in DoD would include the Services, agencies,

geographic locations, products, etc. Finally, this

framework emphasizes the need for coordination of the activities within the corporation —

every activity and decision is aimed at achieving the firm’s vision. Collis and Montgomery

have formulated what they call the Corporate

Strategy Triangle as the framework for development of effective corporate strategies (see

Figure 2-10).35

The foundations of corporate strategy are the

three sides of the triangle:

• Resources;

• Businesses; and

• Structure, Systems, and Processes.

Figure 2-10. Corporate Strategy Triangle

Source: Adapted from D. Collis and C. Montgomery,Corporate Strategy: A Resource-Based Approach (Boston:

Irwin/McGraw-Hill, 1998), p.7.

Belief

Systems

Vision

Goals &

Objectives

Resources

Businesses

Structure Systems Processes
2-10

Firms create corporate advantage when these

foundations and appropriate motivators, as set

in specific goals and objectives, are aligned in

pursuit of the vision.

Some might be tempted to assert that vision is

paramount in this hierarchy, but after a little

thought it becomes clear that in business, as in

life itself, belief systems are the predominate

element. Attaining business success, or anything worthwhile in life for that matter, is likely

to be a difficult undertaking. Strong belief systems ensure the journey is worth taking in the

first place and that the effort is worthwhile.36

These systems define the organization and are

the responsibility of the leadership structure to

communicate and reinforce. Belief systems

provide basic values, purpose, and direction for

the firm.37 Furthermore, if these systems are

lacking or sound systems are violated, any business success becomes short term. Firms that

do not have strong belief systems cannot attain

a position of competitive advantage; firms that

violate their belief systems can not sustain these

positions.

The strength of these systems goes beyond

strategy development. They serve to attract and

retain professional talent. Strong belief systems

have the power to transform a job into an

individual calling with rewards that go beyond monetary reimbursement. Working for

organizations with strong belief systems gives

people a sense of purpose. Without a strong

belief system, the drive to the vision cannot be

sustained.

The Johnson & Johnson Credo (see Figure 2-

12) is an outstanding illustration, communicating the firm’s belief system, boundaries, mission, and vision — those key elements from

which the firm’s strategy is formulated. The

Credo has been guiding Johnson & Johnson

since 1943, and with Johnson & Johnson’s

growth into the global marketplace, it is now

translated into 36 languages.38 Despite revisions, the Credo has not weakened. In fact, this

process has reinforced and strengthened the

belief systems. The Credo philosophy is what

guided the difficult decisions to pull all

TYLENOLTM products off the shelves during

the crises of 1982 and 1986.39 When Jim Burke,

then Johnson & Johnson Chief Executive Officer, was asked about the decision he said, “I

just acted in keeping with our credo and our

beliefs, so I didn’t even have to think about

it.”40
2-11

Our Credo

We believe our first responsibility is to the doctors, nurses and patients,

to mothers and fathers and all others who use our products and services.

In meeting their needs everything we do must be of high quality.

We must constantly strive to reduce our costs in order to maintain reasonable prices.

Customers’ orders must be serviced promptly and accurately.

Our suppliers and distributors must have an opportunity

to make a fair profit.

We are responsible to our employees,

the men and women who work with us throughout the world.

Everyone must be considered as an individual.

We must respect their dignity and recognize their merit.

They must have a sense of security in their jobs.

Compensation must be fair and adequate,

and working conditions clean, orderly and safe.

We must be mindful of ways to help our employees fulfill

their family responsibilities.

Employees must feel free to make suggestions and complaints.

There must be equal opportunity for employment, development

and advancement for those qualified.

We must provide competent management,

and their actions must be just and ethical.

We are responsible to the communities in which we live and work

and to the world community as well.

We must be good citizens — support good works and charities

and bear our fair share of taxes.

We must encourage civic improvements and better health and education.

We must maintain in good order

the property we are privileged to use,

protecting the environment and natural resources.

Our final responsibility is to our stockholders.

Business must make a sound profit.

We must experiment with new ideas.

Research must be carried on, innovative programs developed

and mistakes paid for.

New equipment must be purchased, new facilities provided

and new products launched.

Reserves must be created to provide for adverse times.

When we operate according to these principles,

the stockholders should realize a fair return.

Figure 2-12. Johnson & Johnson Credo

Source: Reproduced with permission. All rights reserved. Retrieved 8 March 2001 from World Wide Web:

http://www.johnson-n-johnson.com/who_is_jnj/cr_usa.html.
2-12

If strategy is the means of getting to the end

point, the firm’s vision is the beacon. The business community has adopted vision statements

as a means of stating direction and purpose. To

be effective, a vision must have some critical

characteristics. John Kotter summed these

characteristics as follows.41

• The vision must be imaginable, conveying

a picture of what the future will look like.

• The vision must be desirable, appealing to

the long-term interests of employees, customers, stockholders, and others who have

a stake in the enterprise.

• The vision must be feasible, composed of

realistic and attainable goals.

• The vision must be focused, providing

guidance in decision-making.

• The vision must be flexible, allowing individual initiatives and alternative responses

in light of changing conditions.

• Finally, the vision must be communicable

— easy to communicate.

A good test of this last element is if the vision

can be clearly and consistently explained in a

short amount of time. Kotter cites five minutes

as a benchmark. A clear illustration is the

Kodak vision cited earlier, “...Be the World

Leader in Imaging.” The vision sets the strategic boundaries of what businesses the firm

will do and not do. For Kodak that boundary is

imaging.

The vision is the long-term objective, or as in

the Kodak example, no reference is even made

to a time frame for achieving the vision. Therefore short-term goals and objectives are needed

to motivate behavior within the firm — establish achievable and visible targets. Performance

measurement and control systems are aligned

with these goals and objectives to properly

motivate and reward employee behavior. These

goals and objectives are the stepping stones

toward achieving the vision and competitive

advantage.

Competitive advantage is based on a firm’s

unique set of resources and how those resources

are used.42 A firm’s resources fall into three categories: tangible, intangible, and organizational

capabilities. Tangible assets are items like production facilities or warehouses, i.e., items you

can touch and see. On the other hand, intangible assets include brand names, trademarks,

know-how, and reputation. Organizational

capabilities are really a complex combination

of assets, people, and processes that are used

by a firm to convert input into output, typically

with better efficiency and quality then a firm’s

competitors. Wal-Mart, overall number three

on the Fortune America’s Most Admired Companies list, illustrates all three types of resources

(see Figure 2-13).43 These resources that give

a firm competitive advantage are hard to

imitate. According to Collis and Montgomery,

resources determine what a firm can do, not

what it wants to do.

What a firm can do is reflected on the “business” side of the triangle. Obviously, the business strategy within each business must align

with the overall corporate strategy. The key is

to operate in businesses that allow a firm to

share resources, capturing economies of scale

and scope. Economies of scale exist when

average cost declines as a good or service is

produced or sold in larger volume.44 To those

of us in the military, economies of scale

equate to average cost-per-unit of a weapon

system, which typically decreases as the production run increases. Economies of scope

exist when the cost of producing or selling

multiple products together is lower than the cost

of producing and selling the same quantity of
2-13

Wal-Mart gets its competitive advantage from these resources:

1) Store locations: Less expensive rent based on location of stores in areas where real estate

expense is less.

2) Brand reputation: Less advertising because it’s a “household” name.

3) Employee loyalty: Employee willingness to accept lower wage and less shrinkage (shoplifting of

merchandise by employees).

4) Inbound logistics: Use of information technology linked directly to suppliers to keep shelves

stocked on a “just-in-time” basis, and packaging of supplies such that packages do not have to

be opened and repackaged based on individual store requirements at Wal-Mart’s regional

distribution centers.

Data from P. Ghemawat, “Wal-Mart Stores’ Discount Operations,” Harvard Business School Case No. 387-018.

COMPETITIVE ADVANTAGE

Industry Average Cost

vs. Wal-Mart Cost

(Percentage of Sales)

RESOURCE

Source: Adapted from D. Collis and C. Miontgomery, Corporate Strategy: A Resource-Based Approach (Boston:

Irwin/McGraw-Hill, 1998), p. 70.

Tangible Store Locations 0.3 (store rental space)

Brand Reputation

Employee Loyalty

Inbound Logistics

1.2 (advertising expense)

1.1 (payroll expense)

0.7 (shrinkage expense)

1.2 (distribution expense)

Intangible

Capabilities

Total Advantage 4.5%*

* Each percentage point is worth $500 million in net income to Wal-Mart

Figure 2-13. Wal-Mart from a Resource-Based View

goods individually.45 Again, in the defense

industry, this relates to the drive for commonality in systems, which, when used to advantage, can lower the cost for each weapon.

Identifying scale and scope effects requires

data-driven analyses and a systematic process

called Value Chain Analysis, which we will

describe later in this chapter.
2-14

Exploiting scale and scope economies requires

profound changes in organizational structure

and systems because they depend on the sharing of resources and coordination, which brings

us to the third side of the Corporate Strategy

Triangle. Structure is the formal organizational

chart for the firm, highlighting where authority resides. Systems refer to the governing policies that guide the firm. Finally, processes are

the informal relationships involved in the dayto-day conduct of business — how things get

done in the business. The corporate strategy

dictates these features, and they must be aligned

with the resources and businesses of the firm.

With a common understanding of strategy, we

now need to look at how to formulate and

implement effective strategies.

Tools of the Trade

There are several analytical tools important

to our analysis of DoD from a business

perspective. These tools are:

• Five Forces Analysis;

• Value Chain Analysis;

• The Value Net;

• Levers of Control; and

• Game Theory.

The first three are essential to formulating an

effective strategy, while the fourth guides the

implementation of the strategy. Finally, as a

firm monitors the horizon for emerging opportunities and threats, Game Theory is an important tool for analyzing the strategic behavior

of all the players and potential players in an

industry.

Five Forces Analysis

As mentioned above, strategy allows a firm to

position itself appropriately within an industry

relative to its competitors. Figure 2-14 depicts

the leading tool in use today for analyzing the

competitive dynamics of an industry, Michael

Porter’s Five Forces Analysis. The framework

relates the profitability of the firms in an

industry to five competitive forces.46

The first force, Rivalry, looks at the intensity

of the rivalry among competitors and its effect

on the value that can be drawn from the industry. There are numerous factors that can increase the intensity of the rivalry, such as low

switching costs and low differentiation. An

excellent example of intense rivalry is found

in the soft drink war between Coca-Cola® and

Pepsi-Cola®. Switching costs are clearly low

— it’s as easy to put a dollar in the Coke® drink

dispenser as the Pepsi® one. After all, despite

all the taste tests, to most people a cola is a

cola — there is little product differentiation.

There are numerous other factors that affect the

degree of rivalry; suffice it to say that this is

one of several forces that together define the

competitiveness of an industry.

Focusing on the horizontal axis, we will describe forces that determine where the value

created in an industry is appropriated. In looking at Suppliers, one assesses the bargaining

power of the firm’s suppliers and that of the

buyer or customer within the particular market. In the mid-1980s, the sweetener industry

had one well-known product, NutraSweetTM.

47

Searle by virtue of its patent for NutraSweet

held the bargaining power. With the public’s

concern over the safety of artificial sweeteners, Searle quickly capitalized on the U.S. Food

and Drug Administration’s approval of

NutraSweet by implementing a strategy to

make NutraSweet the brand name associated

with aspartame. The sweetener rapidly became
2-15

a household name. With the patent and the

brand name in hand, Searle was able to charge

the beverage industry $70 per pound for

NutraSweet. In 1985 Monsanto acquired Searle

and the ownership of NutraSweet. As the only

supplier in the game, Searle and later Monsanto

had tremendous bargaining power over Coke

and Pepsi. In fact, you might recall the quite

visible NutraSweet symbol on a Diet Coke or

Diet Pepsi can.

On the other side of this axis is the force, Buyers and Customers. Continuing the illustration,

in 1987 Monsanto’s European patent expired,

pulling down the entry barrier for a new sweetener entrant, Holland Sweetener Company

(HSC). With HSC’s entry, the European price

for aspartame fell to $22-$30 per pound as the

rivals, Monsanto and HSC, engaged in a price

war. Suddenly, the volume buyers of sweetener

in Europe, including Coke and Pepsi, were the

benefactors of this price reduction. In 1992,

Monsanto’s U.S. patent also expired, and the

price war quickly escalated into the U.S. However, the past efforts to brand NutraSweet left

little desire by Coke or Pepsi to use a generic

aspartame, especially given the debacle of New

Coke in 1985. Neither Coke nor Pepsi wanted

the consumer to think they were tampering with

the recipe. So Coke and Pepsi signed new longterm contracts with Monsanto. Predictably,

Coke and Pepsi captured combined savings of

$200 million annually because of their increased bargaining power with two suppliers

now in the game.48

Figure 2-14. Five Forces Analysis

Source: Adapted from M. Porter, Corporate Strategy: Techniques for Analyzing Industries and Competitiors (NY:

The Free Press, 1980), p.4.
2-16

On the vertical axis, one examines the industry from the perspective of the final two forces,

the threat of new entrants and substitutes. The

key concept in analyzing new entrants is the

concept of entry barriers.49 Barriers exist when

it is difficult or economically challenging for a

new entrant to compete at the same level of the

incumbent(s). Continuing our cola war, new

entrants into the soft drink industry have found

it difficult to displace Coke or Pepsi because

these two rivals have well-established brand

names. The new entrant is unlikely to have the

resources to mount the market campaign

required.

However, a beverage company that has attempted to market a brand strongly is Snapple®.

Snapple is an example of a substitute product

that entered the market in 1972 with a differentiated offering.50 Unlike most Coke and Pepsi

products, Snapple teas and fruit-flavored drinks

are made of natural ingredients. Snapple

entered the market banking on the soft drink

industry’s low switching costs. However,

through the strength of their existing product

line and new product offerings, Coke and

Pepsi’s combined market share of the U.S. soft

drink industry has remained steady at between

74 and 75 percent over the last five years.51

Coke and Pepsi have withstood the onslaught

of new entrants and substitutes like Snapple.

In conducting a Five Forces Analysis, two factors stand out as a common theme among the

forces: cost and differentiation. In fact these

are two of the three generic strategies that

Michael Porter describes as viable choices for

dealing with the competitive forces within an

industry: overall Cost Leadership and Differentiation.

52 Porter goes on to introduce the

“value chain” template. The importance of the

value chain is its ability to disaggregate a firm

into the key activities that determine competitive advantage.

Figure 2-15. Generic Value Chain

Source: Adapted from D. Collis and C. Montgomery, Corporate Strategy: A Resource-Based Approach

(Boston: Irwin/McGraw-Hill, 1998), p. 70.
2-17

Value Chain Analysis

A firm’s value chain is a collection of activities performed by the firm to design, produce,

market, deliver, and support a product.53 In laying out a generic value chain, Porter distinguishes between a firm’s support-type activities and primary-type activities as shown in

Figure 2-15. Under each of these activity types,

any number of activities can be broken out,

depending on the level of analysis sought. In

conducting an analysis of a firm’s strategy, the

activities must be disaggregated such that the

scale and scope drivers of cost and differentiation can be identified within each activity.54 For

further understanding, one should refer to

Figure 2-16, Thermostat Value Chain Analysis.

Take for example a firm that currently manufactures only industrial thermostats, but forecasts little

growth opportunities in industrial thermostats. Yet, it does see potential growth in the consumer

household market, and is considering expanding into that market. Although an expansion from

industrial thermostats to household thermostats seems logical on the surface, the resources that

are required to support both businesses are quite different. When we look at the support and

primary activities involved in developing, manufacturing, selling, and supporting a thermostat, we

see in italics that the resources required for a home thermostat are quite different from those of an

industrial one.

• In the Technology Development support activity, an industrial thermostat requires customized

research and development (R&D) designed for each unique applicaiton, whereas a consumer

thermostat would be designed with attractiveness and user-friendly features as key emphases.

The firm had significant R&D resources, but no experience in product packaging and appearance so important to the consumer.

• In the primary activity of Production Operations, an industrial thermostat is built per a specification unique to application, while a consumer thermostat lends itself to automation and mass

production. Clearly, this expansion would not capture any economies of scale since the average

production cost is not likely to decrease because you can’t mass produce the industrial thermostat. In fact, cost may increase to operate separate production lines or to reconfigure the line for

each application.

• In the primary activities of Outbound Logistics and Marketing & Sales, an industrial thermostat is

directly sold and installed by the engineers, whereas the consumer thermostat is sold through

distributors, requiring extensive advertising and sales representatives to garner support from the

distributors. Here, economies of scope are unlikely to lower costs since you have to add new

skills to produce and sell the consumer thermostat.

• Finally, when it comes to Service, the industrial thermostat has an extensive customer support

and repair program to differentiate the product. On the other hand, the consumer version need

not require any service program.

Thus the firm has little opportunity for scale or scope economies, and should not expand into

household thermostats. Clearly, industrial and commercial thermostats are distinct business units,

requiring distinctly different resources to garner competitive advantage and capture value.

(continued)

Figure 2-16. Thermostat Value Chain Analysis55

Source: Adapted from D. Collis and C. Miontgomery, Corporate Strategy: A Resource-Based Approach

(Boston: Irwin/McGraw-Hill, 1998), p. 70.
2-18

Now one understands how Five Forces Analysis and Value Chain Analysis define the

competitive landscape in which a firm finds itself. However, as discussed earlier, business

isn’t necessarily only about competition, it’s

also about creating value. As we show in the

previously mentioned USPS co-branding

example, firms can be cooperative, thereby

expanding the value of a product or service.

Fortunately we have another tool that fosters

an understanding of the cooperative landscape.

Figure 2-16. Thermostat Value Chain Analysis (continued)
2-19

The Value Net

An expansion of the Five Forces Analysis that

addresses cooperation among firms is The Value

Net (see Figure 2-17). The significance of the

Value Net is that it introduces the concept of

complementors. A firm is your complementor

if the customer values your product more when

they have the other firm’s product or service

than when he has your product alone.56 In the

personal computer world, Microsoft® and Intel®

are complementors. The value of the WindowsTM

operating system is driven by the computing

power of the chip, and the value of the Intel

PentiumTM microprocessor is driven by the increased versatility of the software it hosts. The

relationship is so powerful to have received the

moniker, “Wintel.” Since Microsoft and Intel

are not competitors, neither firm would come

up on one another’s radar screen when conducting a Five Forces Analysis. The Value Net

tool helps identify all the players in the market, including collaborators; and more importantly, the effect these collaborators have on

value creation and who acquires that value.

Levers of Control

Once a firm formulates what it believes to be

an effective strategy, the firm must ensure the

strategy is implemented correctly in order to

create value. The more effective the strategy,

the more likely the company will attain its

objective. The strategy must not only be effective but also subject to constant review and revision — it is an iterative process. Monitoring

and controlling strategy during implementation

is achieved through the use of four levers as

shown in Table 2-1. Beliefs and Boundary Systems were discussed above. The other two

levers warrant further description.

Figure 2-17. Value Net

Source: A. Brandendurger and B. Nalebuff, Co-opetition (NY: Currency Doubleday, 1996), p. 17.
2-20

Diagnostic Control Systems are the formal information systems that managers use to monitor organizational outcomes and correct deviations from preset standards of performance.57

Balanced scorecard, project monitoring systems,

and cost-accounting systems are examples that

can be used diagnostically. One might be

tempted to ask, “How can cost-accounting

systems that are traditionally built on financial

reporting be used as a diagnostic indicator?”

In order to do so, Robert Simons emphasizes

that these systems must be capable of:

• Advance goal-setting;

• Measuring output;

• Calculating variances; and

• Using the variance information for changing

inputs and/or processes appropriately.58

As depicted in Figure 2-18, the diagnostic control system chosen must link the strategy to

intermediate goals. That link is a set of critical

performance measures that must be achieved

for the intended strategy to succeed.59 Done

correctly, the firm can operate on “autopilot,”

allowing management to focus only when a

red flag arises. The Return on Management

(ROM) is increased because less management

time and attention are invested in needless

micromanaging.

Freeing management’s time is essential so that

senior leadership can direct their energies toward growth and innovation. Businesses, like

the military, must monitor the horizon for new

threats and opportunities that can render the

current strategy useless. (Later in this chapter,

we will overview Game Theory, which is a useful set of tools a firm can use to adjust its strategy appropriate to a competitor’s likely actions.) Simons calls these threats and opportunities strategic uncertainties. Understanding

the impact of these uncertainties on the firm’s

business is about learning to adapt and change.

Diagnostic control systems and critical performance variables aren’t conducive to learning.

Interactive Control Systems are as shown in

Figure 2-19.

The distinction between critical performance

variables and strategic uncertainties is an

important one to understand. The former is

about staying on track while the latter is about

Table 2-1. Relationship of Four Levers of Control to Strategy

Control System Purpose Communicates Control of

Strategy as

Belief Systems Empower and expand Vision Perspective

search activity

Boundary Systems Provide limits of Strategic domain Competitive Position

freedom

Diagnostic Control Coordinate and monitor Plans and goals Plan

Systems the implementation of

intended strategies

Interactive Control Stimulate and guide Strategic uncertainties Pattern of actions

Systems emergent strategies
2-21

Figure 2-18. Link from Strategy to Diagnostic Control Systems

Source: Adapted from R. Simons, Performance Measurement & Control Systems for Implementing Strategy

(Upper Saddle River, NJ: Prentice-Hall, 2000), p. 210.

Figure 2-19. Interactive Control Systems Drives Learning

Source: Adapted from R. Simons, Performance Measurement & Control Systems for Implementing Strategy

(Upper Saddle River, NJ: Prentice-Hall, 2000), p. 217.
2-22

questioning whether we are still on the right

track. Table 2-2 summarizes the differences in

the two.

Interactive Control Systems are not necessarily unique systems. Balanced scorecard and

project monitoring systems can be interactive

Table 2-2.

Distinction between Critical Performance Variables and Strategic Uncertainties

Critical Performance Variables Strategic Uncertanties

Recurring What must we do well to achieve our What changes in assumptions could

Questions intended strategy? alter the way we achieve our vision for

the future?

Focus On Implementing strategy Identifying and testing new strategies

Driven By Goal achievement Top management unease and focus

Search For Effectiveness and efficiency Disruptive change

Source: Adapted from R. Simons, Performance Measurement & Control Systems for Implementing Strategy

(Upper Saddle Rive, NJ: Prentice-Hall, 2000), p. 216.

Figure 2-20. Levers of Control

Source: R. Simons, Performance Measurement & Control Systems for Implementing Strategy (Upper Saddle

River, NJ: Prentice-Hall, 2000), p. 305.
2-23

just as they can be diagnostic. However, the

criteria for an interactive system are different.

An interactive control system must have the

following criteria:

• Contains simple to understand information,

like market share;

• Provides information about strategic uncertainties, such as technology advances;

• Is accessible to managers at multiple levels;

• Generates new action plans.60

The bottom line is that an interactive control

system focuses management attention on the

key issues affecting the firm’s ability to capture

value.

The four levers are not operated upon independently. The Levers of Control model (Figure

2-20) depicts the interrelations of these levers

and how they orchestrate a firm’s behavior and

actions in implementing the firm’s strategy.

Moving clockwise, Belief Systems set the values and norms of the firm, while Boundary

Systems establish the firm’s strategic boundary based on those values and norms. In addition, Boundary Systems determine where decision rights reside within the firm. Diagnostic

Control Systems establish the proper metrics,

incentives, and rewards that enable the firm to

operate at faster pace to meet challenges of strategic uncertainty. Interactive Control Systems

allow the firm to monitor the strategic horizon

and adapt quickly through learning. Table 2-3

illustrates the likely outcomes of operating the

levers independently or without any one of

them.

Again, operated as one overarching system, the

Levers of Control allow us to deal with strategic uncertainty, which is a critical parameter

to understand in the day-to-day business

Table 2-3. Organizational Outcomes

Belief Systems Boundary Systems Diagnostic Control Interactive Control Outcomes

(Values, Norms) (Decision Rights) Systems Systems

(Metrics, Rewards) (Knowledge Flows)

– Misconduct

No Yes Yes Yes – Low Inspiration

– Poor Teamwork

– Uncertainty

Yes No Yes Yes – Power Struggles

– Indecision

– Inconsistency

– Low Motivation

Yes Yes No Yes – Passive, Slow

– Pace

– Unclear Purpose

– Poor Decisions

– Strategic

Yes Yes Yes No – Surprises

– Poor Coordination

– Low Learning

Source: Adapted from summary class notes, T. Piper, Achieving Profit Goals & Strategies, Corporate Financial

Management, Program for Management Development (PMD75), Harvard Business School.
2-24

operation. We next turn our discussion to Game

Theory — a tool that helps us understand some

of this uncertainty, namely what decisions

might our firm and the other players make.

Game Theory

Since we have identified the key players, the

tools for formulating an effective strategy, and

the levers for controlling strategy implementation, we are now ready to play the game. We

refer to it as a game; however, it is a serious

and complex game, requiring the utmost knowledge, skill, and preparation. In any game there

are players, who are the decision makers; there

are strategies, which are the choices that a

player makes; there are actions, which are

based on each player’s strategy; and there are

outcomes.

61 Game Theory is a set of tools for

analyzing the decision making in a game where

understanding the strategic behavior of players

is critical.

We use a game tree, which is an extension of a

decision tree, to help illustrate the game dynamics. We can now show a game tree for our

situation in the Prisoner’s Dilemma, Figure

2-21).

The players are Prisoner A and Prisoner B, who

each have a dominant strategy, which is the selfprotecting, risk-averse strategy similar to DoD

and its traditional relationship with private industry. Their actions are either to confess or to

keep quiet. Their prison sentences are the outcomes. Playing this pair of strategies leads to

an outcome in which both sides are worse off

than they would be if they cooperated and

Figure 2-21. Prisoner’s Dilemma Game Tree

Source: Adapted from R. Simons, Performance Measurement & Control Systems for Implementing Strategy

(Upper Saddle River, NJ: Prentice-Hall, 2000), p. 217.
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Figure 2-22. Bitter Competition

We can return to the sweetener story to illustrate the applicaiton of Game Theory in the business

world. Both the Holland Sweetener Company (HSC) and Monsanto had two strategies they could

each pursue: a price war or normal competition. If HSC chose normal competition, then Monsanto

could either respond by competing normally or cutting their prices in order to drive HSC out of the

business. The possible outcomes are shown for each scenario. The best choice is for both to engage

in normal competition. At this time (mid-1980s to early-1990s), the diet soft drink market was growing

significantly (diet soft drink was estimated to reach 50 percent of the U.S. soft drink market by 1995).62

Monsanto could not meet the worldwide demand on its own, so there was room for a second player,

especially one only interested in capturing enough value to be profitable. Thus, HSC might capture 10

percent of the market, while Monsanto would remain the industry leader. On the other hand, if Monsanto

chose to wage a price war, they risked losing some if not all of the Coca-Cola and Pepsi-Cola contracts to HSC, and they would likely be challenged by HSC for dumping or predatory pricing. Dumping

is putting a product into a market at a lower price than your home market. Predatory pricing is selling

below variable cost; i.e., you are selling at a loss. It also turns out that NutraSweet was Monsanto’s

only division turning a profit.

If HSC were to choose to engage in a price war, Monsanto again could either respond by competing

normally or cutting their prices in order to drive HSC out of the business. If Monsanto chose to ignore

HSC’s price-cutting, Monsanto would likely lose some if not all of the Coke and Pepsi contracts. As it

turns out, HSC did engage in a price war and Monsanto reciprocated likewise. As a result, HSC nearly

went under, but hung on since Coke and Pepsi were motivated to keep a second supplier in the

game.63 In fact, HSC did expand their capacity. With Coke and Pepsi signing contracts with HSC,

Monsanto lost $200 million in annual revenues.

Clearly, both HSC and Monsanto should have employed the normal competition strategy in order to

capture more value from the growing diet soft drink market.

Source: Adapted from class notes, S. Bradley, Competition and Strategy, Program for Management Development

(PMD75), Harvard Business School.
2-26

played alternative strategies. Imperfect information or a lack of information causes the

dilemma, which is indicated by the dashed oval

around Prisoner B’s two decision nodes. Prisoner B does not know what decision Prisoner

A has made: did he confess or did he keep

quiet? If neither confesses, they will be convicted of a lesser crime that is easily proven

giving each a one-year sentence as shown in

the bottom outcome. If one confesses and the

other stays quiet, the confessing prisoner will

go free and the one who stayed quiet will receive a ten-year sentence as shown in the two

middle outcomes. If both confess, each prisoner will receive a five-year sentence as shown

in the top outcome. Clearly, both prisoners are

collectively better off if they stay quiet, but

lacking information on what the other did, each

is likely to make the wrong decision and confess to avoid ten years of imprisonment. For a

further illustration of Game Theory refer to

Figure 2-22, Bitter Competition.

Summary

In this chapter, we have provided a definition

of outsourcing, but more important we have

shown the dramatic impact that outsourcing has

had in the private sector in terms of reshaping

the theory of the business. We have also defined the essential tools for defining a theory

of the business. These tools help shape the

firm’s behavior, dictate its decisions about what

to do, and define what the firm considers meaningful results. In the next chapter, we will examine more closely the ways in which the private sector formulates business strategy and the

resulting outsourcing decisions that have been

driven by that choice of strategy.
2-27

ENDNOTES

1. P. Drucker, “The Theory of the Business,” Harvard

Business Review, September-October 1994, p. 95.

2. Report of the Defense Science Board Task Force on

Outsourcing and Privatization, August 1996, p. 7.

3. Retrieved 12 March 2001 from World Wide Web:

https://www.afmia.randolph.af.mil/xpms/

HQ_AF_XPMS/candp/cspglossry.htm.

4. Retrieved 13 March 2001 from World Wide Web:

http://www.hqda.army.mil/acsimweb/ca/q&aa.htm.

5. Retrieved 13 March 2001 from World Wide Web:

http://help.n4.hq.navy.mil/StrategicSourcing.

cfm?doc=1.

6. Retrieved 12 March 2001 from World Wide Web:

http://www.dla.mil/j-8/a-76/A-76Supplementary

HandbookApp1.html.

7. Defense Science Board Task Force Report, p. 7.

8. Retrieved 12 March 2001 from World Wide Web:

https://www.afmia.randolph.af.mil/xpms/

HQ_AF_XPMS/candp/cspglossry.htm.

9. Retrieved 13 March 2001 from World Wide Web:

http://www.hqda.army.mil/acsimweb/ca/q&aa.htm.

10. Retrieved 13 March 2001 from World Wide Web:

http://help.n4.hq.navy.mil/StrategicSourcing.

cfm?doc=1.

11. Retrieved 13 March 2001 from World Wide Web:

http://www.hqda.army.mil/acsimweb/ca/q&aa.htm.

12. Retrieved 13 March 2001 from World Wide Web:

https://www.afmia.randolph.af.mil/xpms/

HQ_AF_XPMS/candp/cspglossry.htm.

13. Retrieved 13 March 2001 from World Wide Web:

http://help.n4.hq.navy.mil/StrategicSourcing.

cfm?doc=1.

14. “Ten Years of Outsourcing Practice: Tactical, Strategic, and Transformational,” Michael F. Corbett &

Associates, Ltd. Primer, retrieved 8 February 2001

from World Wide Web: http://www.firmbuilder.com/

primer/article4.asp.

15. Corbett, Ten Years of Outsourcing Practice.

16. Ibid.

17. T. Field, “10 Years That Shook IT,” CIO, Section 1,

October 1, 1999, p. 73.

18. Field, p. 73.

19. Ibid., p. 77.

20. Ibid., p. 74.

21. Retrieved 26 February 2001 from World Wide Web:

http://www.kodak.com/global/en/service/pubs/corp/

annRept97/ann977.shtml.

22. Corbett, Ten Years of Outsourcing Practice.

23. Ibid.

24. Retrieved 20 February 2001 from World Wide Web:

http://www.usps.gov/moversnet/about.html.

25. Corbett, Ten Years of Outsourcing Practice.

26. P. Drucker, Management Challenges for the 21st

Century, retrieved 1 March 2001 from World Wide

Web: http://www.jaycross/jayhoo/drucker.htm.

27. Ibid.

28. M. Katz and H. Rosen, Microeconomics (Boston:

Irwin, 1994) p. 210.

29. S. Bradley, Competitive Strategy, PMD 75 Class

Notes, Harvard Business School , 28 September 00.

30. M. Porter, Competitive Strategy: Techniques for

Analyzing Industry and Competitors (NY: The Free

Press, 1980), p. xiii.

31. R. Simons, Performance Measurement & Control

Systems for Implementing Strategy (Upper Saddle

River, NJ: Prentice-Hall, 2000), p. 16.

32. Quoted in D. Collis and C. Montgomery, Corporate

Strategy: A Resource-Based Approach (Boston:

Irwin/McGraw-Hill, 1998), p. 26.

33. This section draws heavily from Chapters 1, 2, and

3 of the Collis and Montgomery work.

34. Collis and Montgomery, p. 5.
2-28

35. Ibid., pp. 7-10.

36. Lecture by T. Piper, Corporate Financial Management, Program for Management Development

(PMD75), Harvard Business School, 17 November

2000.

37. R. Simons, Levers of Control (Boston: Harvard

Business School Press, 1995), p. 34.

38. Retrieved 8 March 2001 from World Wide Web:

http://www.johnson-n-johnson.com/who_is_jnj/

cr_index.html.

39. Class notes from T. Piper, Corporate Financial Management, Program for Management Development

(PMD75), Harvard Business School.

40. W. Creech, The Five Pillars of TQM: How to Make

Total Quality Management Work for You (NY:

Truman Talley Books/Dutton, 1994), p. 445.

41. J. Kotter, Leading Change (Boston: Harvard

Business School Press, 1996), p. 72.

42. Collis and Montgomery, p. vii.

43. Fortune’s America’s Most Admired, retrieved 1

March 2001 from World Wide Web: http://www.

fortune.com/index.jhtml?%2Ffortune%2Fuser_

session.channel=Home&_D%3A%2Ffortune%2

Fuser_session.channel=+&search_type=&channel

=&co_id=&list_frag=&channel_temp=Home&

prev_list=&txtSearchFortune=Find+Story&txt

SearchQuote=Get+Quote&fortune_list=2&_D%3A

fortune_list=+&range_value=1&bottom25=976&

disp=yes&_DARGS=%2Fgl_left_nav.jhtml.

44. Collis and Montgomery, p. 63.

45. Ibid.

46. This section draws heavily from Chapter 1 of M.

Porter, Competitive Strategy: Techniques for

Analyzing Industries and Competitors (NY: The Free

Press, 1980) and Chapter 2 of P. Ghemawat, Strategy

and the Business Landscape: Core Concepts (Upper

Saddle River, NJ: Prentice-Hall, 2001).

47. The sweetener industry analysis is from A.

Brandendurger and B. Nalebuff, Co-opetition (NY:

Currency Doubleday, 1996), pp. 72-76.

48. A. Brandendurger and B. Nalebuff, Co-opetition

(New York: Currency Doubleday, 1996), p. 75.

49. Ghemawat, p. 28.

50. Data retrieved on 26 March 2001 from the World

Wide Web: http://snapple.com/yum/beststuff.html.

51. Data retrieved on 22 March 2001 from the World Wide

Web: http://www.beverage-digest.com/editorial/

datastats.html.

52. Porter, p. 35.

53. This section draws heavily from Chapter 2 of M.

Porter, Competitive Advantage: Creating and

Sustaining Superior Performance (NY: The Free

Press, 1985).

54. Adapted from Collis and Montgomery, p. 70.

55. Adapted from Collis and Montgomery, pp. 69-71.

56. Adapted from Brandendurger and Nalebuff, p. 18.

57. Simons, Levers of Control, p. 59.

58. Simons, Performance Measurement & Control

Systems for Implementing Strategy, p. 209.

59. Ibid.

60. Adapted from Simons, Performance Measurement

& Control Systems for Implementing Strategy, pp.

220-221.

61. This section draws heavily from Appendix 15A of

M. Katz and H. Rosen, Microeconomics, pp. 544-

563.

62. Harvard Business School Case No. 9-794-083, Bitter

Competition: The Holland Sweetener Company

versus NutraSweetTM (E), April 11, 1995.

63. Brandendurger and Nalebuff, p. 76.
3-1

3

BUSINESS APPROACHES

TO STRATEGY, INTEGRATION,

AND OUTSOURCING

“One can be Captain of his ship but

one can never be Captain of the Ocean.”

 — Anonymous

Introduction

In Chapter Two we described various models

used to devise strategy. This included an overview of the enabling elements of strategy, such

as belief systems, vision, and mission. In this

chapter we use these models and elements to

describe how business strategies are formulated

in the commercial world and how integration

and outsourcing decisions are made in light of

these decisions. Later we will apply these same

principles to the Department of Defense (DoD).

For now however, it is important to show that

business structure, including the size and scope

of the firm, is driven by business strategy.

As has been stated, firms seek to gain a

competitive advantage. Decisions on which

activities to do internally and which to outsource are made in light of strategic objectives.1

While DoD — through the process set forth in

the Office of Management and Budget (OMB)

Circular A-76 (A-76) — emphasizes cost when

making these decisions, business management

literature emphasizes that lower costs should

not be the primary or the only goal of outsourcing. Michael Corbett [1995] lists the following

goals in descending order of importance:2

1. Improving Business Focus;

2. Gaining Access to Superior Capabilities;

3. Accelerating Re-Engineering Efforts to

Reduce Cycle Times and Improve Quality;

4. Sharing Risks;

5. Reducing Operating Costs;

6. Converting Capital Investments in NonCore Functions into Operating Expense;

7. Gaining Better Control Over Functions

That Are Not Meeting Performance Goals

or Customer Expectations.
3-2

Note that reducing cost is listed fifth. While

this may come as a surprise to many (especially

to those of us in DoD), there are some compelling reasons why successful, responsive, and

highly profitable companies do not make integration and outsourcing decisions solely on the

basis of cost.

We begin by exploring why this is so. This starts

with an examination of the economic forces

that limit the optimal size of the firm and

necessitate outsourcing. From there, the discussion goes beyond economics and resources

to elements of strategy covered in the previous

chapter. For successful businesses, structure is

driven by strategy, not by financial plans.

Outsourcing and integration decisions go beyond economic models and cost comparisons.

Such decisions do not lie within the realm of

bean counters and bookkeepers.

All firms outsource. The key is to understand

how to do it in such a way as to yield the greatest

strategic advantage to the firm.

Limits to the Size of the Firm

We have made the point that effectiveness must

take precedence over efficiency. Accepting this,

one might be tempted to think that the greater

the degree of control, the greater the degree of

effectiveness one can exercise. If the overarching goal is to be effective, why outsource at

all? The answer is that there are limits to what

any organization can effectively do. Strategy

requires focus and focus requires that some

activities be performed outside the firm. In

this section, we will examine what constrains

the size of the firm and what factors cause

diminished effectiveness as size increases.

The firm’s resources are of course finite. Strategy, in its essence, is a series of carefully crafted

premeditated decisions that will most effectively employ these resources in order to gain

a superior position in the market. Any item,

including a simple pencil, represents the application and coordination of a nearly infinite

array of resources and activities (see Figure 3-

1, “I Pencil”). No one entity — even if it were

staffed by the top graduates of the top business

schools — can effectively coordinate all the

resources it takes to manufacture a simple pencil, let alone a complex weapon system. One

key to attaining a competitive advantage is to

determine where the business should position

itself, given its resources, to create value and

then capture a portion of the value created.3

The lesson we draw from “I Pencil” is that

assembling and controlling all the resources to

make a pencil would be capital-intensive and

require a wholly unworkable administrative

hierarchy. Instead of one vast vertically integrated firm, many firms are involved in various aspects of pencil manufacturing. Additionally, market forces control the activities of these

many companies far more effectively than one

central entity could. To secure a place in the

writing instrument business, the pencil manufacturer can rely on other firms to produce the

necessary inputs. The company need not integrate into forestry, graphite mining, and heavy

equipment manufacturing. Other companies

specialize in these markets.

But for a moment assume that the (fictitious)

ABC Pencil Company did decide to backwards

integrate into these activities. In addition to the

cost of the fixed assets, administering such a

conglomeration of business activities would be

exceedingly burdensome. Corporate staffs to

oversee these diverse activities represent a cost

to the firm. Still more costs are involved in a

myriad of coordination matters such as transfer pricing, combining purchases, and consolidating financial statements. Such home office

functions are, in essence, information processing activities and they come with a cost that

must be allocated to the goods the business
3-3

Excerpt from “I Pencil”4

I am a lead pencil — the ordinary wooden pencil familiar to all boys and girls and adults who can read

and write.

Writing is both my vocation and my avocation; that’s all I do.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind

produced in the U.S.A. each year.

Pick me up and look me over. What do you see? Not much meets the eye — there’s some wood,

lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.

Innumerable Antecedents

Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain

all my antecedents. But I would like to suggest enough of them to impress upon you the richness and

complexity of my background.

My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern

California and Oregon. Now contemplate all the saws and trucks and rope and the countless other

gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and

the numberless skills that went into their fabrication: the mining of ore, the making of steel and its

refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to

heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising

of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!

The logs are shipped to a mill in San Leandro, California. Can you imagine the individuals who make

flat cars and rails and railroad engines and who construct and install the communication systems

incidental thereto? These legions are among my antecedents.

Consider the millwork in San Leandro. The cedar logs are cut into small, pencil-length slats less than

one-fourth of an inch in thickness. These are kiln dried and then tinted for the same reason women put

rouge on their faces. People prefer that I look pretty, not a pallid white. The slats are waxed and kiln

dried again. How many skills went into the making of the tint and the kilns, into supplying the heat, the

light and power, the belts, motors, and all the other things a mill requires? Sweepers in the mill among

my ancestors? Yes, and included are the men who poured the concrete for the dam of a Pacific Gas &

Electric Company hydroplant which supplies the mill’s power!

Don’t overlook the ancestors present and distant who have a hand in transporting sixty carloads of

slats across the nation.

Once in the pencil factory — $4,000,000 in machinery and building, all capital accumulated by thrifty

and saving parents of mine — each slat is given eight grooves by a complex machine, after which

another machine lays leads in every other slat, applies glue, and places another slat atop — a lead

sandwich, so to speak. Seven brothers and I are mechanically carved from this “wood-clinched’”

sandwich.

My “lead’” itself — it contains no lead at all — is complex. The graphite is mined in Ceylon. Consider

these miners and those who make their many tools and the makers of the paper sacks in which the

graphite is shipped and those who make the string that ties the sacks and those who put them aboard

ships and those who make the ships. Even the lighthouse keepers along the way assisted in my birth

— and the harbor pilots.

Figure 3-1. “I Pencil”

(continued)
3-4

produces. Instead of internalizing these functions and activities, market forces, through the

invisible hand of a free economy, process information far more efficiently than a staff of

people trying to orchestrate them (see Figure

3-2, The Problem With Planned Economies).5

Resources are moved to where they are needed

by the forces of the market.

Finally, while more difficult to measure, there

is also a cost in lack of management focus and

purpose. Are we a pencil company? Are we a

logging company? Are we a mining company?

What is our core function? Reliance on the

market allows the company to focus on a specific range of activities that it does best. This

boils down to the old truism: you can do a few

things well or many things poorly.

“I Pencil” is, of course, an extreme example

but it is provided to illustrate a point. Firms do

not necessarily gain competitive advantage

Figure 3-1. “I Pencil” (continued)

The graphite is mixed with clay from Mississippi in which ammonium hydroxide is used in the refining

process. Then wetting agents are added such as sulfonated tallow — animal fats chemically reacted

with sulfuric acid. After passing through numerous machines, the mixture finally appears as endless

extrusions — as from a sausage grinder — cut to size, dried, and baked for several hours at 1,850

degrees Fahrenheit. To increase their strength and smoothness the leads are then treated with a hot

mixture which includes candelilla wax from Mexico, paraffin wax, and hydrogenated natural fats.

My cedar receives six coats of lacquer. Do you know all the ingredients of lacquer? Who would think

that the growers of castor beans and the refiners of castor oil are a part of it? They are. Why, even the

processes by which the lacquer is made a beautiful yellow involves the skills of more persons than one

can enumerate!

Observe the labeling. That’s a film formed by applying heat to carbon black mixed with resins. How do

you make resins and what, pray, is carbon black?

My bit of metal — the ferrule — is brass. Think of all the persons who mine zinc and copper and those

who have the skills to make shiny sheet brass from these products of nature. Those black rings on my

ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the

center of my ferrule has no black nickel on it would take pages to explain.

Then there’s my crowning glory, inelegantly referred to in the trade as “the plug,” the part man uses to

erase the errors he makes with me. An ingredient called “factice” is what does the erasing. It is a

rubber-like product made by reacting rape-seed oil from the Dutch East Indies with sulfur chloride.

Rubber, contrary to the common notion, is only for binding purposes. Then, too, there are numerous

vulcanizing and accelerating agents. The pumice comes from Italy; and the pigment which gives “the

plug” its color is cadmium sulfide.

No One Knows

Does anyone wish to challenge my earlier assertion that no single person on the face of this earth

knows how to make me?

— Leonard E. Read

“I, Pencil” by Leonard Reed is reprinted with permission of the Foundation for Economic Education. It can be

found in its entirety at: http://www.fee.org/about/ipencil.html
3-5

through integration and control. In fact, by

needlessly integrating, management may lose

control. Instead, firms gain a competitive advantage by understanding the tangible, intangible, and capability resources at their disposal

and how most effectively to apply them.

In economic terms, this means a business must

understand not only the benefits of integration

but also the relative costs. This is especially

difficult in the public sector where resources

are measured in terms of consumption rather

than in terms of the marginal value they

produce. Figure 3-3 graphically displays this

relationship.

Figure 3-3. Limits to the Size of the Firm

Increasing Firm Scope

Source: D. Collis and C. Montgomery, Corporate Strategy: A Resource Based Approach (Boston, MA: Irwin

McGraw/Hill, 1998), p. 119.

Figure 3-2. The Problem with Planned Economies

Bureaucratic inefficiency is not unique to business. Communist states, with their planned economies

saw their domestic production outstripped by market economies. While in theory a planned economy

could reach an optimal production plan if the central planner knew production possibilities of all the

firms, in practice such information was not available and the bureaucratic apparatus could not keep

pace with market forces. Additionally, when workers do not reap the benefits of their productivity,

incentives shift from maximizing profits to maximizing their own welfare.6Economists use the term

moral hazard to describe this behavior. Moral hazards also apply to the planners. Bureaucrats seek to

maximize their welfare by expanding the size, rather than the value creation, of their agencies. In

much the same way that companies compete for market share, bureaucrats compete for finite public

funds.7 This applies not just to communist societies. It is prevalent in all public agencies and is often

cited as a reason for privatization of government services in the United States.8 Any entity run as a

cost, vice a profit, center is vulnerable to moral hazards.
3-6

Note that as the scope of the firm expands, so

too do the administrative/hierarchy costs. Ensuring that the costs of performing the activity

do not exceed either the benefit derived or the

market price of the good or service is critical

to integration or outsourcing calculations. Too

often, companies (DoD included) do not capture the hierarchy/governance costs associated

with integrating or divesting the activity. Instead, the focus is only on the direct inputs involved. The rationale is often framed in these

terms: Company X wants to charge me $100/

week but if we were to perform this function,

calculations indicate it would only take two of

my people a total of four hours a week at $20/

hour plus $10 per week in materials. One hundred dollars vs. ninety — let’s do the work inhouse.

Unfortunately, this approach leaves many elements out of the calculation. Can our people

do the job as well? What are the missed opportunities of not employing these people four

hours a week on other activities? What is the

cost of the shifting work schedules around this

new activity? Is four hours an over-optimistic

number? What oversight costs does this new

activity represent? Just as behind the warrior

there lies a support structure, behind the laborer

there lies a similar support structure. These

administrative and governance costs must be

recognized in any financial assessment. Unfortunately, these costs are often difficult to measure (see Figure 3-4).

Figure 3-4. Capturing Governance Costs with Accounting Systems

When initially implementing an activity, management generally has a clear understanding of the direct

costs to the firm. The budgeting process accounts for the cost of additional personnel, office equipment,

facilities, etc. However, the governance costs associated with the new activity are far more difficult to

capture. The firm may estimate that 20 percent of a manager’s time is spent on the new activity and

allocate cost accordingly, but this is only an estimate. Even if this figure were completely accurate,

what other activities might suffer because management attention was diluted by 20 percent?

Unfortunately, organizational dynamics are not as organized and compartmentalized as accounting

models would indicate. With one-fifth of management attention gone, other activities may suffer by a

proportional or a non-proportional amount.

When making an outsourcing decision, it is equally difficult to determine the governance costs

associated with the activity to be moved outside the firm, especially if that function is integrated or

divested incrementally. While Activity Based Costing (ABC) and other techniques have helped to put

a price tag on activities, such systems measure not the activity but more accurately, the capacity for

performing that activity.9 Reversing the previous situation, it’s easy to eliminate the direct costs of an

activity but difficult to get rid of 20 percent of a manager. Increased management focus on the remaining

activities may provide a benefit, but projected benefits are difficult to predict and are not generally

addressed in traditional business case analysis.

Of course, increasing the capacity of an accounting system to more accurately measure governance

costs might produce a more accurate business case but to do so would represent an additional

hierarchical cost in and of itself. The cost of an accounting system built to ever increasing levels of

detail would rapidly exceed the benefit to management.10 These systems are abstractions that will

never be completely accurate in their ability to identify the costs associated with governance activities.

They will never be able to completely capture the missed opportunity costs of employing resources

(labor or capital) for one function and forgoing another. No one can know with certainty the true costs

of an activity.
3-7

Analysis of Vertical Integration11

Clearly, there are diminishing returns to the firm

as it expands into more and more areas. How

then does a firm decide what activities it will integrate and what activities it will look for in the

marketplace? In their book, Corporate Strategy,

David Collis and Cynthia Montgomery offer a

series of steps that help to frame this decision

process. This model is depicted in Figure 3-5

and described in the following paragraphs.

Step One –

Disaggregate the Supply Chain

The first step in this analysis is to disaggregate

the industry supply chain into all the steps that

are physically capable of being separated. This

includes not only production activities but also

support and infrastructure activities such as data

processing, payroll, facilities maintenance, procurement, logistics, etc. Once this is done, each

activity can be carefully evaluated by posing a

series of questions.

Step Two – Assess the Market

Is there a reliable market that can provide the

goods or service? What is the capacity of the

market? Is there a possibility that the market

could fail or be taken over by a competitor?

These are among the questions that must be

posed in order to gauge the availability and

dependability of providers outside of the firm.

If there is no viable market, the activity must

be performed internally, an outside supplier (or

suppliers) developed, or the activity may be

discontinued. If, on the other hand, there are

only one or two other sources, suppliers might

hold the company hostage, demanding high

prices, or a competitor could buy up market

capacity to gain an advantage.

This applies not only to protecting current

market share but also staking out potential

markets. This was exactly what happened when

a small company named Minnetonka developed

Softsoap® liquid soap. Big industry players

such as Procter & Gamble and ColgatePalmolive soon noticed the success of this product. However, they were precluded from entering the market because, in a strategic move,

Minnetonka had locked up the total annual

production of the only two suppliers who manufactured a critical element of the soap bottle:

the little plastic pump. This represented a $12

million order — at the time, more than

Minnetonka’s net worth. However, the gambit

was successful. Lacking the pump, competitors could not enter the market. This gave

Minnetonka 18 months to establish and

maintain a strong market position.12

If there is a chance the market will fail, the

activity may have to be integrated. This is often more expensive but the extra cost mitigates

risk. This may mean complete integration so

that the capacity of the integrated activity can

satisfy all firm requirements or it may mean a

partial integration so that the firm will retain a

safety production capacity in the face of a

partial market failure.

Step Three –

Assess the Need for Coordination

If there is a viable market and no strategic risk

of failure, the next step is to determine if a need

exists for intensive coordination. Examples of

coordination needs are products that may need

to be jointly modified in order to maintain successful interface and integration. This is particularly critical in cutting edge technologies

where breakthroughs are dependent on modifying numerous components simultaneously.

For years IBM worked on this principle.

Advances in its mainframe computers were

coordinated among internal hardware manufacturing, operating system development, application software, sales, and service. Closed
3-8

Figure 3-5. Choosing the Scope of the Firm

Source: D. Collis and C. Montgomery, Corporate Strategy: A Resource Based Approach (Boston, MA: Irwin

McGraw/Hill, 1998), p. 128.
3-9

architecture and vertical integration propelled

IBM to the top of the mainframe market and

for years was the mainstay of the IBM Empire. Later, in a strategic blunder, IBM broke

this structure without taking into account the

consequences.13

Step Four –

Assess the Importance of Incentives

Given that there is no market failure and no

need for coordination that can’t be gained

through market mechanisms (i.e., spot markets,

long-term contracts, alliances, or joint ventures), management must now examine the

benefit derived from maintaining the activity

in-house against the cost. Governance costs

must be assessed and compared to the benefit.

For example, in a manufacturing plant, employing an electrician may be beneficial in that the

person works exclusively for the company and

is on call anytime there are electrical problems.

Having equipment down is costly. The inventory costs associated with activity are likely

small, and governance costs insignificant. Furthermore, there is an effective incentive scheme

to insure a sufficient level of performance. If

the electrician’s work is unsatisfactory, there

are other qualified electricians who can be

hired.

But sometimes the governance costs are high

and reliance on the market would provide for a

more effective incentive system. In the last example, we cited the example of an electrician.

Now let’s consider grounds maintenance of a

large facility such as a college campus where

there are considerable fixed and governance

costs. Equipment must be purchased and maintained. A supervisor is needed to schedule, inspect, hire and fire. Additionally, incentives do

not work as well. We could hold the individual

electrician accountable for all electrical work

performed. Now accountability is spread to a

whole department and operating the grounds

maintenance department as a cost center means

that there is not a strong incentive to garner a

high return on the resources allocated as is the

case with a profit center. In this instance,

outsourcing provides a stronger incentive system. A grounds maintenance contract eliminates the need for investment in equipment and

management of an activity. Additionally, management need not be focused on such ancillary

activities as cutting the grass.

Leveraging market incentives applies not only

to support activities typically thought of as

overhead, but also to direct activities. This is

the idea behind franchising. A company like

McDonalds, in order to maintain a world-wide

chain of restaurants, would face huge capital

expenditures. Additionally, once built,

McDonalds likely could not institute an enterprise-wide incentive system that would garner

optimal performance. Instead, the mechanism

of franchising taps into local capital and the

market provides the franchise owner with

entrepreneurial incentives that are more powerful than could be administered by the corporation. Franchising also carries the advantage

of spreading risk and allows for more rapid

market growth than would otherwise be

possible.14

Step Five – Determine if the Activity

Will Garner a Competitive Advantage

This is the most critical element of this decision model. Even if one were able to measure

integration costs and benefits with complete

accuracy, the information would not be sufficient to make an outsourcing or integration

decision. The business environment is fluid, not

static. Economic models are snapshots of data,

and economic analysis typically assumes

rational players and generally isolates one variable while holding all other things equal. However, players aren’t always rational, and all

things are not necessarily equal. The game is
3-10

always changing, and businesses must take into

account the movement and actions of competitors, suppliers, customers, and complementors.15

When asked the key to his success as a hockey

player, Wayne Gretzky stated that he doesn’t

skate to the puck, rather he skates to where the

puck will be. As we saw in Chapter One, the

world marches on at an increasingly dizzying

pace. The range of opportunities and the business theory and models to exploit them are

constantly changing. Understanding and conceptualizing these dynamics is the key to

gaining a competitive advantage.

In addition to market dynamics, there are other

powerful considerations that must be addressed. These considerations go beyond a

clinical view of resource employment, market

failure, incentives, and transaction costs, extending to elements that, while more difficult

to measure, have more power over an organization. These are the elements that allow organizations that possess the same resources to

perform on different levels, and they go back

to the basics of strategy development.

In Chapter Two, we outlined an order of

precedence that began with belief systems,

vision, and mission. From these elements,

strategy is developed; and from strategy, structure is derived. Therefore, before continuing a

discussion of how industry makes integration

and outsourcing (i.e., structural) decisions, we

need to explore the dynamics of the elements

from which business strategies are developed.

In the following paragraphs, we describe elements in the strategic equation that must be

understood before beginning an outsourcing or

an integration exercise.

Creating and Capturing Value

As discussed in Chapter Two, the object of strategy is to position the business in such a way that

it can capture value in a fluid environment that

is affected by the actions and interactions of

various players (i.e., suppliers, buyers, competitors, substitutes, complementors, new

entrants, and the government/public). This is

far more challenging than a zero sum game like

chess where there are only two players, and

only one winner and one loser (or a draw). The

business world, in contrast, represents a positive sum game, which can be far more rewarding. When optimally structured, business

creates value. There can be many winners.16

Positioning the business in such a way that it

interacts with other businesses to create value

makes capturing value a much easier proposition. In their book, Co-opetition, Adam

Brandenburger and Barry Naelebuff make the

point that business is not war, nor is it peace.

Instead, business is about understanding the

value that each player brings to the table. Understanding this value proposition is an essential element in determining the best position

for the business to occupy.

Businesses and individuals typically make

these value determinations without necessarily linking them to strategy. For example, management understands it needs a set of talents

and skills in order to operate. It can acquire

those talents or skills through hiring or it can

develop them within the current pool of employees. People are then placed into positions

where their individual expertise will produce

the most economic benefit for the present or

they are put in training programs where the talents developed will gain the firm benefits in

the future. Airlines, for example, hire pilots to

fly because this is where most value is derived

from their skills. The same is true for trained

mechanics, flight attendants, and investors.

Each contributes a resource and each expects a

return based on the comparative value that he

or she brings to the table.
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The fact of the matter is that these players will

receive a return based not on what resources

they bring, but on what value the firm creates

and what value the firm can capture with those

resources. Combined in the right way, these resources create value. To the flying public, that

value represents a service they are willing to

pay for. Some airlines are more successful than

others, not because they have greater resources

but because they are structured and positioned

in such a way to provide greater value to the

consumer. Witness tiny Southwest Airlines.

This Dallas-based airline enjoys a strong reputation and consistently scores at the top of travel

surveys and rankings of most-admired companies (See Table 3-1). Additionally, it has the

lowest rate of complaints filed at the U.S. Department of Transportation (DOT), year after

year.17 Southwest receives top ratings not because it has more planes or more terminals or

more amenities but because it offers low prices

on point-to-point routes and airplanes that run

on a reliable schedule. Put another way, it offers

better value.

Some, especially in DoD, may be tempted to

say the key to Southwest’s success is its low

price structure, but this ignores the fact that

many other airlines have tried to imitate

Southwest’s business model, yet they haven’t

attained the success Southwest enjoys. Southwest is able to take the same inputs available

to any other competitor and create a better

value. Why? It stems from the fact that value

creation goes beyond totaling the sum of the

parts. In the value creation process, organizations combine not one but three essential

ingredients: resources, processes, and culture.18

Resources, as we have stated, are inputs brought

to the table by the individual players. Processes

(or what Collis and Montgomery termed systems) refer to the mechanisms for combining

and arranging these resources. Much attention

has been focused on process improvement in

the business community and in DoD. Process

improvement programs such as Total Quality

Management (TQM), Just-in-Time (JIT), and

Enterprise Resource Planning (ERP) are aimed

The top domestic and international carriers rated in a survey of airlines and their services.

Top reputation rating = 100.

Rank Airline Rating

1 Southwest 75.0

2 Delta 70.0

3 American 69.5

4 United 67.2

5 Continental 66.0

6 Northwest 65.9

7 America West 64.8

8 Trans World 63.3

9 US Air 62.9

10 Alaska 61.6

Table 3-1. Rating the Airlines
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at creating efficient, reliable processes that will

generate the greatest yield in quantity and

quality for any given input.

There is a third ingredient — culture — that is

less tangible but acts as a significant multiplier

of resources and processes in the quest for value

creation. Culture is deeply rooted in the beliefs

and values of the organization and it is arguably the reason why, given similar resources

and processes, other airlines have not matched

the value Southwest creates and captures.

For those of us in DoD, there are many examples of the power of culture that are closer

to home. Take two ships, two fighter squadrons, or two infantry brigades. Each has approximately the same resources and the same

processes yet one consistently outperforms the

other. Why? It is because the command culture of one unit is superior to that of the other.

Be they soldiers, sailors, airmen, or marines,

they are outperforming their counterparts

because of this intangible force.

Instilling this culture is, of course, a primary

function of leadership and part of what distinguishes leadership from management. Intangibles cannot be managed in — nor can effectiveness. Leaders are the people who do the

right things. The function of management, on

the other hand, emphasizes doing things right.

Strategy starts with leadership.

Understanding the broad context of the previous discussion is critical to any discussion of

outsourcing. Successful companies outsource

as a tool by which to focus their resources,

processes, and culture on the value creation

process. But this is a double-edged sword.

Outsourcing can also contribute resources that

are lower priced but of less value. Outsourcing

can integrate processes that, while less expensive, are inferior. Most devastating of all,

outsourcing has the potential to weaken the

beliefs and values that make up a strong

corporate culture. Conversely, integrating —

bringing activities in house — and not outsourcing can dilute valuable resources; maintaining too many activities can skew processes;

and doing too many things can weaken an

organization’s culture. Keeping this in mind, it

becomes easier to understand why cost reduction is not the primary objective of outsourcing

decisions and why integrating too many

activities can have an equally adverse effect.

Strategy Drives Structure

In the last chapter we discussed the Kodak

Corporation. Its vision is to “be the World

Leader in Imaging.” From this vision flows

Kodak’s strategic objective: to be unique. This

differentiation is one of the three generic strategies that Michael Porter lists in his two books:

Competitive Strategy and Competitive Advantage. In addition to differentiation, Porter describes two other generic strategies: cost leadership and focus (see Figure 3-6).19 While there

are obviously variations on these strategies as

they are applied from one company to the next,

they serve as a good reference point for a

discussion of basic strategy and how the

structure of the firm is tailored to that strategy.

Porter’s Three Generic Business Strategies

Differentiation Focus Cost Leadership

Figure 3-6. Generic Strategies
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Differentiation

Firms sell to markets where there can be many

competitors. The advantage of a firm pursuing

a differentiation strategy is that it is perceived

to be unique and set apart in some way. A firm

pursuing such a strategy will make a determination of what buyers value in a given industry.20 Providing this value sets the firm apart

from its competitors and it is also by providing

this unique value that the firm is able to charge

a premium price. This is why Kodak does not

compete on price. Kodak competes on quality.

This quality may be real or perceived. Many

companies offer products that are arguably of

no better quality than that of its competitors

but these companies have successfully communicated an illusion of superiority. Customers

acting on this perception will exhibit a preference in their buying habits. Even though there

is no discernable difference in the products,

customers associate the product with value.

Brand Image

This is why a company that differentiates takes

great care to build, cultivate, and reinforce a

strong brand image. It is the brand that

communicates the value of the product to the

consumer, and it is the reason that acquiring

firms will pay a premium for a company

product or service with a strong brand name

(see Figure 3-7). Differentiators take great care

to ensure the brand name communicates value.

This is no accident. It is part of a deliberate

strategy and companies that become distracted

from this strategy tend to suffer. This is exactly

what happened to Black and Decker when they

acquired the Housewares Division of General

Electric (GE) in 1984. In their move “from the

garage to the house,” the Black and Decker

brand name was applied to such items as

vacuum cleaners, irons, and toaster ovens. This

had a disastrous effect on sales of Black and

Decker’s line of power tools, especially among

skilled tradesmen (plumbers, electricians, carpenters, etc.). The Black and Decker brand

name did not elevate the status of Dustbuster®

vacuum cleaners. Instead, it diminished the perceived quality of a heretofore-respected line of

power tools.21

Black and Decker’s experience resonates in two

respects. First, it shows the power of a brand

and what can happen if that brand is diluted.

Secondly, it shows that even if the acquisition

of GE Housewares made sense on paper, there

are some powerful intangible forces that must

be taken into consideration even if they are not

readily measurable. Black and Decker’s

strength was its expertise in tools and hardware.

This translated into a brand name and line of

In many instances, intangible assets such as patents or a strong brand command a premium when the

firm is acquired by another entity. This is because, just as a secure patent offers a competitive advantage, so too does a good name. Goodwill represents the price an acquiring firm will pay over the fair

market value of the target company’s assets. Goodwill is recorded on the balance sheet and then

amortized over a number of years. This phenomenon also helps to explain why the market value of a

company’s stock may exceed the book value of the firm, even when the value of future earnings are

taken into consideration.22 This is why when Sandoz Ltd. acquired Gerber, a maker of baby food with

a strong brand name and 70 percent of the U.S. baby food market, it was willing to pay $3.7 billion or

33 times Gerber’s annual profits.23

Figure 3-7. Goodwill
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products that denoted quality. This was their

competitive advantage. By expanding into a

line of home appliances, this advantage was

lost.

Brand image not only helps to sell products, it

is also a powerful force for attracting talent.

People who want to be the best in their chosen

career fields are attracted to organizations that

have a reputation for being the best. The top

accounting firms, the most respected law firms,

and the leading technology firms are at an advantage when recruiting the best accountants,

lawyers, and engineers. However, this advantage is nullified when these companies recruit

talent in areas where their brand doesn’t apply

(e.g., a technology leader hiring highly talented

lawyers).

Integrating and Outsourcing

With this in mind, those pursuing a differentiation strategy should avoid integrating into

areas that might dilute the value of its brand

and products (value being defined by the customer). Conversely, the differentiator may consider outsourcing into areas that strengthen or

reinforce that value. This explains why firms

may outsource activities that may be performed

more economically in house. For example, if

customers value fast delivery, a firm may consider outsourcing logistics and manufacturing

functions if doing so shortens delivery time.

This is because the firm focuses not on cost

but on the premium it can demand for faster

service.

Outsourcing may also be a mechanism to allow managers to concentrate on areas that customers value. In the case of Kodak, outsourcing

automated data processing (ADP) allowed the

company to concentrate on what Kodak is

known for: quality imaging. For the

differentiator, the enhancement of its ability to

set itself apart is at the crux of any outsourcing

decision. For the differentiator, this is the path

to advantage and profitability.

Cost Leadership

A second generic strategy identified by Porter

is cost leadership. We spend considerable time

on this strategy because while it seems clear,

there are numerous strategic implications to

consider. Pursuing cost leadership without

understanding these implications has been the

downfall of many of the companies we have

studied. Before delving into how cost leaders

structure their companies and make integration

and outsourcing decisions, it is important to

step back and apply some of the strategic

analysis introduced in Chapter Two.

Market Analysis

Firms seek to gain a competitive advantage

through lower cost. The assumption is that the

customer values low price above all else. This

is a critical assumption and one that should not

be taken lightly. Often only one segment of the

market makes a buying decision solely on price

(for example people who buy generic or private

label aspirin versus national brands). Market

analysis may point to other segments of the

market that value aspects other than price.

These segments may offer more lucrative

opportunities.

After competing on price alone, Mobil® Oil, a

refiner and gas retailer, used market research

to ascertain that only 20 percent of buyers valued price alone. Instead of going after this fickle

20 percent, Mobil went after a larger segment

of the market that valued things other than

price. Table 3-2 lists these segments.

Instead of a cost leadership strategy that would

target Price Shoppers, Mobil pursued a differentiation strategy aimed at Road Warriors, True

Blues, and Generation F3s. This represented
3-15

the most profitable 59 percent of the market.

Mobil stations were revamped to offer food and

bottled drinks, a selection of gasoline grades,

and pay-at-the-pump features that included

Mobil’s Speedpass® a device that allows a

customer to pay by simply placing a prepurchased debit card against the pump chase.

This example is provided to illustrate that one

should not assume all customers are the same,

that customers value only price, or that cost

leadership is the only viable strategy. Customers are constantly making value determinations.

Gas may sell for ten cents less at a station

located 30 miles away; however, you may value

your time more than the marginal price difference. A traditional grocery store may offer

lower prices, but for a small purchase, the quick

transaction offered by a convenience store may

be preferable. By asking the simple questions:

who are our potential customers? and what do

they value? a business may quickly discern the

rudiments of a better strategy.

Strategic Implications

Expanding outside of retailing to inter-firm

sales, a strategy of cost leadership takes on

additional dynamics that should be taken into

consideration. Remember from Chapter Two

Segments in the Retail Gasoline Market

Market

Segment Representation Characteristics

Road Warriors 16% Higher-income middle aged men who drive 25,000-

50,000 miles a year...buy premium gasoline with a credit

card...purchase sandwiches and drinks from the convenience store...will sometimes wash their cars at the car

wash.

True Blues 16% Usually men and women with moderate to high incomes

who are loyal to a brand and sometimes to a particular

station...frequently buy premium gasoline and pay in

cash.

Generation F3 27% Fuel, Food, and Fast: Upwardly mobile men and women

— half under 25 years of age — who are constantly on

the go...drive a lot and snack heavily from the convenience store.

Homebodies 21% Usually house wives who shuttle their children around

during the day and use whatever gasoline station is

based in town along their route of travel.

Price Shoppers 20% Generally aren’t loyal to either a brand or a particular

station, and rarely buy the premium line...frequently on

tight budgets.

Source: R. Kaplan and D. Norton, The Balanced Scorecard (Boston, MA: The Harvard Business School Press,

1996), p. 66.

Table 3-2 Customer Market Segmentation of the Retail Gasoline Market
3-16

the example of Holland Sweetener. It entered

into a market where the major customers (CocaCola® and Pepsi-Cola®) truly did value price.

Instead of using techniques such as game theory

to think through how various scenarios might

play out, Holland went head-to-head with

Monsanto in a brutal price war. The result was

that Coke® and Pepsi® got what they wanted

— aspartame savings totaling $200 million a

year but Holland received little of the profit

that prompted its entry into the market. A far

more effective move for Holland would have

been to approach these soft drink manufacturers before entering the market and ask to get

paid to enter the market. Holland, at this point,

would have been in a strong negotiation position. Coke and Pepsi, valuing price, would have

likely paid a portion of the projected aspartame

savings for Holland to enter the market as a

spoiler, knowing the entry of a competitor

would drive down price.24

Other Considerations

Understanding what the customer values, how

to create that value, and then how to capture a

portion of the value created are essential to any

strategy.25 Having made this point, let’s assume

that a given firm has conducted the requisite

strategic analysis and has decided to embark

upon a strategy of cost leadership. While this

may seem a clear strategy, there are some important considerations. First of all, differentiation cannot be ignored. The product or service

must have the same overall quality as is found

throughout the industry.26 Customers are constantly making value assessments. If a difference can be discerned, a trade-off calculation

is inevitable.

This brings out the second point: it is advantageous to have competition in the market. Without competition, there is no easy price comparison. Without competition, there are no market forces to motivate and enforce disciplined

cost analysis. And, as Alfred P. Sloan well

understood, and Bill Gates apparently did not,

without competitors there is the risk of

government anti-trust action.27

Not only is it advantageous to have competitors, it is especially advantageous to have big

dominant competitors that can provide a cost

umbrella. These firms typically set the market

price by virtue of the fact that they have the

biggest share of the market.28 With this umbrella the non-dominant player need not price

at a low margin. Instead, it can price at or near

the established market price. Dominant

competitors also tend to pay more attention to

attractive market segments where margins are

high, leaving difficult segments vulnerable to

exploitation.29

Vulnerability of Cost Strategies

to Disruption

This was exactly how mini-mills were able to

gain a foothold in the steel industry. Unlike

integrated mills that transform iron ore, coal,

and limestone into steel products, mini-mills

use melted scrap steel as their principal input.

This scrap is then fabricated into steel products. Until mini-mill technology became available, integrated mills such as U.S. Steel dominated the industry. These integrated mills

dominated because their strategy of integration

produced economies of scale that allowed them

to compete and win based on the price of their

products. These products ranged from sheet

steel at the high end of the market to rebar at

the low end.30

When mini-mill technology was introduced,

these mills were only capable of producing

products like rebar at the low end of the market where quality requirements are low. Since

they did not have sufficient capacity to satisfy

the entire market, the price was set by the integrated mills. Since the fixed and variable costs
3-17

of a mini-mill are much less than that of an

integrated mill, mini-mills could harvest large

margins. These margins of course attracted

other market entrants and drove existing minimill producers to expand capacity. Soon the integrated mills were displaced from rebar. To the

integrated mills, this was considered advantageous since it allowed them to concentrate on

the higher end of the market.31

Unfortunately for the integrated mills, technology marched on. Soon mini-mills were able to

produce products that demanded increasing

levels of quality. Each time, integrated mills

reacted by yielding to the mini-mills until

finally these mills were able to produce sheet

steel. In retrospect, it would have been a better

strategic move on the part of integrated mills

to invest in mini-mill technology. Instead they

concentrated on the most lucrative end of the

market and are now being challenged on price

in a market where customers place a high value

on price.32

As illustrated by the above example, for the

business whose strategy is predominately dependent on cost, the world can be an especially

cruel place. For firms that pursue this strategy,

there is always the risk of retaliation by competitors, or that new business models or disruptive technologies (such as the mini-mill example cited above) will be introduced and

exploited to peel away large segments of the

market. Sustaining cost leadership requires

strategic vigilance of the external environment

and strategic analysis of internal structure.

Strategic Cost Analysis

Obviously, as the name implies, a cost leader

is focused on driving down internal costs in

order to compete effectively. Effectiveness, as

we have said, is at the forefront of any strategy,

and efficiency is inherently a value proposition.

With this in mind, cost leadership may mean

giving up segments of the business that the

customer does not explicitly or implicitly value

or it may mean a radical restructuring of the

business in pursuit of a more effective and

efficient business model. It may also entail

embracing technologies that show promise.

Porter offers six steps to strategic cost

analysis.33

1. Identify the appropriate value chain and

assign costs and assets to it.

2. Diagnose the cost drivers of each value

activity and how they interact.

3. Identify competitor value chains and

determine the relative cost of competitors

and the sources of cost differences.

4. Develop a strategy to lower relative cost

position through controlling cost drivers

or reconfiguring the value chain and/or

downstream value.

5. Ensure that cost reduction efforts do not

erode differentiation or make a conscious

choice to do so.

6. Test the cost reduction strategy for

sustainability.

Note these steps do not entail squeezing budgets or marginal cost reductions. This process,

if followed, may necessitate large-scale adaptation or a complete transformation of the business model. Additionally, the ability to adapt

must be quick since a lower price offered by a

competitor may translate to rapid erosion of

market share. As difficult and painful as this

sounds, businesses are increasingly driving

toward just this type of transformation to gain

competitive advantage.
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The potential for transformation to a lower cost

structure and the capacity to respond rapidly is

precisely the power that is driving the information economy. It allows for radical restructuring of the value chain around more streamlined business models. The revolution in the

ability to transact is redefining many value

chains in many industries. Take for example

the Amazon.com model. Online book purchase

eliminates the need for the large fixed costs

associated with a chain of retail stores and layers of retail inventory. It also streamlines the

variable costs associated with the stores (e.g.,

staff, utilities, housekeeping, etc.).

Rapid restructuring and adaptation is precisely

the strength of the Sense and Respond model

described in Chapter One. This model blurs

organizational boundaries, changing the dynamics of the firm. Ad hoc virtual firms are

now possible consisting of many businesses,

electronically linked, engaged in value creation.

This capacity not only changes the dynamic

of the organization, it changes the dynamic of

cost structure. Under this model, assets are no

longer defined in terms of fixed and variable.

They can now be redefined as committed and

flexible.34

Committed resources are just what the name

implies. These are things the firm is committed to pay for, such as infrastructure, raw materials, contracts, and company salaries. These

resources lead to predictable expense being

incurred regardless of company output. As

such, these resources represent not the cost of

production but rather the cost of capacity.35

Flexible resources, on the other hand, reside

outside the traditional organization and refer

to resources the firm may acquire for levels of

demand. These are resources available through

outsourcing. Because of advances in information technology described in Chapter One, the

cost of acquiring a flexible resource outside the

firm is fast approaching the cost of using the resource.36 This is because information technologies

are driving down the cost to transact and share

information. With many firms linked together

sharing information as well as risk, the cost

of excess capacity can be driven from an

individual firm’s business model.

Integration and Outsourcing

In this context, cost leaders embrace

outsourcing. New information technologies

allow firms to network or link to companies

that position themselves in increasingly specialized areas of the market. Networking allows

a company like American Transtech to specialize in telephone service functions. This technology greatly expands the base of clients it

may effectively serve and allows for exploitation of scale economies.37 Conversely, American Transtech’s clients are quite willing to turn

these functions over since they get better performance. This in turn means better value to

the end customer.

What does the customer value? Even to the cost

leader, the value proposition remains the essential driving force. A low cost provider with

an equally low level of service will likely drive

away customers and market share. Successful

cost leaders understand this. This is why strategic cost analysis is just that: strategic. By first

establishing an effective model, the cost leader

gains far more than by making an ineffective

model efficient.

Focus

The final generic strategy offered by Porter is

focus. This is different from differentiation and

cost leadership in that the company is no longer

targeting a broad market. Instead, the company

is targeting a narrow market segment and will

serve this segment to the exclusion of others.38
3-19

Firms can attain focus in two ways: cost focus

and differentiation focus. While this may sound

like a nuance of strategies already discussed,

the dynamic of competitive scope separates

both types of focus out as a separate generic

strategy with two means of execution. This is

displayed as a matrix in Figure 3-8.39

Differentiation Focus

There are many ways to attain focus. Close

physical proximity to the target segment is one

way to attain a differentiation focus. Having a

supplier right next door eases communication

and allows both companies to align their processes. The location of seat maker Johnson

Controls, a few miles away from Toyota’s manufacturing plant in Georgetown, Kentucky,

eases coordination between the two companies

and allows for small frequent deliveries of

material rather than large bulk shipments.40, 41

This proximity model is also used in the world

of high technology manufacturing. Many companies that focus on narrow segments of the

computer industry locate in the Silicon Valley,

not because it provides them with a cost advantage but because this proximity allows them

to better serve the market segment they have

targeted. The same can be said for DoD support

contractors. Close physical proximity (often in

the same office) provides information that helps

them to better serve their customers.

In addition to co-location, a company can provide differentiation focus by offering a higher

standard of quality. In this case, brand once

again takes on an added significance. Ferrari

targets a narrow market segment of the auto

industry, as does Rolls Royce. Indeed many

luxury items follow this model. Fine china,

crystal, and designer clothes, are products that

appeal to a very narrow segment of the market.

Cost Focus

Other firms use price as a way to focus on a

segment of the market. Factory outlet stores

target a small segment of shoppers looking for

bargains. Costco and BJ’s restrict selection but

offer savings on items that they do carry. These

items are typically offered in bulk quantities.

In addition to companies that focus on retail

segments, there are companies that focus on

specific industrial segments, using cost as an

advantage. This is a particularly successful

strategy in a commodity type market. However,

as we saw in the Holland Sweetener case, the

strategy can backfire.

Figure 3-8. Three Generic Strategies

Source: M. Porter, Competitive Advantage (New York, NY: The Free Press, 1985), p. 12.
3-20

Integration and Outsourcing

By their nature, companies that practice a focus

strategy are generally the sources of outsourcing products and services. This is particularly

true of companies pursuing a strategy of a differentiation focus. They occupy market niches

where they can become highly specialized and

offer these specialized products or services to

companies that wish to outsource, and they are

becoming the giants of the information

economy.

Earlier we examined American Transtech, a

company that specializes in telephone service

products. This is a product that appeals to a

very narrow market segment spread across a

wide range of industries. Similarly, GE Capital Services focuses on credit card operations

for companies that do not wish to internalize

this function.42

In computing and software, open architecture

has enhanced the ability to focus. Intel is focused on the manufacture of computer chips

for personal computers (PCs). Microsoft® can

focus on software; Hewlett Packard on printers. The ability of many focused entities to collaborate has generated large-scale value coordination. Conversely, the inability for focus and

collaboration is largely the reason that Apple

Computer has been eclipsed by companies like

IBM, Compaq, and Dell.

In the information economy, differentiation

focus is becoming an increasingly dominant

strategy. Firms with a narrow scope of operations are now able to link together in a virtual

organization where information flows freely.

Activities, not assets, are emerging as the defining boundary of the organization.43 Information technology allows these activities to be

linked and coordinated independent of the legal

definition of the firm.

Stuck in the Middle

A large number of companies attempt to engage

in more than one of these strategies. By doing

so, they fail to achieve any of them. Porter refers

to these companies as being stuck in the

middle.44 Companies that start out stuck in the

middle have no competitive advantage to begin

with. Companies that lose sight of their core

strategy and drift to the middle soon lose their

competitive advantage. Porter writes:

Becoming stuck in the middle is often

a manifestation of a firm’s unwillingness to make choices about how to

compete. It tries for competitive advantage and achieves none, because

achieving different types of competitive advantage usually requires inconsistent actions. Becoming stuck in the

middle also afflicts successful firms,

who compromise their generic strategy

for the sake of growth or prestige.45

Successful firms do not attempt to be all things

to all people. Successful companies are the ones

that make difficult choices. Unsuccessful companies are ones that refuse to make the difficult choices that are necessitated by adoption

of a strategy, or that make disastrous choices

that move them away from a successful strategy. We offer two examples of this theory in

operation: GE and the Radio Corporation of

America (RCA). The former moved itself out

of the middle and reaped the benefits. The latter

drifted into the middle and suffered the

consequences.

Moving Out of the Middle

Jack Welch has been largely credited with the

modern day success of GE. When named Chief

Executive Officer (CEO) in 1981, Welch took

the reins of a faltering conglomerate with a

large and increasingly inflexible bureaucracy.
3-21

The company was managed through a welldefined hierarchy that consisted of ten groups,

46 divisions, and 190 departments. Within this

structure existed 43 strategic business units designed to support planning for businesses that

ranged from mining to oil refining to outdoor

lawn equipment.46 In 1981, GE was truly all

things to all people.

Welch worked quickly to reposition the company. He eliminated or sold off large chunks

of GE that did not align with his business objectives. In return, he was given the nickname

“Neutron Jack,” a reference to a weapon that

kills only people but leaves buildings standing. However, the message he sent to his employees was clear and unambiguous: “We’re

either going to be number one or number two

or we’re going to get out of the business.”47 In

other words, GE would be recognized as the

world leader in the products and services that

bore its name. This trait would differentiate it

from its competitors. Welch also began carving away layers of middle management. Believing bureaucracies stifle change and innovation, he went to work removing governance

structures and empowering lower-level managers. A series of quotes from Jack Welch is

illuminating.48

Most bureaucracies — and ours is no

exception — unfortunately still think

in incremental terms rather than in

terms of fundamental change. They

think incrementally primarily because

they think internally. [When asked

about the necessity for such radical restructuring, Welch responded that] the

old structure of GE was right for the

1970s, a growing handicap in the

1980s and it would have been a ticket

to the boneyard in the 1990s.

We also reduced the corporate staff.

Headquarters can be the bane of corporate America. It can strangle, choke,

delay, and create insecurity. If you’re

going to have simplicity in the field,

you can’t have a big staff at home.

So we got rid of it, along with a lot of

reports, meetings, and the endless

paper that flowed like lava from the

upper levels of the company.

When we did this, we began to see

people — who for years had spent half

their time serving the system and the

other half fighting it — suddenly come

to life, making decisions in minutes,

face to face, on matters that would

have once produced months of staff

gyrations and forests of paper.

GE eliminated 59,290 salaried and 64,160

hourly positions between 1981 and 1988. Divestiture eliminated an additional 122,700.

Even when offset by acquisitions, total employment declined from 404,000 in 1980 to 292,000

by 1989.49 Subsequently, GE began a meteoric

rise. Between 1981 and 1985, operating profits rose from $1.6 to $2.4 billion. In 1990, this

figure stood at $4.3 billion and by 1999, this

figure reached $9.2 billion.50

As a result of Welch’s actions at GE, the company has enjoyed resounding success and is

routinely lauded as one of the best-run companies on the Fortune 500 list. When asked about

the speed and severity of GE’s restructuring,

Welch responded that his only regret was not

moving faster than he did.51

Arguably, this was a company that had drifted

into the middle and had become entangled in

bureaucratic processes that permeated the corporate culture of GE. Welch moved quickly and

resolutely to shed unproductive resources, instill more effective business processes, and,

most important, to instill a culture that valued
3-22

decisiveness, flexibility, and performance. As

a result, GE has moved itself and its businesses

out of the middle toward to advantage and profitability as depicted in Figure 3-9. Yet another

quote from Welch: “Good business leaders

create a vision, articulate the vision, passionately own the vision and relentlessly drive it to

completion.”52

Drifting into the Middle

Created by the U.S. Government in 1921, RCA

became a powerhouse in broadcast media. It

was a pioneer in areas such as recorded music,

radio, television, and television broadcasting

(creating both NBC and ABC).53 By concentrating in these areas, RCA was able to dominate the radio and television market. At the

heart of RCA was a strong concentration on

research and development (R&D) within these

emerging technologies. RCA’s success in the

development of color television technology

seemed to solidify its place as an established

industry leader.54

Then the company moved away from its core

strategy. RCA was in the business of providing state-of-the-art telecommunications technology. Using Porter’s framework, this was a

form of differentiation focus. RCA was serving a distinct and growing segment (television

and radio) to the exclusion of other technologies and doing quite well. Then from the 1950s

to the 1980s, RCA embarked on a series of

disastrous decisions that moved it away from

its strategy and television market and into

oblivion. First, RCA sunk 40 percent of its

R&D budget into computers, going head to

head with IBM. This was seen as a growing

business and with RCA’s respected R&D resources, one where the company thought it

would have an advantage. However, while RCA

had the technical skill to enter into the computer industry, it did not take into account the

rest of the value chain (see Figure 3-10). Marketing and manufacturing computers was entirely different from marketing and manufacturing televisions. IBM, by contrast, did understand this and gained dominance in the

market. In 1970, when RCA conceded defeat,

it was forced to write off about a quarter of its

net worth. During this same time, RCA lost its

preeminence in color television technology,

ceding dominance to other firms.55

A second move away from RCA’s generic strategy was its foray into conglomeration. In its

heyday, conglomeration was seen as a means

to balance risk over a wide corporate portfolio

of activities. Unfortunately, without a central

competitive advantage to justify binding the

elements of a conglomerate together, the scope

Figure 3-9. GE Moves Out of the Middle
3-23

Figure 3-10. Color Television and Mainframe Computer Value Chains

Source: T. McCraw, American Business, 1920-2000: How It Worked (Wheeling, IL: Harlan Davidson Inc. 2000),

pp. 110-146.

Mainframe Computer Value Chain

Color Television Value Chain
3-24

of activities exceeds the benefit, placing the

individual elements of the conglomerate at a

competitive disadvantage. A case in point is

RCA, which in the 1960s acquired a host of

mismatched businesses including Random

House Publishers, Hertz Rent-a-Car, Banquet TV Dinners, and Arnold Palmer Golfing

Attire. None of these entities benefited from

RCA’s now fading edge in R&D. In fact, by

squandering precious resources on these

acquisitions, RCA further precluded R&D

investment.56

Finally, RCA decided to put its 6,200 scientists and engineers to work on what was seen

as a breakthrough product: the VideoDisk. The

company believed that when ready for market,

the VideoDisk would sell for much less than a

video cassette recorder (VCR) and offer better

quality. Unfortunately, what the public valued

in the initial days of video was not price. Consumers valued the ability to record. Even at a

lower price, the VideoDisk did not offer this

feature. The VCR captured the market.57

In a fitting postscript, Jack Welch of GE purchased RCA in 1986, then sold off almost all

of the company except the NBC television network, which was the target of the acquisition.58

Such is the power of a sound strategy and the

will to follow it. GE flourishes; RCA moved

away from its basic strategy and is no more

(see Figure 3-11).

Strategy and Outsourcing

As we stated at the beginning of this chapter,

all firms outsource. Limits to the scope of the

firm alone necessitate some reliance on the

market. However, outsourcing decisions must

be in congruence with the firm’s strategic

framework. To review, that framework consists

of a firm’s belief systems, vision, and mission.

Within this framework, markets are analyzed

and strategy developed. Strategy drives decisions as to how the firm will position itself to

attain an advantage. This in turn guides what

the firm will and what it will not do.

It follows then that any outsourcing decision

begins with an effective strategy. We conclude

this chapter with an example of a company that

understood this fundamental principle and one

that lost sight of it.

Case Study: Successful Outsourcing

Michael Dell (Dell Computer) built a $12 billion company in 13 years. This phenomenal

success was the product of a strategy that allowed Dell to create value and channel that

value directly to the customer. Instead of using

Figure 3-11. RCA Moves Into the Middle
3-25

a dealer channel that relied on a build-to-inventory model, Dell would build to order and

sell directly to customers. This eliminated the

reseller’s markup and the costs associated with

carrying large inventories. The buyer would get

fast delivery of a computer built to his or her

specification. Dell, in return, could charge a

substantial margin for the computer and still

retain price equity with resellers.59

For this model to work, Dell would need a

tightly coordinated supply chain. But Dell did

not rely on integration to achieve this. Instead,

the company leveraged the power of the information technologies to virtually integrate with

his suppliers.60 This was made possible through

the direct link that the company had with its

customers. Building to order meant that on a

day-to-day basis, Dell would know what

computers it would be assembling and what

components would go into those computers.

This information was then shared with its

suppliers. Deliveries were directly tied to the

production schedule, not to an inventory level.

The virtual integration model necessitates a

long-term relationship with Dell and its suppliers. This offers immediate access to customer

preference information. For its part, Dell values

quality and predictable delivery over price, and

it is willing to pay a premium for supplier performance. Additionally, Dell mitigates volatility by ensuring it has a diverse mix of customers and that no one customer represents more

than 2 percent of revenues.61 This garners the

supplier a better margin over a longer period.

Not only does Dell outsource component production but also most of its 10,000 field service representatives are contracted from other

firms. To the customer requiring after sales service, this relationship is invisible; he assumes

he’s dealing with a Dell employee.62

Another aspect of this model is that by carrying a smaller inventory, Dell can get upgraded

products to market more quickly. If Intel comes

up with a new chip, Dell, with 11 days of

inventory, has a significant advantage over

competitors with 80 days of inventory.63

Dell’s competitive advantage comes from its

strategy, and its strategy drives its lean structure. By selling directly to the customer on a

built-to-order basis, Dell has positioned itself

as an integrator and information processor. Information technology allows it to rely on the

market for all else. This makes Dell a company

that applies the Sense and Respond Model.

Committed resources are minimal — principally its 15,000 employees.64 Flexible resources

are readily available through its virtually integrated suppliers and customer service representatives. By integrating these activities, Dell

would lose its competitive advantage.

Case Study: Unsuccessful Outsourcing

As we have seen, IBM dominated the mainframe computer market. Its competitive advantage was the integrated package it provided.

IBM built the machines, developed the operating system, wrote the code, installed the hardware, and kept service representatives available

to trouble-shoot on behalf of its clients. System

architecture was closed and IBM-proprietary.

Buying IBM meant that the client bought a

complete package.

This was fine with IBM’s customers. Since

mainframes allowed for automated performance of critical processes such as payroll and

account information, it was essential to have

these machines up and running. IBM had an

army of service technicians, some of whom

were posted on-site in the offices of large

clients. A single phone call to the IBM representative brought the combined resources of

the entire company to bear on any problem, be
3-26

it hardware, software, or the operating system.

IBM’s service and dependability were respected and world-renowned. As testimony to

the value of this level of service, it was often

said, “No one was ever fired for buying IBM.”65

Then came the microcomputer. This was truly

a disruptive technology.66 These desktop computers couldn’t approach the power and performance of mainframe computers. However,

while initially they could not meet the demands of IBM’s high-end business market,

they were powerful enough for word processing and the maintenance of small databases.

This was sufficient technology for households

and clerical business functions and, as was the

case with mini-mills in the steel industry, the

technology was improving, taking the dominant player — Apple — up market. By 1980,

just four years after it was founded in a California garage, Apple was the biggest maker of

desktop computers in the world.67 As the demand for desktop computers continued to

expand, Apple was poised to reap the benefit.

Realizing this late in the game, IBM decided it

had to enter the desktop computer market and

fast. This was a decision that had major strategic implications. Up until this time, IBM pursued a strategy that focused on high-end business computer applications. Now it was going

to enter a much broader segment of the computer industry. Recall Porter’s statement that

“achieving different types of competitive advantage usually requires inconsistent actions.”68

IBM made these inconsistent actions and did

not think through the consequences.

Speed was essential if IBM was to capture and

hold a piece of this emerging market. Knowing this, IBM set a goal of getting from product

design to market in 12 months.69 As we have

seen, one of the advantages of outsourcing is

flexibility and speed. With this in mind, IBM

departed from its strategy of internal development

and turned to Microsoft and Intel to develop

the operating system and the microprocessor.70

Again, with speed in mind, IBM departed from

another tenant of its strategy and implemented

an open-architecture policy. The rationale was

that this would enable many programmers to

write applications for the IBM PC.71 These two

moves together meant that IBM would lose

the competitive advantage it had sustained

in the mainframe market. In the PC world, IBM

could not offer the total package. Open architecture meant that other companies could offer

IBM compatible PCs and with the two key

components (the operating system and the

microprocessor) available on the open market,

significant barriers to entry were removed. The

result was that after IBM entered the market, it

was quickly followed by companies like

Compaq and Dell. Absent a competitive advantage, IBM would not obtain the dominance it

enjoyed in its mainframe market.72

Now let’s examine these events within a strategic framework. IBM’s vision was to enter and

stake out a position in the desktop computer

market. This was an emerging and lucrative

market and one that threatened the dominance

of its mainframes. In Wayne Gretzky’s parlance, this was where the puck was going. IBM

would not make the same mistake the integrated

steel mills made. The next step is to craft a strategy that will position the firm so it can create

and capture value. Unfortunately, with speed

in mind, IBM went right from the vision to a

business structure that would attain that vision.

Had the company taken the time to think

through strategy, things may have turned out

differently.

To that date, IBM’s competitive advantage had

been the integrated package it offered. With

speed-to-market the key, the company could

not afford the time necessary to develop its PC

in house. To dominate in the desktop computer
3-27

market, IBM would now need a new advantage. Recall that creating and capturing value

is essential to gaining an advantage but that

players, by entering the game, change the structure of the game. Taking into account that open

architecture and outsourcing were going to

change the competitive landscape, IBM could

have attained an advantage in this emerging

market by considering a simple question articulated by the Roman Statesman Cicero over

2,000 years ago: Cui bono? (Who stands to

gain?)73

Open architecture meant that it would be relatively easy to assemble an IBM-compatible

computer with the requisite ingredients. Of

these, the operating system and the microprocessor would take on added value because

they were proprietary to the two outsourcing

partners. Microsoft and Intel would be the

beneficiaries of this strategy.

With this in mind, IBM could have demanded

equity stakes in both companies and both would

likely have accepted. At this time, IBM was in

a strong bargaining position. To Microsoft and

Intel, IBM represented a vehicle that was

capable of taking on Apple and getting their

products to market. For its part, IBM had the

requisite capital to take a strong position in both

companies. It might have used this position as

leverage to further shape the market to its

advantage or, at the very least, it could have

reaped the value Microsoft and Intel derived

from this new business structure.74

By not addressing the strategic consequences,

outsourcing worked to the detriment of IBM

in the desktop computer market. This is not to

say that outsourcing was a bad move on IBM’s

part. To enter the market at such a late date,

speed was essential. Outsourcing offered that

speed and flexibility. The pertinent lesson is

that outsourcing absent a coherent strategy can

be a recipe for probable disappointment or

potential disaster. IBM modified its strategic

structure but did not modify its strategy. The

result was that by the end of the 80s, microcomputers were eclipsing mainframes,

Microsoft and Intel were rising to dominance

and IBM was experiencing record losses.75

Summary

We began this chapter with the premise that a

firm can be effective across only a limited range

of activities in the value chain. Knowing this,

successful firms position themselves where

they can best create and capture value. To this

end, the firm seeks to develop an effective

strategy that will provide it with a competitive

advantage within the position it has chosen. We

then demonstrated that strategy determines how

the business will define itself and how it will

subsequently structure itself.

In the next chapter, we examine DoD’s strategic framework and its business strategy, both

explicit and implicit. Specific emphasis is given

to the Department’s focus on efficiency and the

employment of A-76 as an outsourcing tool.

At this juncture, the reader may be tempted to

discount the value of any comparison between

DoD and the private sector, but in fact the comparison is quite illuminating. Additionally, one

may also be tempted to assume that industry

will come out ahead in any comparison. However, there are areas where the private sector

pales in comparison to DoD. We encourage you

to read on.
3-28

ENDNOTES

1. E. Pint, Strategic Sourcing: Theory and Evidence

from Economics and Business Management (Santa

Monica, CA: Rand, 1997) , p. 25.

2. Ibid.

3. A. Brandenburger and B Nalebuff, Co-opetition

(New York, NY: Doubleday, 1996), p. 45.

4. Retrieved 20 March from the World Wide Web: http:/

/www.fee.org/about/ipencil.html.

5. D. Collis and C. Montgomery, Corporate Strategy

A Resource-Based Approach (Boston, MA: Irwin

McGraw/Hill, 1998), p. 107.

6. Ibid., p. 108.

7. J. Stiglitz, Economics of the Public Sector (New

York, NY: W. W. Norton & Company, 1988), pp.

204-205.

8. E. Savas, Privatization and Public Private Partnerships (New York, NY: Seven Bridges Press, LLC,

2000), p. 3.

9. R. Kaplan and R. Cooper, Cost and Effect, Using

Integrated Cost Systems to Drive Profitability and

Performance (Boston, MA: Harvard Business

School Press, 1998), pp. 111-135.

10. Kaplan and Cooper, p. 102.

11. This section draws heavily from Chapters 1, 2, and

3 of Collis and Montgomery’s work, cited above.

12. Brandenburger and Nalebuff, pp. 150-151.

13. Adapted from summary class notes, R. Nolan, IBM

Corporation: Turnaround, 91-95, Program for Management Development (PMD75), Harvard Business

School.

14. T. McCraw, American Business, 1920-2000: How

It Worked (Wheeling, IL: Harlan Davidson Inc.

2000), pp. 190-191.

15. Brandenburger and Nalebuff, p. 17.

16. Ibid., p. 45.

17. Scott McCartney, “Airlines’ Reputations Hinge on

the Basics, Study Shows Dependability, Low Fares,

and Financial Stability Are Key in Travelers’ Minds”

Wall Street Journal, New York, April 27, 2000, p. 1.

18. C. Christenson, The Innovator’s Dilemma (Boston,

MA: Harvard Business School Press, 1997), pp. 162-

166.

19. M. Porter, Competitive Advantage (New York, NY:

The Free Press, 1985), pp. 12-17.

20. Porter, p. 14.

21. Harvard Business School Case Black & Decker

Corporation (A) 9-595-057, 20 June 1995.

22. R. Higgins, Analysis for Financial Management

(Boston, MA: Irwin McGraw-Hill, 2001), pp. 22-

23.

23. Collis and Montgomery, p. 28.

24. Brandenburger and Nalebuff, pp. 72-76.

25. Ibid., p. 45.

26. Porter, p. 13.

27. Ibid., pp. 202-207.

28. Ibid., p. 205.

29. Ibid., p. 204.

30. Christenson, pp. 77-101.

31. Ibid.

32. Ibid.

33. Porter, pp. 62-118.

34. Kaplan and Cooper, pp. 120-125.

35. Ibid., pp. 120-121.

36. Ibid., p. 121.

37. S. Bradley and R. Nolan, Sense and Respond

(Boston, MA: Harvard Business School Press,

1998), p. 11.
3-29

38. Porter, p. 15.

39. Ibid., pp. 11-12.

40. Harvard Business School Case 9-693-019 5, Toyota

Motor Manufacturing, U.S.A., Inc., September 1995.

41. Adapted from summary class notes, Sandra Sucher,

Innovation Through Operational Flexibility,

Program for Management Development (PMD75),

Harvard Business School.

42. Bradley and Nolan, p. 11.

43. Ibid., pp. 299-321.

44. Porter, pp. 17-18.

45. Ibid., p. 17.

46. Harvard Business School Case 9-399-150, GE’s

Two-Decade Transformation, Jack Welch’s Leadership, 6 January 1999, pp. 1-12.

47. Ibid.

48. Adapted from summary class notes, Michael

Yoshino, GE’s Two-Decade Transformation, Jack

Welch’s Leadership, Program for Management

Development (PMD75), Harvard Business School.

49. Harvard Business School Case 9-399-150, pp. 1-12.

50. Ibid.

51. Adapted from summary class notes, Michael

Yoshino, GE’s Two-Decade Transformation, Jack

Welch’s Leadership, Program for Management

Development (PMD75), Harvard Business School.

52. Ibid.

53. McCraw, pp. 110-146.

54. Ibid.

55. Ibid.

56. Adapted from summary class notes, T. McCraw, The

Devolution of Decision Rights in American Business from 1920-2000, Program for Management

Development (PMD75), Harvard Business School.

57. T. McCraw: American Business, 1920-2000, pp.

110-146.

58. Adapted from summary class notes, T. McCraw, The

Devolution of Decision Rights in American Business from 1920-2000, Program for Management

Development (PMD75), Harvard Business School.

59. Joan Magretta, “The power of virtual integration:

An interview with Dell Computer’s Michael Dell,”

Harvard Business Review; Boston; Mar/Apr 1998

pp. 1-20.

60. Magretta, pp. 1-20.

61. Ibid.

62. Ibid.

63. Ibid.

64. Ibid.

65. Adapted from summary class notes, R. Nolan, IBM

Corporation: Turnaround, 91-95, Program for Management Development (PMD75), Harvard Business

School.

66. Adapted from summary class notes, C. Christensen,

The Threats and Opportunities Created by

Technology Disruption, Program for Management

Development (PMD75), Harvard Business School.

67. Retrieved 4 April 2001 from World Wide Web: http:/

/www.pbs.org/nerds/part3.html.

68. Porter, p. 17.

69. Brandenburger and Nalebuff, pp. 154-156.

70. Ibid.

71. Ibid.

72. Adapted from summary class notes, R. Nolan, IBM

Corporation: Turnaround, 91-95, Program for Management Development (PMD75), Harvard Business

School.

73. Brandenburger and Nalebuff, p. 71.

74. Ibid., pp. 154-156.

75. Adapted from summary class notes, R. Nolan, IBM

Corporation: Turnaround, 91-95, Program for Management Development (PMD75), Harvard Business

School.
3-30
4-1

4

THE DEPARTMENT

OF DEFENSE’S

BUSINESS STRATEGY

AND

COMPETITIVE

SOURCING PROGRAM

“If you don’t know where you are going,

any path will take you there.”

 — Chinese Proverb

Introduction

Up to this point, our discussion on strategy

alignment has focused on the industry perspective. This chapter starts the discussion of corporate strategy from the Department of Defense

(DoD) perspective. As the Department executes

its Revolution in Business Affairs (RBA), it can

use industry’s lessons learned as a model to

gain valuable insights. Benchmarking to successful companies helps set the standards

required to make DoD more business-like. The

purpose of this chapter is to develop the crosswalk from the Department’s overarching

corporate strategy to specific areas of execution. The chapter traces the development of the

competitive sourcing policies from DoD’s overall corporate strategy. The analysis covers the

alignment of DoD’s strategy in terms of overall effectiveness and then narrows the scope

to the efficiency of the current state of DoD’s

Competitive Sourcing program.

The analysis of the competitive sourcing program takes on an added significance as DoD

transforms itself into a more business-like entity

while coping with internal downsizing. In a

March 12, 2001 report to Congress, DoD reported that it hires the equivalent of about

734,000 employees annually to perform service work. For the first time, this number exceeds the total number of civilian DoD federal
4-2

employees, which today stands at about

640,000.1

 For this reason alone, it is important

to determine whether DoD is using the competitive sourcing program not only effectively

but also efficiently. The chapter begins with

DoD’s corporate strategy, the Department’s

goals and objectives to support the strategy, and

the alignment of the competitive sourcing program to support the strategy. The second part

of this chapter focuses on the competitive

sourcing processes and a review of the results

to date. The chapter closes with a discussion

of recent trends and recommendations.

Strategy Development

Just as large corporations develop corporatelevel strategies to support their overall objectives, DoD develops its strategy along a similar lines. The Department established the corporate goals to support the objectives set forth

in the 1997 Quadrennial Defense Review

(QDR). Congress mandated the QDR requirement in the Military Force Structure Review

Act, which was part of the Fiscal Year (FY)

1997 National Defense Authorization Act. The

purpose of the 1997 QDR was to require DoD

to conduct a comprehensive examination of

America’s defense needs from 1997 to 2015.

The QDR lays the framework for the

Department’s strategic plan. This plan remains

in effect until revived by the next QDR. The

QDR includes an analysis of potential threats,

strategy, force structure, readiness, modernization, infrastructure, and other parts of the

defense program.2

 The intent of the QDR is to

provide the parameters to develop a comprehensive defense program based on striking a

balance between strategy and affordability. The

Defense Department uses the annual Planning, Programming, and Budgeting System to

implement the results of the QDR.

Congress requires DoD to conduct the QDR

every four years. The next QDR is under way

during FY 2001 and will provide, with many

other studies directed by Secretary of Defense

Donald H. Rumsfeld, a re-look and recommendations to shape the armed forces at the dawn

of the 21st century. These reviews are necessary to ensure the applicability of the defense

strategy in an ever-changing world. Threats

change over time. In order to adapt, DoD must

take into account increasingly serious threats

at home and abroad. Combating threats from

rogue nations or terrorist groups armed with

weapons of mass destruction or cyberhackers

bent on destroying critical information networks requires a different approach from the

old Cold War strategy. Now is the time for real

transformational efforts.

The 2001 QDR will mark the fifth strategic

review since the end of the Cold War. The others

were the 1991 Base Force Review, the 1993

Bottom-Up Review, the 1995 Commission on

Roles and Missions of the Armed Forces, and

the 1997 QDR. Despite these well-intentioned

efforts, the Department has not changed

enough. There is a resistance to change especially when asked to change from what was a

successful formula. What has been successful

in the past, though, is not necessarily what will

bring about continued success. Just like a business, DoD must seize the opportunity for

change and adapt to ensure success in the

future. Deputy Defense Secretary Paul

Wolfowitz, a major contributor to the first Base

Force Review for President George H. W. Bush,

recently described the plan as, “...a giant step

toward building a post-Cold War force.” However, Wolfowitz understood the lack of strategic analysis by saying, “But it was largely a

downsizing of the force. We didn’t have a lot

of time to think about the new shape of the

force. We hadn’t thought a lot about the new

threats.”3

 Although the world has changed dramatically over the past ten years, not much has

changed in DoD’s overall strategy and the way

it conducts business. For example, Andrew
4-3

Krepinevich, director of the Center for Strategic and Budgetary Assessments, recently stated,

We really haven’t had a good strategic

review since the end of the Cold War,

and the result is that our force today is

smaller, but very similar to our Cold

War force....The key will be whether

the new strategy (produced by QDR

2001) reduces the risk we face from

future threats, and whether or not there

are sufficient resources identified to

execute that strategy.4

The development of a strategy to achieve the

organization’s goals with supporting objectives

is crucial for an organization’s success. As in

the previous discussion of effectiveness versus

efficiency, DoD must ensure it is first doing

the right things and then do things right. Unfortunately, the emphasis has been on efficiency

not effectiveness. DoD must ensure the entire

organization focuses on the common vision and

relentlessly pursues it.

A Look at Alignment

The following portion of this chapter will use

the Strategic Direction Model to examine the

building and alignment of DoD’s subordinate

goals and objectives to its overall strategy. The

purpose of this examination will be to determine how competitive sourcing links back to

support DoD’s overall mission. The Defense

Systems Management College (DSMC) uses

the Strategic Direction Model as part of the

curriculum to instruct students on strategy

development. The students are predominately

DoD employees with a small mixture of other

governmental agency and defense contractor

employees.

The Strategic Direction Model provides a holistic view of the organization’s mission, vision, values, goals, objectives, processes, actions, activities, procedures, and operations

used to satisfy customer requirements. The

purpose of the model is to align the entire organization within certain boundaries. The intent is to ensure the organization knows where

it is going using the right path. As the quotation at the beginning of the chapter states, “If

you don’t know where you are going, any path

will take you there.” Starting with the customer

requirements, the model forces the organization to answer the basic questions, Who are we?

Why are we? and Where are we going? through

the mission and vision statements. The goals,

objectives and control measures answer the

questions, How will we get there? and When

will we know we are there? Finally, the

organization’s values describe What drives

us? Figure 4-1 shows the Strategic Direction

Model.6

The Secretary of Defense’s 2001 Annual

Defense Report to the Congress and the President (ADR) provides an annual report on DoD’s

strategy, supporting goals, and objectives, and

how well they were met. The National Security Strategy, and in turn the National Military

Strategy delineate a set of fundamental objectives that the ADR builds upon. Figure 4-2

shows these fundamental objectives.

Each dollar that is spent inefficiently is a dollar that is unavailable to meet

other internal Department priorities such as weapon system modernization and readiness.

GAO, GAO-01-244 DoD Challenges5
4-4

Figure 4-1. Strategic Direction Model

Source: PMT302/APMC Class notes, Dr. M. J. Hall, Strategy Making – Developing a Strategy – Driven Organization, Def

Systems Management College, Ft. Belvoir, VA, 2001.
4-5

Figure 4-2. 2001 ADR Fundamental Objectives

Since the founding of the Republic, the United States has embraced the

fundamental and enduring goals of maintaining the sovereignty, political

freedom, and independence of the United States, with its values, institutions, and territory intact; protecting the lives and personal safety of Americans, both at home and abroad; and providing for the well-being and prosperity of the nation and its people.

Chapter 1, 2001 Annual Defense Report

Source: William S. Cohen, Secretary of Defense, Annual Report to the President and the Congress, Chapter 1,

2001, retrieved 12 March 2001 from the World Wide Web: http://www.dtic.mil/execsec/adr2001/

chapter01.pdf.

Similar to a corporation’s focus on customer

requirements, DoD’s customer requirements

are in terms of sovereignty, political freedom,

and independence. It is from this linkage, from

the fundamental objectives above through the

National Security Strategy to the National Military Strategy, that DoD develops its mission,

strategic vision, and corporate goals.

The ADR clearly lays out the mission, vision

and corporate-level goals for DoD. The mission statement answers the fundamental questions of Who are we? and Why are we? The

mission statement defines the basic purpose of

the organization, focusing on its core programs

and activities. The 2001 ADR states the mission as, “To support and defend the Constitution of the United States; to provide for the

common defense of the nation, its citizens, and

its allies; and to protect and advance U.S.

interests around the world.”7

From the mission the next question to answer

is Where are we going? The vision statement

contains this answer. In their book, The New

Strategists: Creating Leaders at All Levels,

Stephen J. Wall and Shannon R. Wall describe

the vision as a “...portrait of future success.”8

In support of the mission, DoD’s vision has

four tenets. First, field the best trained, best

equipped, best prepared fighting force in the

world. Second, support alliances and security

relationships that protect and advance U.S.

security interests. Third, further national interests by working effectively with other federal

agencies, Congress, and the private sector.

Fourth, serve as a model of effective, efficient,

innovative management and leadership.

Once we understand the purpose and the direction to go, the next step in the process is to

answer the question, How will we get there?

Using the mission and vision as guiding principles, DoD established two corporate-level

goals to answer this. The first goal is to shape

the international security environment and

respond to the full spectrum of crises by providing appropriately sized, positioned, and

mobile forces. The second goal is to prepare

now for an uncertain future by pursuing a

focused modernization effort that maintains

U.S. qualitative superiority in key warfighting

capabilities and transforms the force by exploiting the Revolution in Military Affairs (RMA)

and reengineer the Department to achieve a 21st

century infrastructure. Focusing on these goals
4-6

Figure 4-3. Strategic Direction Model

Source: PMT302/APMC Class notes, Dr. M. J. Hall, Strategy Making – Developing a Strategy – Driven Organization, Defense Systems

Management College, Ft. Belvoir, VA, 2001.
4-7

ensures DoD continues to move in the right

direction on the way to achieving the vision.

Using the inputs from the 2001 ADR, the Strategic Direction Model from Figure 4-1 is now

shown in Figure 4-3.

DoD develops a set of objectives to enable the

organization to achieve the corporate-level

goals developed through the QDR. The objectives are measurable, specific actions. The ADR

calls these objectives annual performance

goals. For example, the 2001 ADR states, “The

Department’s annual performance plan plots a

short-term course toward achieving its

multiyear strategic plan. Annual performance

goals (objectives according to the model) establish a measurable path to incremental

achievement of the corporate goals articulated

in the strategic plan. Performance goals are

supported and evaluated by quantifiable output, which is assessed using performance measures and indicators.”9

 Figure 4-4 shows the

corporate goals with associated objectives.

In order to ensure that day-to-day activities of

the organization continue to support the strategic goals of the organization, performance

measures and metrics must be put in place. In

1993, Congress enacted the Government Performance and Results Act (GPRA) because in

their view, federal agencies were focused on

outputs rather than on outcomes.10 The purpose

of the Act is to hold agencies accountable to

achieve specific results and operate in a more

business-like fashion. The GPRA seeks to

improve government-wide program effectiveness, government accountability, and public

confidence by requiring agencies to identify

measurable annual performance goals against

Figure 4-4. Linkage of Corporate Goals to Annual Performance Goals

Corporate Goal 1:

Shape and Respond

• 1.1 Support U.S. regional security

alliances through military-to-military

contacts and the routine presence of

ready forces overseas, maintained at

force levels determined by the QDR.

• 1.2 Maintain ready forces and ensure they

have the training necessary to provide

the United States with the ability to

shape the international security

environment and respond to a full

spectrum of crises.

• 1.3 Maintain the capability to move military

forces from the United States to any

location in the world in response to

aggression, using a combination of

airlift, sealift, and prepositioned

equipment.

Corporate Goal 2:

Prepare

• 2.1 Recruit, retain, and develop personnel to maintain a highly skilled and

motivated force capable of meeting

tomorrow’s challenges.

• 2.2 Transform U.S. military forces for the

future.

• 2.3 Streamline the DoD infrastructure by

redesigning the Department’s support

structure and pursuing business

practice reforms.

• 2.4 Meet combat forces’ needs smarter

and faster, with products and services

that work better and cost less, by

improving the efficiency of DoD’s

acquisition processes.

• 2.5 Improve DoD financial and information management (new goal for FY

2001).
4-8

Figure 4-5. Linking Corporate Goals to Performance Measures
4-9

which actual achievements can be compared.

The intent is to ensure that there is a link from

the day-to-day activities of the agency to its

long-term strategic goals. The complementary

nature of the strategic plans and the annual

plans form the basis for DoD to “manage for

results.”11 The report becomes an annex to the

ADR (albeit published separately). The GPRA

consists of two parts: the performance goals

for the upcoming year consisting of performance targets and metrics, and a “Report Card”

that assesses how well DoD achieved the performance goals during the preceding year. For

example, the 2001 report will assess how well

DoD met its FY 2000 performance goals and

identify future performance goals for FY 2002.

The Department submits the report to Congress

annually.

Each one of the eight performance goals listed

in Figure 4-4 contains several performance

measures and indicators. For example from

Figure 4-4, the corporate goal, Prepare has five

lower level performance objectives. Each of the

objectives is further broken down into performance measures. Figure 4-5 shows this relationship. From DoD’s corporate goal, Prepare,

the competitive sourcing strategy falls under

the performance objective, Streamline Infrastructure through Business Reform. This performance objective further breaks down into

nine metrics: Percent of Budget Spent on

Infrastructure, Unfunded Depot Maintenance,

Public-Private Competition, Logistics Response Time, Total Asset Visibility, Disposal

of Excess Property, Disposal of Real Property,

Defense Working Capital Fund, Net Operating Results, and Defense Transportation

Documentation.

The next phase is to ensure that the measurement control system is in place to provide

the necessary feedback of the performance

results and how these results support the overall strategy. It is best if these performance

measures are as quantifiable as possible; however, in large complex organizations such as

DoD, some qualitative measures are sometimes

unavoidable. In the annual performance plan,

DoD assesses the performance indicators on

two levels. The first level is how well the individual performance indicator met its own numeric targets at the end of the year. For example, did DoD meet its goal for the number

of positions subject to the Office of Management and Budget (OMB) Circular A-76 (A-76)

Competitions or Strategic Sourcing reviews?

The second level is how well the performance

indicator supports the performance measure of

Public-Private Competition. Finally, a subjective determination is made on the achievement

of the corporate goal if one of the metrics or

the interaction of a set of metrics are not met.

In this example, one would ask if we are focusing on the right performance measures to

achieve our desired outcome of streamlining

infrastructure through business reform.

Figure 4-6 shows a streamlined version of the

Strategic Direction Model that focuses on the

Competitive Sourcing process.

In a recent General Accounting Office (GAO)

Report, Major Management Challenges and

Program Risks, while GAO acknowledged

DoD’s improved strategic planning process, it

also pointed out that DoD’s strategic plan was

still not tied to desired mission outcomes. The

report further states that inefficiencies in the

planning process have led to difficulties in

assessing performance in the areas of combat

readiness, support infrastructure reduction,

force structure needs, and the matching of

resources to program spending plans. The report recommended that DoD include more

qualitative and quantitative goals and measures

in its annual performance plan and report to

assess the progress toward achieving the desired

mission outcomes.
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Figure 4-6. Tracing Competitive Sourcing Through the Strategic Direction ModelSource: PMT302/APMC Class notes, Dr. M. J. Hall, Strategy Making – Developing a Strategy – Driven Organization, Defense Systems

Management College, Ft. Belvoir, VA, 2001.
4-11

The example above tracing the linkage from

the mission to the A-76 studies is a good example of the problem noted by GAO. Under

the metric, Public-Private Competition, there

is only one performance measure: number of

positions subject to A-76 competitions or strategic sourcing reviews. One cannot get a true

perspective on DoD’s Public-Private Competitions just by looking at number of positions

competed. Focusing on positions alone leaves

out the important aspect of why DoD is competing those positions. Additionally, reporting

solely on one performance measure misses a

holistic outlook to answer such questions as

the following in Figure 4-7.

As will be shown below, these are important

questions. DoD now lists more than 450,000

civilian positions that could be performed by

the private sector.12 The number of employees

in addition to the amount of DoD budget tied

to support functions, overhead, and infrastructure (estimates being about 60 percent or $180

billion) makes this significant. If DoD were to

spin off a stand-alone company of 450,000

employees with a budget of $180 billion, it

would rank between second and third on the

Fortune 500 list, between Wal-Mart and General Motors (GM). According to Table I-1 in

the Introduction, the spin-off would have about

the same operating expense as GM, while

having more than four times the number of

employees. The sheer size of this portion of

DoD’s budget alone makes it imperative that

leaders ensure the Department receives the best

value for the resources committed. The following sections of this chapter will discuss DoD’s

competitive sourcing programs with follow-on

recommendations.

Figure 4-7. Competitive Sourcing Questions
4-12

Historical Background of DoD Sourcing

Since the American Revolution, America has

relied on a partnership with industry to supply

essential goods and services as part of the defensive strategy. The relatively nonexistent

government infrastructure during the Revolutionary War forced the Continental Congress

to leverage commercial industry to support the

fledgling army. Congress relied on the experience and knowledge of colonial merchants to

develop supply procedures. Whether directed

by congressional committee or supply officers, merchants handled procurement functions.

The merchant directed his own business or entered into a partnership with another. For example, the firm of Otis and Andrews actively

supplied clothing while Willing and Morris

supplied gun powder to the Continental Army.13

The reliance on the competitive forces of the

marketplace has not changed.

The need for sound competitive sourcing strategies is just as important today. The reasons

why organizations opt for sourcing solutions

have not varied significantly since that time

period. Our research has shown DoD organizations generally turn towards outsourcing for

several reasons:

• Improve performance, quality, efficiency

and cost reductions through competition;

• Focus existing personnel and resources on

core activities;

• Sustain readiness;

• Generate savings for modernization.

Since the end of the Gulf War, DoD active military strength has been reduced by over 700,000

people. As stated in Chapter One, this translates into the elimination of eight Army Divisions, eleven Air Force Fighter Wings, four

Navy aircraft carriers and 232 other ships.14

Despite the reductions to the combat forces,

support cost have climbed to nearly $200 billion a year and now consume nearly 70 cents

of every defense dollar, compared to 50 cents

before the drawdown.15 To compound this situation, DoD has been involved in more than 50

contingency operations during this same time

period.16 The high tempo of operations combined with reduced material and financial resources required DoD to re-think the way it

conducts business. In order to implement the

new strategies coming out of the QDR, the

Department had to change the way it conducted

business because the old way no longer worked.

Then Secretary of Defense William Cohen instituted the DRI to address the third point of

the Department’s corporate vision statement,

which was to conduct an RBA. The purpose of

the RBA is to garner the best commercial techniques and procedures and use them to revitalize DoD’s acquisition process. The success of

the RBA is crucial to enable the reallocation of

funds to meet the needs of the warfighter.

Defense Reform Initiative

In November 1997, then Secretary of Defense

William Cohen initiated the Defense Reform

Initiative (DRI) to move DoD into the 21st century. The purpose of the DRI was to provide a

strategic blueprint to revolutionize business

affairs within the Department by incorporating lessons learned from private industry. The

DRI addressed the third element of DoD’s corporate vision: to further national interests by

working effectively with other federal agencies,

Congress and the private sector.17 The initiative was necessary to support the new defense

strategy developed during the 1997 QDR. In

order to execute the new strategy — Shape,

Respond, and Prepare — DoD required a balance of resources between meeting existing

global requirements and ensuring investment

for the future. The DRI initiatives sought to
4-13

improve DoD’s old business practices in order

to free and reallocate resources currently tied

up in overhead and support activities. Initially,

the DRI consisted of a series of initiatives in

four areas:

• Reengineer: Adopt modern business practices to achieve world-class standards of

performance.

• Consolidate: Streamline organizations to

remove redundancy and maximize synergy.

• Compete: Apply market mechanisms to

improve quality, reduce costs, and respond

to customer needs.

• Eliminate: Reduce excess support structures to free resources and focus on core

competencies.

While the scope of the DRI has broadened over

time, the competitive sourcing program has

endured as a critical enabler for defense reform.

As part of the DRI, the Department announced

a goal to conduct A-76 competitions involving

30,000 Full Time Equivalents (FTEs) per year

through FY 2003 for a total of 150,000 FTEs.18

This was a significant increase to the number of FTE functions that had been competed

annually up to that point. Full Time Equivalent is a standardized term that represents one

work year enabling the government to use similar units for comparisons. For example, during

the 18-year span from 1979 through 1996, DoD

competed “only” just over 90,000 FTE

functions. In fact until 1997, 1983 represented

the one-year historical high point in which DoD

competed a little over 10,000 FTEs. Historically half of the competitions were won by the

private sector while the rest remained government in-house; the combined average savings

was 31 percent. However, according to the 1999

Defense Reform Initiative Directive (DRID) 20

Report, closer examination showed that when

the private sector won, operating costs dropped

by 38 percent whereas when the government

in-house team won, the operating costs reduced

by an average of 19 percent.19 Now DoD intends to vastly escalate the number of publicprivate competitions in a quest to realize additional savings. Figure 4-8 taken from the DRI

1997 report clearly shows the magnitude of

change and the major undertaking confronting

DoD.

A second result of the DRI was a budget action

in response to the anticipated savings from the

competitions. Today DoD anticipates cumulative savings to be $11.7 billion through FY

2005 and then $3.5 billion annually thereafter.21

These numbers include the cumulative results

of planned A-76 and strategic sourcing initiatives from FYs 1997 through 2005. Through

A-76, DoD expects to study about 203,000

positions, and achieve $9.2 billion in savings

and $2.8 billion in annual recurring savings

after 2005. Through the strategic sourcing program, DoD expects to study an additional

42,000 positions, achieve $2.5 billion in savings

with an additional $0.7 billion in recurring

savings after 2005.22

This is not a short term effort (DRI) simply to save money; but rather a long

term transformation that fundamentally reorients mindsets throughout the

department.

(Then) Secretary of Defense Cohen

February 25, 200020
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An important aspect of the implementation of

the DRI was that the anticipated savings were

taken out of the budget immediately up front

without proof that the savings would actually

occur. This action has placed severe pressure

on the program to live up to its expectations.

Figure 4-9, taken from a CD-ROM published

by DoD, entitled DRI Checkpoint 2000: On the

Figure 4-8. Comparing DRI Objectives (1997-2003) to

the Historical Annual Number of FTE Positions Competed

Source: Defense Reform Initiative, Chapter 3, 1997, retrieved 21 March 2001, http://www.defenselink.mil/pubs/

dodreform/chapter3.html#top.

Figure 4-9. Projected DoD Savings through Competitive and Strategic Sourcing

Source: President’s Budget 2001 DRO 2000 CD: Chapter 4.01
4-15

Road to Excellence, shows the steep savings

ramp DoD must climb in order to meet its expectations. Questions must be, Are the processes in place? and Do the personnel conducting the competitions have the training and incentives required to execute the competitions

to realize the expected savings DoD is expecting? The following paragraphs will examine

these fundamental questions.

DRI Directive 20 Report

In order to improve the identification of the

commercial activities for the A-76 competitions, then Deputy Secretary of Defense, Dr.

John J. Hamre, signed Defense Reform Initiative Directive #20: Review of Inherently Governmental Functions, on January 16, 1998. Dr.

Hamre directed the development of uniform

guidelines, criteria, and reason codes for DoD

components to determine which functions and

positions are inherently governmental in nature,

commercial activities exempt from A-76 competition, and commercial activities that should

be competed.23 The DRID 20 requirements provided a means to monitor the progress of the

Services in the implementation of the sourcing

goals established during the DRI. The Office

of Federal Procurement Policy, Policy Letter

92-1, defines inherently governmental functions as those activities that “require either the

exercise of discretion in applying governmental authority or the use of value judgments in

making decisions on behalf of DoD.”24 Commercial activities that are exempt from competition are those functions relating to national

security concerns or legislative prohibition

(depot maintenance, firefighters, security

guards). The third category contains those functions that should be competed. The Department

published the results of the inventory in December 1999. The results included an analysis

of over 2.95 million positions. These positions

included 2.2 million military and over 740,000

government civilian positions. The results are

shown graphically in Figure 4-10.

The results of the 2.95 million position inventory broke out as follows: DoD classified a total

of 2,049,111 (69 percent) positions as inherently

governmental; 618,506 (21 percent) positions

as commercial exempt from competition; and

Figure 4-10. Results of the DRID 20 Inventory
4-16

283,000 (10 percent) positions as commercial

subject to competition. Of those positions subject to competition, over 52,900 were military,

with the remainder civilian.25

The DRID 20 report provided a comprehensive snapshot in time of the allocation of work

functions across DoD and the identification of

a potential pool of competitive sourcing candidates. In fact, the pool of candidates identified

in the report exceeded the FY 1997 Commercial Activity Report by a total of 81,000 positions. However, it was also recognized that the

total number would have to be increased to meet

planned budget requirements.26

Additionally, DoD recognized several other

shortcomings. Inconsistencies in the identification of workload mix and coding of positions

existed among the Services. For example, in

an August 2000 GAO report on competitive

sourcing entitled More Consistency Needed in

Identifying Commercial Activities, the GAO

found the Army used a centralized approach

that standardized coding across the Service. In

contrast, the Navy and Air Force used a more

decentralized approach that resulted in commands applying different codes to the same

functions.27

The differences among the Services also led to

inconsistencies in coding of positions. For

example, the Army listed its public affairs

activities at its military academy as commercial while the Navy listed its public affairs

activities at Annapolis as inherently governmental.28 The Department established integrated process teams to review the procedures

and the teams still function today. The number

of positions available for competition will

change as DoD refines its core competencies

as the new administration clarifies its strategic

plan. The DRID 20 process provided the first

step in an iterative process to identify those

functions that were inherently governmental in

nature and those functions that were commercial activities. The following year Congress

enacted the Federal Activities Inventory Reform (FAIR) Act. The DRID 20 report and

methodology provided a foundation for DoD’s

future actions to meet FAIR Act requirements.

Federal Activities Inventory Reform Act

On October 12, 1998, President Clinton signed

the FAIR Act of 1998 (Public Law 105-270).

The law requires all executive agencies to submit to Congress an annual list of activities that

are not inherently governmental functions and,

as such, are possible candidates for A-76 studies. The law defines inherently governmental

functions as those functions so intimately related to the public interest as to require performance by government employees.29 The significance of the FAIR Act is that although Congress required commercial inventories prior to

enactment, now the results were made openly

available and the public could challenge what

was or was not on the list.

In 2000, DoD listed 452,807 positions that

could be performed in the private sector. Of

these positions, DoD listed only 178,771 as

commercial subject to competition. Those

activities identified as commercial subject to

competition do not include any uniformed positions or depot maintenance work because the

law does not require DoD to report those positions. Also, the law does not require agencies

to competitively source any of the activities.

However, the FAIR Act report does provide a

starting point. According to Stan Soloway,

president of the Professional Services Council

and former Deputy Under Secretary of Defense

for Acquisition Reform, “On some levels it isn’t

taken seriously enough.” He went on to say the

Act provides, “a base to discuss what the

government should be doing. It’s not an end in

itself.”30
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The August 2000 GAO report on the consistency of DoD’s identification of commercial

activities concluded many of the inconsistencies in the DRID 20 report still held true for

subsequent FAIR Act submissions. The report

concluded:31

• Variations in how DoD components developed the inventories and lack of clear guidance on category activities that were not core

activities may have limited the potential to

identify additional commercial positions.

• Further inconsistencies in reporting procedures will persist without clear guidance on

what activities are core commercial activities.

• Even if additional commercial functions are

identified, the GAO did not expect DoD to

significantly increase the number of functions under the A-76 process due to already

aggressive competition goals.

• Factors such as the inability to group positions due to geographic dispersion or to

separate commercial activities from inherently governmental work may limit the

number of functions that can be studied.

The report recommended the Secretary of

Defense increase the consistency in the identification of commercial activities by making

top-level decisions on whether certain activities should be considered eligible for competition. To date, this work is still ongoing by DoD;

however, there is no desire to determine a strict

set of guidelines throughout DoD.

At the time of writing, as the new administration takes shape, the initial indications are that

FAIR Act inventories in relation to A-76 competitions will grow in importance. On March

9, 2001, Sean O’Keefe, Deputy Director of

OMB, published a memorandum outlining

performance goals and management initiatives

for the FY 2002 budget. The memo directs

agencies to complete public-private or direct

conversion competitions on not less than 5 percent of the FTEs listed on their FAIR Act inventories. The 5 percent threshold includes the

positions that DoD exempted from competition; for example the figure would represent

over 22,640 of the 452,807 commercial positions

on their FAIR Act list. The memo highlights

the President’s commitment to open at least

one-half of the Federal positions listed on the

FAIR Act inventory of commercial functions

to competition with the private sector.

One area of concern with the recent OMB

guidance is the use of direct conversions of positions. The A-76 Supplemental Handbook lists

four instances when agencies can directly

convert positions to the private sector without

performing cost-comparison studies:32

• Agencies can convert a federal activity if it

involves ten or fewer positions.

• If a function involves 11 or more positions,

the agencies must place the reassigned

federal employees to comparable federal

positions for which they are qualified.

• Commercial activities of any size may be

converted to contractors who qualify as preferential procurement sources under section

8(a) of the 1953 Small Business Act.

• Agencies may also apply for a waiver from

the A-76 process to directly convert positions.

However, trying to achieve the OMB thresholds solely through direct conversions will be

met with resistance. This method has naturally

drawn strong opposition from the American

Federation of Government Employees (AFGE).

For example, Mr. Bobby Harnage, President
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of the AFGE, recently stated before the Subcommittee on Readiness of the House Armed

Services Committee in March 2001, “This

direct conversion process is federal service contracting in its essence: a corporate welfare

boondoggle.”33 As DoD seeks to meet the OMB

guidance, it must use a balance of direct conversions with competing functions through the

A-76 process.

OMB Circular A-76

The OMB Circular A-76, issued in 1966, establishes federal policy for the performance of

commercial activities. The Circular defines a

commercial activity as an activity that is operated by a federal executive agency and provides

a product or service that could be obtained from

a commercial source.34 The policy recognizes

the principle that the government should not

be in competition with the commercial sector.

As such, the general policy of the government

is to rely on commercial sources to supply its

products and services if the product or service

can be procured more economically from a

commercial source.

The Supplement to Circular A-76, first issued

in 1979 and revised in March 1996, provides

the guidelines to determine whether the commercial activities should be performed by DoD,

the private sector, or another federal agency.

The policy is based on the idea that competition enhances quality, economy, and productivity. The handbook provides guidance for

managers to make sound and justifiable business decisions.35 The basic purpose of an A-76

study is to determine the cost efficiency of retaining services provided by a government organization or contracting for those services with

a commercial firm. The policy states that in

accordance with the Circular and the Supplement, whenever commercial sector performance of a government-operated commercial

activity is permissible, a comparison of the cost

of contracting and the cost of in-house performance shall be performed to determine who

will do the work.

As stated in the handbook, the A-76 policy is

not designed to simply contract work out.

However, the program is used to:36

• Balance the interests of the parties to a

make-or-buy cost comparison;

• Provide a level playing field between public

and private offerors to a competition;

• Encourage competition and choice in the

management and performance of commercial

activities.

On the surface the A-76 cost comparison process is very straightforward. An organization

determines an activity to study, develops a work

statement that describes what needs to be done,

receives bids from the commercial sector, compares these with the in-house cost estimate, then

selects the lowest-cost provider. However, in

practice the A-76 process has proven a very

controversial and challenging program. For

example, due to inconsistencies in the selection process, the former Deputy Secretary of

Defense mandated a review because of the controversy surrounding the Air Force’s awarding

of service contracts at Lackland Air Force Base.

The Service reversed its decision twice before

DoD put a halt to the contract award and all

other Air Force A-76 competitions pending review. Figure 4-11 shows an overview of the A76 process and is followed by a discussion of

the key activities according to the Supplemental

Handbook.

Once an agency determines it will use the A76 process and all notifications are complete,

the first step is to write the Performance Work

Statement (PWS) and the Quality Assurance

Surveillance Plan (QASP). The PWS should
4-19

Acquisition actions A-76 actions

Develop and issue solicitation Develop MEO and government bid

Independent review of government bid

Receive contractor proposals

Evaluate proposals and

conduct negotiations

Select contractor proposal to compete

with government bid

Conduct cost comparison

Public review and appeal process

Final cost comparison and congressional notification

Award contract or implement MEO

Develop PWS & QASP

Congressional notification and public announcement (46 or more)

Activity nominated for A-76 Study

Is activity military essential or inherently governmental?

Retain/reengineer

1

2

3

4 5

6

7

8

9

Yes

No

Figure 4-11. A-76 Cost Comparison Process

Source: Tom Dolan, It Used To Be Called Outsourcing and Privatization, Then it Became Competitive Sourcing

and Privatization, Now It’s The DoD Strategic and Competitive Sourcing Program, Class notes, PMT 305,

Defense Systems Management College, April 2001, Slide 8.

clearly define what is being requested, the performance standards and measures, and

timeframes required. One important point of

emphasis is that the PWS should articulate what

work needs to be done, not how to accomplish

it. The how is the essence of the offeror’s proposal. The Handbook points out that special

care should be taken when developing the PWS

to ensure it does not limit Service options,

arbitrarily increase risk, reduce competition,

unnecessarily violate industry service or service grouping norms, or omit statutory or regulatory requirements without full justification.37

The importance of developing a complete PWS
4-20

is critical for the success of the future steps.

The Inspector General of DoD reported that

70 percent of the increases in outsourced

contracts are due to changes in the PWS.

The A-76 study team derives the QASP based

on performance standards to adequately determine if the services rendered by whoever does

the work meet the standards set in the PWS.

Specific elements to be addressed by the QASP

are the inspection methods used, the reports

required, and the resources to be employed with

estimated man-hours.

At this point a parallel effort can begin. First,

the government team develops its management

plan consisting of the most efficient organization (MEO), QASP, in-house cost estimate, and

the transition plan. The MEO describes how

the in-house government team will perform the

work according to the PWS, as well as manpower, budget, and facility requirement. The

QASP is developed as the MEO quality assurance plan. The in-house cost estimate shows

how much it will cost the team to operate under the assumptions, as the MEO and the transition plan outline how the current organization will transition into the MEO in the proposal. While the government team is doing its

part, the contracting officer issues the solicitation to the contractors for them to develop their

proposals. The evaluation of the proposals occurs with the selection of one contractor. At

this point in the selection process there is one

contractor team and the government’s MEO.

During the evaluation of the proposals, the

Federal Acquisition Regulation (FAR) and

the A-76 supplemental handbook require the

selection team to conduct specific steps during

a “best value” approach. While the private sector offerors can submit proposals that offer a

higher level of performance or service, the government in-house management plan and cost

estimate base the offer on the PWS. Therefore

the two proposals can differ. When the

government’s selection authority reviews the

private sector proposals to determine which one

represents the best overall value to the government, it looks at performance levels, proposal

risk, past performance, and cost. Private sector

proposals will often offer a higher level of performance or service compared to the original

PWS.

In fact, a June 29, 2000 ruling for Rice Services Ltd. held that the selected best value offer

becomes the benchmark for the MEO, not the

PWS.39 The selection authority then evaluates

the government’s MEO to determine if it can

achieve the same level of performance and

quality as the selected private sector proposal.

If not, the government can make changes to

the MEO in order to meet the new performance

standards. The intent of this step is to ensure

that the government bases its in-house cost

estimate on the same scope of work and performance levels as proposed by the best value

selected private sector offeror. Once the selection authority determines that the two proposals are based on the same levels of performance,

the cost estimates are compared.40

According to Chapter Four of the A-76 Supplemental Handbook, there must be a minimum

cost differential of the lesser of 10 percent of

personnel costs or $10 million over the performance period before converting to or from inhouse, contract, or inter-service support agreement performance.41 The purpose of the minimum cost differential is to ensure the government does not convert for marginal estimated

savings.

Any of the participants may appeal the selection authority’s decision if they believe that the

costs submitted by the winning offeror were

not fair, accurate, or calculated according to

the procedure outlined in the A-76 Supplemental Handbook. The appeal process can be used
4-21

in the Invitation for Bids or Request for Proposal process, whichever is used. The participant making the appeal must do so in writing

within 20 days after the date that all supporting documentation is made publicly available.

The Appeal Authority has 30 days to adjudicate any appeals after they are received. While

DoD continues to use the A-76 process, the

Services are looking for alternatives to achieve

savings. One such alternative that will be

discussed next is strategic sourcing.

Strategic Sourcing

On April 3, 2000, the Under Secretary of

Defense for Acquisition, Technology and

Logistics published interim guidance on strategic sourcing programs. The guidance broadens DoD’s competitive sourcing tools to include

strategic sourcing as an alternative means to

achieve savings in areas that are exempt from

the A-76 competitive process. The strategic

sourcing program is designed to perform functional assessments to determine if processes can

be eliminated, improved, or streamlined regardless of whether activities are commercial or

inherently governmental in nature.42 One fundamental advantage of strategic sourcing over

the traditional A-76 approach is that strategic

sourcing generates smarter business decisions

because it addresses the question of whether a

function should be performed at all before answering the question of who should perform

it. The traditional A-76 process lacked this first

step.

Strategic sourcing is not an avoidance of the

traditional A-76 process. The new approach

however, focuses on functions rather than billets. This enables DoD to make business decisions based on an enterprise-wide basis versus

a compartmentalized approach. The advantage

of strategic sourcing is that it provides a more

holistic approach in analyzing areas under

study because many organizations consist of

an embedded mixture of functions that are both

inherently governmental and commercial in

nature.

The move towards strategic sourcing was made

because of the realization that conducting A76 studies alone would not achieve the necessary savings goals and study goals as originally

planned, and the A-76 process would not in

all cases result in the most efficient infrastructure. Figure 4-12 shows the strategic sourcing

decision process.43

The key step in the strategic sourcing process

is to properly define the entire function or

activity to optimize or improve the level of

performance at a reduced cost. This procedure

is accomplished regardless of whether the function or activity is commercial or inherently

governmental. The decision process in Figure

4-12, enables the Service components to consider a wide range of options. Functions that

cannot be eliminated, combined, or converted

to private sector performance are candidates for

functional assessments, a process reengineeringbased approach designed to achieve the most

efficient operation.

The Navy was the first Service to implement

the new approach and expects to review 88,000

civilian positions by 2005. About half of the

88,000 positions will be under the A-76 cost

comparison process and the other half through

the strategic sourcing process.44 The Naval Sea

Systems Command’s Weapon Station at Crane,

IN, served as the strategic sourcing pilot program for the Navy. The program began in FY

1998 and expects cumulative savings of $158

million by FY 2005.

Crane initiated its strategic sourcing approach

in 1998 after receiving DoD guidance to cut

$20 million from its annual budget by 2005.

The cut put 576 of the base’s 3,100 jobs in jeopardy. Duane Embree, executive director at
4-22

Figure 4-15. Strategic Sourcing Program Decision Tree

Source: Under Secretary of Defense Memorandum, Department of Defense Strategic and Competitive Sourcing

Program Interim Guidance, Attachment 1: Strategic Sourcing Program, February 29, 2000.

No

No

No

No

No

No

No

No

Yes

Yes

Is the Commercial Activity performed by 10 or

less DoD civilian employees and/or any number

of military?

Identify and Review Entire Function or Organization

(i.e., in-house/contracted commercial activities, inherently governmental, military essential, and restricted activities)

Is it still needed in whole or part?

(i.e., validate requirement)

Are the Commercial Activities severable from

Exempt Activities?

(i.e., inherently governmental, military essential, rotation,

career progression, etc.)

Are any of the Commercial Activities New

Requirements or Severable Expansions?

Is an A-76 Cost Comparison Waiver desired?

(i.e., in-house or contract has no chance of winning or in-house or

contract results in significant cost/quality improvement)

Can the Commercial Activity be privatized?

Can another DoD Component perform the

Commercial Activity more cost effectively?

Has a qualified NIB/NISH/JWOD firm

offered to perform the work?

Has an 8(a) Native American owned firm

offered to perform the work?

Perform A-76 Cost Comparison – Is Private Sector/

ISSA Performance more efficient and cost effective

than in-house MEO?

Convert to Government’s Most

Efficient Organization

Update CAMIS and Inherently Governmental/

Commercial Activities Inventory

Can another DoD

Component or Federal

Agency perform the

work more cost

effectively?

Eliminate Activity

Reengineer or

Benchmark Using

Validated

Methodologies

It is not a requirement

to seek these sources

before proceeding.

An A-76 cost

comparison may be

limited to the MEO and

the NAO firm.

An A-76 cost

comparison is optional.

ISSA that is a nonDoD Component

Dotted line around text

indicates these steps

are optional.

Convert to ISSA Convert or Retain

(if converting, develop

waiver package to

include justification,

cost analysis and

legislative action plan)

Convert to

Contract

Convert to

DoD ISSA

Seek Legislative Relief

and, if needed,

create source

Convert to

Contract

(If fair and

reasonable, prices

can be obtained)

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

No

No
4-23

Crane stated, “We felt we were facing a death

of 1,000 cuts. Outsourcing those jobs would

have fragmented Crane without our becoming

a better organization.”45

Rather than plunge into an A-76 study, Crane’s

management team sought permission to waive

the immediate outsourcing process in lieu of

conducting a comprehensive review of the entire workforce to decide what tasks should be

streamlined, eliminated, or if need be, outsourced. For example, the intent was not only

to review the base’s 1,330 support jobs, traditionally under the purview of A-76, but also to

expand the reengineering process to review the

1,700 core scientific, engineering, and technical positions. The core positions are normally

in the inherently governmental realm. By 2005

Crane expects to save $44 million annually.

This more than doubles the initial savings

directed by the Navy. At Crane, the managers

and workers not only look for ways to increase

efficiency but also ask the fundamental question, should government employees perform

the function in the first place? According to

Navy Captain Scott Wetter, Crane Commander,

“If we have no value to add, we should go away.

It’s as simple as that.”46

Each of the other Services will begin strategic

sourcing in 2001. In the upcoming years

through 2005, the Army plans to open 18,000

jobs to strategic sourcing and the Marines

7,000.47 The Air Force is considering about

14,000 positions.48

Results to Date

The competitive sourcing program is one of

the most scrutinized programs in DoD because

of the billions of dollars at stake and the longterm effects on the federal workforce. Congress, industry, unions, and DoD all have their

arguments both pro and con of the long-term

value. The oversight and reporting requirements

continue to grow especially with the new

administration and the call for transformation.

In FY 2000, the GAO published five studies

on competitive sourcing, three in the month of

August alone. The RAND Corporation, the

Center for Naval Analysis, and a host of other

organizations have also produced many recent

reports on the subject. Even with the oversight

and reporting, the debate continues as to the

actual long-term savings and benefits of the

program. However, many of the reports do

produce some common themes to both the

benefits and shortcomings of the current system and recommendations for the future. The

remainder of this chapter will discuss these

findings.

In the most comprehensive review to date,

Congress required DoD, in Section 8109 of the

2000 Defense Appropriations Act, to report on

all instances since 1995 in which missions or

functions of DoD were reviewed pursuant to

OMB Circular A-76. The Act required DoD to

furnish detailed information for each study.

Figure 4-13 shows the requirements for the report. In the report, DoD cited 286 A-76 studies

involving 10,661 manpower authorizations.

Of the 286 studies reported, 138 involved cost

comparisons (91 percent of manpower authorizations) between the public and private sector,

while the remaining 148 studies (9 percent of

the manpower authorizations) involved direct

conversions either to or from government inhouse performance.49 Of the 138 cost comparisons, 83 (60 percent) were won by the government team while the private sector won the remaining 40 percent. Of the 148 direct conversions, 134 were moved to the private sector. Of

the 286 studies, only eight involved work performed by the private sector. In those cases, six

were cost comparisons with the public and private sector each winning three. The remaining

two private sector studies resulted in direct conversions from the private to the public sector.50
4-24

The Department reported significant savings

in its analysis. The report back to Congress

states, “ Overall, the 286 A-76 reviews reduced

costs by an estimated 39 percent for FY 1999,

yielding an estimated $290 million in savings.

This estimated 39 percent reduction is a ‘snapshot in time’ for the 286 reviews in 1999 only.”51

However, while GAO agreed that savings were

being realized from the competitive sourcing

studies and acknowledged DoD’s attempts for

accuracy, limitations in baseline cost data, study

costs, and other factors made it difficult to substantiate the estimated savings suggested in

DoD’s report.52

Factors that Influence Savings

Many of the common research themes that raise

questions as to the actual amount of savings

stem from the problems with study initiation,

development of baseline costs, unrecognized

costs, tracking savings, and completing planned

studies. The following sections will discuss

each one of these topics in more detail.

Section 8109. (a): Report on OMB Circular A-76 reviews of work performed by DoD

employees.

• Report on all instances since 1995 in which missions or functions of DoD have been

reviewed pursuant to OMB Circular A-76

• Disposition of each review

• Provide the outcome for each study

• Include a description of the types of missions or functions

• Locations

• If applicable, the name of the contractor performing the work

• Cost to perform the missions or functions at the time of the review

• Current cost to perform the mission or function

Section 8109. (b): Report on OMB Circular A-76 reviews of work performed by DoD

contractors.

• Report on all instances where work has been converted to DoD civilian or military

• Include a description of the types of missions or functions for each instance of contracting in

• Locations where the work was performed

• The name of the contractor that was performing the work

• Cost of the contractor performance at the time the work was contracted

• Current cost to perform the mission or function

• Recommendations for maximizing the possibility of effective public-private competition

for work that has been contracted

Section 8109. ( c): Comptroller General Review.

Not later than 90 days after the Secretary submits the report, the Comptroller General

shall submit whether the department has complied with the requirements of the report.

Figure 4-13.

Requirements of Section 8109 of the 2000 Department of Defense Appropriations Act
4-25

Study Initiation and the

Performance Work Statement

In the area of study initiation, a concern is the

development of the Performance Work Statement (PWS). The entire cost comparison process hinges on the PWS. The OMB Circular

A-76 requires a performance-based PWS. The

team developing the PWS must describe what

results need to be achieved, not how to achieve

those results. A well-crafted PWS describes the

desired performance level in terms of quality,

quantity, and timeliness. A poorly developed

PWS often leads to custo-mer dissatisfaction,

contractor default, and reduced efficiency and

effectiveness by stifling the creativity of the

marketplace to develop innovative solutions to

unique problems.

Although on the surface it appears an easy task

to write the PWS — describe what you want

done — the government team walks a fine line

during the PWS development. The team must

strike a balance between ensuring the PWS

describes the desired outcomes and not becoming too prescriptive. In a study published by

the Center for Naval Analysis in February 2001,

the report cited several examples of an overly

prescriptive PWS. The purpose of the study was

to determine the long-term costs and performance effects of DoD’s competitive sourcing

program. The study analyzed 16 completed

competitions and attempted to determine cost

savings for each. The study found nearly all

the PWSs required the potential contractors to

follow vast numbers of military instructions or

manuals. Specific examples include:53

• The type of grass seed to use;

• The numbers of insects that must be counted

before initiating treatment;

• The number and type of personnel the

contractor was to provide;

• The use of government paint specifications

for housing.

Figure 4-14 provides further illustration where

an overly prescriptive PWS will lead to unnecessary costs.54 Part of the problem is due to

the make up of the team writing the PWS. This

team normally includes in-house workers who

are already performing the tasks. Therefore, it

is quite natural for them to think in terms of

In May 1998, the Air Force Audit Agency reviewed the mess attendant contract at McConnel Air

Force Base to determine if this outsourced function was effectively and efficiently managed. Their

review of the existing contract and the Invitation for Bids (IFB) for the follow-on contract found the

contract requirements were overstated and included work which was no longer needed. For example, the PWS overstated the monthly meal count by nearly 7,000 meals (20,000 monthly meals

as opposed to an historical usage of 13,000) and the IFB included provisions for short order cooks

even though cooking duties were not part of the mess attendant contract. The PWS also indicated

that the contractor was responsible for the watering of live plants, dusting silk plants, and drycleaning the drapes within the dining facilities. However, a separate contractor receives $2,400 a

year to maintain the live plants, there are no silk plants in the dining facilities, and the drapes were

replaced with venetian blinds nearly five years prior. By revising the PWS to better match anticipated workload requirements with its actual need, the Air Force can reduce its operating costs by

$381,000 annually.

Figure 4-14. Overly Prescriptive PWS Example
4-26

the old way of doing business and describing

the work as it is currently performed. A second

potential problem is that the people who write

the PWS could be the same people who create

the in-house MEO. This creates a conflict of

loyalties. Rather than opening avenues for creativity and innovation, it hinders change to new

ways of solving problems. Potential solutions

are to give more training in best commercial

practices of PWS writing to those who perform

the function, or to assign the writing to a separate, non-partial group. The need for a good

PWS cannot be overstated. In fact the DoD

Inspector General has reported that 70 percent

of increases in outsourced contracts result from

changes in the PWS.55

Baseline Cost Estimates

A second issue affecting the government’s ability to determine savings is the development of

the Baseline Cost Estimate (BCE). This is due

to several factors. First, the BCE uses an average salary for the positions under study, as

opposed to actual costs. Second, the salary and

benefits are computed on the number of positions authorized instead of the actual positions

filled. Using the actual costs provides a more

realistic baseline to determine savings as a

result of the competition because the “baseline”

is an inflated number to begin with.

In an August 2000 study conducted by the GAO

entitled Savings Are Occurring But Actions

Needed to Improve Accuracy of Savings Estimates, GAO analyzed nine A-76 competitions.

The GAO found a variety of cost estimating

approaches. Of the nine, GAO found seven

cases where the component used personnel reductions as a baseline for estimating savings.

Along with the two issues discussed above,

GAO also found that while most of the savings

were attributed to personnel costs, nearly 15

percent of the costs for the MEO or contractor

were not, in fact, personnel costs. However,

these were not included in the BCE. Neither

GAO nor DoD could accurately determine the

savings in any of the nine cases analyzed.56

An example of the problems associated with

determining a true baseline cost can be shown

in one of the cases GAO reviewed in the study.

The case involved a missile maintenance activity at Redstone, AL. The activity had several organizational changes occurring independent of the study. Some of these changes included a reduced workload of 40 percent and

decreased personnel requirements. However,

these changes were included in the baseline cost

estimate. At the time of the review, neither GAO

nor the base officials could separate or estimate

the reductions related solely to the A-76 study.

It should be noted DoD has recognized the

problem with BCEs. On March 14, 2001, DoD

published DoD 4100.XX-M, A-76 Costing

Manual. The document provides policy and

procedures to develop the in-house cost estimate for the competitive sourcing program.

Proper implementation will go a long way in

helping DoD correct this known deficiency but

it will not affect the hundreds of studies already

undertaken which comprise the bulk of the

estimated $11.7 billion in savings that DoD

hopes to achieve from the program.

Unrecognized Costs of the Competition

The savings from the competitive sourcing program do not come without a price. These costs

fall under the category of unrecognized costs.

These costs are considered unrecognized because they are not taken into account in reporting the savings associated with the competitive sourcing program. As will be shown, these

costs can be substantial. Four factors make up

unrecognized costs. These factors are the costs

to conduct the study, personnel transition costs,

contract administration costs, and scope of

work changes.
4-27

The first factor is the costs associated with conducting the study. A-76 competitions have

proven to be extremely manpower-intensive.

The government team must develop the PWS,

QASP, and MEO; conduct the source selection

board; and award the contract. These activities

take time and pull personnel away from their

normal duties. In many cases, these are the

same duties that the government plans to compete. The exact costs to conduct each study (per

position) can vary considerably from Service

to Service and from competition to competition. The Services use a planning figure of

$2,000 per position.57 However, this number

can be much higher. One source estimates that

it costs between $2,000 and $6,000 per position competed.58

In the study involving the nine cases discussed

earlier, GAO estimated the cost per position

ranged from $364 for a Navy child care center

in San Diego, CA, to almost $9,000 for a Navy

regional family services center also in San

Diego.59 Based on these figures, the cost to conduct the A-76 competitions can run into the

millions of dollars. According to the President’s

Budget for FY 2001, DoD estimated $555 million in study costs for A-76 and strategic sourcing studies for FYs 1997-2005. If the actual

costs to conduct the studies rose to a not uncommon $4,000 per position, the study costs

would erode over $1 billion in overall projected

savings by DoD (roughly 10 percent).

The second category of unrecognized costs are

the personnel transition costs associated with

implementing the competition award. These

costs take the form of separation costs for

reductions in force, voluntary separation incentives, severance pay, placing affected employees in other positions, and reassigning uniform

personnel back to operational assignments.

Typically, most of the sourcing competitions

involve some type of service activity. Therefore,

the costs associated (and hence the savings)

with the activity are mostly personnel costs.

However, like the costs to conduct the study,

transition costs can be high — particularly in

cases involving the transition from military

positions to government civilian or contractor

personnel.

Referring back to the GAO study, Altus Air

Force Base shows the impact of transition costs

on estimated savings.60 Of the nine cases analyzed by GAO, Altus represented the largest

savings over a five-year period—almost 38

percent. In the Altus example, 97 percent of

the costs identified in the MEO were personnel-related. In 1996, the Air Force planned to

convert its largely military aircraft maintenance

workforce at Altus into either government or

contractor employees based on the results of

their A-76 study. The existing organization had

1,444 authorized positions (1,401 military and

43 civilians); however, the actual number assigned was 1,248 (1,206 military and 42 civilian). Altus had 14 percent fewer workers on

hand than authorized. The government’s MEO

won the competition. The MEO had 735 civilian positions. The case reported significant savings due to the reduction in personnel costs.

The five-year baseline cost for the existing

operation was $265 million while the MEO cost

$166 million. However, when one takes a Service-wide outlook, the savings to the Air Force

were much smaller because the salaries of the

1,248 military never really went away. Additionally, over the five year period from 1996

through 2001, the Air Force estimated it would

cost $3.7 million in “save pay.” Save pay refers to the money given to a federal employee

to compensate for the lower pay when, during

the course of a reduction in force, the employee

moves to a lower-graded position. The employee retains his or her pay according to the

previous pay grade. One could argue that the

net effect was actually an increase to the Air

Force payrolls of 735 personnel.
4-28

The Altus example also shows the impact of

using actual versus authorized positions as discussed in the problems with the baseline cost

estimate portion of this chapter. Just by using

actual numbers the BCE would show significant savings while no change to the existing

organization.

The Services show no indication of reducing

military end strength as a result of the competitive sourcing program. Putting soldiers,

sailors, and airmen back into warfighting units

is a good thing. However, their salaries don’t

really disappear from the Service budgets.

Therefore while Altus can claim a savings in

isolation, the overall impact to the Service is

much less. In fact, the Services plan to study

the activities involving 44,816 military positions.61 The results of these studies will most

likely replace the uniform personnel with government or contractor personnel. Another significant point to the change of workers is that

the Services will have to increase their operations and maintenance accounts to pay the salaries of the government or contractor employees. The transfer of positions with subsequent

inflation of the savings numbers has not gone

unnoticed among critics. According to Bobby

Harnage, president of the American Federation

of Government Employees, “We have heard a

lot of lies the last few years about how much

smaller DoD’s workforce has become. DoD’s

workforce has not gotten any smaller; it’s

merely been reconfigured.”62

A third unrecognized cost category is the administrative costs to oversee contracts when a

private firm wins the competition. Just as the

other costs described above, these costs can

vary significantly based on the type and size

of the activity in question. For example, in the

nine GAO case studies, the private sector firm

won six of the competitions. The administration costs of these six cases ranged from a low

of $12,000 per year for the child care center in

San Diego, to over $635,000 per year at WrightPatterson Air Force Base for base operations

support.63 Like the cost to conduct the study

and transition costs, administration costs are

not factored into the reported savings estimates.

The fourth unrecognized cost involves changes

in the scope of work, which can make it virtually impossible to compare estimated savings

at the beginning of the competition to actual

long-term savings. Sometimes the changes

occur as a result of inadvertent omission of

tasks from the original scope of work which

must be added back in. Other times the changes

occur due to organizational changes that increase or decrease workload functions. The

GAO found several examples of changes in

scope during its analysis of the nine cases. In

one such instance, a scope of work change

added 6 percent to the original contract cost.64

Tracking Costs

In order to evaluate the success of the competitive sourcing program, DoD must improve

its ability to document actual program costs and

program changes. Without this documentation,

DoD will never be able to accurately determine

the program’s effectiveness and efficiency. This

takes on added importance as the leadership

continues to make budgetary decisions based

on inaccurate and inflated cost savings estimates. The research shows numerous examples

of the lack of clear and accurate cost reporting

and the difficulties in determining long-term

savings. This section will discuss some of the

problems of tracking costs using examples from

recent studies.

One of the factors discussed as a continuing

problem with cost reporting is the Commercial Activities Management Information System (CAMIS). When the leadership at an installation selects an activity for a cost comparison, they establish a CAMIS data file to record
4-29

the results of their competition. The data file

contains information such as cost comparisons,

functions, milestones, and the outcome. The

GAO has repeatedly expressed concerns about

the accuracy and completeness of the CAMIS

data beginning as early as 1990.65 This is particularly true in cases involving in-house wins

where the records of cost performance and

workload changes have not been routinely kept

up-to-date. For example, in its report entitled

Results of A-76 Studies Over the Past Five

Years, GAO noted that in the section 8109 report DoD submitted to Congress, DoD excluded information of 53 studies (nearly 20

percent of the studies conducted over the past

five years) due to lack of data.

The lack of accurate data was also cited in the

February 2001 Center for Naval Analysis report, Long-Run Costs and Performance Effects

of Competitive Sourcing. The original intent of

the study’s authors was to report on 30 competitions with an equal number of in-house and

contractor wins. However, insufficient and

missing data eliminated about two-thirds of the

49 competitions initially selected for review.

The group found the inaccuracies were particularly prevalent for in-house wins. Out of the

24 in-house wins initially reviewed, they only

found sufficient data to report on two. The overall lack of historical data forced the study group

to report on only 16 studies, two in-house and

14 contractor wins.66 Although the study concluded that long-term savings do exist, the need

to reform the process to ensure accurate data

was cited as an improvement that must be made

for DoD to better evaluate the competitive

sourcing program’s effectiveness.

To its credit, DoD has recognized the problems

with the CAMIS database and is under a massive review in an attempt to update over 1,500

files. Additionally, they will move to a webbased program to provide real-time data for

better tracking. This should help alleviate some

of the problems. However, proper controls must

be placed in the system to ensure that users

continue to update the information. Data that

are not current are useless — as the computer

axiom points out: “garbage in” equals “garbage

out.”

Initiating and Completing Studies

As part of the DRI, DoD set very aggressive

A-76 goals in terms of the number of positions

to study and the associated estimated savings.

By taking the anticipated savings away up front,

the pressure is now on to produce. The challenge remains to complete the number of

planned studies and achieve the results. For

example in 1999, DoD established a goal to

study nearly 230,000 positions and save $11.2

billion between 1997 and 2005. However, as a

recent GAO report indicates, DoD has fallen

behind in its plan for initiating the planned

amount of studies and has had some difficulties completing the studies within the two-year

goal.67 Some of the factors that contribute to

DoD’s difficulty in increasing the number of

positions studied under A-76 were discussed

in the FAIR Act portion of this chapter. This

challenge has forced DoD to look for other

ways to achieve its goals, such as the strategic

sourcing initiatives discussed earlier in the

chapter, reorganizations and consolidations,

and the use of direct conversions.

Figure 4-15 illustrates the difficulty DoD has

had in accomplishing its goals. Although some

assumptions went into building the graphs, they

do show a significant trend. Since DoD based

its budgetary savings estimates on planned

studies, one would conclude that DoD will not

achieve its anticipated savings within its expected timetable of 2005. We use the two most

recent years in which there would be complete

data to illustrate this point. The figure assumes

a two-year completion estimate to formulate

the graphs. The reported number of completed
4-30

studies may not have all been started exactly

two years before but one can see a definite trend

in relation to planned versus completed. For

instance in the 1997 bar graph, the number of

studies completed in 1999 does not necessarily mean those studies were started in 1997.

Some could have been started in prior years or

in 1998. The same is true for the studies completed in 2000. Those studies may not have all

started in 1998. However, even if the completed

studies for 1999 and 2000 do contain studies

initiated in other years it still shows a significant decrease in completing the studies which

in turn would not enable DoD to generate the

savings that have already been taken out of the

budget. In 1997, DoD planned on conducting

studies totaling 34,000 positions but actually

announced 28,673 positions. Two years later,

DoD had only completed enough studies to

total 5,373 positions of the announced positions

in 1997.

The relationship between announced and completed studies is not a recent trend. In a 1997

RAND documented briefing entitled Cancellations and Delays in Completion of Department of Defense A-76 Cost Comparisons, the

authors analyzed A-76 cost comparison data

from FYs 1978 through 1994. The analysis

found that between those years, approximately

five A-76 cost comparisons were canceled for

every eight completed (2,268 total cost comparisons and 1,418 were canceled).68 Additionally, the briefing found the mean time to complete the studies was 810 days and over 10 percent of the cost comparisons took at least four

years.

The trends in Figure 4-15 and in the RAND

brief raise two other important points. First, if

a competition is canceled, this generally means

those functions remained in house and the

government’s in-house team is under no

obligation to change according to what would

be the MEO. Second, since DoD expects to

generate about 30 percent savings on each

completed competition, taking into account

that historically 40 percent of the initiated

Figure 4-15. Comparing Planned Versus Completed A-76 Data

52,630d

31,679b

11,619e

Positions

Planned

for 1998

Positions

Announced

in 1998

Positions

Completed

in 2000

Number

of

Positions

.....

Note: Assumes 24 month cycle to complete the A-76 study a 1997 DRI Report

b

 GAO/NSIAD-00-106, Table 2

c

 GAO/NSIAD-00-106, Table 3

d GAO/NSIAD-00-106, Page 9

e

 Telephone interview with DoD official

34,000a

28,673b

5,373c

Positions

Planned

for 1997

Positions

Announced

in 1997

Positions

Completed

in 1999

Number

of

Positions

.....
4-31

competitions are subsequently canceled, the expected savings for each initiated competition

will therefore be much less.

Summary

In this chapter, we have shown the clear linkage between the National Security Strategy,

National Military Strategy, and DoD corporate

strategy. This linkage is imperative. A corporate strategy that is aligned to the overarching

strategies ensures the business functions of

DoD support the effective and efficient attainment of the nation’s security and military

objectives. However, by using the sole performance measure of the number of positions

subject to A-76 competitions and strategic

sourcing reviews, DoD has turned the competitive sourcing program into a manpower-driven

exercise, not a value-based one.

This analysis pointed to specific areas of improvement sought by DoD. The Department is

implementing an RBA with the purpose of freeing resources for the RMA. As part of this RBA,

DoD has undertaken OMB Circular A-76 and

strategic sourcing initiatives. The objective of

these initiatives is to generate the cost savings

needed to fuel the RMA. The results presented

appear promising. However, there are clear

challenges facing DoD in the attainment of its

goals. In the next chapter we look in more detail

at the results and whether they can meet the

objective.
4-32

ENDNOTES

12. Katy Saldarini, Final Round of Outsourcing Lists

Released, retrieved 12 February 2001 from the World

Wide Web: http://www.govexec.com/dailyfed/0201/

021201k1.htm.

13. Erna Risch, Supplying Washington’s Army, Center

of Military History United States Army, Washington DC, 1981, pp. 14-15, retrieved 16 March 2001

from the World Wide Web: http://www.army.mil/

cmh-pg/books/RevWar/risch/risch-fm.htm.

14. Office and Management and Budget, Budget of the

United States Government, Fiscal Year 2000

(Washington, DC: Government Printing Office,

1999), p. 152.

15. Thomas G. McInerney and Erik R. Pages, “Bolstering Military Strength by Downsizing the Pentagon,”

Issues in Science and Technology, 14, No. 2 (Winter

1997), p. 79.

16. General Accounting Office, Major Management

Challenges, p. 19.

17. Defense Reform Initiative, 1997, Introduction, p. 1,

retrieved 8 February 2001 from the World Wide Web:

http://www.defenselink.mil/pubs/dodreform/

intro.html.

18. Defense Reform Initiative, Chapter 3, http://www.

defenselink.mil/pubs/dodreform/chapter3.html#top.

19. Office of the Secretary of Defense, Report on the

DRID 20, p. 1.

20. Defense Reform Overview Presentation, retrieved

21 March 2001 from the World Wide Web: http://

www.defenselink.mil/dodreform/briefs/toc.htm.

21. CD-ROM, On the Road to Excellence, DRI

Checkpoint 2000, Section 4, Office of the Secretary

of Defense, 2000. Can also be found at http://www.

defenselink.mil/dodreform.

22. General Accounting Office, Savings Are Occurring,

but Actions Are Needed to Improve Accuracy of Savings Estimates, GAO/NSIAD-00-107 (Washington,

DC: Government Printing Office, August 2000),

p. 4.

1. George Cahlink, “Pentagon Says It Uses 700,000

Service Contractors,” retrieved 30 March 2001 from

the World Wide Web: http://www.govexec.com/

dailfed/033001.

2. Quadrennial Defense Review, retrieved 6 March

2001 from the World Wide Web: http://defenselink.

mil.pubs/qdr/sec1.html.

3. Tom Bowman, “Pentagon Faces Transformation,”

Baltimore Sun, (March 12, 2001), retrieved 12 March

2001 from the World Wide Web: http://ebird.dtic.

mil/march2001/e20010314faces.htm.

4. Kitfield, James, “Much Is Riding On Pentagon’s

Latest ‘Strategic Review,’” National Journal (March

6, 2001), retrieved 6 March 2001 from the World

Wide Web: http://www.govexec.com/dailyfed/0301/

030601nj.htm.

5. General Accounting Office, Major Management

Challenges and Program Risks, Department of Defense, GAO/NSAID-01-244, (Washington, DC:

Government Printing Office, January 2001), pp. 6-

7.

6. Mary-jo Hall, Ph.D. “Strategy Making – Developing a Strategy – Driven Organization,” (Class notes

for PMT302/ APMC, Defense Systems Management

College, January 2001) pp. 1-2.

7. William S. Cohen, Secretary of Defense, Annual Report to the President and the Congress, Appendix I,

Government Performance and Results Act, Department of Defense FY 2000 Performance Report, p. 1,

retrieved 1 April 2001 from the World Wide Web:

http://www.dtic.mil/execsec/adr2001/I.pdf.

8. Stephen J. Wall and Shannon R. Wall, The New

Strategists, (New York: The Free Press, 1995), p.

120.

9. Cohen, p. 3.

10. Hall, p. 1.

11. Office of Management and Budget, Circular Number A-11, Part 2, Preparation and Submission of

Strategic Plans and Annual Performance Plans,

(July 1998), p. 1.
4-33

23. Deputy Secretary of Defense Memorandum, Department of Defense Reform Initiative Directive #20:

Review of Inherently Governmental Functions,

January 16, 1998.

24. Office of Federal Procurement Policy Letter 92-1,

Inherently Governmental Functions, September 23,

1992.

25. Office of the Secretary of Defense, Report on the

DRID 20, p. 6.

26. Ibid., p. 18.

27. General Accounting Office, More Consistency

Needed in Identifying Commercial Activities,

NSIAD-00-198 (Washington, DC: Government

Printing Office, August 2000), p. 15.

28. General Accounting Office, More Consistency

Needed, p. 17.

29. Retrieved 12 February 2001 from the World Wide

Web: http://www.whitehouse.gov/omb/procurement/fairact.html.

30. Saldarini, http:www.govexec.com/dailyfed/0201/

021201kl.htm.

31. General Accounting Office, More Consistency

Needed, pp. 19-20.

32. Executive Office of the President, Office of Management and Budget, Circular No. A-76 Revised

Supplemental Handbook, Performance of Commercial Activities, March 1996, pp. 4-5.

33. Jason Peckenpaugh, Agencies Eye Privatizing Jobs

to Meet OMB Goal, Govexec.com, retrieved 6 April

2001 from the World Wide Web: http://www.

govexec.com/dailyfed/0401/040601p1.htm.

34. Executive Office of the President, OMB, Circular

A-76 (Revised 1999), p. 2.

35. Executive Office of the President, OMB, Circular

No. A-76 Revised Supplemental Handbook, p. iii.

36. Ibid.

37. Ibid., p. 11.

38. Tom Dolan, It Used To Be Called Outsourcing and

Privatization, Then it Became Competitive Sourcing and Privatization, Now It’s The DoD Strategic

and Competitive Sourcing Program, Class notes,

PMT 305, Defense Systems Management College,

April 2001, Slide 13.

39. Dolan, Slide 15.

40. General Accounting Office, Some Progress, But

Continuing Challenges Remain in Meeting Program

Goals, GAO/NSIAD-00-106 (Washington, DC:

Government Printing Office, August 2000), p. 28.

41. Executive Office of the President, OMB, Circular

No. A-76, p. 28.

42. CD-ROM, On the Road to Excellence, http://

www.defenselink.mil/dodreform.

43. Under Secretary of Defense Memorandum, Department of Defense Strategic and Competitive Sourcing

Program Interim Guidance, Attachment 1: Strategic

Sourcing Program, February 29, 2000.

44. Larry Druffel, Ph.D. “Strategic Sourcing’s Link to

ESOP & Non-Profit Privatization,” Outsourcing and

Privatization Forum, Volume III, Issues 7&8, July

& August 2000, p. 3.

45. George Cahlink, “Downsizing Detour, DoD Managers Are Proving That Outsourcing Jobs Isn’t Always The Best Way To Save Billions,” Government

Executive, January 2001, retrieved 5 January 2001

from the World Wide Web: http://ebird.dtic.mil/

Jan2001/s20010105downsizing.htm.

46. Cahlink.

47. Ibid.

48. General Accounting Office, Some Progress, But

Continuing Challenges Remain in Meeting Program

Goals, GAO/NSIAD-00-106 (Washington, DC:

Government Printing Office, August 2000), p. 32.

49. Under Secretary of Defense Memorandum to

Honorable Albert Gore, Jr., President of the Senate,

July 14, 2000.
4-34

50. General Accounting Office, Results of A-76 Studies

Over the Past 5 Years, GAO/NSAID-01-20 (Washington, DC: Government Printing Office, December

2000), pp. 7-8.

One should note that GAO found DoD excluded

information on 53 studies completed during 1999

because the information was incomplete when DoD

compiled its report in June 2000. Further analysis

of the 53 studies did not dramatically change the

results. The percentage of cost comparisons resulting in private sector performance increased from 40

percent to 41 percent. The number of direct conversions increased to 195 studies which was an increase

of six. Finally, the number of currently performed

private sector studies did not change from the

originally stated eight.

51. Under Secretary of Defense Memorandum to

Honorable Albert Gore, Jr.

52. General Accounting Office, Results of A-76 Studies

Over the Past 5 Years, GAO-01-20 (Washington, DC:

Government Printing Office, December 2000), p. 4.

53. Frances Clark, Cheryl Rosenblum, Murrel Coast,

and Elaine Smallwood, Long-Run Costs and Performance Effects of Competitive Sourcing, Center

for Naval Analysis, February 2001, p. 54.

54. George A. Coggins, Competitive Sourcing and Savings: Are We On Target?, Air Command and Staff

College, Air University, April 2000, p. 21.

55. Dolan, Slide 13.

56. General Accounting Office, Savings Are Occurring

But Actions Needed to Improve Accuracy of Savings Estimates, GAO/NSIAD-00-107 (Washington,

DC: Government Printing Office, August 2000),

pp. 10-11.

57. General Accounting Office, Some Progress, But

Continuing Challenges, p. 15.

58. Congress, DoD at odds Over Savings From

Privatization, National Journal’s Congress Daily, 13

May 1999, p. 25.

59. General Accounting Office, Some Progress, But

Continuing Challenges, p. 12.

60. General Accounting Office, Savings Are Occurring.

This discussion relies heavily on the Altus example

used throughout the report.

61. General Accounting Office, Some Progress, But

Continuing Challenges, p. 19.

62. Cahlink, http://www.govexec.com/dailyfed/0301/

033001g1.htm.

63. General Accounting Office, Savings Are Occurring,

p. 13.

64. Ibid.

65. General Accounting Office, Results of A-76 Studies,

p. 9.

66. Clark et al., p. 11.

67. General Accounting Office, More Consistency

Needed, p. 19.

68. Edward G. Keating, Cancellations and Delays in

Completion of Department of Defense A-76 Cost

Comparisons, (RAND: Santa Monica, CA), p. X.
5-1

5

WHY RESULTS HAVE

BEEN MARGINAL

“Never give an order unless you are certain it will be carried out.”

— General Douglas MacArthur

Introduction

In Chapter Four, we examined the business

strategy of the Department of Defense (DoD)

and the results to date. As we saw, DoD is committed to driving down infrastructure costs primarily through public/private competitions

modeled around Office of Management and

Budget (OMB) Circular A-76 (A-76). This is

being done in an effort to free up funds for force

recapitalization and as a means to finance dayto-day operations. As we illustrated, despite

aggressive efforts to meet savings targets, DoD

has attained only limited success.

This chapter addresses why the results of A-76

initiatives and their derivations have fallen far

short of expectations and why further pursuit

of this strategy will be likely to generate only

marginal results. More important, we examine

how this focus on efficiency may result in adverse consequences (eroding business advantages that DoD has long held) and removing

value. We address not only the indicators that

demonstrate that A-76 is a flawed business

strategy, but also the underlying causes. These

causes include a review of systems, processes,

and culture that must be addressed before

implementing any strategy.

In this chapter we cite data collected from a

survey administered and analyzed as part of

our research. This survey was sent to a sample

of approximately 1,300 DoD personnel; 234

responses were received. Questions focused on

DoD business strategies, outsourcing initiatives, and the alignment of strategy to outsourcing. Appendix D contains a complete

description of the survey methodology, the

questionnaire, and a complete summary of

results.

A Strategic Framework for

the Department of Defense

In Chapter Two we introduced a strategic

framework and order of precedence that may

be used to understand and analyze business

strategy. We now take that framework and use

it to assess DoD. By way of review this framework consisted of the following items in Figure

5-1.
5-2

Aligning these elements is a critical component of any successful strategy. One flows from

the other. When well crafted and well integrated, this framework drives a successful

enterprise. However, when these elements are

incompatible or misaligned, the resulting incongruities stifle performance and produce

marginal results. In this section, we explore the

first three of these elements: beliefs, vision, and

mission.

Belief Systems

In his book Levers of Control, Robert Simons

defines belief systems as “the explicit set of

organizational definitions that senior managers

communicate formally and reinforce systematically to provide basic values, purpose, and

direction for the organization.” Simons goes on

to say that these beliefs “espouse the values

and direction that senior managers want subordinates to adopt.”1

 With that definition in

mind, we begin this section with examples of

these beliefs and the people who have adopted

them. The following excerpt is taken from the

Center for Strategic and International Studies

(CSIS) study entitled Report on American Military Culture in the Twenty-First Century.

On the dusty back streets of

Mogadishu, Somalia, on October 3,

1993, two U.S. Army sergeants did the

nearly unthinkable. While their helicopter hovered over another downed

helicopter to provide air cover to its

wounded occupants, Sergeants Gary

Gordon and Randall Shughart came

under such heavy enemy fire that their

own chopper could not remain on

station. Unwilling to abandon fallen

comrades, Gordon and Shughart volunteered to stay behind to face insurmountable odds. Permission was

reluctantly granted.

Lowered by rope to the ground, Sergeants Gordon and Shughart extricated

the wounded pilot of the downed helicopter under withering enemy fire, an

action that the pilot, Chief Warrant

Officer Michael Durant, believes saved

his life. Gordon and Shughart held off

the growing number of attackers until

their own ammunition ran out, and they

were killed. Both Gary Gordon and

Randall Shughart were posthumously

awarded the Medal of Honor.

Several years later, on routine naval operations in Pusan Harbor, Korea, when

one of Ensign Daniel Johnson’s men

Sourrce: Adapted from summary class notes, T.

Piper, Corporate Financial Management,

Program for Management Development

(PMD75), Harvard Business School.

Beliefs

Vision

Mission

Strategy

Structure

• Organizational

• Control

Critical Performance Variables

Performance Measure

Profit Planning Process

• Operating Plan

• Financial Plan

Performance Evaluation

• Objective vs. Subjective

• Controllable/Non-Controllable

• Strategic Profitability Analysis

Rewards, Incentives, Punishments

Figure 5-1. Strategic Framework
5-3

became entangled in a line that was

pulling him to a probable death, Ensign Johnson rushed to his aid. The

citation of the Navy and Marine Corps

Medal that was awarded to Ensign

Johnson stated, “Immediately, without

hesitation, and in the face of known

risk to his own life, Ensign Johnson

ran to the assistance of the entrapped

line handler.” The sailor survived with

the loss of a leg and four fingers. Ensign Johnson lost one finger and both

legs below the knee. Columnist George

Will later wrote that Johnson said he

took that action because “...officers

are trained to be responsible for the

well being of their men.” From his

hospital bed, the brave young officer

said of his Navy experience: “I developed a lot of self-confidence when I

was doing my job. No regrets.”2, 3

We could go on to cite many other examples

of heroic actions taken by U.S. servicemen and

women throughout history. These are actions

taken in both war and peace, actions taken often

with utter disregard to personal safety. They

are actions taken completely absent the motivation of stock options, profit sharing, or sales

goals. And they are taken because of deeply

held beliefs: loyalty to comrades, commitment

to a team, a belief in something that goes

beyond personal well-being.

The belief systems of DoD and the Services

emphasize integrity, personal accountability,

and a sense of duty. This is no accident. To a

large degree these beliefs are what sets the military apart and they play a large part of what

drives ordinary people to do extraordinary

things.4

 From the first day in uniform, military

personnel are told that they are part of a proud

tradition, that they have accepted a noble calling, and that they have a duty that goes beyond

each one of them personally.

Arguably, this is one of the reasons that the

Services attract and retain talent in an environment where the private sector offers better pay

and conditions. This is borne out by a 1999

General Accounting Office (GAO) Survey

which cited military values and lifestyle as the

most frequently selected reason among officers

assigned to critical specialties who decided to

stay in the military. This was followed by esprit

de corps as the second most frequently cited

reason. Among enlisted members, military

values and lifestyle ranked as the fourth most

frequently cited reason. For both officers and

enlisted personnel, these reasons ranked ahead

of base pay.

5

These beliefs are also aptly expressed by the

quotes of veterans who decided not to make

the military a career and by the people who

employ them. The following quotes were taken

from recent interviews conducted by DoD.6

“Being mission-focused...being oriented towards one thing is really what

I brought over to civilian life.”

Tony Dumaine, U. S. Army

“I realize now that it instilled in me

discipline, motivation, loyalty...values

the military likes to promote.”

Matthew Bernard, U. S. Army

“Many values — like integrity, adaptability, loyalty — are instilled into the

individual while they’re in the service.

These values stay with them when they

get out, and are with them for life.”

James Klasek, Director of Recruiting

Premier Technology Group, Inc.

These sentiments speak eloquently as to the

degree these beliefs permeate and define military culture and with it, the culture of DoD in

general. These values are shared by those in
5-4

uniform and by civil service personnel within

the Department.

The power of a set of core beliefs, long understood by the military, has not been lost on leaders in the business world. They understand that,

in business as in the military, a strategic framework starts with a set of belief systems that

defines the organization. As we stated in Chapter Two, attaining business success, or anything

worthwhile in life for that matter, is likely to

be a difficult undertaking. The same is, of

course, true of military success. It is likely to

be exceedingly difficult and, unlike most business enterprises, extremely dangerous. In both

cases, belief systems ensure the journey is

worth taking in the first place and that the effort

is worthwhile.7

 What, other than a strongly held

set of beliefs, would allow someone who had

lost both legs to say he had “no regrets.”8

In this context it is easier to understand why

successful businesses place a great deal of value

on strong belief systems. Strategy is built on

the foundation of a strong set of core beliefs,

the ability to define the worth of the endeavor,

and the power to motivate and to define how

the members of the organization will conduct

themselves. These systems define the organization and as such they are the responsibility

of the leadership structure to communicate and

reinforce. Belief systems provide basic values,

purpose, and direction for the firm.9

When properly crafted, belief systems provide

inspiration, momentum, and direction.10 In

Chapter Two, Figure 2-12, we cited Johnson

& Johnson’s Credo as an example of a set of

codified beliefs that guide the firm. Note that

maximizing profit is not the principal reason

for Johnson & Johnson’s existence, nor is it

the principal reason for most high performance

companies.11 As Simons points out, “Higher

ideals are needed to instill pride and motivate

productive effort.”12

DoD has long embraced high ideals and the

pride they instill. No less powerful and no less

compelling than corporate belief systems are

the credos of the uniformed services. Table 5-1

lists these guiding principles.

Note that just as maximizing profit is not the

principal reason for existence with high

Table 5-1. Guiding Principles of the Uniformed Services

Army • Duty

• Honor

• Country

Navy and Marine Coprs • Honor

• Courage

• Commitment

Air Force • Integrity

• Service

• Excellence

Coast Guard • Honor

• Respect

• Devotion to duty
5-5

performance companies, minimizing cost is not

listed as the principal reason for existence

among the uniformed services. Guiding principles go beyond this. Additionally, just as these

principles define a set of values that the corporation will not go beyond to earn a profit, they

define a set of values that members of DoD

will not go beyond to generate savings.

This was borne out by our survey data. When

asked which of three issues are important considerations when conducting an outsourcing

study, impact on mission performance and impact on personnel were cited as considerations

that ranked above impact on cost. These data

are displayed in Table 5-2.

Respondents were free to indicate that all

ranked the same (i.e., respondents could strongly

agree with all three) or to differentiate. Note

that 96.6 percent of the 233 people who responded to this question either strongly agreed

or agreed that impact on mission performance

was an important consideration. And 91 percent of those same respondents either agreed

or strongly agreed that impact on personnel was

an important consideration. Compare this to

87.6 percent of respondents who either agreed

or strongly agreed that impact on cost was an

important consideration. By contrast, when

asked what are the most important objectives

of outsourcing, the most often cited response

was cost control or cost savings. It would seem

that Department personnel understand that

outsourcing is being initiated to reduce and

control cost, but as these data demonstrate,

members of DoD view mission and personnel

as more important considerations.

This trend was more pronounced among those

111 respondents who identified themselves as

being in a command position. Table 5-3 shows

this group broken out separately.

Within this group, 98.2 percent either strongly

agreed or agreed that impact on mission

performance is an important consideration,

90.9 percent strongly agreed or agreed that

impact on personnel is important, and 85.5

percent strongly agreed or agreed that impact

on cost is an important consideration. As one

might expect in the context of DoD’s belief

systems, those in command positions are highly

concerned with performing their mission and

Table 5-2. Importance Attributed by DoD Personnel

Regarding Impact of Outsourcing

Which of the following issues are important considerations

when conducting an outsourcing study?

Impact on Cost Impact on Impact on Mission

Personnel Performance

Strongly Agree 36.5% 57.9% 77.2%

Agree 51.1% 33.1% 19.4%

Neither Agree

nor Disagree 6.4% 4.3% 0.9%

Disagree 3.9% 3.0% 0.4%

Strongly Disagree 2.1% 1.7% 2.2%
5-6

taking care of their people. When outsourcing,

cost is not the primary consideration. This is at

odds with A-76 — DoD’s principal outsourcing

tool — which stipulates that cost is the primary

consideration.

We return to the examples of heroism that began this section. These examples of uncommon

bravery exhibit common traits. They are examples of loyalty, devotion to duty, and selfsacrifice. Commitment to a team, mission

accomplishment, responsibility toward others

— these are valued characteristics in the military. As such, these actions are revered and

rewarded. They are at the core of our belief

systems and they embody the values that define military culture. They are also attributes

that impact on the execution of outsourcing

initiatives, especially cost-driven initiatives.

Vision

Just as its belief systems are documented and

carefully spelled out, so too is the DoD vision.

As stated in DoD’s strategic plan, it is the vision

of the Department to:

• Field the best trained, best equipped, best

prepared fighting force in the world.

• Support alliances and security relationships

that protect and advance U.S. security

interests.

• Further national interests by working effectively with other federal agencies, Congress,

and the private sector.

• Serve as a model of effective, efficient,

innovative management and leadership.13

This vision defines DoD’s strategic domain. It

is clear, concise, and in complete alignment

with the strong belief systems that are the bedrock of DoD and the Services. For many readers, review of this report may be the first occasion they have had to read or reflect on what to

us is a compelling and well-crafted vision. This

assessment is validated by the contemporary

business literature we’ve reviewed. Recall the

critical characteristics of an effective vision

described by John Kotter and presented in

Chapter Two.14

Table 5-3. Importance Attributed by Those in Command

Regarding Impact of Outsourcing

For respondents in a command position, which of the following issues

 are important considerations when conducting an outsourcing study?

Impact on Cost Impact on Impact on Mission

Personnel Performance

Strongly Agree 36.4% 60.9% 89.0%

Agree 49.1% 30.0% 9.2%

Neither Agree

nor Disagree 8.2% 4.6% 0%

Disagree 4.6% 2.7% 0.9%

Strongly Disagree 1.8% 1.8% 0.9%
5-7

• The vision must be imaginable, conveying

a picture of what the future will look like.

• The vision must be desirable, appealing to

the long-term interests of employees, customers, stockholders, and others who have

a stake in the enterprise.

• The vision must be feasible, comprising

realistic and attainable goals.

• The vision must be focused, providing

guidance in decision making.

• The vision must be flexible, allowing individual initiatives and alternative responses

in light of changing conditions.

• Finally, the vision must be communicable

— easy to communicate.

The DoD vision scores well under these criteria. To be the best, to advance U.S. interests, to

be highly effective, to serve as a model for

others — this describes a vision that is imaginable, desirable, feasible, focused, and flexible.

Many companies go to great lengths to articulate such a vision. In our view, DoD’s vision is

on par with any vision statement found in the

business world.

Unfortunately, DoD has fallen short in communicating this powerful vision. Only 35.9

percent of 234 survey respondents have read

the Strategic Plan. For the 111 who identified

themselves as being in a command position,

only a third had read the Strategic Plan. Before

the vision can be communicated, it must be

read and understood, especially by those in

command.

Mission

Belief systems are a core set of values that provide strength and sustenance to the organization.

Vision is the statement of direction and purpose. Mission then follows as a way of meshing these two into a company-specific statement that provides the broad purpose or reason that the business exists.15 These missions

are generally written down in formal documents known as mission statements.16 DoD is

no exception. Here too, the Department and the

Services score quite well. In fact, reading

DoD’s mission statement, one is reminded that

the Department’s beliefs, vision, and mission

predate the modern business literature we are

using to evaluate them.

The mission of the Department of Defense is to support and defend the Constitution of the United States; to provide for the common defense of the

nation, its citizens, and its allies; and

to protect and advance U.S. interests

around the world. To accomplish this

mission, the Department maintains

trained forces ready to respond to

threats to U.S. security arising anywhere on the globe.

In peacetime, the United States works

with friends and allies to promote a

stable world that supports economic

growth and provides opportunities for

emerging democracies. The routine

deployment of U.S. forces overseas,

combined with the maintenance of

ready forces at home, promotes stability and deters the use of force against

U.S. interests. The same military forces

that help shape the international environment can also respond quickly to

threats to U.S. security when crises

arise.17

For DoD, beliefs, vision, and mission are well

aligned and self-reinforcing. This is depicted

in Table 5-4. Taken together, these principles

guide us. They dictate, both explicitly and
5-8

implicitly, what direction DoD will take on a

daily basis. Just as the Johnson & Johnson’s

Credo, Figure 2-12, guides the company through

calm and crisis, this strategic framework guides

the Department in much the same way.

From DoD Beliefs, Vision,

and Mission, to DoD Strategy

From beliefs, vision, and mission, flows strategy. Recall Porter’s generic strategies described

in Chapter Three, then review Table 5-4. The

DoD and the Services would appear to fit well

with a generic strategy of differentiation. DoD

seeks to be unique; to be the best trained, best

prepared fighting force in the world. The names

United States Army, United States Navy, United

States Air Force, and United States Marine

Corps convey certain meanings. As such they

are powerful brand names that carry significant value. The Services rely on this brand

image for a number of things including recruiting personnel, acquiring resources, and intimidating would-be adversaries.

Conversely, statements and beliefs in Table 5-

4 do not sound like an organization committed

to a strategy of cost leadership. The Department does not seek to be the low-cost defense

provider worldwide and the Services do not vie

for the title of most cost-efficient branch of the

armed services.

Yet cost leadership is the goal of outsourcing

policies such as A-76 and their derivations.

What is the impact of crafting beliefs, vision,

and mission to pursue one strategy and simultaneously attempting to pursue another? Recall again Porter’s admonition about becoming stuck in the middle, that the pursuit of

multiple strategies requiring inconsistent

actions and “being all things to all people is a

recipe for strategic mediocrity and belowaverage performance, because it means that a

firm has no competitive advantage at all.”18

Survey data indicate DoD personnel sense this

inconsistency of multiple strategies. When

asked to respond to the following statement:

Table 5-4. Reinforcing Aspects of DoD Beliefs, Vision, and Mission

Beliefs

Duty Honor Country Commitment Integrity Service Excellence Respect Devotion

Mission Vision

To support and defend the Constitition of Field the best trained, best prepared fighting

the United States. force in the world.

To provide for the common defense of the Support alliances and security relationships

nation, its citizens and its allies. that protect and advance U.S. security interests.

To protect and advance U.S. interests

around the world.

To work with friends and allies to promote Further national interests by working effectively

a stable world that supports economic growth with other federal agencies, Congress, and the

and provides opportunities. private sector.

To maintain trained forces ready to respond. Serve as a model of effective, efficient,

innovative management and leadership.
5-9

“DoD is headed in the right direction with

respect to outsourcing issues,” only 29.6 percent of 233 respondents agreed or strongly

agreed. Those disagreeing or strongly disagreeing with this statement represented 55.8 percent

of respondents. A summary of responses is

depicted in Table 5-5.

If these data are representative, it’s quite remarkable that DoD is aggressively pursuing

outsourcing policies that so many disagree

with. More striking still are the 111 respondents in command positions. Of this group, 56.7

percent either disagree or strongly disagree that

DoD is headed in the right direction with regard

to outsourcing. Their responses are shown in

Table 5-6.

These are the very people charged with execution of A-76 and related outsourcing initiatives.

It would appear that these individuals do not

necessarily embrace DoD outsourcing policy

in its current form.

Continuing this line of analysis, we looked specifically at the 78 respondents in positions of

command who have been involved in an

outsourcing effort. Their attitudes are even

more pronounced. Of this group, fully 64.1 percent disagree or strongly disagree that DoD is

DoD is headed in the right direction with respect to outsourcing issues

(All respondents)

Strongly Agree 3.0%

Agree 26.6%

Neither Agree

nor Disagree 17.6%

Disagree 35.2%

Strongly Disagree 17.6%

Table 5-5. DoD Attitudes Toward Outsourcing Policy

Respondents in a command position responding to the statement:

DoD is headed in the right direction with respect to outsourcing issues

Strongly Agree 3.6%

Agree 24.3%

Neither Agree

nor Disagree 15.3%

Disagree 33.3%

Strongly Disagree 23.4%

Table 5-6. Commander’s Attitudes Toward DoD Outsourcing Policy
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headed in the right direction regarding outsourcing initiatives. Responses are depicted in

Table 5-7.

While we are in no way stating that installation commanders are not executing outsourcing

policy based on their personal assessments, it

should be noted that they are concerned about

these issues and their concern rises markedly

after they have gone through the experience of

outsourcing in its current form. At the very

least, their feedback is worth gathering and

assessing. While comments offered on a survey

administered to a random sample of DoD personnel are not well suited for the type of broad

feedback needed, we list some of the comments

submitted by installation commanders.

• Military forces must always be EFFECTIVE on the battle[field] and we are building organizations that are designed to be

most EFFICENT [sic] during peacetime.

• The only outsourcing issue I have had

personal experience with is A-76. It is a

terrible process.

• I am not sure where DoD is heading quite

frankly...and rules, regulations, etc. thus far

have only made waters murkier.

• It appears as though few consider the

broader strategic impact of changes done in

isolated areas.

• I think we need to cut this BS out!

In his book Leading Change, John Kotter points

out that one of the reasons that firms fail is that

they do not create a sufficiently powerful guiding coalition.20 If the change vehicle is the A76 process, these data indicate that no coalition is possible, at least no majority coalition.

Even for the 41 respondents who identified

themselves to be in staff/policy positions, 53.7

percent disagreed or strongly disagreed DoD

was headed in the right direction with respect

to outsourcing. In our analysis we could find

no one group where a majority of respondents

strongly agreed or agreed with this statement.

The closest category consisted of the ten respondents who identified their area of expertise as budget/finance. Of this group, 30 percent agreed DoD was headed in the right

direction with respect to outsourcing. None in

Respondents in a command position and have been involved in

an outsourcing effort responding to the statement:

DoD is headed in the right direction with respect to outsourcing issues

Strongly Agree 3.9%

Agree 16.7%

Neither Agree

nor Disagree 15.4%

Disagree 38.5%

Strongly Disagree 25.6%

Table 5-7. Attitudes of Commanders Who Have Undergone Outsourcing
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this category strongly agreed with this

statement.

Implementing Strategy

Through Levers of Control20

Belief systems represent only one of the

moorings that secure an effective business

strategy. We turn now to the other three levers

of control introduced in Chapter Two. By way

of review, they are boundary systems, interactive control systems, and diagnostic control

systems. This model is depicted in Figure 5-2.

Boundary Systems

Boundary systems are mechanisms for letting

firms manage strategic risk. They communicate

specific risks to be avoided and take two forms:

business conduct boundaries and strategic

boundaries.21 Business conduct boundaries

communicate clearly what behaviors are off

limits. Bribing officials, colluding to fix prices,

disclosing proprietary information are examples of typical conduct boundaries. These

conduct boundaries are especially rigorous in

DoD. Ethical standards are strict and well enforced. In DoD, even the appearance of misconduct will not be tolerated. This applies to

both personal conduct and business conduct.

Members of DoD, especially those of us in

uniform, are held to a higher standard than the

public at large. Indeed, DoD takes great pride

in this higher standard. It is yet another factor

that sets the Department apart and makes it

unique.

While DoD does well in setting and enforcing

business conduct boundaries, it is in the area

of setting and enforcing strategic boundaries

Figure 5-2. Levers of Control

Source: R. Simons, Performance Measurement and Control Systems for Implementing Strategy

(Upper Saddle River, NJ: Prentice-Hall, 2000), p. 305.
5-12

that DoD has fallen short. Strategic boundaries

are established to manage a different kind of

risk — the risk of wasting scarce resources on

initiatives that do not support the business’s

strategy.22 Recall the mission of the DoD: to

support and defend the Constitution of the

United States; to provide for the common defense of the nation, its citizens, and its allies;

and to protect and advance U.S. interests around

the world. Now examine some of the activities

DoD is engaged in.

• Photography

• Photographic processing

• Film and videotape production

• Art and graphics services

• Distribution of audiovisual materials

• Equipment installation, operation, and

maintenance

• Vending machines

• Dietary services

• Veterinary services

• Machine, carpentry, electrical, plumbing,

painting, and other shops

• Industrial gas production and recharging

• Equipment and instrument fabrication,

repair, and calibration

• Plumbing, heating, electrical, and air conditioning services, including repair

• Custodial and janitorial services

• Trucking and hauling

• Office furniture and equipment

• Advertising and public relations services

• Library operations

• Stenographic recording and transcribing

• Mail/messenger

• Reproduction, copying, and duplication

• Landscaping, drainage, mowing, and care

of grounds

• Guard and protective services

• Recreational areas

• Refuse collection and processing

• Laundry and dry cleaning

• Bus service

This is but a partial list of activities (cited in

Attachment A) of the latest revision of A-76.

They are cited as inherently commercial

activities currently performed by government

that should be subject to competition and

outsourcing. This OMB Circular was first

issued in 1966 but the underlying policy of not

competing with the private sector goes back to

1955 and the Eisenhower administration.23

These activities, while important to the dayto-day functioning of the Department, do not

lie within the strategic domain that is reflected

in DoD’s Strategic Plan. The activities cited

above are critical to many businesses but that

does not mean that they will perform the

functions internally. Recall Kodak’s decision

in Chapter Two to outsource its data processing requirement. This was a critical function
5-13

to Kodak but one that did not fit within its

strategic domain.

Why do companies set these boundaries? It is

because activities in areas that do not lie within

their strategic domain tend to distract attention

from the core strengths and strategy of the business.24 This is why Microsoft has expressly

stated that it will not build hardware or enter

the telecommunications business, even though

these are profitable markets and Microsoft has

sufficient resources to enter them. It is also the

reason why Lee Iacocca, during Chrysler’s

dramatic turnaround, refocused the firm’s resources on North American auto and truck

manufacturing, declaring European, African,

and non-automobile business off limits.25

Businesses know that there are many opportunities but only limited resources. Simons states

the hard work of strategy is not deciding what

to do; rather it is deciding what not to do.

26 To

this end, firms generally have formal systems

to analyze any new business venture that lies

outside its strategic domain. This analysis goes

beyond potential financial performance and

establishment of a sustainable competitive

position. It includes factors such as whether

the distinctive competencies of the firm are

suited to the new venture and whether entry

into this market might result in an undesirable

strategic position, such as the position in which

Holland Sweetener found itself entering the

aspartame market (see Chapter 2).27

One could either argue that DoD does not set

strategic boundaries or that once set, they are

not well enforced. Either way, the overwhelming predilection of the Department seems to

be to integrate activities rather than to look to

other outside sources. This is detrimental on

two accounts. First it dilutes management attention and siphons off precious resources from

activities that should represent DoD’s strategic focus. Second, it means that many of these

activities, once integrated, are subject to outsourcing studies under A-76. This dilutes still

more management attention and ties up additional resources. Better to have a strong boundary system from the outset than to compensate

for it later.

Diagnostic Control Systems

Simons states that diagnostic control systems

are “the formal information systems that managers use to monitor organizational outcomes

and correct deviations from preset standards

of performance.”28 These information systems

are used to set goals, measure outputs, compute performance variances, and provide feedback.29 Performance evaluations are a good

example of this. Individuals are notified of the

grading standards, measured against performance of those standards in relation to other

individuals, and given feedback via a periodic

report.

The same diagnostic control systems are

applied to business activities. Sales and profit

goals are set, performance is measured, feedback is obtained, and any variance is analyzed.

When these systems are aligned and integrated,

individual effort contributes to the effective

operation of the business. When these systems

are not well aligned and integrated, confusion

and uncertainty are generally the result.

In the business community, for many years

these diagnostic control systems emphasized

financial goals and performance. However,

there is a growing realization that emphasizing financial performance alone may cause

actions that are counterproductive to a firm’s

long-term strategy. Current business literature

favors diagnostic control systems such as the

Balanced Scorecard, which, as the name implies, seeks to strike a balance between financial measures and other perspectives such as

the customer, business processes, and learning
5-14

and growth.30 These balanced criteria are then

applied uniformly throughout the business.

It is this uniformity that is lacking in DoD. A

quick scan of personnel evaluations used by

the military show that individuals are graded

on criteria such as mission accomplishment,

teamwork, equal opportunity, and leadership.

Individual units are graded primarily on mission accomplishment. However, continuing up

the hierarchy, these effectiveness measures are

eclipsed by financial efficiency measures such

as the savings targets discussed earlier.

Furthermore, these measures are not subject to

rigorous feedback in the form of variance analysis nor are the inputs adjusted. These financial

goals, especially the savings targets associated

with A-76 and competitive sourcing, tend to

become “must achieve” goals rather than “can

achieve” goals. This is often the difference

between reasonable, achievable goals and unreasonable, unachievable goals. While goals

should be challenging, they should not be

unobtainable. Beyond a certain point, people

tend to see the goal as either impossible or not

worth the effort. This tends to lower rather than

raise motivation.31 This tendency is depicted

in Figure 5-3.

Recall DoD’s competitive sourcing goal, which

projects cumulative savings of $11.7 billion

through fiscal year 2005 and then $3.5 billion

annually thereafter.32 This and past iterations

of this goal have been cited by the GAO as

being unrealistic.33 Survey results indicate that

personnel in DoD share this view. The level of

frustration and dissatisfaction expressed in their

responses leads us to believe that motivation

to achieve cost savings is tailing off.

Figure 5-3. Relationship between Motivation and Goal Difficulty

Source: R. Simons, Performance Measurement and Control Systems for Implementing Strategy

(Upper Saddle River, NJ: Prentice-Hall, 2000), p. 242.
5-15

Interactive Control Systems

These are the control systems that allow managers to view the strategic landscape over the

horizon. These systems communicate strategic

uncertainty and convey it to corporate leadership. These are the systems that show management what lies ahead in the strategic path that

could cause the strategy to fail.34

Interactive control systems go beyond budget

and operating plans and are not standardized

like a financial report. They vary from company to company but they have four defining

characteristics.

1. Information generated by the system is an

important and recurring agenda addressed

by the highest levels of management.

2. The interactive control system demands frequent and regular attention from operating

managers at all levels of the organization.

3. Data generated by the system are interpreted

and discussed in face-to-face meetings of

superiors, subordinates, and peers.

4. The system is a catalyst for the continual

challenge and debate of underlying data,

assumptions, and action plans. It is a

mechanism for enabling the organization

to learn and adapt.35

As we saw in Chapter One, new technologies

may undermine a company’s strategic position,

so too could demographic changes, the entry

of a competitor, or government regulation.36

Senior management must be ever vigilant of

the competitive landscape and position their

business or businesses accordingly. Interactive

control systems may take the form of market

research data that would have shown Henry

Ford that consumers were coming to see cars

as a measure of affluence and that they craved

variety over price. Interactive control systems

may take the form of technical reports that

would have shown the integrated steel mills that

mini-mill technology was improving to the

point that it would one day be capable of producing sheet steel. Interactive control systems

may take the form of value chain analysis that

would have shown Radio Corporation of

America (RCA) that, despite its preeminence

in research and development (R&D), it did

not have the requisite marketing, sales, service,

or logistics structure to take on IBM in the

computer industry.

From the perspective of DoD, operational elements rely heavily on such interactive control

systems. The Department conducts war games,

strategic reviews, and battle exercises designed

to show vulnerabilities in wartime strategies.

Unfortunately and somewhat ironically, DoD’s

business functions invest precious few resources in such systems. Instead of being proactive, the Department is often in a reactive

mode. Planning horizons are relatively short

(generally one funding cycle out) and problems

are generally dealt with as they occur instead

of before the underlying issue becomes problematic. Many of the DoD briefings and presentations we have viewed in the course of this

research use phrases such as “we should have

seen this coming,” or “this was a train wreck

just waiting to happen.” Establishing better

interactive control systems might preclude or

at the very least minimize incidents that cause

such statements to be made.

Compliance and Execution Incentives

DoD, perhaps more than any other agency, expects compliance throughout the chain of command. However, compliance can be swift and

determined or it can be slow and grudging.

Business leaders understand this. They are organized for performance taking great care to

establish in their work units the appropriate
5-16

incentives and the requisite span of control and

accountability.37

In both a business and a military context, span

of control denotes how many and which subordinates and functions report to each manager

in the organization.38 This relationship is depicted in the organizational chart. These charts

are remarkably similar for both business and

industry primarily because traditional hierarchical business structures were patterned after

military structures. Within these spans of

control are spans of accountability.

Spans of Accountability

and the Profit Motive

Spans of accountability describe the range of

performance measures used to evaluate a

manager’s achievements.39 In business, these

measures at some point take into account

specific financial measures such as sales,

inventory and, most important of all, profit.

Profit in its essence measures the return generated on assets committed to an activity. This is

a powerful measure and a powerful motivation.

Profit accountability indicates that the manager

is accountable for costs, revenues and, often,

assets. Profit center managers must make tradeoffs between costs and revenues.40 This

becomes the mechanism that tends to drive

efficiency once an effective strategy is devised.

In fact, it is such a powerful force that it must

be balanced so that gains in short-term efficiencies do not erode long-term strategic

advantage.41

Public sector agencies, on the other hand, do

not exist to earn a profit. Absent this profit

motive, an important impetus to generate efficiencies is also removed. In the calls to have

DoD act in a more business-like manner, one

should always keep in mind that in the business world, the profit motive drives firms to be

efficient within their business strategies. Absent

this, the playing field differs significantly.

One should also be wary of statements that

assert government services are a bargain

because the government does not earn a profit.

In fact, large-scale studies show that prices

charged by profit making contractors are substantially lower, on average, than the cost of

non-profit government work.42 Competitive

forces of the marketplace weed out first the

ineffective, then the inefficient. These forces

account for cost disciplines that more than

compensate for any lack of margin.

Cost Center Accountability

Public (non-profit) agencies largely follow a

model of cost center accountability. This means

that managers are given a budget and asked to

deliver the desired level of goods or services

within those spending constraints. Cost managers need only monitor specific expense

lines.43 Furthermore, these expense lines are

generally limited. Installation commanders, for

example, are not generally accountable for expenses associated with salary, capital investment, or inventory obsolescence. Their span of

control does not cover these areas. This is primarily a result of the high degree of compartmentalization associated with government

accounting. Salaries are paid from one account,

capital equipment with another, issue of initial

supply stocks with a third, and replenishment

of supplies with a fourth. This is done to ensure that funds are spent as they are intended

to be, but it also limits the degree of control

managers can exercise and it precludes making many trade-offs.

DoD activities operating under working fund

accounts have a wider span of accountability.

Commanders of these activities are accountable for salaries, inventory obsolescence, and

a wide range of other expenses, but there are
5-17

still limits to the degree of autonomy they can

exercise. Working fund managers are tasked

with using these assets to generate a range of

services and charging for them only to the

extent they can break even. Furthermore, law

or regulation generally protects these activities

so that they have a captive group of customers that must buy from them — primarily the

operating forces they serve.

Impetus to Generate Savings

Operating cost or break even centers means that

any savings generated through outsourcing or

any other initiative by and large are not available for the installation commander or working capital fund manager to reinvest or realize

as profit. The money is swept up and used to

fund activities outside their span of control. In

fact the system is set up such that those that

generate the most savings lose the most while

those that generate the least savings retain the

most.

Absent a natural enticement toward greater

efficiency, DoD, with congressional oversight,

established savings goals and created a commensurate funding shortfall. Each of the Services was given individual savings targets to

be met on an annual basis. Progress on meeting these targets is reported to Congress and

scored by various agencies including the GAO.

The mechanism for attaining these savings targets is public-private competitions using the

A-76 process.44

However, as was indicated in Chapter Four,

despite the aggressive targets and equally

aggressive enforcement of A-76 competitions,

the results have still fallen below expectations.

In an effort to rely more on the carrot and less

on the stick, the Bush Administration recently

announced that it would push to let agencies

retain savings garnered from public-private

competitions.45

We are skeptical as to whether this will prove

an effective mechanism. Agency retention is

not the same thing as retention by the affected

activity where economic incentives would have

the most impact. However, even if savings

were retained at the activity level, it is doubtful that a cost-driven outsourcing strategy will

be embraced. As discussed previously, DoD

personnel place mission accomplishment and

the welfare of Department personnel ahead

of savings goals. This is particularly true of

base and installation commanders. It shouldn’t

be surprising. Mission effectiveness is what

DoD’s belief system emphasizes and on what

they are graded. This defines their span of

accountability.

Strategy or Execution Failure?

The simple answer to this question is “yes.”

Everything we have described about the

Department’s belief system, vision, and mission point clearly toward a strategy of differentiation. Yet, as we saw in Chapter Four, the

crux of A-76, strategic sourcing, competitive

sourcing, and many of the Defense Reform

Initiatives, is cost savings — pulling DoD away

from a differentiation strategy toward a cost

leadership strategy. This is depicted in Figure

5-4. Unfortunately without the requisite

changes in the belief system, vision, etc., this

can only serve to leave us in the “gray zone”

— the equivalent of “no man’s land” on the

tennis court between the service and end lines

where you are at the mercy of your opponent.

Given the emphasis on cost, we are also seeing

execution problems as we try to implement the

various Revolution in Business Affairs initiatives. Recalling Table 2-3 from Chapter Two

on the likely outcomes of operating the levers

of control independently or without any one of

them, we can see the source of the problems.

In Table 5-8 we have highlighted some of the

outcomes that were borne out in our survey.
5-18

The lesson is quite clear. You cannot change

corporate strategy independent from major

changes in the organization.

Transformation Urgency

In much the same way the body’s immune

system responds to repel a foreign organism,

Table 5-8. Organizational Outcomes

Belief Systems Boundary Systems Diagnostic Control Interactive Control Outcomes

(Values, Norms) (Decision Rights) Systems Systems

(Metrics, Rewards) (Knowledge Flows)

– Misconduct

No Yes Yes Yes – Low Inspiration

– Poor Teamwork

– Uncertainty

Yes No Yes Yes – Power Struggles

– Indecision

– Inconsistency

– Low Motivation

Yes Yes No Yes – Passive, Slow

– Pace

– Unclear Purpose

– Poor Decisions

– Strategic

Yes Yes Yes No – Surprises

– Poor Coordination

– Low Learning

Source: Adapted from summary class notes, T. Piper, “Achieving Profit Goals and Strategies,” Corporate Financial

Management, Program for Management Development, PMD75, Harvard Business School.

Figure 5-4. Three Generic Strategies

Source: M. Porter, Competitive Advantage (NY: The Free Press, 1985), p. 12.
5-19

DoD has responded to cost-based outsourcing.

Just as the immune system does not recognize

the foreign body, DoD does not recognize a

foreign strategy. But this is not to say that all

outsourcing initiatives will be rejected or that

DoD is content with business as usual. In fact,

there is a strong sense that transformation does

need to occur and that business as usual is

unacceptable. In our survey we asked the

following question regarding the need for

change:

Need exists for significant improvement in the way DoD and the departments/agencies conduct business

operations (commercial-like activities).

Yes No

Of the 232 who responded to this question, 86.6

percent responded “Yes.” This is a strong indication that the sense of urgency is shared sufficiently across DoD. For the 111 respondents

that identified themselves as being in a command position, the percentage responding yes

to this question rose to 91 percent.

In his book John P. Kotter on What Leaders

Really Do, Kotter examines the role of leadership in bringing about change in an organization. He lists some common mistakes made by

senior leaders that prevent an organization from

making a successful transformation. Error number one is not establishing a great enough sense

of urgency. Based on his own experiences,

Kotter believes the urgency rate is sufficient to

effect change when about 75 percent of an

organization’s management is convinced that

“business-as-usual is totally unacceptable.”46

Using Kotter’s figure as a benchmark, it seems

that the stage is set for some kind of a transformation in the way DoD operates its business

functions, based on our limited survey results.

Just as beliefs can be harnessed, so too can

this sense of urgency. In the next chapter we

will examine potential ways to channel this

energy to transform DoD in ways that are

commensurate with the Department’s strategy.

Summary

In this chapter we used strategic tools and

concepts introduced in previous chapters to

build an analytical framework with which to

examine DoD. This began with an analysis of

the beliefs, vision, and mission. DoD has a

strong and enduring set of beliefs, its vision is

well crafted, and its mission is well aligned.

This structure denotes an organization pursuing a strategy of differentiation. This is at odds

with A-76 and other cost-based outsourcing

initiatives, which are more aligned to a strategy

of cost leadership.

The structures that anchor strategy are the

levers of control consisting of belief systems,

boundary systems, diagnostic control systems,

and interactive control systems. While DoD has

strong belief systems, the other three levers are

wanting or misaligned. These inequities lead

to predicted outcomes that are reflected in the

survey we administered to a random sample of

DoD personnel.

Further complicating current outsourcing

strategies is the financial structure of DoD,

which mitigates any economic incentive an installation commander might have to aggressively implement a cost-based outsourcing

strategy. However, even if economic incentives

were better aligned to achieve the desired result

of cost savings, belief systems and underlying

strategy would likely obviate a better incentive

structure.

Finally, uniformly negative attitudes toward

DoD outsourcing policy doesn’t mean that

personnel within the Department do not see a

need for changing business practices. In fact,
5-20

over 85 percent of 234 survey respondents

are dissatisfied with business as usual. There

is potential for a critical mass of people within

the organization who share this sense of

urgency to drive change.

In Chapter Six we will explore the benefits of

a new corporate strategy approach and whether

such an approach can be implemented. This

approach is constructed to fit within both the

differentiation strategy for which DoD is suited

as well as the practical realities of DoD’s

operating environment.
5-21

ENDNOTES

17. Retrieved 10 April 2001 From World Wide Web:

http://www.dtic.mil/execsec/adr2000/appi.html.

18. M. Porter, Competitive Advantage – Creating and

Sustaining Superior Performance (New York, NY:

The Free Press, 1985), p. 12.

19. Kotter, Leading Change, p. 6.

20. This section draws heavily from Chapters 10-14 of

Performance Measurement and Control Systems for

Implementing Strategy by Simons and from Piper’s

summary class notes, Corporate Financial Management.

21. Ibid., pp. 275-296.

22. Ibid., p. 289.

23. Office of Management and Budget Circular Number A-76 (Revised 1999).

24. Simons, Performance Measurement and Control

Systems, p. 293.

25. Ibid., p. 290.

26. Ibid., p. 292.

27. Ibid., pp. 292-293.

28. Simons, Levers of Control, p. 59.

29. Simons, Performance Measurement and Control

Systems, p. 209.

30. R. Kaplan and D. Norton, The Balanced Scorecard

(Boston, MA: Harvard Business School Press,

1996), pp. 24-29.

31. Simons, Performance Measurement and Control,

pp. 242-243.

32. CD-ROM, On the Road to Excellence, DRI Checkpoint 2000, Section 4, Office of the Secretary of

Defense, 2000. Can also be found at http://www.

defenselink.mil/dodreform.

33. General Accounting Office, DoD Competitive Sourcing — Questions About Goals, Pace, and Risks of

Key Reform Initiative, (Washington, DC: Government Printing Office February 1999), p. 1.

1. R. Simons, Levers of Control (Boston, MA: Harvard

Business School Press, 1995), p. 34.

2. E. Dorn, H. Graves, W. Ulmer Jr., J. Collins, and T.

Jacobs, “American Military Culture in the TwentyFirst Century,” A Report of the CSIS International

Security Program (Washington, DC: The CSIS

Press, 2000), p. 1.

3. George F. Will, “An Officer’s Duty,” Washington

Post, October 21, 1999, p. A 29.

4. Dorn et al., pp. 1-6.

5. General Accounting Office, Military Personnel Perspectives of Surveyed Service Members in Retention

Critical Specialties,GAO/NSIAD-99-197BR

(Washington, DC: Government Printing Office,

August 1999), p. 22.

6. Retrieved 19 April 2001 from World Wide Web:

http://www.todaysmilitary.com/smart_choice.html.

7. Lecture by T. Piper, Corporate Financial Management, Program for Management Development

(PMD75), Harvard Business School, 17 November

2000.

8. Will, p. A 29.

9. Simons, Levers of Control, p. 34.

10. Adapted from Piper, Corporate Financial Management.

11. R. Simons, Performance Measurement & Control

Systems for Implementing Strategy (Upper Saddle

River, NJ: Prentice-Hall, 2000), p. 29.

12. Simons, Performance Measurement & Control

Systems, p. 29.

13. Retrieved 10 April 2001 From World Wide Web:

http://www.dtic.mil/execsec/adr2000/appi.html.

14. J. Kotter, Leading Change (Boston: Harvard Business School Press, 1996), p. 72.

15. Simons, Performance Measurement and Control

Systems, p. 28.

16. Ibid., p. 29.
5-22

34. Simons, Levers of Control, pp. 91-123.

35. R. Simons, Levers of Control (Boston, MA: Harvard

Business School Press, 1995), pp. 96-97

36. Simons, Performance Measurement and Control

Systems, p. 215.

37. Ibid., pp. 38-57.

38. Ibid., p. 51.

39. Ibid., p. 52.

40. Ibid., p. 53.

41. Kaplan and Norton, pp. 2-41.

42. E. Savas, Privatization and Public Private Partnerships (New York, NY: Seven Bridges Press, 2000),

p. 25.

43. Simons, Performance Measurement and Control,

pp. 52-53.

44. General Accounting Office, DoD Competitive Sourcing, p. 1.

45. Retrieved 19 April 2001 from World Wide Web http:/

/www.govexec.com/dailyfed/0401/041901p1.htm.

46. J. Kotter, John P. Kotter on What Leaders Really Do

(Boston: Harvard Business Review), pp. 78-79.
6-1

6

DOD CORPORATE

STRATEGY AND

OUTSOURCING

“We must put strategy first, then spending. Our defense vision

will drive our defense budget, not the other way around.”

— President George W. Bush

Introduction

Until now, we have compared Department of

Defense (DoD) outsourcing results to the private sector’s outsourcing experience. We have

also examined whether DoD’s diminished

performance results from a failure in strategy

formulation, strategy execution, or both.

Finally, we have addressed the question of

urgency: is there a real urgency and if so, is

that sense of urgency shared adequately across

DoD in order to effect change?

The need for change is evident. Yet why has

change been slow to fruition? As we noted in

the previous chapter, the Office of Management

and Budget (OMB) Circular A-76 (A-76) and

strategic sourcing initiatives are at odds with

DoD’s generic corporate strategy of differentiation. This is the cause for inconsistent actions that diminish the competitive advantage

DoD has worked hard to obtain. In addition to

the problems caused by the pursuit of multiple

strategies, the levers of control for executing

strategy are lacking on three counts. First, they

do not dictate firm strategic boundaries. These

boundaries are essential to setting DoD strategic domain — what functions it will operate,

what it will outsource — and establishing where

decision rights reside between the corporate,

Office of the Secretary of Defense (OSD) level,

and the Service level. Second, diagnostic control systems are not aligned. Effectiveness is

measured and rewarded at the unit level where

A-76 is executed, while economics is emphasized at the headquarters or staff level where

A-76 is not executed. Last, interactive control

systems, which would enable leadership to

identify strategic uncertainties, are woefully

missing — a point that is even more remarkable given an organization that extensively

uses interactive planning systems daily in its

warfighting element.
6-2

In this chapter, we will formulate a model for

DoD corporate strategy and outline the methodology for making effective outsourcing

decisions commensurate with that model. We

will also describe the required levers of control

to monitor strategy execution effectively and

bring about change. Chapter Seven will follow

with recommended actions to remedy the

situation and set the stage for transformation.

DoD Corporate Strategy

To develop strategy, one must understand the

competitive environment. To do this businesses

conduct strategic analyses. In Chapter Two, we

introduced several tools for analyzing strategy.

In this section, we turn to one of those tools,

Five Forces Analysis, to gauge the competitive

landscape facing DoD at the beginning of the

21st century.

Five Forces Analysis

Figure 6-1 shows the framework for Five Forces

Analysis. These forces consist of suppliers,

potential entrants to the market, buyers and

customers, substitute products or services, and

rivalry among existing competitors. What follows is an analysis of DoD business functions

within the framework of these forces, beginning with the horizontal axis and concluding

with the vertical axis.

Suppliers

As we saw in Chapter One, the Defense Industry has suffered in the post-Cold War era. The

downsizing of the military force structure and

military budgets brought about a series of

mergers and acquisitions that resulted in a massive consolidation. Thirty-two major defense

Figure 6-1. Five Forces Analysis

Source: Adapted from M. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors

(NY: The Free Press, 1980), p.4.
6-3

contractors have consolidated into seven.1

 For

those remaining, procurement spending has

been cut nearly in half.2 Smaller budgets have

meant greater competition for smaller production runs and fewer new starts.3

 Compounding

this is the unpredictability of annual procurement spending. Figure 6-2 shows the shortfall

in planned versus actual procurement spending

since 1995.

While the Defense Industry has suffered, other

areas of the economy have prospered. Despite

recent market setbacks, the high technology

Information Economy segments have flourished. Over the past five to ten years, these new

economy industries have consistently outperformed the Defense Industry. Furthermore,

earnings in the Defense Industry pale in comparison to earnings offered by the technology

sectors. In 1999 the key defense companies

average margins were 4.3 percent compared

with margins ranging from 20 to 40 percent

attained by commercial high technology companies.4

 While investors are willing to take on

high-risk for high-return, they are generally not

willing to enter into the high-risk, low-return

world of modern defense. The instability of

defense programs, compounded with the relative attractiveness of other markets, has worked

to drive investor capital out of the Defense Industry. This is reflected by the flat performance

of defense stocks in relation to other industries.

Compounding this is the leveraged position

of the industry. Debt loads have increased

as a result of consolidation.5

 Unfortunately,

these firms were taking on debt at the same

time that their earnings and attractiveness to

Figure 6-2. Planned vs. Actual Procurement Spending

(Fiscal Years 1995-1999)

$ Constant FY 00 Billions

Source: American Institute of Aeronautics and Astronautics (AIAA) Defense Reform 2001: A Blueprint for Action

Final Report February 14-15, 2001, Washington, DC, p. 6.
6-4

investors was sliding. Decreased performance

has translated into lower bond ratings, an increased cost to borrow, and an increased cost

of capital. In some instances the cost of borrowing capital has exceeded the companies’ rate

of return.6

All of this has an impact on the industry, on

DoD, and on the security of this great nation.

The price DoD pays for its products and

services reflects the cost of providing them plus

a fair and reasonable profit. As the cost of

capital increases so too does the price the

Department pays. While DoD has long benefited from a robust Defense Industry, arguably the industry is no longer robust. In fact,

Harry Stonecipher, President and Chief Operating Officer of The Boeing Company, referred

to the industry as a “no growth business.”7

 At

the end of the 1990s there were only a handful

of industries that fell below the Defense

Industry’s average rate of return. These industries included shoe manufacturing and groceries.8

 When formulating its corporate strategy,

DoD must take into account the health of the

industrial base — our major supplier.

Buyers and Customers

In keeping with DoD’s vision and mission, we

place operational forces in this category.

Support activities within the Department by and

large exist to provide products and services to

the unified commanders and the warfighting

elements under their command. Operational

forces then work to fulfill the mission of DoD

as outlined in the mission statement. This is an

important distinction. Each DoD support element occupies a specific place in the value

chain. Support activities serve primary activities. Primary activities then support the ultimate

buyer and customer: the nation and its citizens.

The next question is what do operational forces

value? There are likely segments that place a

premium on price, whether acquisition cost or

life cycle cost. Others prefer availability or

speed of delivery to cost. Still others might be

willing to pay a premium acquisition cost for a

higher level of quality and the expectation of a

lower life cycle cost. Mobil, as we saw, was

able to discern buyer segments where it could

compete on a basis other than price. DoD

agencies and the Services could use the same

techniques to discern where it could provide

products and services that are differentiated in

a way that might appeal to the type of product

or service valued by the end user.

Potential Entrants to the Market

Government agencies have at their disposal a

subtle but effective barrier to entry. They can

merely refuse to let the commercial sector compete for their business. By statute or regulation, agencies can be limited to obtaining products or services from within the government,

or outside providers may be allowed in — only

under very strict conditions. Conversely, a commercial firm cannot dictate competition unless

it is willing to risk litigation. The government

can in effect create a monopoly.

Government monopolies are established for a

number of reasons. For example, the activity

may provide products or services that by their

nature are monopolies, or overlapping agencies

may be combined leaving the surviving agency

with monopoly status.9

 Regardless of the reason, government monopolies share two characteristics. First, absent competition and the

market discipline that results from competition,

agencies tend to become less effective and less

efficient over time. Second, once established,

government agencies are rarely disestablished.

In fact, they tend to grow.10

While this barrier to entry helps to rationalize

some business elements of DoD, it also works

to foster an element of complacency. Absent
6-5

the threat of bankruptcy, organizations can

squander resources or run deficits for extended

periods of time. Absent competition, individual

comparisons, preferences, and the resulting

value assessments are masked. And absent

market incentives, no individual financial

performance incentives are tied to return on

resources (i.e., profit).11

For both business and government, any barrier

to entry is a double-edged sword. It allows an

organization to secure a position in the market

but it also tends to stifle performance and, over

time, reduce its ability to react when a new

player exposes and exploits vulnerability. Barriers to entry may be breached by new technology, new customer preferences, or by

changes to law and regulation. Firms should

always question whether, absent the barrier to

entry, it can compete effectively. The same

applies to government agencies.

DoD must recognize that the commercial sector is not only a potential new entrant, but as

we learned from Adam Brandenburger and

Barry Nalebuff’s book, Co-opetition, they are

also potential partners. As we discuss next, the

commercial sector has valuable resources that

can complement the Department’s resources

thereby creating more value for its customer,

the warfighter.

Substitute Products or Services

Substitutes were historically something DoD

support activities did not have to worry about.

Fifty years ago, who else but the military could

boast of capabilities that could support operations worldwide, 24 hours a day, seven days a

week? Today, many companies support ongoing worldwide operations rivaling the scope of

DoD. Forty years ago, DoD and its defense contractors were the undisputed leaders in cuttingedge technology. Today, much of DoD technology lags behind what is available commercially.

Thirty years ago, DoD developed groundbreaking technology for routing information

and used this technology to launch a communications network.12 Today, this technology

powers the Internet and DoD is racing to exploit

this commercially available potential.

Today, DoD is coming to grips with the fact

that the commercial sector is now able to provide products and services that are on par with

or better than what DoD can provide internally.

In many cases, this means these products and

services can be readily substituted for what the

government has traditionally provided.

Rivalry among Existing Competitors

Government agencies, like DoD, do not compete for market share but they do compete for

resources among other federal agencies, like

the Department of Energy, and within themselves. We saw earlier that defense spending is

down significantly over the past decade.

Defense spending as a percentage of total

federal outlays and as a total of net public

spending is steadily declining (see Figure 6-3).

This trend has become more pronounced over

time. In 1965, DoD spending represented 38.8

percent of federal outlays and 25.2 percent of

net public spending. By 1975, these figures

were down to 25.5 percent and 16.5 percent,

respectively. Ten years later, at the height of

the Reagan Administration defense build up,

both figures remained roughly at the same 1975

levels. Yet, by 2000, these figures had declined

to 14.8 percent and 9.1 percent, respectively.13

This is not to say defense spending has been

declining during the same period (1965-2000).

In fact, it has remained relatively constant at

approximately $300 billion (in Constant Year

2001 dollars), except for two spikes coinciding with the end of the Vietnam War in 1970

and at the height of the Reagan Administration
6-6

build up in 1985.14 This lends some credence

to the arguments that an increase to the topline defense budget authority is unlikely —

absent a major conflict or dramatic change in

overall national security or military strategy.

If, from 1965 to 2000, defense outlays are constant at around $300 billion, how then could

defense spending fall in relation to total federal

outlays?

The answer is that total federal spending has

increased at a faster pace. In particular, nondiscretionary spending has increased dramatically. This category of spending includes

entitlement programs such as Medicare, social

welfare programs, and payment on the national

debt. Unlike discretionary spending, these

accounts are not part of the annual Congressional appropriations process. These accounts

pay automatically and their growth is squeezing discretionary accounts, like defense, that

are subject to annual appropriations. In 1965,

discretionary spending accounted for 35

percent of federal outlays. By 1990, it had risen

to 60 percent of federal outlays.15 This figure

is projected to reach 63 percent in 2000 and

rise to 74 percent by 2010.16 Federal agencies

will continue to fight for a dwindling slice of

Figure 6-3. Decline in Federal Discretionary Budget Spending

Source: Data consolidated into one figure: Office of the Under Secretary of Defense (Comptroller), National

Defense Budget Estimates for FY 2001 report, Table 6-1, March 2000; retrieved 30 April 2001 from the

World Wide Web: http://www.defenselink.mil/pubs/almanac/; D. Ippolito, Blunting the Sword (Washington,

DC, National Defense University Press, 1994), p. 113; and, Congressional Budget Office Report, The

Budget and Economic Report – An Update, Table 1-2, July 2000; retrieved 12 April 2001 from the World

Wide Web: http://www.cbo.gov/showdoc.cfm?index=2241&sequence=2.
6-7

discretionary dollars and, as the slice of defense

spending declines, the battle then carries over

to an internal struggle within DoD. Without

significant change, this rivalry is likely to

intensify.

The Department currently resides in the business landscape summarized in Figure 6-4. From

this analysis we can develop an effective

corporate strategy for DoD.

Formulating a DoD Corporate Strategy

As we relayed in Chapter Three, Michael Porter describes three generic strategies firms can

pursue: cost leadership, differentiation, or focus. A firm may derive competitive advantage

from having the lower-cost product or service

at an equivalent quality or a differentiated product or service at a reasonable price relative to

its competitors. In addition, scope is a critical

component of competitiveness. A firm can seek

to market to a broad target or a narrow one.

This is illustrated in Figure 6-5.

For DoD, the competitive scope is clearly a

broad one. The Department must provide the

people, equipment, and training to a very broad

range of customers who are engaged in a full

spectrum of military operations. This rules out

pursuing a narrow cost-focused or differentiation-focused strategy, leaving DoD to determine whether competitive advantage can best

be obtained by being a cost leader or through

differentiation.

Arguably, DoD has been a differentiator for

some time now. The Department, its various

agencies, and the Services have aimed to recruit the best people and provide them with the

best equipment and training. This was especially true after DoD went to an all-volunteer

force in the 1970s and during the Reagan

Administration build up of the 1980s. This

Figure 6-4. Five Forces Analysis of DoD
6-8

strategy paid immense dividends as evidenced

by the remarkable operational achievements

during Desert Shield/Desert Storm and the

Kosovo Operation. Yet DoD is faced with the

need to maintain readiness and fund an extensive modernization program under the umbrella

of limited resources. The question is, should

DoD now adopt a cost leadership strategy and

completely restructure in line with this new

strategy or should it continue to pursue a differentiation strategy and develop the proper

processes to make this strategy successful?

The Department’s mission and analysis suggest that DoD should continue to pursue differentiation for several reasons. First and foremost, DoD’s corporate strategy is itself a strategy subordinate to the National Security Strategy (NSS) and National Military Strategy

(NMS). As a result, the corporate strategy must

align with the goals of the NSS and NMS. As

long as these goals continue to emphasize engage, shape, respond, and prepare, DoD cannot pursue a cost leadership strategy.17 According to Michael Porter, a successful cost leadership strategy depends on products or services

that are on par with competitor offerings in

terms of quality.18 Having equipment and services that are merely on par with any potential

U.S. enemy is clearly not a formula for success. This nation’s continued security demands

a defense force that is unequaled in capability.

Second, DoD’s customers — the warfighters

— still value and demand a differentiated product or service. In order to execute their mission and exploit enemy vulnerabilities they

need the best. Nonetheless, cost is certainly a

critical aspect of the warfighters’ requirement.

Even the differentiator cannot ignore costs. As

Porter states, “A differentiator thus aims at cost

parity or proximity relative to its competitors,

by reducing cost in all areas that do not affect

differentiation.”19 Successful commercial firms

that aim at differentiation are doing this.

Finally, DoD must have a viable supplier base

to properly equip the warfighter. Given an

industry that is already suffering, a cost leadership strategy runs the risk of squeezing even

more out of the suppliers. In the end this could

drive more suppliers away from government

business or the balance of power may shift to

the suppliers with the unintended consequence

of driving up procurement cost, resulting in

DoD paying unreasonably high prices for onpar products or services.

Figure 6-5. Generic Strategies

Source: M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (NY: The Free

Press, 1985), p. 12.
6-9

If, as this suggests, DoD should continue to

rely on a differentiation strategy, what then

explains the dire straits it is currently in? Going back to the analysis above, several items

leap out. As we said, government agencies like

DoD can simply create a monopoly. The dangers of this are complacency, inefficiency, and

reduced ability to react.

One way of creating that monopoly is to vertically integrate. However, those pursuing a

differentiation strategy should avoid integrating into areas that might dilute the value of its

brand and products. In the past, DoD may have

been correct to integrate into various operations

in order to capture what Porter terms the economies of combined operations or economies of

information.20 Combined operations produced

such efficiencies as reduced transportation

costs. At the same time, integrated operations

reduced the need to capture some types of information vital to the process. Through vertical integration, DoD captured the benefit of coordination and control to facilitate massive,

worldwide operations required at the time. Yet

the costs of vertical integration born by DoD

are those typical of the traditional hierarchical

organization:

• Weaker incentives;

• Bureaucracy; and

• Inflexibility due to the commitments in capital and resources.21

However, today’s Information Economy enables virtual organizations to capture and use

information far more effectively then was the

case in the past. The earlier Cisco discussion

clearly illustrates this point. Cisco has complete coordination and control of its processes

even under its virtual corporation model because it has the critical information to make

sound decisions without the burden of owning

all the assets. Information technology is rapidly diminishing the importance of organizational boundaries. The Department has been

slow to react to this change.

An additional symptom apparent today in DoD

is a diluting of brand image. Those critical factors that make the United States Armed Forces

the best in the history of the world are suffering today. First, DoD is experiencing difficulty

recruiting and retaining the best people, and

second, the equipment is aging. Without the

best people, the best equipment, and the best

training, readiness will suffer.

As stated in Chapter Three, firms that differentiate take great care to build, cultivate, and

reinforce a strong brand image. However, the

Services have suffered from recruiting shortfalls and retention problems. The booming

economy of the 1990s certainly contributed to

the problem, but nonetheless, DoD is suffering from what marketers would call brand erosion. The Army has gone so far as dropping

the second most memorable slogan of the century according to Advertising Age.22 The “Army

“What I do know is that savings tend to come later, not earlier; that is, for example,

when you have to do things to rearrange yourself so you can save some money, you

tend not to get the benefit of that — whether it’s a company or a department of

government — you don’t get the benefit of that the first year. It tends to come in the

second or third or fourth year.”

Secretary of Defense Donald Rumsfeld
6-10

of One” has replaced “Be All That You Can

Be.” The question is, will this new slogan solve

the Army’s recruitment problem or will it

introduce future image problems?

The counterpart of the strong brand image —

quality equipment — is also suffering. The

effects of monetary and contingency pressures

are now apparent in terms of aging equipment

and increasing maintenance costs. Unfortunately this phenomenon is so prevalent throughout DoD that it has become known as the “death

spiral.” Future defense readiness will continue

to decline as long as modernization dollars

are limited and equipment continues to age,

requiring increased maintenance (see Figure

6-6).

However, the answer is not to pursue cost

savings and efficiency as the primary goal.

After all, these are symptoms. The Department

must remedy the cause, not treat the symptoms.

This analysis indicates that DoD must redirect

itself to the differentiation strategy first and

pursue cost effectiveness as a secondary goal.

In other words, DoD seeks, in order of precedence: product innovation, high quality, and

low cost — the best value for its customer, the

warfighters. This is the strategy that has made

it the world’s best military and is the strategy

that, when properly executed, will allow DoD

to transform to meet the challenges of the new

millennium.

Figure 6-6. Readiness Death Spiral
6-11

DoD Corporate Strategy Execution

and Outsourcing

With DoD’s corporate strategy set as a differentiator, the onus is on the OSD as the corporate headquarters of DoD to ensure the strategy is effectively executed — what Cynthia

Montgomery calls “being a good corporate

parent.” In Chapter Two, we introduced two

mechanisms that OSD could use to facilitate

this endeavor. First, we will use Collis and

Montgomery’s Corporate Strategy Triangle as

the framework for ensuring all activities within

DoD are aligned with the differentiation strategy. Then we will examine the essential elements needed to establish effective levers of

control. It is through these levers that DoD can

positively effect change. As we go through this,

we will examine how outsourcing fits into the

process, addressing the findings of our research.

Aligning DoD to

the Differentiation Strategy

The Corporate Strategy Triangle framework

allows OSD to build on the Department’s

strengths. Without such a framework one can

expect the observations noted in this research.

What are DoD’s strengths? As we have already

discussed:

• Belief systems: duty, honor, country,

courage, commitment, integrity, service,

excellence, and respect;

• Mission and vision: engage, shape,

respond, and prepare;

• Resources: the best people, the best equipment, and the best training.

These are a solid foundation from which to

build the DoD Corporate Strategy Triangle.

However, our research pointed to three critical

problems in need of correction:

1. DoD corporate strategy is not communicated effectively.

2. Linkage between the corporate strategy and

performance measures is lacking.

3. Pursuit of cost-based outsourcing initiatives is misaligned from DoD corporate

strategy.

Michael Beer, Russell Eisenstat, and Bert

Spector state in their book, The Critical Path

to Corporate Renewal, that a firm’s competitive advantage stems from its ability to engender the necessary level of coordination, commitment, and competence. These are the

essential human resource elements that drive

corporate revitalization. Teamwork is essential

to find and act on product improvement, quality, and cost opportunities. Therefore any revitalization effort a firm undertakes must focus

on enhancing coordination.23

As we show in Chapter Four, the link from the

national military strategy to DoD corporate

strategy exists. Yet, 64 percent of the 232 survey respondents and 33 percent of the 111

commanders surveyed regarding DoD corporate strategy have not read it. If key personnel

within DoD, who are critical to successful

change, have not even read that strategy, you

simply cannot achieve coordination nor instill

commitment.

Furthermore, the survey responses of the approximate 130 individuals who have undertaken an outsourcing effort indicate the

outsourcing initiatives currently under way may

not be aligned to a common vision and there

may not be a linkage between the levels of DoD

(see Table 6-1).

Perhaps the reason for these results is that, in

addition to A-76, DoD is exploring strategic

sourcing initiatives and each of the Services is
6-12

experimenting with competitive or strategic

sourcing efforts. According to the OUTSOURCING JOURNAL.COM, economies of

scale are the “holy grail of outsourcing.”24 Yet

a corporation cannot capture the full economies

of scale when each business unit is permitted

to operate independently. As we said in Chapter Two, the framework also sets the boundary

between strategic and tactical decision making. The commercial sector has recognized that

to realize the full benefits of outsourcing, it is

a strategic investment decision, and not something to be left to subordinate units.

With this kind of fragmented approach, it is

not surprising that the performance measures

in use by DoD are lacking. The Department’s

focus on metrics has centered on such arbitrary

measures as number of positions subject to A76 competitions or unreasonable cost savings

goals. These measures focus on efficiency and

don’t address the fundamental questions:

Was the outsourcing effort aligned to:

Yes

DoD corporate strategy? 42.3%

Your service or agency’s strategy? 66.2%

Your major command’s strategy? 67.0%

Your unit’s strategy? 37.6%

Your function or department’s strategy? 35.9%

Table 6-1. Outsourcing Initiative Alignment to Corporate Strategy

Table 6-2. Relationship of Four Levers of Control to Strategy

Control System Purpose Communicates Control of

Strategy As

Beliefs Systems Empower and Vision Perspective

expand search

activity

Boundary Systems Provide limits of Strategic domain Competitive position

freedom

Diagnostic Control Coordinate and Plans and goals Plan

Systems monitor the

implementation of

intended strategies

Interactive Control Stimulate and guide Strategic Pattern of actions

Systems emergent strategies uncertainties

Source: R. Simons, Performance Measurement & Control Systems for Implementing Strategy (Upper Saddle

River, NJ: Prentice-Hall, 2000), p. 304.
6-13

• Does this activity fit within DoD strategic

domain?

• Does it add value to the Department?

• Are there other sources that clearly have a

differentiated product or service?

The levers of control can help set the appropriate measures, but they can do far more.

Controlling Strategy Implementation

through Levers of Control

Robert Simons’ Levers of Control are the means

by which strategy is effectively executed. By

way of review, the levers are belief systems,

boundary systems, interactive control systems,

and diagnostic control systems. The levers

ensure alignment to the corporate strategy by

monitoring and controlling implementation as

shown in Table 6-2. These levers of control

provide the additional detail on the framework

from which DoD should undertake any

outsourcing initiatives.

Most important, the levers are the means to

fundamental transformation at the cultural level

of DoD. As the subtitle of Simons’ book suggests, How Managers Use Innovative Control

Systems to Drive Strategic Renewal, they are

the mechanism by which DoD leadership can

strategically realign the Department to pursue

a differentiation strategy. Used correctly, the

levers will give DoD strategic responsiveness,

adaptability, and a means to maximize the

performance of a differentiation strategy.

Belief Systems

As was stated in the previous chapter, DoD’s

belief system, vision, and mission are in concert with a differentiation strategy. This is not

to suggest that a senior leadership review of

DoD or Service belief systems wouldn’t be

beneficial. Returning once again to the Johnson

& Johnson Credo, Figure 2-12, it has withstood

and been strengthened as a result of extensive

reviews by the firm’s leadership through the

years.25 In fact, any strategy review should

include an extensive review on how that strategy is to be implemented. The driving force to

DoD’s ability to transform is its core ideology

and belief system.

It is within the belief system that an important

lesson for future outsourcing success resides.

Stemming from one of DoD’s strengths, people

as a key resource, one must consider impact

on personnel in any outsourcing effort. The survey made this point clear. As the corporate parent, OSD must establish general guidelines rather

than overarching policy by which personnel

issues involved in outsourcing initiatives are

dealt. Unit-level managers can then use these

guidelines to structure unique, win-win solutions at the local level. Mechanisms such as transition to private sector and equitable compensation and benefit packages can be successfully

negotiated to ensure effectiveness. Teamwork

and commitment are imperative for success.

Teamwork is a trademark of DoD. This aspect

will not change. What will change is the makeup of the team. Some will get a “United States

Treasury” paycheck while others will get a

“Corporate America” paycheck. Yet they will

all remain the best people working together

to ensure the Department fulfills its mission.

Can we make this adjustment? The team principle has been a key factor in recent successes,

showing that we can.

The Department’s acquisition community has

undergone just such a transformation. Under

acquisition reform, the relationship between the

government and contractors is evolving from

an adversarial one-to-one of teamwork that recognizes and leverages the benefits of partnership and collaboration. The Department must
6-14

build upon this to capture the positive benefits

of partnerships in many other activities to include outsourcing initiatives. The boundary

lever can help OSD determine how outsourcing

initiatives support the differentiation strategy.

Boundary Systems

The boundary system lever plays two critical

roles in the transformation of DoD. First, it will

enable OSD to set the boundary between

strategic and tactical management. In fact,

strategic management is about more than management. It’s leadership that sets the domain

in which the firm will operate and establishes

an environment conducive to successful change.

Tactical management, on the other hand, is

about implementation and day-to-day management of the business. Second, the boundary

system draws a clear demarcation between

strategic and tactical decision rights, enabling

the senior leadership of a firm to focus on questions of strategic import, such as “are we doing

the right things?”

According to David Teece, strategic management is about matching a firm’s capabilities to

the ever-changing environment to attain its best

performance.26 Thus, strategic boundaries are

established to manage the risk of wasting scarce

resources on activities that do not support

DoD’s strategy — reducing investment in areas

that don’t affect differentiation. Conversely,

DoD may consider outsourcing areas that

strengthen or reinforce value to the warfighter,

focusing not on cost but on the premium it can

demand for better value. Put simply, DoD

should outsource activities where it no longer

provides a differentiated product or service.

Historically, a comparative analysis of whether

to vertically integrate into a business area or

function examined the trade between the benefits and costs of bringing the function into the

firm’s hierarchy and the same for relying on

the market (see Table 6-3).

Today’s Information Economy allows a firm

like Cisco to have the benefits of both structures: coordination and control, and strong

incentives and competition. Moreover, as the

firm gains competence in writing and enforcing outsourcing contracts or agreements, this

cost diminishes significantly. Thus it becomes

quite clear why firms worldwide are investing

so much into outsourcing. The Department can

learn and adapt from the commercial outsourcing successes and failures based on its years of

experience in writing and enforcing contracts.

As we said in Chapter Four, strategic sourcing

is a step in the right direction since the focus is

on activities versus billets. The OSD needs to

take the lead in designating activities DoD

should source from elsewhere — set the strategic domain. To capture economies of scale

Table 6-3. Comparative Analysis of Vertical Integration

Corporate Hierarchy Competitive Market

Benefits • Coordination • Strong incentives

• Control • Competition

Costs • Weaker incentives • Ability to write/enforce contracts

• Bureaucracy

• Inflexibility due to commitments
6-15

and scope, activities must be identified at the

corporate level with input from the business

units — the agencies and Services under DoD.

The agencies and Services must certainly be

included in the decision-making process, but

they should not be making that investment

decision. The agencies and Services attention

should be on monitoring and controlling

implementation.

Setting decision rights at the appropriate level

is primarily about empowering individual leaders appropriately in order for them to manage

their units effectively. The Naval Sea Systems

Command Weapon Station strategic sourcing

pilot program at Crane, IN, illustrates this point

clearly. The Weapon Station commander was

empowered to take the risk of conducting a

review of all base activities. He was not hindered by a corporate “one size fits all” A-76

policy. Moreover, the commander had one

simple criterion regarding these activities: do

we add value?

Successful transformation of DoD will rely

heavily on such empowerment and risk-tolerant

pilot programs at the lower levels. As Michael

Beer states, organizational revitalization requires risk-free experimentation within the

firm’s strategic domain starting at the bottom

of an organization and building change momentum as one learns and adapts from these experiments. As the people in the organization

gain the competence, the culture within the

organization begins to change and the process

becomes institutionalized.27 Of course, one

must recognize whether the change process is

on track, which means one requires sound

information systems.

Diagnostic Control Systems

As we stated in Chapter Two, diagnostic control systems are the formal information systems

that managers use to monitor organizational

outcomes and correct deviations from preset

standards of performance.28 These systems have

matured well beyond the traditional measures

like plans, budgets, and financial systems.

These measures have become knowledge fountains, spouting critical information to monitor

and change behavior. Balanced Scorecard

(BSC), project monitoring systems, and costaccounting systems are examples of systems

that are used diagnostically. The diagnostic

control system chosen must link the strategy

to intermediate goals by means of a set of

critical performance measures that are balanced

and not cost-centric. These are the measures

that motivate personnel, help build further

commitment, and foster competence.

The good news is that the Department and the

Services have already experimented successfully in such initiatives as BSC. We must look

to capitalize and build upon the positive aspects

of that experience quickly. The bad news is

that DoD’s current budget and cost accounting systems are not adequate even in a costcentric approach nor robust enough to perform

diagnostically.

As noted earlier, DoD suffers from the “Readiness Death Spiral.” This is akin to what Kaplan

and Cooper term the “differentiation death

spiral.”29 This death spiral is fueled by a firm’s

inability to estimate the incremental costs of

achieving differentiation. As a firm increases

product diversity, indirect and support costs

escalate to handle the increased variety and

complexity. Kaplan and Cooper recommend

activity-based costing (ABC) be employed to

give insight into the additional costs of differentiation. Armed with these cost data, a firm

can make sound decisions on lowering costs.

The benefit of ABC in the public sector is

illustrated by the city of Indianapolis. City budgets declined for four consecutive years, while

service output increased. A single refuse crew
6-16

now serves 1,200 homes a day, up from 680.30

There are numerous other opportunities for

learning and adaptation within the public and

private sector.

Successful re-engineering of DoD’s traditional

control systems into diagnostic systems will

enable the Department to operate on what

Kaplan called “auto pilot.” Clear boundaries

and effective diagnostic controls will increase

DoD’s Return on Management (ROM). This is

essential to give the senior leadership throughout DoD the time to watch the horizon for strategic uncertainties and monitor the tension

within the Department. Interactive control systems are the means for DoD to learn and adapt

— to become a “learning organization.”31

Interactive Control Systems

Interactive control systems question whether

you are on the right track. These systems allow you to monitor and respond to the strategic uncertainties of the business landscape. For

DoD, the eroding readiness levels are its equivalent to declining market share. Advanced systems must be developed that signal the need

for change, provide insight onto the details of

the issue or problem, and lead directly to a

corrective plan of action.

The very framework presented in this report is

a step towards developing just such a control

system. Similar systems exist today within the

warfighting elements of DoD. As an organization, DoD should adapt John Kotter’s habits

that support lifelong learning:

• Risk taking: willingness to experiment;

• Humble self-reflection: honest assessment

of successes and failures;

• Solicitation of opinions: aggressive collection of information and ideas;

• Careful listening: propensity to listen to

others;

• Openness to new ideas: willingness to have

an open mind.32

Leadership is the critical resource that will

allow DoD to learn and adapt at a much quicker

pace, a pace that will enable DoD to keep up

with the rapidly changing environment.

Is the New Approach Achievable?

Today’s situation dictates that this approach

must be achievable. Perhaps the more appropriate question is whether DoD can effect positive change. Two powerful books on change

and organizational transformation, John

Kotter’s Leading Change and Michael Beer,

Russell Eisenstat, and Bert Spector’s The

Critical Path to Corporate Renewal, provide

insight into how DoD can succeed. Kotter’s

Leading Change is based on his analysis of

dozens of change initiatives at various organizations over 15 years.33 The Critical Path to

Corporate Renewal, is based on an in-depth

study of six corporations that made an effort at

fundamental change.34

Three powerful lessons stem from these research efforts: the first from Kotter’s work, the

second emphasized in both, and the last one

from Beer, et al. First, appropriate change tends

to be associated with a process that creates

motivation strong enough to overcome all

sources of inertia.35 Second, solid leadership is

required to make the process work.36 Third, lasting change cannot be imposed from the top,

focusing narrowly on one specific area, using

standardized solutions, and aiming to make

sweeping change throughout the organization.37

Comparing these findings to the results of this

research effort yields both optimism and cause

for concern.
6-17

On the positive side, the urgency is there. This

urgency is what makes fundamental change

possible because it’s the first impulse required

to counter inertia. Solid leadership is abundant

in the Department with its long and decorated

history of developing and nurturing leadership.

In addition, within the outsourcing efforts there

are examples of the type of leadership needed

for such, like that of the Naval Sea Systems

Command Weapon Station commander at

Crane. The Department must adapt this ability

for developing keen military savvy into a penchant for developing sound business acumen

as well.

Unfortunately, the A-76 process and strategic

sourcing initiatives are not, in general, the

means for making such a change. These are

change mechanisms that are imposed from the

top, focused on cost savings alone, done

through a more standardized approach, and

aimed at making this change throughout the

organization. Additionally, such processes

coupled with frequent changes, such as A-76

process versus strategic sourcing, tend to inoculate employees to change because of growing cynicism, a fact borne out in the survey.38

To effect positive change — change that is

institutionalized into the organization — the

focus must be on changing the culture in DoD.

Why culture? As the research by Beer, et al

indicated, the corporation that made this kind

of successful transformation instilled the key

human resource activities of coordination,

commitment, and competence. Yet DoD, as a

traditional command-and control organization,

fundamentally lacks these attributes. Such an

organization requires very little coordination

at the lower levels and therefore demands

less commitment and competence from its

employees.

The type of cultural change required in DoD is

depicted in Table 6-4. As one can see, the new

culture relies heavily on strategic management

that understands the dynamics of the changing

environment and makes quick decisions in

response. It also empowers employees to make

decisions appropriate to their level, and encourages prudent risk-taking and experimentation.

Finally, it gives everyone in the organization

the necessary information to make timely and

informed decisions.

As DoD develops coordination, commitment,

and competence, it should develop the lever of

control systems needed to monitor the change

process effectively (see Table 6-5). The levers

help develop the essential human resources of

coordination, commitment, and competence.

The belief system develops both coordination

and commitment through the vision and core

ideology of teamwork. The boundary system

Table 6-4. Change in Culture Required of DoD

DoD of the 20th Century DoD in the 21st Century

Inward focus External focus

Centralized Empowering

Slow to make decisions Quick to make decisions

Bureaucratic Open and candid

Risk averse Prudent risk takers
6-18

also fosters coordination and it helps build

commitment and competence by empowering

individuals to take risks and grow through

experience. Competence and commitment are

also developed through the diagnostic control

systems by providing meaningful performance

data — results. Finally, commitment is further

enhanced through interactive control systems

that indicate DoD is still on the right track.

Coordination, commitment, and confidence are

thus mutually reinforcing, building a sense of

efficacy among the organization’s members.39

Done correctly, it’s as close as one can come

to a perpetual motion machine.

This is the type of organizational renewal that

successful commercial firms have undergone

and that the former Tactical Air Command underwent under the leadership of General Bill

Creech (see Figure 6-7, Revitalizing Tactical

Air Command). What is left for DoD is to build

upon that body of knowledge and adapting the

change process to the Department.

There are infinite obstacles to overcome and

infinite opportunities to seize upon. Five Forces

Analysis provides the snapshot of the obstacles

to overcome and the opportunities to seize. It

also lights the way to success. The Corporate

Strategy Triangle framework, building on

DoD’s core ideology, bends the light, showing

the correct way to steer toward success. The

levers of control are the steering mechanism

for navigating through the change process (see

Figure 6-8).

Summary

In this chapter we have demonstrated that

DoD’s corporate strategy must be that of a

differentiator in order to meet the demands of

the national security and military strategies

and the environment it finds itself in today. We

also provided a framework from which DoD

should operate, building on the Department’s

strengths and identifying areas for improvement. This framework is one that works for leading commercial firms and will work for DoD.

Table 6-5. Linking Change Processes to Levers of Control

Kotter’s Beer, Eisenstat, Spector Simon’s

Leading Change Critical Path Levers of

Steps Steps Control

1. Establishing Urgency 1. Mobilizing Energy Belief Systems

2. Creating Coalition 2. Developing Task-aligned Vision

3. Developing Vision 3. Fostering Consensus, Competence,

4. Communicating Vision and Cohesion

5. Empowering Employees 4. Spreading Revitalization through Boundary Systems

Process

6. Generating Short-term Wins 5. Monitoring (and Strategizing) Diagnostic Control

Systems

7. Consolidating Gains and 6. Consolidating by Formalizing Interactive Control

Producing More Change 7. (Monitoring and) Strategizing Systems

8. Anchoring New Approaches

in Culture
6-19

Revitalizing Tactical Air Command

The story of General Bill Creech, Tactical Air Command* (TAC)

commander at the time, and the revitalization of TAC is a tale

of transforming a centralized, bureaucratic organization of the

20th century to a decentralized, responsive organization for

the 21st century. It is all about TAC renewal through a process

of change — cultural change.

General Creech brought about this change by focusing on the

human factor of an organization to gain coordination, commitment, and competence. The critical change process principles

were:

• Leadership: achieved coordination by embracing all the elements required for success — the people, the equipment,

the training, the planning, the strategy, and the tactics.

• Empowerment: achieved commitment by empowering the individuals that owned the process or

product, making everyone a leader in the change process.

• Teamwork: achieved competence by changing big functions to small teams that focused on quality

of team products and outputs.

Before this transformation, TAC had a difficult time maintaining its aircraft fleet, resulting in lost training

sorties despite ample budget and authorization. The following outputs resulted from successful change:

• The number of aircraft grounded for maintenance in a fleet of more than 4,000 aircraft was reduced

73 percent.

• The number of “Hangar Queens,” aircraft grounded for more than three weeks, was reduced from

an average of 234 a day to only eight a day.

• The rate of fixing aircraft the same day noted “broke” was improved by 270 percent.

• Finally, in Desert Shield/Desert Storm the average fighter “Mission Capable” rate was over 95

percent throughout the high-tempo operations as compared to rates of 50 percent and lower at

General Creech’s arrival.40

Even more remarkable than these results is the fact General Creech and the people of TAC accomplished this feat between 1978 and the mid-1980s, well before the impact of the Reagan Administration build up. The accomplishment was well recognized and lauded. In fact, the Presidential Blue

Ribbon Commission on Defense Management, chaired by David Packard, cited the decentralized,

quality-oriented initiative as the model for how DoD should be managed.41

(*Tactical Air Command is now Air Combat Command)

Source: Adapted from W. Creech, The Five Pillars of TQM: How to Make Total Quality Management Work for You.

(New York: Truman Tulley Books/Dutton, 1994), pp. 1-40, 115-157.

Figure 6-7. Revitalizing Tactical Air Command
6-20

Success in the business world begins with

effective leadership that sets strategy first and

then builds the corporation around that strategy.

A corporation that:

• Is built on a firm foundation of a sound

belief system, with an effective mission and

vision statement;

• Exploits valuable resources continuously to

build competitive advantage; and

• Learns and adapts responsively.

This is the framework that will again place

DoD’s attention onto effectiveness, determining the right thing to do versus efficiency. The

framework that can and will lead to increased

readiness and mission performance.

Figure 6-8. DoD Framework for Change

Infinite obstacles...

... infinite opportunities
6-21

ENDNOTES

17. 2001 Annual Defense Report, Chapter One, retrieved

26 April 2001 from the World Wide Web: http://

www.dtic.mil/execsec/adr2001/toc.html, p. 5.

18. M. Porter, Competitive Advantage: Creating and

Sustaining Superior Performance (NY: The Free

Press, 1985), p. 14.

19. Porter, p. 14.

20. Ibid., pp. 303-304.

21. Personal communication from C. Montgomery, 24

May 2001.

22. “The New Army”, Weekly Standard, April 30, 2001,

p. 20; retrieved 25 April 2001 from the Current News

Supplement World Wide Web edition: http://ebird.

dtic.mil/.

23. M. Beer, R. Eisenstat, and B. Spector, The Critical

Path to Corporate Renewal (Boston: Harvard

Business School Press, 1990), pp. 12-14.

24. OUTSOURCING JOURNAL.COM, May 2001,

Maximizing the Benefits of Economies of Scale,

p. 1, retrieved from the World Wide Web: http://

www.outsourcing-journal.com/issues/may2001/

insights.html.

25. Class notes from T. Piper, Corporate Financial Management, Program for Management Development

(PMD75), Harvard Business School.

26. D. Teece, “Economic Analysis and Strategic Management,” California Management Review, Vol.

XXVI, No. 3, Spring 1984, p. 87.

27. Personal communication from M. Beer, 24 May

2001.

28. R. Simons, Levers of Control (Boston: Harvard

Business School Press, 1995), p. 59.

29. R. Kaplan and R. Cooper, Cost & Effect: Using

Integrated Cost Systems to Drive Profitability and

Performance (Boston: Harvard Business School

Press, 1998), p. 170.

30. Kaplan and Cooper, p. 249.

1. The Economist (Volume 356, Issue 8183), London:

August 12, 2000: Anonymous, pp. 61-62.

2. Retrieved 12 April 2001 from the World Wide Web:

http://www.dtic.mil/execsec/adr 1999/apdx_b.html.

3. American Institute of Aeronautics and Astronautics

(AIAA) Defense Reform 2001: A Blueprint for

Action Final Report February 14-15, 2001,

Washington, DC: p. 3.

4. AIAA Defense Reform 2001, p. 5.

5. Ibid.

6. Ibid.

7. Remarks at the American Institute of Aeronautics

and Astronautics (AIAA) Defense Reform 2001

Conference, February 14, 2001, Washington, DC.

8. AIAA Defense Reform, p. 5.

9. E. Savas, Privatization and Public/Private Partnerships (NY: Seven Bridges Press, 2000), p. 31.

10. Savas, pp. 18-36.

11. J. Stiglitz, Economics of the Public Sector (NY: W.W.

Norton Y Company, 1988), pp. 198-210.

12. Harvard Business School Case Number 9-198-120,

5 November 1998, p. 1.

13. Retrieved 12 April 2001 from the World Wide Web:

http://www.defenselink.mil/pubs/almanac/.

14. Office of the Under Secretary of Defense (Comptroller), National Defense Budget Estimates for FY

2001 report, Table 6-1, March 2000; retrieved 30

April 2001 from the World Wide Web: http://www.

defenselink.mil/pubs/almanac/.

15. D. Ippolito, Blunting the Sword (Washington, DC,

National Defense University Press, 1994), p. 113.

16. Congressional Budget Office Report, The Budget

and Economic Report—An Update, Table 1-2, July

2000; retrieved 12 April 2001 from the World Wide

Web: http://www.cbo.gov/showdoc.cfm?index=

2241&sequence=2.
6-22

31. Personal communication from M. Beer, 24 May

2001.

32. J. Kotter, Leading Change (Boston: Harvard

Business School Press, 1996), pp. 182-184.

33. Kotter, p. ix.

34. Beer, et al., p. 2.

35. Kotter, p. 20.

36. Kotter, p. 20 and Beer, et al., pp. 179-181.

37. Beer, et al., p. 24.

38. Ibid., p. 41.

39. Ibid., p. 104.

40. W. Creech, The Five Pillars of TQM: How to Make

Total Quality Management Work for You. (New York:

Truman Tulley Books/Dutton, 1994), p. 136.

41. Creech, p. 151.
7-1

7

CONCLUSIONS AND

RECOMMENDATIONS

“A prudent question is one half of wisdom.”

— Francis Bacon

Management and Budget (OMB) Circular A76 (A-76) and related cost-focused initiatives.

Furthermore, this sense of urgency is sufficiently high as to make change possible and

successful if change is commensurate with the

tenets of DoD strategy. If, as Kotter states, a

75 percent dissatisfaction rate represents a

threshold that must be reached before successful change can be enacted, DoD meets this

threshold. Of 232 survey respondents, 85 percent indicated that a need exists for significant

improvement in the way DoD and the departments/agencies conduct business operations.

Do DoD outsourcing initiatives align with

the DoD business strategy?

Current initiatives do not align with DoD business strategy. DoD has historically followed a

generic strategy of differentiation. DoD’s

beliefs, values, and mission are aligned to

support this strategy. A-76 and related initiatives, with their focus on cost, are not wellsuited for an organization such as DoD, which

competes on quality, not cost.

Conclusions

Based on the information presented in this

report, we will now address our hypothesis.

Specifically, that on-going outsourcing initiatives will not result in the necessary performance improvements and changes required to

transform the Department of Defense (DoD)

to meet the challenges of the 21st century because these efforts are focused on doing things

right versus doing the right thing. We do this

by addressing the questions first posed in this

report.

Does transformation urgency exist?

There are strong indications that transformation urgency does exist. This was borne out in

the survey. Respondents clearly indicated that

business as usual is unacceptable. This was a

sentiment shared by all groups regardless of

status (i.e., assignment, pay grade, area of

functional expertise, etc.). Additionally, there

is a strong degree of dissatisfaction with the

mechanisms DoD is currently using to transform business processes — namely the Office of
7-2

This misalignment of strategy and outsourcing

policy has generated a great deal of concern

within DoD. This is especially true of base and

installation commanders who must implement

A-76. Installation commanders, more so than

any other group surveyed, place mission performance and personnel ahead of cost. This is

at odds with current outsourcing policies that

place cost ahead of performance and personnel.

Has the A-76 process generated the results

expected?

As measured by savings goals, the A-76 process has not generated the results expected.

These goals are set unrealistically high and

motivation to meet them is low. Additionally,

any incentive to attain cost saving is secondary to impact on mission performance and

personnel. These latter two are central to

DoD’s differentiation strategy and are strongly

reflected in the Department’s belief system.

Furthermore, mission performance and responsibility toward subordinates are the basic tenets

of diagnostic control systems at the unit level

where A-76 must be executed. Cost savings,

on the other hand, are the driving metric at

the headquarters and staff level. This is the part

of the hierarchy that creates but does not

implement outsourcing strategy in its current

form.

More important, A-76 has not generated the

business process improvements needed to

transform DoD from an old to a new model.

A-76, by its nature, is a mechanism to make

the old model as economical as is possible. It

is not a process that is designed to foster more

effective business structures.

Has Strategic Outsourcing generated the

results expected?

Successes have been a function of the autonomy given to local leadership and to a focus

on process over economies. Local activities,

working within a set of broad objectives versus a narrow methodology, are able to effect

real change. Solutions are generated locally

rather than being dictated from above. Instead

of focusing on marginal savings, these activities have focused on process improvements as

the primary consideration and bottom-line cost

as a secondary concern. This improvement of

business processes entails a focus on effectiveness. These more effective processes are, in

turn, more efficient.

This is an inherently different approach than

that of A-76. Under A-76, DoD has the same

model with the same vulnerabilities both before and after these outsourcing initiatives.

Further, while the model may be slightly less

expensive, it is not more effective. In fact, survey data indicate that mission performance may

be suffering as a result of pursuing A-76.

So long as the outsourcing strategy is costdriven, it will be at odds with DoD’s generic

business strategy. One of two things can happen

to rectify this conflict. Either DoD can modify

outsourcing policies or it can take measures to

adopt a new strategy of cost leadership. We

recommend the former.

Have shortfalls resulted from execution

problems or are they strategy-related?

Shortfalls result from incongruities in execution and business strategy as well as a reliance

on actions that are at odds with DoD’s belief

systems. These systems emphasize mission performance and responsibility for subordinate

personnel. Absent a change in these core

beliefs, such considerations will always take

precedence over economies.

While secondary to the incentives to perform

and care for subordinates, economic incentives

are still a leverage point and a force for change.
7-3

However, the current economic structure does

not bring these incentives to bear. At the unit

level, where these policies are executed, savings are not retained. Instead, monies saved are

swept-up and retained by the Department for

application elsewhere. This leaves no financial

incentive to execute current policies. Instead,

they must be dictated by means such as upfront budget cuts.

From the perspective of strategy, current

outsourcing policy imposes a process that emphasizes cost against a strategy that emphasizes

quality and performance. DoD’s vision emphasizes being the best-trained, best-equipped

fighting force in the world. Current Department

policies indicate this vision is to be attained

within the current structure but that the structure must be made more affordable. Absent fundamental changes in the organization, at some

point reducing cost will erode performance.

This may already be occurring.

What are the benefits of a new corporate

strategy approach?

A new approach will allow DoD to apply differentiation strategies that are in congruence

with the Department’s traditional beliefs, mission, and values. This will, in turn, leverage

the Department’s inherent strengths in order to

make the fundamental changes required for

more effective operations in the new strategic

environment.

Such a new approach would also emphasize control mechanisms that set and maintain strong

strategic boundaries. As has been pointed out,

these boundaries have been lacking in the past,

allowing DoD to integrate into numerous areas

that lie outside its inherent strategic domain.

This new approach would also bring diagnostic controls into alignment up and down the

structure of the Department, minimizing or

eliminating situations where a unit, graded on

mission effectiveness, reports to a headquarters staff that is in turn graded on the efficiency

of its subordinate units.

Finally, this new approach would emphasize

interactive controls that would focus leadership

attention on and over the strategic horizon. This

would emphasize DoD business strategy as a

strategy of action rather than a strategy of

reaction.

Can such an approach be implemented?

Within DoD the sense of urgency is such that

change can be implemented. This is not to say

change will be easy, only that the environment

is ripe for action. An examination of change

efforts in the business world shows that they

are difficult and often painful undertakings.

This is why, without this sense of urgency, they

likely cannot be executed.

A sense of urgency is only the first part. After

that, the change must be led by individuals who

have an unflagging vision of what the right

things are for the organization and the drive

and determination to get there. The ability to

channel this urgency is what sets apart a Jack

Welch or a Lee Iacocca from an ordinary chief

executive officer. These extraordinary people

tapped into the sense of urgency to turn around

flagging organizations and returned them to

unprecedented profitability.

Fortunately, DoD has a climate that is capable

of and does generate just these types of leaders. Unfortunately, in the current environment,

it has also rewarded those who do not share

the vision of differentiation that has traditionally guided DoD. This is another regrettable

result of pursuing the conflicting strategies of

differentiation and cost leadership.
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While the sense of urgency does exist within

the Department, we do not have data that

indicate the degree to which this sense of

urgency exists within Congress and among the

American public. Unlike a corporation, which

is answerable to a limited group of shareholders, DoD is answerable to a wide range of

groups and interests, culminating with the

citizens of this country. If the sense of urgency

is not shared, it is likely that the support for

change that is needed from outside the Department will not be sufficient to initiate and sustain

transformation.

Voicing the sense of urgency that exists within

DoD and the reasons for it is the challenge the

Department must face. Once the public adopts

this sense of urgency, transformation is possible. This is what drove the unprecedented

change in times of war. It is also what has driven

transformation in times of peace.

Unfortunately, what the public sees tends to

dilute any sense of urgency. Internal DoD

audits, press reports, and external audits such

as General Accounting Office (GAO) reports

focus only on waste and inefficiency. They

rarely focus on a lack of effectiveness or a need

for transformation. Waste and inefficiency are

problems that will always need to be addressed

but by the same token, they are problems that

exist to varying degrees in every organization,

including the top-rated companies in the world.

There are more pressing questions to be addressed than whether or not things are being

done right. The more powerful question is

whether or not we are doing the right things in

the first place.

Recommendations

From this research and the conclusions that

flow from it, we offer a set of recommendations. As was stated in the introduction, we are

fully cognizant of the difficulties and political

realities involved in effecting major changes

in large public agencies such as DoD. However, while change is difficult, change must

happen. It is clear that tinkering with the old

model will not create effective business processes that are in congruence with DoD’s core

ideology. Nor will tinkering with the old model

garner the efficiencies sought by the Department. Continued reliance on cost-based strategies is a continuation down the death spiral.

What is needed is a new approach. What is

needed is renewal through transformation.

Recommendation Number One: Suspend

Cost-Based Outsourcing Initiatives

A-76, Strategic Sourcing, and other cost-driven

outsourcing will not produce the level of savings projected by DoD. Savings targets are

unrealistic and unobtainable. Aggressive implementation of cost-based outsourcing is the strategic mechanism enacted to attain these savings goals. However, any strategy is worth little

if it cannot be successfully executed.

More important, by emphasizing cost-based

initiatives, DoD risks losing sight of its primary

mission: to fight and win our nation’s wars.

Given this, mission cost will always be a secondary consideration not a primary focus. By

vastly expanding the number of positions studied in order to achieve an unattainable savings

target, the Department loses perspective and

risks a great deal.

Instead of focusing on core warfighting areas

that properly lie within DoD’s strategic domain,

the Department is instead focused on activities

that do not benefit operational forces. Pursuit

of cost-based outsourcing is diluting the ability

of leadership to concentrate attention on mission effectiveness. This, in turn, impacts mission performance. Resources, especially leadership resources, directed to an ever-expanding

number of cost studies are resources that are
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not directed to the support of operational forces

and the development of war-fighting skills.

Further, Department personnel see cost-based

outsourcing as a budgetary manpower drill

performed with little regard to mission effectiveness. An examination of these programs in

practice tends to validate this position. No cost

is assessed to the disruption caused by A-76

studies or to the resources that must be applied

to execute them. Nor are there any diagnostic

measures applied in order to gauge customer

satisfaction or organizational effectiveness before, during, or after the studies. When asked

to respond to the statement, “Outsourcing has

improved my mission performance,” 59 of the

75 installation commanders (79 percent) responded “no.” Unfortunately, cost-based outsourcing relies only on efficiency measures.

There are no effectiveness measures applied to

the process. The sole metric is cost to perform

the function.

However, complicating matters are current

limitations of DoD’s accounting systems and

the way in which accounts are fragmented and

compartmentalized. Savings at one activity or

in one account do not necessarily result in savings throughout DoD. Expanding the cost

analysis beyond the individual activity may in

fact show an overall cost increase across the

Department.

There is also an impact on organizational learning and growth. What is the consequence of

cost-based outsourcing on a culture that has

traditionally emphasized pride and service? For

personnel performing functions that garner

DoD a competitive advantage, what message

is sent when they are told that quality of

performance is secondary to cost? Given the

vitality of the private economy, how does DoD

attract and retain quality personnel in an

environment where cost is apparently valued

above talent and ability? Better, faster, cheaper

is often used as a mantra for streamlining

initiatives. Unfortunately, under cost-based outsourcing, the mantra becomes cheaper, cheaper,

cheaper.

Finally, cost-based outsourcing assumes the

current business models are already effective

when, in fact, they are not. A cursory view of

industry shows that the private sector is leveraging technology to create business models that

are far more robust and effective than those

employed by DoD. Firms are using technology to develop and execute strategies that were

not possible only a short time ago. Now that

these strategic models have been developed and

proven, DoD can adopt them to bring about a

true revolution in business affairs. This begins

with a properly crafted strategy built around

the strengths of the Department’s ideological

foundations. Once such a strategy is crafted,

outsourcing decisions become strategy-based,

not cost-based.

Recommendation Number Two:

Expand and Revalidate Survey Results

Survey responses indicated a high degree of

dissatisfaction with A-76 and other cost-based

outsourcing initiatives. However, it should be

noted that the sample population was quite

small and it was skewed toward installation

commanders, the executors of current outsourcing policies. Thirteen hundred surveys were

sent out and 234 responses were received. Of

these 234 responses, 111 identified themselves

as being in a position of command (30 Army,

63 Air Force, and 18 Navy).

The nature of the responses indicates to us that

there are significant issues with which the

Department must come to grips. The first step

in doing this is to conduct additional polling

to validate these results. Additionally, we
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recommend the Department conduct interviews

in order to gauge more thoroughly the issues

embodied in these responses.

When asked to elaborate, many respondents

elaborated in great detail about outsourcing

policies. One-on-one interviews would better

capture this valuable feedback.

Recommendation Number Three:

Acknowledge and Communicate

DoD Business Strategy

Nearly two-thirds of those responding to our

survey indicated they have not read the DoD

Strategic Plan. More alarming still is that twothirds of the 111 respondents in positions of

command indicated they have not read the

Department’s Strategic Plan. We hold that it is

very difficult to articulate a strategic plan if one

hasn’t read it in the first place. Successful organizations, especially large ones such as DoD,

need well-understood cohesive strategies in

order to attain effectiveness. Leaders must

clearly understand the elements of the strategic plan and align their organizations in conjunction with overarching goals and objectives.

This requirement is equally applicable to the

business functions that compose DoD.

If DoD’s Strategic Plan exists only on paper or

a web site, it is of little use. It must exist in the

thoughts and actions of everyone in the organization from leaders on down in order to be

effective. Leaders must become owners of the

overarching vision and communicate it daily.

This is how strategic plans are put into effect.

This is lamentable since DoD has a very wellcrafted strategic plan built around the beliefs,

values, and mission that inherently define the

Department. Like the Johnson & Johnson

Credo, it should be more than a slogan. It is a

powerful plan that should be read, understood,

and articulated.

Recommendation Number Four:

Set Strategic Boundaries and

Establish Decision Rights

The basic tenet behind A-76 is that the government should not compete with its citizens.

Government therefore, should rely on commercial sources and only perform functions inhouse that are inherently governmental in

nature. If this policy dates back to 1955, how

then did DoD get to the point where it finds

itself with over 150,000 full-time positions that

are commercial in nature and are subject to A76 studies? The inescapable answer is that this

policy has been largely ignored.

The Department must firmly establish strategic boundaries around a well defined strategic

domain. This would preclude many of the

costly and difficult to reverse integration decisions that have led the Department to the point

where resources applied to infrastructure vastly

overshadow resources directed to core mission

performance.

However, even if DoD had relied on a simple

check of the Yellow Pages to see if the activity was available commercially before integrating activities over the past 45 years, the

Department would likely still find itself overintegrated. It does not take a great deal of

rationalization to justify any activity as being

inherently governmental if the qualifying characteristic is that the function is, “so intimately

related to the public interest as to mandate

performance by Government employees.”

We hold that the concept of “inherently

governmental” should be abandoned when

addressing DoD business strategy. Instead, the

integration decision should revolve around

whether or not integrating the activity provides

the Department with a competitive advantage

(or conversely, whether integrating the activity will generate a strategic disadvantage). More
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to the point, if an organization can do a few

things well or many things poorly, what are the

few things DoD should do to be effective in

the performance of its mission?

Such an approach will yield a much different

answer than cost-based restructuring. It will

also define a core strategic domain and a set of

strategic boundaries. Once those boundaries are

defined, they must in turn be enforced. This is

not to say that the boundaries cannot be revisited or revised. In fact they should; but only in

the context of a continued examination and

analysis of competitive advantage.

Unambiguous strategic boundaries then define

the areas in that leadership can operate in. It is

within these bounds that leaders must be

allowed to experiment and take business risks

in order to generate business returns. Decision

rights that allow for this experimentation should

then be delegated to individual unit commanders. This moves the organization away from a

rigid risk-averse hierarchy toward a responsive

entity that can adapt and learn.

Recommendation Number Five:

Develop Balanced Diagnostic Controls

Business elements within DoD need to establish a set of diagnostic controls that strike a

balance between cost-performance and other,

equally important, performance measures.

Financial measures are important in any public or private sector enterprise. However, overreliance on this one measure can bring unintended consequences that adversely effect

organizational performance.

Financial measures are lagging indicators. As

such, they reflect short-term strategic outcomes.

Unfortunately, if they become the sole focus

of the firm, they can be the incentive for poor

tactical choices that can degrade long-term

strategy. The front page of the Wall Street

Journal typically features stories about firms

that have succumbed to the temptation to

generate short-term financial performance.

A loss of balance leads to a loss of perspective

and adverse results that no one wanted or

anticipated. Therefore, in addition to the financial perspective, we recommend that DoD

include the three other measures highlighted

in Kaplan and Norton’s Balanced Scorecard:

• Customer Perspective;

• Internal-Business Perspective; and

• Learning and Growth Perspective.

Unified commanders and the operating forces

in their charge are the customers of DoD business functions. Often business entities within

the Department lose sight of this. As a consequence, decision making becomes focused on

the resources, not on making the most of those

resources in support of operating forces. Measurable and verifiable indicators of how well

these customers are being served should be just

as important as DoD financial measures.

Internal business measures ensure that management will focus on improving processes in

order to create customer satisfaction and contribute to financial success. Cost-based outsourcing does little to motivate process improvement. The focus of cost-based outsourcing is the bottom line. A focus on internal business processes and metrics to measure improvement would go a long way to ensure DoD is

pursuing effectiveness first and efficiency

second.

Finally, learning and growth measures ensure

that the long-term investments are made that

will promote success into the future. Of course,

short-term financial gains can be made by limiting long-term investment. This is one of the
7-8

dangers of current outsourcing policy. The push

for marginal savings is driving talented personnel out of DoD. This may yield savings today,

but it spells potential disaster in the future. For

this reason, investments in personnel, education, technology, and systems, must be given

equal weight with financial measures in any

assessment of how well DoD is performing in

fulfillment of its mission.

Recommendation Number Six:

Develop Interactive Controls

This is a critical step in allowing the Department to be proactive rather than reactive. Interactive systems are necessary in order to test

the strategic assumptions of the Department

and make the necessary adjustments to position DoD where it can create value for its

operating forces.

Had DoD a robust set of interactive controls, it

might have better gauged where technology

was going and how the Department should take

advantage of it. This is precisely what some of

the successful businesses mentioned throughout this work were able to do. This was not by

accident. Successful companies look far beyond the current budget horizon in order to

determine what will comprise a successful strategy and what it is that will cause the strategy

to fail.

A great reminder of the need for strategy as

long-term perspective is found in the local

Washington, DC area. The Chesapeake and

Ohio (C&O) Canal was started in 1828. It was

to be a 360-mile stretch of waterway connecting the Chesapeake with Pittsburgh and the

Ohio River. Twenty-two years later and at great

cost, when the canal reached Cumberland, the

railroad had already been there eight years. The

C&O was obsolete before it was finished. In

retrospect, it was folly to make such an

investment, especially in light of the way rail

technology was progressing. Chesapeake and

Ohio management surely could have seen their

strategy was in trouble — but did they even

take the trouble to look?

Are business entities within DoD building

C&O canals? Are their more effective ways to

achieve the Department’s mission? Interactive

controls facilitate learning. Without these controls, DoD will likely not know the answers to

these questions until they become painfully

evident.

Recommendation Number Seven:

Leverage Superior Technical Capabilities

Technology is revolutionizing the business

world. The power of this technological change

is transforming successful firms from lumbering hierarchical structures focused on planning

to lean responsive structures focused on action.

Key to this is the ability to capture, process,

and transmit information rapidly and accurately. Information processing is precisely the

function performed by the vast majority of DoD

business activities.

DoD makes and sells very little. With the exception of material provided by Defense Depots, the goods that operating forces depend

upon are created in the private sector. To a large

degree, what DoD infrastructure does is to

provide not goods but services and to act as a

medium for information to pass back and forth

from industry to operational units.

If DoD creates value by facilitating this information flow, the tools of the information

economy have arrived at precisely the right

time to bring about the transformation the

Department has been striving for. What is more,

DoD does not have to wait for its personnel

to become adept at applying this technology.

There are firms that are already adept. Instead

of integrating these activities, they may be
7-9

outsourced to such firms, leaving DoD to focus

on such areas as applying rather than processing

information.

Recommendation Number Eight:

Refocus Management Attention

Currently within DoD, Return on Management

(ROM) is low and getting worse. The amount

of productive organizational energy released

pales in comparison with the amount of time

and attention invested. Efforts that go toward

cost-based outsourcing release little productive

organizational energy. Attention focused on

financial measures in the absence of other balancing measures releases little productive energy. Attention focused on the preservation of

resources, rather than the use of those resources

to create value, releases little productive energy.

The Department, as part of an overarching strategy, needs to refocus management attention on

the release of productive energy. This begins

with the things we have already mentioned: the

establishment of uniform strategies, strategic

boundaries, realistic goals, proper incentives,

clear decision rights, and the systems to put

these things in effect.

Increasing ROM means creating a culture that

de-emphasizes cost focus and risk aversion and

instead emphasizes value creation and strikes

a much needed balance between risk and return.

Most important, increasing ROM means abandoning some business areas so that DoD can

focus on others.

At the dawn of the 21st century, DoD finds itself over-integrated. Resources are scattered

over a wide array of activities. Some of these

activities provide the Department with an advantage, some do not. DoD needs to focus on

the areas that yield advantage and rely on the

commercial sector for activities that lie outside

of that strategic domain.

This begins with developing strategies that focus on effectiveness as opposed to strategies

that focus on efficiency. This means DoD must

change its focus from doing things right to

doing the right things.

Recommendation Number Nine:

Seize the Moment

The most difficult aspect of any organizational

transformation is the creation of a powerful

guiding coalition. The good news is that that

coalition is out there. Eighty-seven percent of

the 232 who responded to the question agreed

that the need exists for significant improvement in the way DoD and the departments/

agencies conduct business operations. A review of their comments indicates this view

is strongly held. Personnel in the department

are not complacent. They want change and

they understand the need for change — the

commitment is there.

Of course, any real transformation is difficult

but is it any less painful than the execution of

current cost-based strategies? In our experience, people are willing to take the difficult

path if they understand the need to take it. This

understanding exists. The Department needs to

abandon the easy but ineffective path of marginal cost savings and take the more difficult

but more effective path of defining business

structure in terms of effective strategy, not in

terms of cost.

Now is the time to act and to act decisively.

In this environment, where the need for

change is so well understood and the opportunity for change is so great, organizational

transformation is possible. The Department of

Defense should seize this unique moment.
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APPENDIX A

CIRCULAR A-76

EXECUTIVE OFFICE OF THE PRESIDENT

OFFICE OF MANAGEMENT AND BUDGET

WASHINGTON, D.C. 20503

CIRCULAR NO. A-76 (REVISED 1999)
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Epilogue-1

EPILOGUE

One of the things we were impressed with at the Harvard Business School was the emphasis on

ethics and the responsibilities of business leaders. Successful leaders understand that the decisions

they make go beyond the bottom line. A poor decision may jeopardize not only the financial wellbeing of shareholders but also the financial security of company employees. More devastating

still is a series of seemingly good decisions built on the precept of a poor or outdated strategy.

This is what leads to the loss of competitive advantage and the demise of companies.

In the private sector, business leaders must be constantly mindful of this. The competitive landscape may change very quickly, as events of the past 15 years have demonstrated. Failure to adapt

can have severe repercussions. In a competitive environment, better business models replace less

effective ones. In business — as in nature — the strong survive.

Many believe the public sector is insulated from the harsh realities of competition. This is only

partially true. Whereas private firms compete for revenue, market share, and advantage over

their competitors, public sector entities compete for increasingly scarce resources. This type of

competition prompts a focus on inputs and efficiency rather than a focus on outputs and

effectiveness.

In our estimation, this results in a different competitive landscape that fosters different modes of

thought and differing perceptions, including how businesses operate. In this report we have

endeavored to go beyond the mere slogan that the Department of Defense (DoD) should operate

more like a business. Our goal was to offer a new perspective to demonstrate what operating like

a business actually means. It means much more than business efficiency. It entails a focus on the

productive use of resources, processes, and culture to garner a competitive advantage. Operating

like a business begins with an effective strategy.

We submit that a primary focus on effectiveness entails a critical shift in perspective that is much

needed within DoD. We hope that this discussion has been worthwhile and that it has provided a

framework for understanding not only some of the vexing issues the Defense Department currently

faces but also better strategies for dealing with them.
Epilogue-2
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APPENDIX A

CIRCULAR A-76

EXECUTIVE OFFICE OF THE PRESIDENT

OFFICE OF MANAGEMENT AND BUDGET

WASHINGTON, D.C. 20503

CIRCULAR NO. A-76 (REVISED 1999)

August 4, 1983

TO THE HEADS OF EXECUTIVE DEPARTMENTS AND ESTABLISHMENTS

SUBJECT: Performance of Commercial Activities

1. Purpose. This Circular establishes Federal policy regarding the performance of commercial

activities and implements the statutory requirements of the Federal Activities Inventory Reform

Act of 1998, Public Law 105-270. The Supplement to this Circular sets forth the procedures

for determining whether commercial activities should be performed under contract with

commercial sources or in-house using Government facilities and personnel.

2. Rescission. OMB Circular No. A-76 (Revised), dated March 29, 1979; and Transmittal

Memoranda 1 through 14 and 16 through 18.

3. Authority. The Budget and Accounting Act of 1921 (31 U.S.C. 1 et seq.), The Office of

Federal Procurement Policy Act Amendments of 1979. (41 U.S.C. 401 et seq.), and The

Federal Activities Inventory Reform Act of 1998. (P. L. 105-270).

4. Background.

a. In the process of governing, the Government should not compete with its citizens. The

competitive enterprise system, characterized by individual freedom and initiative, is the

primary source of national economic strength. In recognition of this principle, it has been

and continues to be the general policy of the Government to rely on commercial sources

to supply the products and services the Government needs.

b. This national policy was promulgated through Bureau of the Budget Bulletins issued in

1955, 1957 and 1960. OMB Circular No. A-76 was issued in 1966. The Circular was

previously revised in 1967, 1979, and 1983. The Supplement (Revised Supplemental

Handbook) was previously revised in March 1996 (Transmittal Memorandum 15).
A-4

5. Policy. It is the policy of the United States Government to:

a. Achieve Economy and Enhance Productivity. Competition enhances quality, economy,

and productivity. Whenever commercial sector performance of a Government operated

commercial activity is permissible, in accordance with this Circular and its Supplement,

comparison of the cost of contracting and the cost of in-house performance shall be

performed to determine who will do the work. When conducting cost comparisons,

agencies must ensure that all costs are considered and that these costs are realistic and

fair.

b. Retain Governmental Functions In-House. Certain functions are inherently Governmental

in nature, being so intimately related to the public interest as to mandate performance

only by Federal employees. These functions are not in competition with the commercial

sector. Therefore, these functions shall be performed by Government employees.

c. Rely on the Commercial Sector. The Federal Government shall rely on commercially

available sources to provide commercial products and services. In accordance with the

provisions of this Circular and its Supplement, the Government shall not start or carry on

any activity to provide a commercial product or service if the product or service can be

procured more economically from a commercial source.

6. Definitions. For purposes of this Circular:

a. A commercial activity is one which is operated by a Federal executive agency and which

provides a product or service that could be obtained from a commercial source. Activities

that meet the definition of an inherently Governmental function provided below are not

commercial activities. A representative list of commercial activities is provided in

Attachment A. A commercial activity also may be part of an organization or a type of

work that is separable from other functions or activities and is suitable for performance

by contract.

b. A conversion to contract is the changeover of an activity from Government performance

to performance under contract by a commercial source.

c. A conversion to in-house is the changeover of an activity from performance under contract

to Government performance.

d. A commercial source is a business or other non-Federal activity located in the United

States, its territories and possessions, the District of Columbia or the Commonwealth of

Puerto Rico, which provides a commercial product or service.

e. An inherently Governmental function is a function which is so intimately related to the

public interest as to mandate performance by Government employees. Consistent with

the definitions provided in the Federal Activities Inventory Reform Act of 1998 and
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OFPP Policy Letter 92-1, these functions include those activities which require either the

exercise of discretion in applying Government authority or the use of value judgment in

making decisions for the Government. Services or products in support of inherently

Governmental functions, such as those listed in Attachment A, are commercial activities

and are normally subject to this Circular. Inherently Governmental functions normally

fall into two categories:

(1) The act of governing; i.e., the discretionary exercise of Government authority.

Examples include criminal investigations, prosecutions and other judicial functions;

management of Government programs requiring value judgments, as in direction of

the national defense; management and direction of the Armed Services; activities

performed exclusively by military personnel who are subject to deployment in a

combat, combat support or combat service support role; conduct of foreign relations;

selection of program priorities; direction of Federal employees; regulation of the use

of space, oceans, navigable rivers and other natural resources; direction of intelligence

and counter-intelligence operations; and regulation of industry and commerce,

including food and drugs.

(2) Monetary transactions and entitlements, such as tax collection and revenue

disbursements; control of the Treasury accounts and money supply; and the

administration of public trusts.

f. A cost comparison is the process of developing an estimate of the cost of Government

performance of a commercial activity and comparing it, in accordance with the

requirements of the Supplement, to the cost to the Government for contract performance

of the activity.

g. Directly affected parties are Federal employees and their representative organizations

and bidders or offerors on the instant solicitation.

h. Interested parties for purposes of challenging the contents of an agency’s Commercial

Activities Inventory under the Federal Activities Inventory Reform Act of 1998 are:

(1) A private sector source that (A) is an actual or prospective offeror for any contract or

other form of agreement to perform the activity; and (B) has a direct economic interest

in performing the activity that would be adversely affected by a determination not to

procure the performance of the activity from a private sector source.

(2) A representative of any business or professional association that includes within its

membership private sector sources referred to in (1) above.

(3) An officer or employee of an organization within an executive agency that is an

actual or prospective offeror to perform the activity.
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(4) The head of any labor organization referred to in section 7103(a) (4) of Title 5,

United States Code that includes within its membership officers or employees of an

organization referred to in (3) above.

7. Scope.

a. Unless otherwise provided by law, this Circular and its Supplement shall apply to all

executive agencies and shall provide administrative direction to heads of agencies.

b. This Circular and its Supplement apply to printing and binding only in those agencies or

departments which are exempted by law from the provisions of Title 44 of the U.S. Code.

c. This Circular and its Supplement shall not:

(1) Be applicable when contrary to law, Executive Orders, or any treaty or international

agreement;

(2) Apply to inherently Governmental functions as defined in paragraph 6.e.;

(3) Apply to the Department of Defense in times of a declared war or military mobilization;

(4) Provide authority to enter into contracts;

(5) Authorize contracts which establish an employer-employee relationship between the

Government and contractor employees. An employer-employee relationship involves

close, continual supervision of individual contractor employees by Government

employees, as distinguished from general oversight of contractor operations. However,

limited and necessary interaction between Government employees and contractor

employees, particularly during the transition period of conversion to contract, does

not establish an employer-employee relationship.

(6) Be used to justify conversion to contract solely to avoid personnel ceilings or salary

limitations;

(7) Apply to the conduct of research and development. However, severable in-house

commercial activities in support of research and development, such as those listed in

Attachment A, are normally subject to this Circular and its Supplement; or

(8) Establish and shall not be construed to create any substantive or procedural basis for

anyone to challenge any agency action or inaction on the basis that such action or

inaction was not in accordance with this Circular, except as specifically set forth in

Part 1, Chapter 3, paragraph K of the Supplement, “Appeals of Cost Comparison

Decisions” and as set forth in Appendix 2, Paragraph G, consistent with Section 3 of

the Federal Activities Inventory Reform Act of 1998.
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d. The requirements of the Federal Activities Inventory Reform Act of 1998 apply to the

following executive agencies:

(1) an executive department named in 5 USC 101,

(2) a military department named in 5 USC 102, and

(3) an independent establishment as defined in 5 USC 104.

e. The requirements of the Federal Activities Inventory Reform Act of 1998 do not apply to

the following entities or activities:

(1) the General Accounting Office,

(2) a Government corporation or a Government controlled corporation as defined in 5

USC 103,

(3) a non-appropriated funds instrumentality if all of its employees are referred to in 5

USC 2105(c), or

(4) Depot-level maintenance and repair of the Department of Defense as defined in 10

USC 2460.

8. Government Performance of a Commercial Activity. Government performance of a

commercial activity is authorized under any of the following conditions:

a. No Satisfactory Commercial Source Available. Either no commercial source is capable

of providing the needed product or service, or use of such a source would cause

unacceptable delay or disruption of an essential program. Findings shall be supported as

follows:

(1) If the finding is that no commercial source is capable of providing the needed product

or service, the efforts made to find commercial sources must be documented and

made available to the public upon request. These efforts shall include, in addition to

consideration of preferential procurement programs (see Part I, Chapter 1, paragraph

C of the Supplement) at least three notices describing the requirement in the Commerce

Business Daily over a 90-day period or, in cases of bona fide urgency, two notices

over a 30-day period. Specifications and requirements in the solicitation shall not be

unduly restrictive and shall not exceed those required of in-house Government

personnel or operations.

(2) If the finding is that a commercial source would cause unacceptable delay or disruption

of an agency program, a written explanation, approved by the assistant secretary or

designee in paragraph 9.a. of the Circular, must show the specific impact on an agency

mission in terms of cost and performance. Urgency alone is not adequate reason to
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continue in-house operation of a commercial activity. Temporary disruption resulting

from conversion to contract is not sufficient support for such a finding, nor is the

possibility of a strike by contract employees. If the commercial activity has ever

been performed by contract, an explanation of how the instant circumstances differ

must be documented. These decisions must be made available to the public upon

request.

(3) Activities may not be justified for in-house performance solely on the basis that the

activity involves or supports a classified program or the activity is required to perform

an agency’s basic mission.

b. National Defense.

(1) The Secretary of Defense shall establish criteria for determining when Government

performance of a commercial activity is required for national defense reasons. Such

criteria shall be furnished to OMB, upon request.

(2) Only the Secretary of Defense or his designee has the authority to exempt commercial

activities for national defense reasons.

c. Patient Care. Commercial activities performed at hospitals operated by the Government

shall be retained in-house if the agency head, in consultation with the agency’s chief

medical director, determines that in-house performance would be in the best interests of

direct patient care.

d. Lower cost. Government performance of a commercial activity is authorized if a cost

comparison prepared in accordance with the Supplement demonstrates that the

Government is operating or can operate the activity on an ongoing basis at an estimated

lower cost than a qualified commercial source.

9. Action Requirements. To ensure that the provisions of this Circular and its Supplement are

followed, each agency head shall:

a. Designate an official at the assistant secretary or equivalent level and officials at a

comparable level in major component organizations to have responsibility for

implementation of this Circular and its Supplement within the agency.

b. Establish one or more offices as central points of contact to carry out implementation.

These offices shall have access to all documents and data pertinent to actions taken under

the Circular and its Supplement and will respond in a timely manner to all requests

concerning inventories, schedules, reviews, results of cost comparisons and cost

comparison data.

c. Be guided by Federal Acquisition Regulation (FAR) Subpart 24.2 (Freedom of Information

Act) in considering requests for information.
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d. Implement this Circular and its Supplement with a minimum of internal instructions.

Cost comparisons shall not be delayed pending issuance of such instructions.

e. Ensure the reviews of all existing in-house commercial activities are completed within a

reasonable time in accordance with the Federal Activities Inventory Reform Act of 1998

and the Supplement.

10. Annual Reporting Requirement. As required by the Federal Activities Inventory Reform

Act of 1998 and Appendix 2 of the Supplement, no later than June 30 of each year, agencies

shall submit to OMB a Commercial Activities Inventory and any supplemental information

requested by OMB. After review and consultation by OMB, agencies will transmit a copy of

the Commercial Activities Inventory to Congress and make the contents of the Inventory

available to the public. Agencies will follow the process provided in the Supplement for

interested parties to challenge (and appeal) the contents of the inventory.

11. OMB Responsibility and Contact Point. All questions or inquiries should be submitted to

the Office of Management and Budget, Room 6002 NEOB, Washington, DC 20503. Telephone

number (202) 395-6104, FAX (202) 395-7230.

12. Effective Date. This Circular and the changes to its Supplement are effective immediately.
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Attachment A

OMB Circular No. A-76

EXAMPLES OF COMMERCIAL ACTIVITIES

Audiovisual Products and Services

Photography (still, movie, aerial, etc.)

Photographic processing (developing, printing, enlarging, etc.)

Film and videotape production (script writing, direction, animation, editing, acting, etc.)

Microfilming and other microforms

Art and graphics services

Distribution of audiovisual materials

Reproduction and duplication of audiovisual products

Audiovisual facility management and operation

Maintenance of audiovisual equipment

Automatic Data Processing

ADP services – batch processing, time-sharing, facility management, etc.

Programming and systems analysis, design, development, and simulation

Key punching, data entry, transmission, and teleprocessing services

Systems engineering and installation

Equipment installation, operation, and maintenance

Food Services

Operation of cafeterias, mess halls, kitchens, bakeries, dairies, and commissaries

Vending machines

Ice and water

Health Services

Surgical, medical, dental, and psychiatric care

Hospitalization, outpatient, and nursing care

Physical examinations

Eye and hearing examinations and manufacturing and fitting glasses and hearing aids

Medical and dental laboratories

Dispensaries

Preventive medicine

Dietary services

Veterinary services
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Industrial Shops and Services

Machine, carpentry, electrical, plumbing, painting, and other shops

Industrial gas production and recharging

Equipment and instrument fabrication, repair and calibration

Plumbing, heating, electrical, and air conditioning services, including repair

Fire protection and prevention services

Custodial and janitorial services

Refuse collection and processing

Maintenance, Overhaul, Repair, and Testing

Aircraft and aircraft components

Ships, boats, and components

Motor vehicles

Combat vehicles

Railway systems

Electronic equipment and systems

Weapons and weapon systems

Medical and dental equipment

Office furniture and equipment

Industrial plant equipment

Photographic equipment

Space systems

Management Support Services

Advertising and public relations services

Financial and payroll services

Debt collection

Manufacturing, Fabrication, Processing, Testing, and Packaging

Ordnance equipment

Clothing and fabric products

Liquid, gaseous, and chemical products

Lumber products

Communications and electronics equipment

Rubber and plastic products

Optical and related products

Sheet metal and foundry products
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Machined products

Construction materials

Test and instrumentation equipment

Office and Administrative Services

Library operations

Stenographic recording and transcribing

Word processing/data entry/typing services

Mail/messenger

Translation

Management information systems, products and distribution

Financial auditing and services

Compliance auditing

Court reporting

Material management

Supply services

Other Services

Laundry and dry cleaning

Mapping and charting

Architect and engineer services

Geological surveys

Cataloging

Training – academic, technical, vocational, and specialized operation of utility systems

(power, gas, water steam, and sewage)

Laboratory testing services

Printing and Reproduction

Facility management and operation

Printing and binding – where the agency or department is exempted from the provisions of

Title 44 of the U.S. Code

Reproduction, copying, and duplication

Blueprinting

Real Property

Design, engineering, construction, modification, repair, and maintenance of buildings and

structures; building mechanical and electrical equipment and systems; elevators;

escalators; moving walks
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Construction, alteration, repair, and maintenance of roads and other surfaced areas

Landscaping, drainage, mowing and care of grounds

Dredging of waterways

Security

Guard and protective services

Systems engineering, installation, and maintenance of security systems and individual

privacy systems

Forensic laboratories

Special Studies and Analyses

Cost benefit analyses

Statistical analyses

Scientific data studies

Regulatory studies

Defense, education, energy studies

Legal/litigation studies

Management studies

Systems Engineering, Installation, Operation, Maintenance, and Testing

Communications systems – voice, message, data, radio, wire, microwave, and satellite

Missile ranges

Satellite tracking and data acquisition

Radar detection and tracking

Television systems – studio and transmission equipment, distribution systems, receivers,

antennas, etc.

Recreational areas

Bulk storage facilities

Transportation

Operation of motor pools

Bus service

Vehicle operation and maintenance

Air, water, and land transportation of people and things

Trucking and hauling
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APPENDIX B

FEDERAL ACTIVITIES INVENTORY

REFORM ACT OF 1998

105TH CONGRESS
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APPENDIX B

FEDERAL ACTIVITIES INVENTORY

REFORM ACT OF 1998

105TH CONGRESS

An Act To provide a process for identifying the functions of the Federal Government that are not

inherently governmental functions, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in

Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Federal Activities Inventory Reform

Act of 1998'’.

SEC. 2. ANNUAL LISTS OF GOVERNMENT ACTIVITIES NOT INHERENTLY

GOVERNMENTAL IN NATURE.

(a) Lists Required.—Not later than the end of the third quarter of each fiscal year, the head

of each executive agency shall submit to the Director of the Office of Management and

Budget a list of activities performed by Federal Government sources for the executive

agency that, in the judgment of the head of the executive agency, are not inherently

governmental functions. The entry for an activity on the list shall include the following:

(1) The fiscal year for which the activity first appeared on a list prepared under this

section.

(2) The number of full-time employees (or its equivalent) that are necessary for the

performance of the activity by a Federal Government source.

(3) The name of a Federal Government employee responsible for the activity from whom

additional information about the activity may be obtained.

(a) OMB Review and Consultation.—The Director of the Office of Management and Budget

shall review the executive agency’s list for a fiscal year and consult with the head of the

executive agency regarding the content of the final list for that fiscal year.

(b) Public Availability of Lists.—

(1) Publication.—Upon the completion of the review and consultation regarding a list of

an executive agency—

(A) the head of the executive agency shall promptly transmit a copy of the list to

Congress and make the list available to the public; and

(B) the Director of the Office of Management and Budget shall promptly publish in

the Federal Register a notice that the list is available to the public.
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(2) Changes.—If the list changes after the publication of the notice as a result of the

resolution of a challenge under section 3, the head of the executive agency shall

promptly—

(A) make each such change available to the public and transmit a copy of the change

to Congress; and publish in the Federal Register a notice that the change is

available to the public.

(a) Competition Required.—Within a reasonable time after the date on which a notice of the

public availability of a list is published under subsection (c), the head of the executive

agency concerned shall review the activities on the list. Each time that the head of the

executive agency considers contracting with a private sector source for the performance

of such an activity, the head of the executive agency shall use a competitive process to

select the source (except as may otherwise be provided in a law other than this Act, an

Executive order, regulations, or any executive branch circular setting forth requirements

or guidance that is issued by competent executive authority). The Director of the Office

of Management and Budget shall issue guidance for the administration of this subsection.

(b) Realistic and Fair Cost Comparisons.—For the purpose of determining whether to contract

with a source in the private sector for the performance of an executive agency activity on

the list on the basis of a comparison of the costs of procuring services from such a source

with the costs of performing that activity by the executive agency, the head of the executive

agency shall ensure that all costs (including the costs of quality assurance, technical

monitoring of the performance of such function, liability insurance, employee retirement

and disability benefits, and all other overhead costs) are considered and that the costs

considered are realistic and fair.

SEC. 3. CHALLENGES TO THE LIST.

(a) Challenge Authorized.—An interested party may submit to an executive agency a challenge

of an omission of a particular activity from, or an inclusion of a particular activity on, a

list for which a notice of public availability has been published under section 2.

(b) Interested Party Defined.—For the purposes of this section, the term “interested party”,

with respect to an activity referred to in subsection (a), means the following:

(1) A private sector source that—

(A) is an actual or prospective offeror for any contract, or other form of agreement,

to perform the activity; and

(B) has a direct economic interest in performing the activity that would be adversely

affected by a determination not to procure the performance of the activity from

a private sector source.

(2) A representative of any business or professional association that includes within its

membership private sector sources referred to in paragraph (1).

(3) An officer or employee of an organization within an executive agency that is an

actual or prospective offeror to perform the activity.

(4) The head of any labor organization referred to in section 7103(a)(4) of title 5, United

States Code, that includes within its membership officers or employees of an

organization referred to in paragraph (3).
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(c) Time for Submission.—A challenge to a list shall be submitted to the executive agency

concerned within 30 days after the publication of the notice of the public availability of

the list under section 2.

(d) Initial Decision.—Within 28 days after an executive agency receives a challenge, an

official designated by the head of the executive agency shall—

(1) decide the challenge; and

(2) transmit to the party submitting the challenge a written notification of the decision

together with a discussion of the rationale for the decision and an explanation of the

party’s right to appeal under subsection (e).

(e) Appeal.—

(1) Authorization of appeal.—An interested party may appeal an adverse decision of the

official to the head of the executive agency within 10 days after receiving a notification

of the decision under subsection (d).

(2) Decision on appeal.—Within 10 days after the head of an executive agency receives

an appeal of a decision under paragraph (1), the head of the executive agency shall

decide the appeal and transmit to the party submitting the appeal a written notification

of the decision together with a discussion of the rationale for the decision.

SEC. 4. APPLICABILITY.

(a) Executive Agencies Covered.—Except as provided in subsection (b), this Act applies to

the following executive agencies:

(1) Executive department.—An executive department named in section 101 of title 5,

United States Code.

(2) Military department.—A military department named in section 102 of title 5, United

States Code.

(3) Independent establishment.—An independent establishment, as defined in section

104 of title 5, United States Code.

(b) Exceptions.—This Act does not apply to or with respect to the following:

(1) General accounting office.—The General Accounting Office.

(2) Government corporation.—A Government corporation or a Government controlled

corporation, as those terms are defined in section 103 of title 5, United States Code.

(3) Nonappropriated funds instrumentality.—A part of a department or agency if all of

the employees of that part of the department or agency are employees referred to in

section 2105(c) of title 5, United States Code.

(4) Certain depot-level maintenance and repair.—Depot-level maintenance and repair of

the Department of Defense (as defined in section 2460 of title 10, United States

Code).

SEC. 5. DEFINITIONS.

In this Act:

(1) Federal government source.—The term “Federal Government source”, with respect

to performance of an activity, means any organization within an executive agency

that uses Federal Government employees to perform the activity.
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(2) Inherently governmental function.—

(A) Definition.—The term “inherently governmental function” means a function

that is so intimately related to the public interest as to require performance by

Federal Government employees.

(B) Functions included.—The term includes activities that require either the exercise

of discretion in applying Federal Government authority or the making of value

judgments in making decisions for the Federal Government, including judgments

relating to monetary transactions and entitlements. An inherently governmental

function involves, among other things, the interpretation and execution of the

laws of the United States so as—

(i) to bind the United States to take or not to take some action by contract,

policy, regulation, authorization, order, or otherwise;

(ii) to determine, protect, and advance United States economic, political,

territorial, property, or other interests by military or diplomatic action,

civil or criminal judicial proceedings, contract management, or otherwise;

(iii) to significantly affect the life, liberty, or property of private persons;

(iv) to commission, appoint, direct, or control officers or employees of the

United States; or

(v) to exert ultimate control over the acquisition, use, or disposition of the

property, real or personal, tangible or intangible, of the United States,

including the collection, control, or disbursement of appropriated and other

Federal funds.

(A) Functions excluded.—The term does not normally include—

(i) gathering information for or providing advice, opinions, recommendations,

or ideas to Federal Government officials; or

(ii) any function that is primarily ministerial and internal in nature (such as

building security, mail operations, operation of cafeterias, housekeeping,

facilities operations and maintenance, warehouse operations, motor vehicle

fleet management operations, or other routine electrical or mechanical

services).

SEC. 6. EFFECTIVE DATE.

This Act shall take effect on October 1, 1998.

Approved October 19, 1998.
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Government Performance and Results Act of 1993

One Hundred Third Congress of the United States of America

AT THE FIRST SESSION

Begun and held at the City of Washington on Tuesday, the fifth day of January, one thousand

nine hundred and ninety-three

An Act To provide for the establishment of strategic planning and performance measurement in

the Federal Government, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in

Congress assembled,

SECTION 1. SHORT TITLE

This Act may be cited as the Government Performance and Results Act of 1993.

SEC. 2. FINDINGS AND PURPOSES.

(a) FINDINGS- The Congress finds that—

1. waste and inefficiency in Federal programs undermine the confidence of the American

people in the Government and reduces the Federal Government’s ability to address

adequately vital public needs;

2. Federal managers are seriously disadvantaged in their efforts to improve program

efficiency and effectiveness, because of insufficient articulation of program goals

and inadequate information on program performance; and

3. congressional policymaking, spending decisions and program oversight are seriously

handicapped by insufficient attention to program performance and results.

(b) PURPOSES- The purposes of this Act are to—

1. improve the confidence of the American people in the capability of the Federal

Government, by systematically holding Federal agencies accountable for achieving

program results;

2. initiate program performance reform with a series of pilot projects in setting program

goals, measuring program performance against those goals, and reporting publicly

on their progress;

3. improve Federal program effectiveness and public accountability by promoting a

new focus on results, service quality, and customer satisfaction;

4. help Federal managers improve service delivery, by requiring that they plan for meeting

program objectives and by providing them with information about program results

and service quality;
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5. improve congressional decisionmaking by providing more objective information on

achieving statutory objectives, and on the relative effectiveness and efficiency of

Federal programs and spending; and

6. improve internal management of the Federal Government.

SEC. 3. STRATEGIC PLANNING.

Chapter 3 of title 5, United States Code, is amended by adding after section 305 the following

new section: Sec. 306. Strategic plans

a. No later than September 30, 1997, the head of each agency shall submit to the Director of

the Office of Management and Budget and to the Congress a strategic plan for program

activities. Such plan shall contain—

1. a comprehensive mission statement covering the major functions and operations of

the agency;

2. general goals and objectives, including outcome-related goals and objectives, for the

major functions and operations of the agency;

3. a description of how the goals and objectives are to be achieved, including a description

of the operational processes, skills and technology, and the human, capital, information,

and other resources required to meet those goals and objectives;

4. a description of how the performance goals included in the plan required by section

1115(a) of title 31 shall be related to the general goals and objectives in the strategic

plan;

5. an identification of those key factors external to the agency and beyond its control

that could significantly affect the achievement of the general goals and objectives;

and

6. a description of the program evaluations used in establishing or revising general

goals and objectives, with a schedule for future program evaluations.

b. The strategic plan shall cover a period of not less than five years forward from the fiscal

year in which it is submitted, and shall be updated and revised at least every three years.

c. The performance plan required by section 1115 of title 31 shall be consistent with the

agency’s strategic plan. A performance plan may not be submitted for a fiscal year not

covered by a current strategic plan under this section.

d. When developing a strategic plan, the agency shall consult with the Congress, and shall

solicit and consider the views and suggestions of those entities potentially affected by or

interested in such a plan.

e. The functions and activities of this section shall be considered to be inherently

Governmental functions. The drafting of strategic plans under this section shall be

performed only by Federal employees.

f. For purposes of this section the term agency means an Executive agency defined under

section 105, but does not include the Central Intelligence Agency, the General Accounting

Office, the Panama Canal Commission, the United States Postal Service, and the Postal

Rate Commission.
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SEC. 4. ANNUAL PERFORMANCE PLANS AND REPORTS.

(a) BUDGET CONTENTS AND SUBMISSION TO CONGRESS

Section 1105(a) of title 31, United States Code, is amended by adding at the end thereof

the following new paragraph: (29) beginning with fiscal year 1999, a Federal Government

performance plan for the overall budget as provided for under section 1115.

(b) PERFORMANCE PLANS AND REPORTS

- Chapter 11 of title 31, United States Code, is amended by adding after section 1114 the

following new sections:

Sec. 1115. Performance plans

a. In carrying out the provisions of section 1105(a)(29), the Director of the Office of

Management and Budget shall require each agency to prepare an annual performance

plan covering each program activity set forth in the budget of such agency. Such plan

shall—

1. establish performance goals to define the level of performance to be achieved by a

program activity;

2. express such goals in an objective, quantifiable, and measurable form unless authorized

to be in an alternative form under subsection (b);

3. briefly describe the operational processes, skills and technology, and the human,

capital, information, or other resources required to meet the performance goals;

4. establish performance indicators to be used in measuring or assessing the relevant

outputs, service levels, and outcomes of each program activity;

5. provide a basis for comparing actual program results with the established performance

goals; and

6. describe the means to be used to verify and validate measured values.

b. If an agency, in consultation with the Director of the Office of Management and Budget,

determines that it is not feasible to express the performance goals for a particular program

activity in an objective, quantifiable, and measurable form, the Director of the Office of

Management and Budget may authorize an alternative form. Such alternative form shall—

1. include separate descriptive statements of—

(A) (i) a minimally effective program, and

(ii) a successful program, or

(B) such alternative as authorized by the Director of the Office of Management and

Budget, with sufficient precision and in such terms that would allow for an

accurate, independent determination of whether the program activity’s

performance meets the criteria of the description; or

2. state why it is infeasible or impractical to express a performance goal in any form for

the program activity.
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c. For the purpose of complying with this section, an agency may aggregate, disaggregate,

or consolidate program activities, except that any aggregation or consolidation may not

omit or minimize the significance of any program activity constituting a major function

or operation for the agency.

d. An agency may submit with its annual performance plan an appendix covering any portion

of the plan that—

1. is specifically authorized under criteria established by an Executive order to be kept

secret in the interest of national defense or foreign policy; and

2. is properly classified pursuant to such Executive order.

e. The functions and activities of this section shall be considered to be inherently

Governmental functions. The drafting of performance plans under this section shall be

performed only by Federal employees.

f. For purposes of this section and sections 1116 through 1119, and sections 9703 and 9704

the term—

1. agency has the same meaning as such term is defined under section 306(f) of title 5;

2. outcome measure means an assessment of the results of a program activity compared

to its intended purpose;

3. output measure means the tabulation, calculation, or recording of activity or effort

and can be expressed in a quantitative or qualitative manner;

4. performance goal means a target level of performance expressed as a tangible,

measurable objective, against which actual achievement can be compared, including

a goal expressed as a quantitative standard, value, or rate;

5. performance indicator means a particular value or characteristic used to measure

output or outcome;

6. program activity means a specific activity or project as listed in the program and

financing schedules of the annual budget of the United States Government; and

7. program evaluation means an assessment, through objective measurement and

systematic analysis, of the manner and extent to which Federal programs achieve

intended objectives.

Sec. 1116. Program performance reports

a. No later than March 31, 2000, and no later than March 31 of each year thereafter, the

head of each agency shall prepare and submit to the President and the Congress, a report

on program performance for the previous fiscal year.

b.

1. Each program performance report shall set forth the performance indicators established

in the agency performance plan under section 1115, along with the actual program

performance achieved compared with the performance goals expressed in the plan

for that fiscal year.

2. If performance goals are specified in an alternative form under section 1115(b), the

results of such program shall be described in relation to such specifications, including

whether the performance failed to meet the criteria of a minimally effective or

successful program.
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c. The report for fiscal year 2000 shall include actual results for the preceding fiscal year,

the report for fiscal year 2001 shall include actual results for the two preceding fiscal

years, and the report for fiscal year 2002 and all subsequent reports shall include actual

results for the three preceding fiscal years.

d. Each report shall—

1. review the success of achieving the performance goals of the fiscal year;

2. evaluate the performance plan for the current fiscal year relative to the performance

achieved toward the performance goals in the fiscal year covered by the report;

3. explain and describe, where a performance goal has not been met (including when a

program activity’s performance is determined not to have met the criteria of a

successful program activity under section 1115(b)(1)(A)(ii) or a corresponding level

of achievement if another alternative form is used)—

A. why the goal was not met;

B. those plans and schedules for achieving the established performance goal; and

C. if the performance goal is impractical or infeasible, why that is the case and

what action is recommended;

4. describe the use and assess the effectiveness in achieving performance goals of any

waiver under section 9703 of this title; and

5. include the summary findings of those program evaluations completed during the

fiscal year covered by the report.

e. An agency head may include all program performance information required annually

under this section in an annual financial statement required under section 3515 if any

such statement is submitted to the Congress no later than March 31 of the applicable

fiscal year.

f. The functions and activities of this section shall be considered to be inherently

Governmental functions. The drafting of program performance reports under this section

shall be performed only by Federal employees.

Sec. 1117. Exemption

The Director of the Office of Management and Budget may exempt from the requirements of

sections 1115 and 1116 of this title and section 306 of title 5, any agency with annual outlays of

$20,000,000 or less.

SEC. 5. MANAGERIAL ACCOUNTABILITY AND FLEXIBILITY.

(a) MANAGERIAL ACCOUNTABILITY AND FLEXIBILITY

- Chapter 97 of title 31, United States Code, is amended by adding after section 9702, the

following new section: Sec. 9703. Managerial accountability and flexibility

a. Beginning with fiscal year 1999, the performance plans required under section 1115

may include proposals to waive administrative procedural requirements and controls,

including specification of personnel staffing levels, limitations on compensation or

remuneration, and prohibitions or restrictions on funding transfers among budget
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object classification 20 and subclassifications 11, 12, 31, and 32 of each annual budget

submitted under section 1105, in return for specific individual or organization

accountability to achieve a performance goal. In preparing and submitting the

performance plan under section 1105(a)(29), the Director of the Office of Management

and Budget shall review and may approve any proposed waivers. A waiver shall take

effect at the beginning of the fiscal year for which the waiver is approved.

b. Any such proposal under subsection (a) shall describe the anticipated effects on

performance resulting from greater managerial or organizational flexibility, discretion,

and authority, and shall quantify the expected improvements in performance resulting

from any waiver. The expected improvements shall be compared to current actual

performance, and to the projected level of performance that would be achieved

independent of any waiver.

c. Any proposal waiving limitations on compensation or remuneration shall precisely

express the monetary change in compensation or remuneration amounts, such as

bonuses or awards, that shall result from meeting, exceeding, or failing to meet

performance goals.

d. Any proposed waiver of procedural requirements or controls imposed by an agency

(other than the proposing agency or the Office of Management and Budget) may not

be included in a performance plan unless it is endorsed by the agency that established

the requirement, and the endorsement included in the proposing agency’s performance

plan.

e. A waiver shall be in effect for one or two years as specified by the Director of the

Office of Management and Budget in approving the waiver. A waiver may be renewed

for a subsequent year. After a waiver has been in effect for three consecutive years,

the performance plan prepared under section 1115 may propose that a waiver, other

than a waiver of limitations on compensation or remuneration, be made permanent.

f. For purposes of this section, the definitions under section 1115(f) shall apply.

SEC. 6. PILOT PROJECTS.

(a) PERFORMANCE PLANS AND REPORTSChapter 11 of title 31, United States Code, is amended by inserting after section 1117 (as added

by section 4 of this Act) the following new section: Sec. 1118. Pilot projects for performance

goals

1. The Director of the Office of Management and Budget, after consultation with the head

of each agency, shall designate not less than ten agencies as pilot projects in performance

measurement for fiscal years 1994, 1995, and 1996. The selected agencies shall reflect a

representative range of Government functions and capabilities in measuring and reporting

program performance.

2. Pilot projects in the designated agencies shall undertake the preparation of performance

plans under section 1115, and program performance reports under section 1116, other

than section 1116(c), for one or more of the major functions and operations of the agency.
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A strategic plan shall be used when preparing agency performance plans during one or

more years of the pilot period.

3. No later than May 1, 1997, the Director of the Office of Management and Budget shall

submit a report to the President and to the Congress which shall—

1. assess the benefits, costs, and usefulness of the plans and reports prepared by the

pilot agencies in meeting the purposes of the Government Performance and Results

Act of 1993;

2. identify any significant difficulties experienced by the pilot agencies in preparing

plans and reports; and

3. set forth any recommended changes in the requirements of the provisions of

Government Performance and Results Act of 1993, section 306 of title 5, sections

1105, 1115, 1116, 1117, 1119 and 9703 of this title, and this section.

(b) MANAGERIAL ACCOUNTABILITY AND FLEXIBILITY

- Chapter 97 of title 31, United States Code, is amended by inserting after section 9703

(as added by section 5 of this Act) the following new section: Sec. 9704. Pilot projects for

managerial accountability and flexibility

1. The Director of the Office of Management and Budget shall designate not less than

five agencies as pilot projects in managerial accountability and flexibility for fiscal

years 1995 and 1996. Such agencies shall be selected from those designated as pilot

projects under section 1118 and shall reflect a representative range of Government

functions and capabilities in measuring and reporting program performance.

2. Pilot projects in the designated agencies shall include proposed waivers in accordance

with section 9703 for one or more of the major functions and operations of the agency.

3. The Director of the Office of Management and Budget shall include in the report to

the President and to the Congress required under section 1118(c)—

1. an assessment of the benefits, costs, and usefulness of increasing managerial

and organizational flexibility, discretion, and authority in exchange for improved

performance through a waiver; and

2. an identification of any significant difficulties experienced by the pilot agencies

in preparing proposed waivers.

4. For purposes of this section the definitions under section 1115(f) shall apply.

(c) PERFORMANCE BUDGETING

- Chapter 11 of title 31, United States Code, is amended by inserting after section 1118

(as added by section 6 of this Act) the following new section: Sec. 1119. Pilot projects for

performance budgeting

a. The Director of the Office of Management and Budget, after consultation with the

head of each agency shall designate not less than five agencies as pilot projects in

performance budgeting for fiscal years 1998 and 1999. At least three of the agencies
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shall be selected from those designated as pilot projects under section 1118, and

shall also reflect a representative range of Government functions and capabilities in

measuring and reporting program performance.

b. Pilot projects in the designated agencies shall cover the preparation of performance

budgets. Such budgets shall present, for one or more of the major functions and

operations of the agency, the varying levels of performance, including outcome-related

performance, that would result from different budgeted amounts.

c. The Director of the Office of Management and Budget shall include, as an alternative

budget presentation in the budget submitted under section 1105 for fiscal year 1999,

the performance budgets of the designated agencies for this fiscal year.

d. No later than March 31, 2001, the Director of the Office of Management and Budget

shall transmit a report to the President and to the Congress on the performance

budgeting pilot projects which shall—

1. assess the feasibility and advisability of including a performance budget as part

of the annual budget submitted under section 1105;

2. describe any difficulties encountered by the pilot agencies in preparing a

performance budget;

3. recommend whether legislation requiring performance budgets should be

proposed and the general provisions of any legislation; and

4. set forth any recommended changes in the other requirements of the Government

Performance and Results Act of 1993, section 306 of title 5, sections 1105,

1115, 1116, 1117, and 9703 of this title, and this section.

e. After receipt of the report required under subsection (d), the Congress may specify

that a performance budget be submitted as part of the annual budget submitted under

section 1105.

SEC. 7. UNITED STATES POSTAL SERVICE.

Part III of title 39, United States Code, is amended by adding at the end thereof the following new

chapter:

CHAPTER 28—STRATEGIC PLANNING AND PERFORMANCE MANAGEMENT

Sec.

2801. Definitions.

2802. Strategic plans.

2803. Performance plans.

2804. Program performance reports.

2805. Inherently Governmental functions.

Sec. 2801. Definitions

For purposes of this chapter the term—

1. outcome measure refers to an assessment of the results of a program activity compared to

its intended purpose;
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2. output measure refers to the tabulation, calculation, or recording of activity or effort and

can be expressed in a quantitative or qualitative manner;

3. performance goal means a target level of performance expressed as a tangible, measurable

objective, against which actual achievement shall be compared, including a goal expressed

as a quantitative standard, value, or rate;

4. performance indicator refers to a particular value or characteristic used to measure output

or outcome;

5. program activity means a specific activity related to the mission of the Postal Service;

and

6. program evaluation means an assessment, through objective measurement and systematic

analysis, of the manner and extent to which Postal Service programs achieve intended

objectives.

Sec. 2802. Strategic plans

a. No later than September 30, 1997, the Postal Service shall submit to the President and

the Congress a strategic plan for its program activities. Such plan shall contain—

1. a comprehensive mission statement covering the major functions and operations of

the Postal Service;

2. general goals and objectives, including outcome-related goals and objectives, for the

major functions and operations of the Postal Service;

3. a description of how the goals and objectives are to be achieved, including a description

of the operational processes, skills and technology, and the human, capital, information,

and other resources required to meet those goals and objectives;

4. a description of how the performance goals included in the plan required under section

2803 shall be related to the general goals and objectives in the strategic plan;

5. an identification of those key factors external to the Postal Service and beyond its

control that could significantly affect the achievement of the general goals and

objectives; and

6. a description of the program evaluations used in establishing or revising general

goals and objectives, with a schedule for future program evaluations.

b. The strategic plan shall cover a period of not less than five years forward from the fiscal

year in which it is submitted, and shall be updated and revised at least every three years.

c. The performance plan required under section 2803 shall be consistent with the Postal

Services strategic plan. A performance plan may not be submitted for a fiscal year not

covered by a current strategic plan under this section.

d. When developing a strategic plan, the Postal Service shall solicit and consider the views

and suggestions of those entities potentially affected by or interested in such a plan, and

shall advise the Congress of the contents of the plan.

Sec. 2803. Performance plans

a. The Postal Service shall prepare an annual performance plan covering each program

activity set forth in the Postal Service budget, which shall be included in the comprehensive

statement presented under section 2401(g) of this title. Such plan shall—
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1. establish performance goals to define the level of performance to be achieved by a

program activity;

2. express such goals in an objective, quantifiable, and measurable form unless an

alternative form is used under subsection (b);

3. briefly describe the operational processes, skills and technology, and the human,

capital, information, or other resources required to meet the performance goals;

4. establish performance indicators to be used in measuring or assessing the relevant

outputs, service levels, and outcomes of each program activity;

5. provide a basis for comparing actual program results with the established performance

goals; and

6. describe the means to be used to verify and validate measured values.

b. If the Postal Service determines that it is not feasible to express the performance goals

for a particular program activity in an objective, quantifiable, and measurable form, the

Postal Service may use an alternative form. Such alternative form shall—

1. include separate descriptive statements of—

A. a minimally effective program, and

B. a successful program, with sufficient precision and in such terms that would

allow for an accurate, independent determination of whether the program activity

performance meets the criteria of either description; or

2. state why it is infeasible or impractical to express a performance goal in any form for

the program activity.

c. In preparing a comprehensive and informative plan under this section, the Postal Service

may aggregate, disaggregate, or consolidate program activities, except that any aggregation

or consolidation may not omit or minimize the significance of any program activity

constituting a major function or operation.

d. The Postal Service may prepare a non-public annex to its plan covering program activities

or parts of program activities relating to—

(1) the avoidance of interference with criminal prosecution; or

(2) matters otherwise exempt from public disclosure under section 410(c) of this title.

Sec. 2804. Program performance reports

a. The Postal Service shall prepare a report on program performance for each fiscal year,

which shall be included in the annual comprehensive statement presented under section

2401(g) of this title.

b.

1. The program performance report shall set forth the performance indicators established

in the Postal Service performance plan, along with the actual program performance

achieved compared with the performance goals expressed in the plan for that fiscal

year.

2. If performance goals are specified by descriptive statements of a minimally effective

program activity and a successful program activity, the results of such program shall

be described in relationship to those categories, including whether the performance

failed to meet the criteria of either category.
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c. The report for fiscal year 2000 shall include actual results for the preceding fiscal year,

the report for fiscal year 2001 shall include actual results for the two preceding fiscal

years, and the report for fiscal year 2002 and all subsequent reports shall include actual

results for the three preceding fiscal years.

d. Each report shall—

1. review the success of achieving the performance goals of the fiscal year;

2. evaluate the performance plan for the current fiscal year relative to the performance

achieved towards the performance goals in the fiscal year covered by the report;

3. explain and describe, where a performance goal has not been met (including when a

program activity’s performance is determined not to have met the criteria of a

successful program activity under section 2803(b)(2))—

(A) why the goal was not met;

(B) those plans and schedules for achieving the established performance goal; and

(C) if the performance goal is impractical or infeasible, why that is the case and

what action is recommended; and

4. include the summary findings of those program evaluations completed during the

fiscal year covered by the report.

Sec. 2805. Inherently Governmental functions

The functions and activities of this chapter shall be considered to be inherently Governmental

functions. The drafting of strategic plans, performance plans, and program performance reports

under this section shall be performed only by employees of the Postal Service.

SEC. 8. CONGRESSIONAL OVERSIGHT AND LEGISLATION.

1. IN GENERAL- Nothing in this Act shall be construed as limiting the ability of Congress

to establish, amend, suspend, or annul a performance goal. Any such action shall have

the effect of superseding that goal in the plan submitted under section 1105(a)(29) of title

31, United States Code.

2. GAO REPORT- No later than June 1, 1997, the Comptroller General of the United States

shall report to Congress on the implementation of this Act, including the prospects for

compliance by Federal agencies beyond those participating as pilot projects under sections

1118 and 9704 of title 31, United States Code.

SEC. 9. TRAINING.

The Office of Personnel Management shall, in consultation with the Director of the Office of

Management and Budget and the Comptroller General of the United States, develop a strategic

planning and performance measurement training component for its management training program and otherwise provide managers with an orientation on the development and use of strategic planning and program performance measurement.
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SEC. 10. APPLICATION OF ACT.

No provision or amendment made by this Act may be construed as—

1. creating any right, privilege, benefit, or entitlement for any person who is not an officer

or employee of the United States acting in such capacity, and no person who is not an

officer or employee of the United States acting in such capacity shall have standing to file

any civil action in a court of the United States to enforce any provision or amendment

made by this Act; or

2. superseding any statutory requirement, including any requirement under section 553 of

title 5, United States Code.

SEC. 11. TECHNICAL AND CONFORMING AMENDMENTS.

a. AMENDMENT TO TITLE 5, UNITED STATES CODE- The table of sections for chapter

3 of title 5, United States Code, is amended by adding after the item relating to section

305 the following: 306. Strategic plans.

b. AMENDMENTS TO TITLE 31, UNITED STATES CODE1. AMENDMENT TO CHAPTER 11- The table of sections for chapter 11 of title 31,

United States Code, is amended by adding after the item relating to section 1114 the

following: 1115. Performance plans.

1116. Program performance reports.

1117. Exemptions.

1118. Pilot projects for performance goals.

1119. Pilot projects for performance budgeting.

2. AMENDMENT TO CHAPTER 97- The table of sections for chapter 97 of title 31,

United States Code, is amended by adding after the item relating to section 9702 the

following: 9703. Managerial accountability and flexibility. 9704. Pilot projects for

managerial accountability and flexibility.

c. AMENDMENT TO TITLE 39, UNITED STATES CODE- The table of chapters for part

III of title 39, United States Code, is amended by adding at the end thereof the following

new item: 2801.

Speaker of the House of Representatives.

Vice President of the United States and

President of the Senate.
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APPENDIX C

DEPARTMENT OF DEFENSE

APPROPRIATION ACCOUNTS
C-2
C-3

Table C-1. Appropriation Accounts by Service

APPENDIX C

DEPARTMENT OF DEFENSE

APPROPRIATION ACCOUNTS

Appropriation Scope of Work Effort Service Appropriation

Accounts Numerical Codes

Army Navy USMC Air

Force

Research, RDT&E Activities, Automated Information 2040 1319 3600

Development, Systems Equipment & Software, and

Test, and Research & Development Facilities

Evaluation

(RDT&E)

Procurement Production Labor/Hardware, Initial Spares,

Repair Parts, Support Equipment &

Facilities, Automated Information Systems

Equipment & Software >= $100K

Aircraft 2031 1506 3010

Missiles 2032 3020

Weapons 1507

Weapons & Tracked Combat Vehicles 2033

(W & TCV)

Shipbuilding and Conversion (SCN) 1611

Ammunition 2034 1508 1508 3011

Procurement, Marine Corps 1109

Other Procurement 2035 1810 3080

Operation & Replenishment Spares, Civilian Salaries, 2020 1804 1106 3400

Maintenance Minor Construction < $500K, Travel,

(O&M) Automated Information Systems

Equipment & Software < $100K,

Software Development/ Modifications/

Purchase/ Lease

Military Military Pay & Allowances, Permanent 2010 1453 1105 3500

Personnel Change of Station Moves, Retired Pay

(MILPERS) Accrual

Military Major Construction Projects >$500K 2050 1205 3300

Construction

(MILCON)
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The RDT&E and Procurement Appropriation Accounts are collectively referred to as “Modernization.” These two accounts have more flexibility in terms of obligation than one-year O&M

money (see Figure C-1). Therefore modernization money is commonly used to pay O&M bills

during the annual budget formulations and unexpected or contingency O&M bills during execution.

Procurement

Ships

RDT&E

O&M

MILCON

MILPERS

Years

1 2 3 4 5 6 7 8 9 10

Obligation Period Expenditure Period

Figure C-1. Appropriation Account Life

Source: Adapted from the Defense Systems Management College, Advanced Program Management Course,

Financial Management lesson slides for FM 721 and FM 752.
D-1

APPENDIX D

OUTSOURCING SURVEY
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D-3

APPENDIX D

OUTSOURCING SURVEY

Study Methodology and Selected Survey Data

The purpose of the study was to provide an analytical framework for examining the Department

of Defense (DoD) from a corporate perspective. With that corporate framework we would develop an approach to outsourcing consistent with a corporate strategy that benefits DoD across

the spectrum of DoD-wide, regional, and base-level activities. We tested the hypothesis by answering the following questions through literature searches, interviews with leading DoD and

industry experts and outsourcing participants, and a survey:

• Does a transformation urgency exist?

• Do DoD outsourcing initiatives align with DoD Business Strategy?

• Has the OMB Circular A-76 Process generated the results expected?

• Has Strategic or Competitive Sourcing generated the results expected?

• Have shortfalls resulted from execution problems or are they strategy-related?

• What are the benefits of a new corporate strategy approach?

• Can such an approach be implemented?

We constructed a survey (a copy is located at the end of this appendix) to provide data critical to

addressing questions one and two. The survey instrument was designed based on the Outsourcing

Justification Practices study conducted by Pretium Partners, Inc. in partnership with the Fisher

College of Business at The Ohio State University, and Michael F. Corbett & Associates. The

Pretium study focused on determining and understanding the factors involved in justifying

outsourcing decisions, including the tangible and intangible benefits of outsourcing. The study

surveyed a random sampling of U.S. and Canadian companies with $1 billion or more in annual

revenue. More than 60 companies responded with detailed information. Our outsourcing survey

was modeled after this one in order to facilitate a comparison of the results.

The outsourcing survey was built online with the SurveySuite survey generation tool, which is

available for free at the following web address: http://intercom.virginia.edu/cgi-bin/cgiwrap/intercom/SurveySuite/ss_index.pl. The survey was sent to over 1,300 members of the Department

of the Air Force (USAF), Department of the Army (USA), Defense Logistics Agency (DLA), and

Department of the Navy (USN). We received over 230 responses, which is about an 18 percent

response rate.
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For the USAF and USA, the survey was sent to personnel who are or may be involved in outsourcing

initiatives. In the USAF, the survey was sent to the A-76 Commercial Activity program managers

and to USAF base and group commanders. Likewise, all garrison and deputy garrison commanders in the USA were specifically targeted.

On the other hand, a completely random sampling was taken from the DLA and USN, using the

DLA E-mail directory and Navy/Marine Corps (USMC) White Pages respectively. Although

selected at random, command billets were specifically targeted in the USN and USMC. By targeting command and supervisory positions, we were aiming at determining whether the sense of

urgency had reached mid-level managers sufficiently to effect change and whether the linkages

between DoD corporate strategy and lower-level strategies exist.
D-5

OUTSOURCING SURVEY

2001 DAU RESEARCH FELLOWS

The 2000-2001 DAU Research Fellows are conducting research on the Effectiveness of

DoD’s Implementation of Outsourcing and Privatization. Our research project focuses on

providing a corporate approach to outsourcing that will benefit the entire DoD. The term

outsourcing includes A-76, competitive sourcing, strategic sourcing, and privatization. In

order to facilitate our research, we ask for 10-15 minutes of your time to complete the

following online survey. The information gathered will be presented in a final report scheduled for release in September 2001. For those of you wishing to establish a dialogue with

the Research Fellows or request a copy of the report, a space for your contact information

has been provided at the end of the survey instrument. We thank you for your input and for

devoting time from your busy schedule.

To view the current summary of the DoD Strategic Plan visit the Annual Defense Report

web site at http://www.dtic.mil/execsec/adr2000/appi.html.

For more information on the DAU Research Fellows program visit http://www.dsmc.dsm.mil/

pubs/mfrpts/mrflist.htm.

Contact Information:

Lt Col Warren Anderson, USAF (703) 805-3776

LTC John McGuiness, USA (703) 805-4655

CDR John Spicer, USN (703) 805-5410

1. Privacy Act Statement

The privacy policy is clear: No personal information is collected about you when you

visit the web site. Here is how we handle information that is collected and stored

automatically about your visit to the web site. While accessing the survey we will gather

and store certain information about your visit automatically. This information does not

identify you personally. We automatically collect and store only the following information

about your visit: the Internet domain (for example, “youragency.gov” if you connect

from a government domain, “yourorganization.mil” if you connect from a military domain,

or “xcompany.com” if you use a private Internet access account and IP address (an IP

address is a number that is automatically assigned to your computer whenever you are

surfing the Web) from which you access our web site; the type of browser and operating

system used to access our site; the date and time you access our site; the pages you visit;

and if you linked to the web site from another web site, the address of that web site. We

use this information only for statistical reports to determine the number of visitors to our

site and the types of technology used. We do not track or record information about

individuals and their visits. We do not enable “cookies” (A cookie is a file placed on
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your hard drive by a web site that allows it to monitor your use of the site). Links to

Other Sites: This web site has no links to any other web sites. If you have comments or

questions about the Privacy Policy, please contact Lt Col Warren Anderson, (703) 805-

3776; LTC John McGuiness, (703) 805-4655; or, CDR John Spicer, (703) 805-5410,

Monday through Friday.

2. DoD Strategic Plan

The following questions concern the DoD Strategic Plan as outlined in the FY 2000

Annual Defense Report, Appendix I, Government Performance and Results Act. Please

mark only one response per question for questions 2.1 - 2.3.

2.1. I have read the DoD Strategic Plan.

Yes No

2.2. Need exists for significant improvement in the way DoD and the departments/

agencies conduct business operations (commercial-like activities).

Yes No. Please skip to question 3.1

2.3. Business areas the DoD should change or reform. Should the DoD make immediate

changes in the following areas?

Yes No Not Sure

a. Acquisition process

b. Financial management

c. Information management

d. Outsourcing initiatives

e. Other. Please specify in question 2.4

2.4. Other area the DoD should change:

3. DoD Outsourcing Efforts

These questions concern DoD’s overall efforts in outsourcing. Please mark only one

response per question for questions 3.1, 3.3, and 3.4.

3.1. DoD is headed in the right direction with respect to outsourcing issues.

Yes No

3.2. Please provide any additional comments regarding your response to question 3.1

above.
D-7

3.3. Are the following outsourcing objectives important?

Not Very Somewhat Very Extremely

Important Important Important Important Important

a. For cost control

b. For cost savings

c. Resources are not

available internally

d. To better manage the

department, unit, or

function

e. To improve business

focus on the primary

mission

f. To access better

capabilities

g. To bring new

solutions to

customers, faster,

better, and cheaper

h. To improve

organizational

effectiveness

(performing the

right function)

i. To improve

organizational

efficiency

(performing the

function cheaper)

j. To respond to

shortening product

life cycles

k. To redefine

relationships with

suppliers and

business partners
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3.4. Outsourcing Considerations. The following issues are important considerations

when conducting an outsourcing study.

Strongly Neither Agree Strongly

Agree Agree nor Disagree Disagree Disagree

a. Impact on Cost

b. Impact on

Personnel

c. Impact on Mission

Performance

4. Your Organization

This section queries sourcing efforts at your organizational or base level. Please mark

only one response per question for questions 4.1, 4.3 - 4.7, and 4.9 - 4.11.

4.1. Are there activities within your command/organization that can be better performed

by the private sector?

Yes No Don’t know

4.2. If you answered yes to question 4.1 above, please list some examples or otherwise

mark N/A.

___ Not Applicable

4.3. Have you been involved in an outsourcing effort?

Yes No. Please skip to question 5.1

4.4. Outsourcing Processes. Please mark your agreement with the statement, “The

_________________________ process is a good process.”

Strongly Neither Agree Strongly

Agree Agree nor Disagree Disagree Disagree

a. A-76

b. Navy’s Strategic

Sourcing

c. Air Force’s

Strategic Sourcing

d. Army’s Competitive

Sourcing
D-9

4.5. Did you use metrics to measure the performance of the outsourced activity?

Yes No

4.6. Were the metrics effective?

Yes No Not Applicable

4.7. Did you change the metrics after implementation to provide greater visibility into

your process?

Yes No Not Applicable

4.8. If you answered yes to question 4.7 above, please briefly explain or otherwise

mark N/A.

___ Not Applicable (N/A)

4.9. Outsourcing Alignment to Strategy and Planning. Was the outsourcing effort aligned

to:

Yes No Not Sure N/A

a. DoD Corporate Strategy

b. Your Service’s/ Department’s/

Agency’s Strategy

c. Your Major Command’s

Strategy

d. Your Unit’s Strategy

e. Your Function’s/

Department’s Strategy

f. Human Resource Strategy

g. Operational Plans

4.10. Outsourcing has improved or enhanced my mission performance.

Yes No. Please skip to question 5.1
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4.11. Outsourcing Benefits. Please rate the following potential benefits resulting from

your outsourcing effort on a 5-point basis, with 1 being the least important and 5

being the most important.

Least Most

 Important Important

12345

a. Reduced cost

b. Provided savings

c. Provided resources that were

not available internally

d. Allowed better management of

the department, unit, or function

e. Improved business focus onto

the primary mission

f. Allowed access to better

capabilities

g. Brought solutions to customers,

faster, better, and cheaper

h. Improved organizational

effectiveness (performing the

right function)

i. Improved organizational

efficiency (performing the

function cheaper)

j. Enabled shortened product

life cycles

k. Redefined better relationships

with suppliers and business

partners

l. Other benefit. Please explain

in question 4.12

4.12. Please briefly describe the other benefit derived from your outsourcing effort. If

you did not mark other benefit, please respond N/A.

___ Not Applicable
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5. Demographics

The questions in this section ask about you and your current position. All responses are

confidential. Please mark only one response per question.

5.1. What department or branch of service are you in or are you in industry?

___ Office of Secretary of Defense

___ United States Marine Corps

___ United States Army

___ United States Navy

___ United States Air Force

___ Other DoD Agency

___ Other Government Agency

___ Industry Representative

5.2. What is your rank / grade? If Industry please mark N/A.

___ O-1 to O-2 / GS-09 to GS-11

___ O-3 to O-4 / GS-12 to GS-13

___ O-5 to O-6 / GS-14 to GS-15

___ General Officer / Flag Officer / Senior Executive

___ Other

___ Not Applicable

5.3. How many years of government service do you have? If Industry please mark N/

A.

___ 0 – 5 years

___ 6 –10 years

___ 11 – 15 years

___ 16 – 20 years

___ 21 – 25 years

___ 26 years or longer

___ Not Applicable
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5.4. Are you in a supervisory or command position? Please mark all that apply.

___ Command

___ Supervisor

___ Not in a command/supervisory position

5.5. What is your current function or area of expertise?

___ Program Management

___ Research and Development

___ Engineering

___ Supply/Logistics

___ Budget/Finance

___ Contracting

___ Other

5.6. What best describes the role of your unit.

___ Policy/Staff

___ Support/Business enterprise

___ Operational

___ Other

5.7. Please rate your own expertise in outsourcing.

___ Very Little (Less than a year)

___ Some (1 – 2 years)

___ Average (2 – 4 years)

___ Above Average (4 – 5 years)

___ Significant (More than 5 years)

6. Contact Information Please provide contact information if you desire.

6.1. Name

6.2. Phone Number (DSN and Commercial)

6.3. If you would like a copy of the final report, please provide your mailing address.
D-13

SURVEY RESPONSES

The following figures summarize the survey responses.

Need exists for significant improvement in the way DoD 

and the departments/agencies conduct business operations 

(commercial like activities)

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

Responses 86.64% 13.36% 0%

Yes No Not Sure

I have read the DoD Strategic Plan

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 35.90% 64.10% 0%

Yes No Not Sure
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Business areas that DoD should change or reform.

Should DoD make immediate changes in the following 

areas?

Acquisition Process

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 75.37% 7.88% 16.75%

Yes No Not Sure

Business areas that DoD should change or reform.

Should DoD make immediate changes in the following 

areas?

Financial Management

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 74.02% 10.29% 15.69%

Yes No Not Sure
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Business areas that DoD should change or reform.

Should DoD make immediate changes in the following 

areas?

Information Management

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 65.50% 15.00% 19.50%

Yes No Not Sure

Business areas that DoD should change or reform.

Should DoD make immediate changes in the following 

areas?

Outsourcing Initiatives

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 72.68% 12.20% 15.12%

Yes No Not Sure
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Commanders responding to the statement: DoD is headed 

in the right direction with respect to outsourcing.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 3.00% 24.32% 15.32% 33.33% 23.42%

Strongly Agree Agree N eithe r Agree 

nor D isagree D isagree Strongly D isagree

DoD is headed in the right direction with respect to 

outsourcing.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Responses 3.00% 26.61% 17.60% 35.19% 17.60%
D-17

Are the following outsourcing objectives important?

For cost control

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 19.91% 27.71% 19.48% 22.08% 10.82%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important

Commanders who have undergone outsourcing responding 

to the statement: DoD is headed in the right direction with 

respect to outsourcing.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 3.85% 16.67% 15.38% 38.46% 25.64%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree
D-18

Are the following outsourcing objectives important?

For cost savings

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 24.35% 20.87% 20.87% 25.65% 8.26%

Extremely 

Important

Very 

Important Important Somewhat Important

Not Very 

Important

Are the following outsourcing objectives important?

Resources are not available internally

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 18.86% 31.58% 18.42% 21.49% 9.65%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important
D-19

Are the following outsourcing objectives important?

To better manage the department, unit or function

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 14.04% 25.00% 19.30% 23.25% 18.42%

Extremely 

Important

Very 

Important Important Somewhat Important

Not Very 

Important

Are the following outsourcing objectives important?

To improve business focus on the primary mission

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 18.34% 24.89% 18.34% 18.34% 20.09%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important
D-20

Are the following outsourcing objectives important?

To access better capabilities

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 21.59% 32.16% 20.26% 17.62% 8.37%

Extremely 

Important

Very 

Important Important Somewhat Important

Not Very 

Important

Are the following outsourcing objectives important?

To bring new solutions to customers faster, better, and 

cheaper

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 23.04% 30.00% 17.83% 20.43% 8.70%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important
D-21

Are the following outsourcing objectives important?

To improve organizational effectiveness (performing the 

right function)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 21.74% 30.87% 20.87% 15.65% 10.87%

Extremely 

Important

Very 

Important Important Somewhat Important

Not Very 

Important

Are the following outsourcing objectives important?

To improve organizational efficiency (performing the 

function cheaper)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 18.61% 23.81% 24.68% 21.21% 11.69%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important
D-22

Are the following outsourcing objectives important?

To redefine relationships with suppliers and business 

partners

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Responses 12.66% 18.34% 24.89% 26.64% 17.47%

Extremely 

Important

Very 

Important Important Somewhat 

Important

Not Very 

Important

Are the following outsourcing objectives important?

To respond to shortening product life-cycles

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 15.22% 30.00% 23.91% 20.00% 10.87%

Extremely 

Important

Very 

Important Important Somewhat Important

Not Very 

Important
D-23

The following issues are important considerations when 

conducting an outsourcing study.

Impact on cost

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Responses 36.48% 51.07% 6.44% 3.86% 2.15%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree

For commanders: The following issues are important 

considerations when conducting an outsourcing study.

Impact on cost

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Responses 36.36% 49.09% 8.18% 4.55% 1.82%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree
D-24

For commanders: The following issues are important 

considerations when conducting an outsourcing study.

Impact on personnel

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 60.91% 30.00% 4.55% 2.73% 1.82%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree

The following issues are important considerations when 

conducting an outsourcing study.

Impact on personnel

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 57.94% 33.05% 4.29% 3.00% 1.72%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree
D-25

The following issues are important considerations when 

conducting an outsourcing study.

Impact on mission performance

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

Responses 77.16% 19.40% 0.86% 0.43% 2.16%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree

For commanders: The following issues are important 

considerations when conducting an outsourcing study.

Impact on mission performance

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

Responses 88.99% 9.17% 0.00% 0.92% 0.92%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree
D-26

Are there activities within your command/organization that 

can be better performed by the private sector?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 45.73% 36.32% 17.95%

Yes No Not Sure

Have you been involved in an outsourcing effort?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 58.19% 41.81% 0.00%

Yes No Not Sure
D-27

Please mark your agreement with the statement: 

“The A-76 process is a good process.”

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 5.44% 17.01% 20.41% 27.89% 29.25%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree

Please mark your agreement with the statement: 

“The Navy’s Strategic Sourcing process is a good process.”

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

Responses 3.33% 5.83% 79.17% 8.33% 3.33%

Strongly Agree Agree Neithe r Agree 

nor D isagree Disagree Strongly Disagree
D-28

Please mark your agreement with the statement: 

“The Air Force’s Strategic Sourcing process

is a good process.”

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 2.48% 10.74% 70.25% 10.74% 5.79%

Strongly Agree Agree N eithe r Agree 

nor D isagree D isagree Strongly D isagree

Please mark your agreement with the statement: 

“The Army’s Competitive Sourcing process

is a good process.”

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 1.68% 9.24% 73.75% 9.24% 5.88%

Strongly Agree Agree N eithe r Agree 

nor D isagree D isagree Strongly D isagree
D-29

Did you use metrics to measure the performance of the 

outsourced activity?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 63.19% 36.81% 0%

Yes No Not Sure

Were the metrics effective?

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

Responses 32.62% 25.53% 41.84%

Yes No Not Sure
D-30

Did you change the metrics after implementation to provide 

greater visibility into your process?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Responses 12.59% 34.97% 52.45%

Yes No Not Sure

Was the outsourcing effort aligned to: 

DoD corporate strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 42.31% 14.62% 43.08%

Yes No Not Sure
D-31

Was the outsourcing effort aligned to: 

Your Service’s/agency’s strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Responses 66.17% 18.05% 15.79%

Yes No Not Sure

Was the outsourcing effort aligned to: 

Your major command’s strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 66.92% 17.69% 15.38%

Yes No Not Sure
D-32

Was the outsourcing effort aligned to: 

Your unit’s strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Responses 37.61% 51.28% 11.11%

Yes No Not Sure

Was the outsourcing effort aligned to: 

Your function’s/department’s strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Responses 35.90% 48.72% 15.38%

Yes No Not Sure
D-33

Was the outsourcing effort aligned to: 

Human resource strategy?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 24.58% 46.61% 28.81%

Yes No Not Sure

Was the outsourcing effort aligned to: 

Operational plans?

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 31.97% 46.72% 21.31%

Yes No Not Sure
D-34

Outsourcing has improved or enhanced my mission 

performance.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

Responses 26.62% 73.38% 0.00%

Yes No Not Sure

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Reduced Cost

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 29.79% 21.28% 29.79% 19.15% 0.00%

5 Most 

Important

432 1 Least 

Important
D-35

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Provided Savings

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 31.25% 20.83% 29.17% 18.75% 0.00%

5 Most 

Important

432 1 Least 

Important

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Provided resources that were not available internally

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Responses 36.73% 20.83% 29.17% 18.75% 0.00%

5 Most 

Important

432 1 Least 

Important
D-36

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Allowed better management of the department, unit, or 

function

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 31.25% 20.83% 29.17% 18.75% 0.00%

5 Most 

Important

432 1 Least 

Important

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Improved focus onto the primary mission

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Responses 36.96% 28.26% 28.26% 6.52% 0.00%

5 Most 

Important

432 1 Least 

Important
D-37

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Allowed access to better capabilities

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Responses 39.58% 22.92% 25.00% 12.50% 0.00%

5 Most 

Important

432 1 Least 

Important

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Brought solutions to customers, faster, better, and cheaper

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 29.41% 21.57% 29.41% 19.61% 0.00%

5 Most 

Important

432 1 Least 

Important
D-38

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Improved organizational effectiveness (doing the right 

function)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 31.91% 29.79% 27.66% 10.64% 0.00%

5 Most 

Important

432 1 Least 

Important

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Improved organizational efficiency (performing the 

function cheaper)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 22.92% 27.08% 31.25% 18.75% 0.00%

5 Most 

Important

432 1 Least 

Important
D-39

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Enabled shortened product life-cycles

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Responses 15.22% 28.26% 32.61% 23.91% 0.00%

5 Most 

Important

432 1 Least 

Important

Please rate the following potential benefits resulting from 

your outsourcing effort on a 5-point basis, with one being 

the least important and five being the most important.

Redefined better relationships with suppliers and business 

partners

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Responses 17.78% 22.22% 35.56% 24.44% 0.00%

5 Most 

Important

432 1 Least 

Important
D-40

ENDNOTES

1. Value Assessment in Outsourcing: A Study of

Outsourcing Justification Practices, Pretium

Partners, Inc., Columbus, OH.
E-1

APPENDIX E

CONTACTS
E-2
E-3

APPENDIX E

CONTACTS

Leantha Sumpter

Assistant Deputy Under Secretary of Defense

 (Acquisition Process and Policies)

Washington, DC

August 2000

Marilyn Wasleski

General Accounting Office

Washington, DC

August 2000

Barry Holman

General Accounting Office

Washington, DC

August 2000

Debra McKinney

General Accounting Office

Washington, DC

August 2000

Cynthia A. Montgomery

Timken Professor of Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Michael Beer

Cahners-Rabb Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

David E. Bell

George M. Moffett Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Frank Anderson

President

Defense Acquisition University

Fort Belvoir, VA

August 2000

Darleen A. Druyun

Principal Deputy, Assistant Secretary of the

 Air Force for Acquisition and Management

Washington, DC

September 2000

Joann Langston

The Army Chair, Executive Institute

Defense Systems Management College

Fort Belvoir, VA

August 2000

Tony Kausal

The Air Force Chair, Executive Institute

Defense Systems Management College

Fort Belvoir, VA

August 2000

Stan Soloway

Deputy Under Secretary of Defense,

 (Acquisition Reform)

Washington, DC

September 2000

Michael Sullivan

The Navy Chair, Executive Institute

Defense Systems Management College

Fort Belvoir, VA

August 2000
E-4

Stephen P. Bradley

William Ziegler Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Richard L. Nolan

William Barclay Harding Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Thomas R. Piper

Lawrence E. Fouraker Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Louis T. Wells

Herbert F. Johnson Professor of

 International Management

Harvard Business School

Boston, MA

September 2000 – May 2001

Michael Y. Yoshino

Herman C. Krannert Professor of

 Business Administration

Harvard Business School

Boston, MA

September 2000 – May 2001

Randal A. Yim

Deputy Under Secretary of

 Defense (Installations)

Washington, DC

February 2001

Joseph Sikes

Director

Office of the Deputy Under Secretary of

 Defense (Installations), Competitive

 Sourcing and Privatization

Washington, DC

January 2001

Diane Shute

Grant Thorton, LLP

Washington, DC

August 2000

Paul L. Solomon

Assistant Director

Office of the Deputy Under Secretary of

 Defense (Installations), Competitive

 Sourcing and Privatization

Washington, DC

January - May 2001

Lorna A. Delay

Senior Program Analyst

Office of the Deputy Under Secretary of

 Defense (Installations), Competitive

 Sourcing and Privatization

Washington, DC

January – May 2001

Hal Stevens

Carnegie-Mellon

Software Engineering Institute

Washington, DC

August 2000

Dave Johnson, Ph.D.

Army Corps of Engineers

Washington, DC

August 2000
E-5

James Wakefield

Department of the Army

Office of the Assistant Chief of Staff for

 Installation Management, Competitive

 Sourcing Office

Washington, DC

January - May 2001

Sedi Graham

Department of the Army

Office of the Assistant Chief of Staff for

 Installation Management, Competitive

 Sourcing Office

Washington, DC

August 2001

John Anderson, Ph.D.

Office of the Assistant Secretary of the Army,

 Manpower and Reserve Affairs

Washington, DC

February 2001

Dave Hoen

Office of the Under Secretary of Defense

 (Comptroller)

Washington, DC

January 2001

Steve Else

Director

Center for Public-Private Enterprise

Washington, DC

August 2000 – May 2001
E-6
F-1

APPENDIX F

SELECTED BIBLIOGRAPHY
F-2
F-3

APPENDIX F

SELECTED BIBLIOGRAPHY

Christenson, Clayton M. The Innovator’s

Dilemma. Boston, Massachusetts: Harvard

Business School Press, 1997.

Collis, David J., and Cynthia A. Montgomery.

Corporate Strategy: A Resource-Based

Approach. Boston, Massachusetts: Irwin/

McGraw-Hill, 1998.

Creech, Bill. The Five Pillars of TQM: How to

Make Total Quality Management Work for

You. New York, New York: Truman Tulley

Books/Dutton, 1994.

General Accounting Office. Major Management Challenges and Program Risks,

Department of Defense. Washington, DC:

Government Printing Office, 2001.

————. More Consistency Needed in Identifying Commercial Activities. Washington

DC: Government Printing Office, 2000.

————. Results of A-76 Studies Over the

Past 5 Years. Washington DC: Government

Printing Office, 2000.

————. Savings Are Occurring, but Actions

Are Needed to Improve Accuracy of Savings Estimate. Washington DC: Government Printing Office, 2000.

————. Some Progress, But Continuing

Challenges Remain in Meeting Program

Goals. Washington DC: Government Printing Office, 2000.

Beer, Michael, Russell A. Eisenstat, and Bert

Spector. The Critical Path to Corporate

Renewal. Boston, Massachusetts: Harvard

Business School Press, 1990.

Bradley, Stephen P., and Richard L. Nolan.

Sense and Respond: Capturing Value in the

Network Era. Boston, Massachusetts:

Harvard Business School Press, 1998.

Brandendurger, Adam M., and Barry J.

Nalebuff. Co-opetition. New York, New

York: Currency Doubleday, 1996.

Center for Naval Analysis. Frances Clark, et

al. Long Run Costs and Performance

Effects of Competitive Sourcing. Alexandria, Virginia: Center for Naval Analysis,

2001.

Clark, Francis, et al. Long Run Costs and Performance Effects of Competitive Sourcing.

Alexandria, Virginia: Center for Naval

Analysis, 2001.

Center for Strategic and International Studies:

Edward Dorn, et al. American Military

Culture in the Twenty-first Century : A

Report of the CSIS International Security

Program. Washington, DC: Center for Strategic and International Studies, 2000.

Dorn, Edward, et al. American Military Culture

in the Twenty-first Century : A Report of

the CSIS International Security Program.

Washington, DC: Center for Strategic and

International Studies, 2000.
F-4

Ghemawat, Pankaj. Strategy and the Business

Landscape: Core Concepts. Upper Saddle

River, New Jersey: Prentice-Hall, 2001.

Ippolito, Dennis S. Blunting the Sword: Budget Policy and the Future of Defense. Washington, DC: National Defense University

Press, 1994.

Kaplan, Robert S., and Robin Cooper. Cost &

Effect: Using Integrated Cost Systems to

Drive Profitability and Performance. Boston, Massachusetts: Harvard Business

School Press, 1998.

Kaplan, Robert S., and David P. Norton. The

Balanced Scorecard: Translating Strategy

into Action. Boston, Massachusetts:

Harvard Business School Press, 1996.

————. The Strategy Focused Organization:

How Balanced Scorecard Companies

Thrive in the New Business Environment.

Boston, Massachusetts: Harvard Business

School Press, 2001.

Keating, Edward. Cancellations and Delays in

Completion of Department of Defense A76 Cost Comparisons. Santa Monica, California: RAND Corporation, 1997.

Kotter, John P. Leading Change. Boston, Massachusetts: Harvard Business School Press,

1996.

McCraw, Thomas K. American Business,

1920-2000: How It Worked. Wheeling,

Illinois: Harlan Davidson Inc., 2000.

Office of Management and Budget. Circular

No. A-76 Revised Supplemental Handbook,

Performance of Commercial Activities.

Washington, DC: Government Printing

Office, 1996.

Porter, Michael E. Competitive Advantage:

Creating and Sustaining Superior Performance. New York, New York: The Free

Press, 1985.

————. Competitive Strategy: Techniques

for Analyzing Industry and Competitors.

New York, New York: The Free Press,

1980.

Savas, Emanuel S. Privatization and PublicPrivate Partnerships. New York, New York:

Seven Bridges Press LLC, 2000.

Simons, Robert. Levers of Control. Boston,

Massachusetts: Harvard Business School

Press, 1995.

————. Performance Measurement & Control Systems for Implementing Strategy.

Upper Saddle River, New Jersey: PrenticeHall, 2000.

Stiglitz, Joseph E. Economics of the Public

Sector. New York, New York: W.W. Norton

and Company Inc., 1988.

Williams, Cindy. Holding the Line — U.S.

Defense Alternatives for the Early 21st

Century. Boston, Massachusetts: Belfer

Center for Science and International

Affairs, John F. Kennedy School of Government, 2001.
G-1

APPENDIX G

ACRONYMS
G-2
G-3

APPENDIX G

ACRONYMS

ABC – Activity Based Costing

ADP – automatic data processing

ADR – Annual Defense Report

AF – Air Force

AFGE – American Federation of Government Employees

AOL – America Online

BRAC – Base Realignment and Closure

BUR – Bottom-Up Review

CAMIS – Commercial Activities Management Information System

CD – Compact Disc

CSIS – Center for Strategic and International Studies

DAU – Defense Acquisition University

DEC – Digital Equipment Corporation

DLA – Defense Logistics Agency

DoD – Department of Defense

DRI – Defense Reform Initiative

DRID – Defense Reform Initiative Directive

DSB – Defense Science Board

DSMC – Defense Systems Management College

ERP – Enterprise Resource Planning

EU – European Union

FAIR – Federal Activities Inventory Reform Act

FAR – Federal Acquisition Regulation

FTE – Full Time Equivalent

FY – fiscal year
G-4

GAO – General Accounting Office

GE – General Electric

GM – General Motors

GOCO – Government Owned / Contractor Operated

GPRA – Government Performance and Results Act

GS – General Schedule

HBS – Harvard Business School

IBM – International Business Machines

ISSA – Interservice Support Agreement

IT – Information Technology

JIT – Just-in-Time

JWOD – Javits-Wagner-O’Day

LM – Lockheed Martin

MCE – Manufacturing Cycle Effectiveness

MEO – Most Efficient Organization

NAFTA – North Amercian Free Trade Agreement

NATO – North Atlantic Treaty Organization

NG – Northrop Grumman

NIB – National Industries for the Blind

NISH – National Industries for the Severely Handicapped

OFPP – Office of Federal Procurement Policy

OMB – Office of Management and Budget

OPM – Office of Personnel Management

OSD – Office of the Secretary of Defense

PC – Personal Computer

PIP – Privatization in Place

PMD – Program for Management Development

PPBS – Planning, Programming, and Budgeting System

PWS – Performance Work Statement
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QASP – Quality Assurance Surveillance Plan

QDR – Quadrennial Defense Review

R&D – Research and Development

RBA – Revolution in Business Affairs

RCA – Radio Corporation of America

RMA – Revolution in Military Affairs

ROM – Return on Management

SC – Supply Corps

TAC – Tactical Air Command

TMSI – Targeted Marketing Solutions, Inc.

TQM – Total Quality Management

U.S. – United States

USA – United States Army

USAF – United States Air Force

USN – United States Navy

USPS – United States Postal Service

VCR – Video Cassette Recorder

WG – Wage Grade

WTO – World Trade Organization

WWW – World Wide Web
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APPENDIX H

ABOUT THE AUTHORS
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APPENDIX H

ABOUT THE AUTHORS

Lt Col Warren M. Anderson, USAF, has had various acquisition-related jobs during his career.

These included work in laboratory research and development, test and evaluation, policy formulation, and program analysis. He has worked on spacecraft thermal control systems, hypersonic

technology, antisatellite weapons, ballistic missiles, and satellite systems. Most recently he was

Chief of the SAF/AQ Staff Group. Lt Col Anderson holds a Bachelor of Science in Chemistry,

Bachelor of Aerospace Engineering, and Master of Science in Industrial Management from the

Georgia Institute of Technology. He is a graduate of Squadron Officer School, Air Command and

Staff College, and the Advanced Program Management Course. He is a Level III Certified Acquisition Professional in Program Management, Test and Evaluation, and Systems Planning, Research, Development, and Engineering. Lt Col Anderson is also a graduate of the Program for

Management Development at the Harvard Business School.

 (wanderson@pmd75.hbs.edu)

LTC John J. McGuiness, USA, has served in various Infantry leadership and command positions. His acquisition assignments include Assistant Product Manager for Mortar Systems and

Department of the Army Staff Coordinator for Bradley Systems. His most recent assignment was

as the Systems Integration Officer, Office of the Assistant Secretary of the Army for Acquisition,

Logistics, and Technology. LTC McGuiness holds a Bachelor of Science degree from the United

States Military Academy, West Point, and a Master of Science degree from the Air Force Institute

of Technology. He is a graduate of the Infantry Officer Basic Course, the Armor Officer Advanced Course, Combined Arms and Service Staff School, the Army Command and General

Staff College, and the Advanced Program Management Course. He is also a graduate of the

Program for Management Development at the Harvard Business School.

(jmcguiness@pmd75.hbs.edu)

CDR John S. Spicer, SC, USN, is a career United States Navy Supply Corps officer. His sea

assignments include Supply Officer aboard USS GURNARD (SSN 662) and Stock Control Officer aboard USS INDEPENDENCE (CV 62). His shore assignments include instructor, Navy

Supply Corps School; Afloat Inventory Management and Outfitting Officer, COMNAVAIRPAC;

and H-60 Weapon System Manager, Philadelphia Naval Inventory Control Point. CDR Spicer

holds a Bachelor of Arts in Public Administration from Drake University and a Master of Science

in Management (Acquisition and Contract Management) from the Naval Postgraduate School.

He is a Level III Certified Acquisition Professional in Acquisition Contracting and Acquisition

Logistics. CDR Spicer is also a graduate of the Program for Management Development at the

Harvard Business School.

(jspicer@pmd75.hbs.edu)
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