Setting priorities for defense programs. (President's Perspective).

As we approach the beginning of a new budget cycle at the Defense Department--the president's fiscal 2003 budget--there is the usual talk about funding shortfalls and potential program terminations. It may be useful to review what we know about defense budget cycles and, in the process, remind

The intent here is not to hypothesize about the fate of any one weapon system. But I think that it's important for the defense industry to be aware of the issues that affect the Pentagon's decisions on what gets funded and what doesn't.

This is particularly relevant today, because, even though the defense budget is going up, modernization dollars are tight. As we have seen with recent program decisions, there are no sacred cows.

To begin with basics, it is difficult to remember when the nation has ever fielded the forces to fully underwrite any declared strategy. Except for a few years during the Reagan administration, the United States has not fully resourced the forces that it did field. That is the situation we face today. After years of under-funding, the service programmers and budgeteers face the same dilemmas each budget cycle--what to fund fully, what to fund partially and what to cancel.

This exercise in setting priorities, in most cases, puts the emphasis on near-term combat readiness. The upshot is that resources are directed to training activities (steaming days, tank miles and flying hours, for example). Other accounts are used to sustain the readiness of the fighting systems (depot maintenance and war-readiness spares). There are also some must-pay bills, such as salaries and medical benefits.

Other accounts are vulnerable, to a greater or lesser degree. While some major acquisition programs tend to get protected, others--such as procurement of munitions--rend to get stretched out with lower annual production runs. Other accounts get hit even harder. Base operating support, real-property maintenance and military construction often are funded at fractions of the real need.

The Pentagon's budget currently on the Hill is significantly higher than last year's, but is still under-funded. Most of the increase covers expenses associated with the current war on terrorism, past unpaid bills, increased health-care costs, inflation and program-cost growth. Even though the budget overall is $48 billion higher than last year's, only $10 billion of that is for new requirements.

The real question is: How will the administration prioritize defense spending? A quick reading of the concept documents and speeches provides insight into the decision processes of the Bush administration. The Quadrennial Defense Review is a document well worth reading more than once. It lays out the strategy for defense, anticipated scenarios, regions of the world for action and criteria for system goodness--namely, "transformation."

In a speech at the National Defense University, Secretary Rumsfeld gave the concept of transformation a place of prominence. It must be concluded that being "transformational" is a key attribute for systems that compete for funding.

Another important consideration is program performance. In this context, it is useful to go over comments made recently by Undersecretary of Defense for Acquisition, Technology and Logistics Edward "Pete" Aldridge, who has put the word out that his office is watching closely every program and that he will not tolerate excessive cost overruns and performance problems. Aldridge has placed several major programs on a special watch status, based on their compliance with the Nunn-McCurdy law.

That legislation stipulates that when a program is 15 percent over budget, the Pentagon has to notify Congress. When there is a 25 percent overrun, the secretary of defense has to certify four criteria for the program to continue: Is the program essential for national security? Is there an equally capable alternative of lesser cost available? Is cost under control? Is there management in place to keep it under control?

If those four criteria cannot be certified, then the fund obligation stops. Aldridge believes that Nunn-McCurdy is a good tool to deal with programs that are sick. "It is the hardest thing to do, to take a weapon out of the budget," Aldridge said. "It is just so easy to put one in.

A factor that figures prominently in program stability is the ability of the service program managers to predict the cost of a weapon system over its entire life. Both Aldridge and Dov Zackheim, the Pentagon's comptroller, have said repeatedly that they will take a harsh stance toward programs that underestimate their cost, under the assumption that Congress will make up the difference. To determine whether a program is over budget, the Defense Department no longer relies on the services' or the contractors' own estimates, but on the CAIG (Cost Activities Improvement Group) figures. The CAIG's figures usually are within 2 percent of the actual cost of a program, according to Aldnidge. The service estimates, conversely, are anywhere between 17 and 19 percent too low.

For the past 15 years, we tried to buy defense capability on the cheap--avoiding hard choices about how to restructure the post-Cold War force, while neglecting to adequately fund the forces we inherited from that era. Despite the large increases contained in the 2003 budget, more "hard choices" are on the way. The traditional priorities--force readiness and current operations--will continue to dominate funding allocations. Programmers and budgeteers will continue to look for programs to cut or eliminate. Funding decisions about program survival, force recapitalization and new systems will be guided by the new criteria laid our by the administration--program performance and contributions to transformation.