Original audio cassette(s), signed legal release forms, and edited interview transcripts are on file in the Defense Acquisition History Oral History Collection, U.S. Army Center of Military History, Fort Leslie J. McNair, Washington, D.C.

Dr. F.M. "Mike" Scherer

UNITED STATES ARMY
CENTER FOR MILITARY HISTORY

DEFENSE ACQUISITION HISTORY PROJECT

DISCUSSION BY
DR. FREDERIC M. "MIKE" SCHERER

AT FORT McNAIR, D.C.
7 JUNE 2006

Discussant:  Dr. F.M. “Mike” Scherer
Participants:  DAHP historians
Date:  7 June 2006
Location:  Fort McNair, D.C.

[The group prepared some questions for Dr. Scherer to review in advance of the discussion.  Question 1 reads:  Before the publication of The Weapons Acquisition Process in 1962, the term “acquisition” was rarely used in that context.  The words most frequently used were “research and development” combined with “production” and especially “procurement.”  After 1962, “acquisition” gradually took hold in the Department of Defense.  Today, the term “acquisition” is fully institutionalized (e.g., under secretary of Defense for Acquisition, Technology, and Logistics; Defense Acquisition University).  It is the umbrella term for all aspects of acquiring materiel, much as “logistics” was in the 1940s and 1950s.  Today, “logistics” has a much narrower meaning, encompassing supply, distribution, and maintenance.  Who selected “acquisition” as the title for your book?  And was there a particular reason for its selection?]

DR. SCHERER:  I did some research in my files.  I'm in the process of downsizing and I’m about to throw all that stuff away, but I hadn't thrown anything away yet.  I had a bunch of memoranda, including, as it turned out, a memorandum that presumably Paul Cherington, (Paul W. Cherington, headed the Weapons Acquisition Research Project (WARP) and later became James J. Hill Professor of Transportation at Harvard University.  From 1958 to 1961, WARP studied twelve major defense contracts including the Atlas, Jupiter, and Polaris missiles, the F4H interceptor, and the Nike Zeus anti-missile. Their case studies covered more than 1,200 draft pages.  See: http://www.thecrimson.com/printerfriendly.aspx?ref=107339 .) our project leader, wrote.  The revised edition is [dated] 7 December 1957.  There is not one word of “weapons acquisition” in that memorandum.  By early July 1958, [there were] several memoranda, all headed: “the Weapons Acquisition Research Project.”  I found one memorandum that I must have written after being there for two weeks, which does not have anything about “weapons acquisition.”  So the name must have been given some time in June or early July 1958.

Now, why would that have happened?  All of us began gathering in early June 1958, and I'm sure we had intensive meetings trying to figure out what we were all about.  My guess is that somebody asked, “What shall we call ourselves?”  And someone—I'm sure it was not myself because I'm not clever enough—must have come up with the name Weapons Acquisition as a simple way of talking about what we said in our initial memorandum. 

The initial memorandum—7 December 1957, is the revision—says: “Proposed Harvard Business School Study of the Relations Between Government and Business which Affect the Speed and Economy of Advanced Weapons System Development and Production.”  That was, at this time, standard nomenclature.  So all I can deduce is that some clever fellow in June 1958, which is when the project actually got going, said, “We need a short name.”  My guess is, knowing the parties involved, either Paul Cherington came up with the idea—he was the director of the project—or our outside consultant, David Novick (David Novick joined the RAND Corporation in 1949, where he established the cost analysis department.) of the RAND Corporation, came up with it.  (I did look at Dave's earlier writing to see if he had used the word “weapons acquisition,” and I couldn't find it.)

So I think it must have been the result of a brainstorming session in June 1958, when our project got going. If you want, I do have this original memorandum, almost surely by Paul Cherington, although it's not signed, which initiates the project.
I don't know if you know this, but the way the project got started, Sputnik went up.  When was it?  October '57?  [The Soviet Union launched Sputnik on 4 October 1957.]  And around the Harvard Business School, people began asking:  How is it that our nation can be behind the Russians in space exploration and probably also missile technology?  And then the refrain came up:  How is it that the business system under which weapons are developed, how has that failed?  We, the Harvard Business School, need a research project to explore this.  This memorandum tells about the original objectives of the project, almost surely written by Paul Cherington.

I have a note on it: Joe Peck. (Yale economist Merton J. “Joe” Peck co-authored The Weapons Acquisition Process with Dr. Scherer.)  Joe was the other economist on the project.  I signed up after talking to Joe Peck about what he planned to do.  I must have signed up in December 1957 but didn't join the project formally.  I think everybody else joined at the same time in June 1958.  So that's the history of our project and the history of the name.  I have not been able to find any prior use of the term “weapons acquisition.”  That doesn't mean it doesn't exist.

DR. CONVERSE:  That doesn't exist in the documents at that time. In other words, it's not being used in the government, at least through 1958, at least as far as I know, in the context of acquiring weapons systems.

DR. SCHERER:  Now, we did do a one-pager that's dated 11 July 1958, which is headed:  Research Project on Business and Government Relations in Weapons Acquisition.  I think we handed this out widely to everyone we talked to.  So that must be the first publication or dissemination of the term. The later—July 1958—memorandum calls us the Weapons Acquisition Research Project.

DR. FOX:  Novick was such a force at RAND and imposing figure on this project that it might be useful to see if there were RAND publications prior to this date that used the term “weapons acquisition.”

DR. SCHERER:  That should be easy because RAND used to have a printed catalog of its publications.  I don't know if they still do.  Probably computerized now.

DR. SHIMAN:  I think it's all online now.  I don't know, going back to the '50s, but—

DR. SCHERER:  In those days, they hadn't actually physically published the catalog.

DR. BROWN:  We have a copy in the library here that goes back to 1948 or '49.

DR. SCHERER:  I did look up the few RAND publications still in my library and could not find the term, but I did not retain Dave Novick's seminal RAND memorandum that gave rise to PPBS [Planning, Programming, and Budgeting System].  That was the start of PPBS.  I'm sure you know this.

DR. FOX:  I have a contact at the Army Acquisition Study at RAND, the study that they've conducted in the past three years.  I'd be happy to contact them and see if they have any information on this.  I would think that they would have done some research on their own publications internally.

DR. SCHERER:  Dave must have published this PPBS RAND memorandum probably about '56 or '57.  It went over like a lead balloon within the Air Force.  Then it came to [Secretary of Defense Robert S.] McNamara's (Robert S. McNamara was secretary of Defense from 1961 to 1968. ) attention as he was coming in to the department—well, Charlie Hitch, (Charles J. Hitch served as assistant secretary of Defense (Comptroller), 1961-1965.  At the time, the Systems Analysis function belonged to the comptroller’s office. ) too, I guess—and he implemented it. 

So that's the history. That both tells the history of my involvement, namely I started in June of '58, and the best I can say about how our name was created.

DR. CONVERSE:  Have you been aware from the years about the term, how it became adopted?

DR. SCHERER:  Yes, I did see it, but I didn't really know that we were it.

DR. CONVERSE:  I think you were.  Acquisition is the umbrella term that encompasses the activities associated with research and development, test and evaluation, production, and procurement (contracting).  In the 1940s and 1950s, the comparable umbrella term often used was “logistics.”

DR. SCHERER:  Yes.

DR. CONVERSE: Since the 1950s, the meaning of “logistics” has narrowed.

DR. SCHERER:  “Logistics” is now getting stuff to the place where you need it, when you need it.

CONVERSE:  It's a narrower use of the term, compared to what it used to be.

DR. FOX:  But I think if you were to go to OSD today and say, “What is included in logistics?” they would say, as you just point out, “Supply, maintenance, transportation, procurement, and medicine.”  I think all of those units would fit under the umbrella and probably some other things that I don't know about of logistics and OSD.

DR. CONVERSE:  When you say procurement, do you mean contracting?

DR. FOX:  Yes, unless that has been pulled out, because the vast amount of procurement for supplies and—well, supplies, generically, would always have been under the umbrella, to the best of my knowledge, of logistics. To the best of my knowledge, it still is.

DR. CONVERSE:  That would be more true in the Army and the Navy than in the Air Force, I would think, especially the Army.

DR. FOX:  That would make sense.

DR. SCHERER:  If we've beaten that horse to death, let me just add one thought because the memorandum you sent me said, among other things, that you're doing a sixth volume on the history of research in DoD.

DR. LASSMAN:  That's me.

DR. SCHERER:  Okay. I have a thought about that. I mean maybe you know about this, maybe you don't know about it, but it's terribly, terribly important. The transistor got invented around '49 or '50, of course, at Bell Laboratories.  One interesting thing is that Bell did not put transistors in the guidance system for its first missile, the Nike/Ajax—although it did so for the second iteration, Nike/Hercules.  The technology wasn't advanced enough. The [transistors] weren't reliable enough to be put into the Nike/Ajax.  The first major use was in the Minuteman, the guidance system of the Minuteman.
The Minuteman went into development around '57 or thereabouts, maybe '58, and as people were designing guidance systems now built around transistors, someone said, “Hey, these transistors are really wonderful and they allow us to do a lot of miniaturization of the electronics that cost so much to transport in a missile.  Wouldn't it be nice if we could miniaturize this stuff even better?”  I can't give you exact dates, although I can give you the reference. About '58 or '59, the services came together with DoD and embarked upon a major program aimed at miniaturizing transistors even more.  Somehow they were going to put a bunch of transistors together, stack them vertically. That was one of the projects.  There were a dozen or so contracts that were put out to try to miniaturize transistors even more. The Air Force was the most prophetic. They called their program the Molecular Electronics Program, which is a technology we're about to reach. We're not quite there yet; they were forty years too early. 

In any event, they put out, as I recall—I've got some history of it in a book I wrote—they put out twelve or fourteen contracts to industry to do this. One company that sought the contract was Shockley's firm, Shockley Instruments.  Victor Jones went from Shockley Instruments to Harvard and taught physics at Harvard for thirty years.  I heard this story at a cocktail party, actually, in Cambridge, when I bumped into him.

DR. LASSMAN:  This is one of his group?

DR. SCHERER:  Yes.  He said he made several trips by air from San Francisco to Washington trying to get a contract in this miniaturization program for Shockley Instruments [Shockley Semiconductor Laboratory in Beckman Instruments] and failed.  It went to other people.  But in expressing its demand for miniaturization with these contracts, the military and DoD sent out a signal that they really, really wanted inventions that would get down the size of the electronic circuitry.  That set Jack Kilby to work at Texas Instruments without a contract.  Meanwhile Shockley had broken up and a dozen of them had defected and created Fairchild Semiconductor.

At Fairchild, you had the inventions by Jean Hoerni and by—who was the first CEO of Intel?

DR. LASSMAN:  Noyce.

DR. SCHERER:  Robert Noyce.  Among the three of those, you had the invention of the integrated circuit, which is one of the great technological achievements of the twentieth century, setting in motion a whole train of things that have profound implications for the military. 

Well, that was clearly in response to an expressed military demand.  The point is the technology push contract didn't do the job.  It was the expression of demand pull and the ingenuity to which it gave rise that solved the problem.  This is a very important moral. 

If you want, you can just e-mail me and I'll give you the reference.  There are a couple of articles in Aviation Week in this period that explain what's going on.

DR. LASSMAN:  I've seen several on the Molecular Electronics Program.  I know some of the big electrical equipment manufacturers got big Air Force contracts.

DR. SCHERER:  Yes.  Well, they had contracts out to do this.  The Air Force had the most inventive name.

DR. LASSMAN:  Yes.  I have seen several references actually in Aviation Week.

DR. SCHERER:  It's in my chapter on semiconductors in my book, Industry Structure, Strategy, and Public Policy (F.M. Scherer, Industry Structure, Strategy, and Public Policy (Addison Wesley, 1997).)—about the third page or so of the chapter on semiconductors.  I think it's a great story.

DR. LASSMAN:  When you talk of demand pull, that's in the commercial sector, though.

DR. SCHERER:  No. It works in military.  If you express a need, they will come.

DR. LASSMAN:  DoD pretty much single-handedly created the market for semiconductors.

DR. SCHERER:  In the early years.  Well, actually, it bifurcated because you had hearing aids first and pocket radios with low-end transistors.  But the DoD created the market for high-end transistors.

DR. LASSMAN:  And they pulled the advances because of the demand for increasingly better performance.

DR. SCHERER:  Yes.

DR. BERLAGE:  Do you think that's still the same situation?  Or has it turned out to be the other way in weapons acquisition, that the innovation is coming from outside the normative, that it's coming more from industry and business, going in the other direction?

DR. SCHERER:  Well, I think you have to bifurcate there.  Component technology or—there are little things that go in—lasers, all that kind of stuff is really being driven on the civilian side and spilling over into the military, especially things like microprocessors, faster microcomputers, and all that sort of stuff—disk drives, storage, all the kinds of things you want to do with computers and electronics and, for that matter, communication, although there you've got a more complex interaction because of the military development of networking.  But a lot of this is coming from the civilian sector and spilling back to the military.  There was a time when simply the expression of military demand would induce people to develop aircraft and the like for military purposes, essentially at private risk at that time, with the start of the World War II.  It's really never existed before. 

The only major systems development I can remember after the war where a company actually developed a major possible combat aircraft at private risk was the Northrop T-38.  It turned out to be a trainer [later sold overseas as the F‑5].  Northrop developed a plane at private risk that was the predecessor to the F‑16. They sold a lot of them, actually, but never turned out to be a weapon system.  It turned out to be a trainer, especially for the National Guard and foreign governments.  By and large, at the system level, the military has to decide what it wants and put out technology push contracts. 

I guess there are a couple other messy in-betweens, like synchronous orbit satellites and the like, which were originated by a military contractor but initially, at least, for civilian purposes.  Hughes did that. 

I'll follow your outline or let you raise the questions.

DR. FOX:  Well, unless somebody wants to insert another question, why don't you move on through?  I should say, and this is a compilation of questions that people sitting here have submitted, Question Number 2 has a number of similarities to Number 7, but I thought they were sufficiently different that I kept them separate.  You may want to address them at the same time.

[Question 2 reads:  In the 1950s, dozens of firms competed for major weapon system contracts.  Today, as a result of consolidation, there are only a handful, principally Boeing, Lockheed-Martin, and Northrop Grumman.  Was this process inevitable?  And does this consolidation pose dangers to national security?

Question 7 reads:  Please share with us any observations you have on the status of the industrial base today.  Do you believe the consolidation of the defense industry and the globalization of it over the past two or three decades (with its resulting foreign dependencies) pose serious problems for U.S. defense acquisition?]

DR. SCHERER:  Well, the declarative statement [in Question 2] is certainly true and so also is the statement that very few companies are now there.  I got this from somebody in the Pentagon, this chart showing the mergers in the industry. (“This” refers to the graph, titled “Consolidations in the Defense Industry” and hand-numbered 1 in the file that attends this interview.)  I got this when I was doing some work on the proposed merger between Lockheed-Martin and Northrop Grumman.  There were really two turning points in this history.  One was [William J.] Perry's (William J. Perry became director of Defense Research and Engineering (DDR&E) in April 1977.  In October 1977, the position became the under secretary of Defense for Research and Engineering, and Dr. Perry held the office until 1981.  He returned as deputy secretary of Defense in 1993 and was sworn in as secretary of Defense in 1994, serving until 1997.) “Last Supper,” when he got all the heads of the major defense companies together and—this is the early '90s—said in effect, “Look, there's not room for all you guys.  We don't have the money to procure systems from all of you.  You're going to have to merge.”  Now, that may or may not have been right-headed. In hindsight, it was more right than wrong. It induced a lot of mergers. 

One should not attribute what happened, however, only to Perry. There was something parallel going on that really complicated the process.  It's been a long time since I have worked on this and so I don't remember the details exactly, but about the time of Perry's Last Supper, the Pentagon people were talking up on the Hill and Congress passed an appropriations bill or rider that provided compensation to contractors for downsizing costs or reorganization costs incurred as a result of merger. Now, think of yourself as a big defense contractor faced with a shrinking market for your product.  You’ve got a half a dozen or a dozen plants or labs out there that you know are redundant, but if you close them down now unilaterally, your stockholders are going to take a hit for retirement costs, buy-out costs, and other kinds of shutdown costs.  This bill said that if you do this as part of the rationalization that follows a merger, we, the Pentagon, will pick up your downsizing costs.

You could have done the downsizing in either of two ways.  You could have done it by having each company shrink and downsize its own set of facilities, but then it would have taken the hit to its bottom line because of downsizing costs.  Or you could do it by merging with someone and say, “Ah, now the merger's going to lead to this rationalization.  Pay us for it, Pentagon, under this provision of the law.”  Well, obviously that's going to create a bias for mergers. 

The combination of the Last Supper and this legislation led to this massive merger wave that finally came to a head—must have been '97 or '98, I don't remember exactly when—when Lockheed-Martin proposed to acquire Northrop Grumman, which would have basically brought the number of mainline airframe contractors from three to two.  At that point, a couple of things happened.  The key was probably that you had some new faces in the Pentagon.  You replaced the traditional deputy secretaries, under secretaries of Defense who had come out of industry or out of Wall Street or out of law firms.  You replaced them with Jacques Gansler, ( Jacques Gansler was under secretary of Defense for Acquisition, Technology and Logistics, 1997-2001. He also served as deputy assistant secretary of Defense for Materiel Acquisition and assistant director of Defense Research and Engineering (Electronics).) an economist by training, who had written a couple of books about competition in the defense industry.  Jacques just had a completely different attitude toward this and he was under secretary of Defense, I think, at the time.  He said, “Wait a minute.  How many independent sources of initiative should we be maintaining?  And isn't this one going a bridge too far?” 

So Jacques got a study group going within the Pentagon.  Somehow or other, I don't know the exact mechanism, the Department of Justice antitrust people got involved.  I know there was close liaison between Gansler's group and the Department of Justice because I was on the DOJ team.  DOJ decided that it would bring an antitrust complaint against this merger, supported by the Pentagon.  At first, Lockheed said, “No way, no way.  We're not going to listen to these guys.  We're going to go forward.  If we have to fight it out in court, we will.”  They hired their economist to defend the merger.  They wrote their memoranda defending the merger. 

They were all set to go to court over it, when somehow or other, Lockheed-Martin's people in Arlington were canvassing the corridors of the Pentagon and they realized that at the lower tiers, the colonels and the majors, in the Pentagon hierarchy, there was no support whatsoever for the merger.  At that point, Lockheed-Martin voluntarily called off the merger.  So that was sort of the cessation of this big movement, leaving three major aerospace systems firms, plus some electronics firms.

My own view of the history is that there were two bridges too far.  That one was stopped and maintained some diversity of initiative, but two other mergers should have been stopped and weren't because you didn't have Jacques Gansler in the Pentagon.  Boeing should not have merged with McDonnell Douglas.  That was just the wrong solution.  I remember, I was laughed out of town with my solution.  McDonnell Douglas, which was a damn good company, had two problems.  The problem that the merger purported to solve was McDonnell Douglas's failing civilian airliner business.  I proposed that McDonnell Douglas be broken up and that Wall Street arrange a merger between McDonnell Douglas's civilian Aircraft Division, basically Douglas, and one of the major Russian aerospace companies or, failing that, with Mitsubishi, which had long had intentions to get back into the civilian airliner business.  I was laughed out of town on that.  If you look at the situation, now Boeing has a major design bureau in Moscow.  A major part of their new 787, the Dreamliner, is being done by Mitsubishi. In fact, what I proposed has happened but without a merger.

Now, the other part of McDonnell's problem was that the Joint Strike Fighter competition had been— not terminated but reduced from three to two and McDonnell was left out.  So they didn't have a new major military fighter aircraft system in the hopper.  I was less impressed by that problem than others were because the F/A-18 was a hell of a good airplane. Its major problems were being solved with a redesign and rebuild.  Its major problem was it didn't have sufficient range.  That was being solved.  My view was that for a considerable time to come, McDonnell was going to have a good market for F/A-18s and then let the future bring what it does.  In any event, that's not the way it went.  That was one bridge too far.
The other bridge too far was when Raytheon merged with Hughes. That was a serious mistake. These were two damn good companies that should have been maintained independently.  But besides that, I think most of what happened was inevitable.

Another way of seeing this is this little chart, (See the chart labeled “Figure 11-2: Unit costs of representative bombers and fighters, 1942-1990” and hand-numbered 2 in the file that attends this interview.) which I'm sure you know—this is just is my own version of it—that shows the unit costs of representative fighters in constant 1982 dollars.  You see the World War II P-47 costing half a million dollars or so; and the P-40, $300,000 per unit or so.  Just taking the fighter aircraft alone, the F-15E, costing in 1982 dollars about $40 million a clip.  If you extended this chart into the future, I can't do the purchasing power adjustments, but the YF-22 is probably costing you about, in '82 dollars, maybe $200 million per copy.  This trend is being continued.  The fact that these systems have become so enormously complex and costly means it's inevitable that the services can't afford many of them and therefore can't keep on paying the stable of contractors they did during the, say, 1950s.

I had a student at Harvard roughly ten years ago, an Air Force officer.  She did what is known among economists as a Hedonic Cost Analysis.  In this particular case, she put the unit cost of aircraft on the left-hand side of a regression equation, and on the right-hand side, she put a whole mess of technical characteristics: cruise speed, max speed, range, payload, turn circle, and a whole bunch of other things like that.  She found improvements in performance, for the most part, could explain in some sense—it's kind of a statistical tautology—the increases in unit costs.  So you might say that the changes in technology have made these developments inevitable.  Nevertheless, given that both strategic requirements and technology are changing, still, you want to maintain at least several independent centers of technical initiative in order to make sure that you get a good solution, even if not the absolutely best technical solution.  You don't want that number to shrink much more than it has already shrunk.

DR. FOX:  You may want to address this later on, in which case just set it aside and go ahead and do that, but in light of what you've written in the Peck and Scherer volume and then your follow-on Economic Incentives volume, (F.M. Scherer, Weapons Acquisition Process: Economic Incentives (Harvard University Press, 1964).) it seems to me if I had asked you in 1962 what you would predict would happen to the cost of weapons systems, you might not have been able to draw that exact chart, but I think you would have drawn something very similar to this.

DR. SCHERER:  Yes. We already had the F-111 which was just getting started when we finished our work.  So you had quite a trend already there.

DR. FOX:  If one follows what you're saying about incentives—with which I agree totally—one would predict that inherent in the method of government contracting, and in particular in the method of allocating overhead costs or reimbursing contractors for overhead costs, you would be stunned if this situation didn't occur this way.

DR. SCHERER:  Yes.  Yes.  But I think it's the technology that's driving it. The technology and Kurth.  James Kurth at Swarthmore College wrote a book or article or something about the difficulty of closing down defense contracting plants.  I'd extend that to the laboratories and development centers.  It's damn hard to get these things to close down.  We have closed them down in the context of mergers, but it's difficult, given the way contracts are priced.  Essentially, we'll cover your costs one way or another that contracts are priced. There's an inevitability to what happened here.
Let me just say one more thing about merger that I omitted before.  When the Department of Justice was ready to enter into the fray over Lockheed-Martin/Northrop Grumman, my job, among other things, was analyzing the proposed efficiencies that would derive from the merger and the cost savings.  I remember getting a couple of exhibits for my analysis showing seventy or eighty laboratories and plants that Lockheed was going to shut down and save the money on in the wake of the merger.  I did a detailed, lab-by-lab, plant-by-plant analysis of what each of these units scheduled for closure did and came to a very remarkable discovery.  Most of the labs or plants that were scheduled for being shut down had at least one counterpart lab or plant within the company in which it was currently situated.  If it's a Lockheed lab that works on guidance questions, Lockheed had two or three other labs that worked on guidance questions.
What this said to me was, hell, they could have shut these things down and amalgamated their operations within the company.  Okay.  They had to downsize.  But they could have amalgamated these operations within the company without the merger.  So why did they use the merger?  It's because of this provision in the appropriations bill that says if we do it within the company without a merger as provocation, we swallow the downsizing costs.  If we make a merger, however, Uncle Sam will swallow the costs. 

I was really dumbstruck by this analysis.  It was so powerful.  I mean, I think of ninety or so cases I looked at, seventy of them had within-company counterparts.

DR. LASSMAN:  Did you ever find an explanation for that?  Is it just more of the same thinking, that you had multiple centers of expertise competing within the corporation or within the company for similar projects or trying to develop the same kinds of products?  How had that happened over the course of the company's history?

DR. SCHERER:  Well, the major reason is that they had acquired lots of other guys and they had not fully rationalized.  I can't readily think of companies that will normally set up competing facilities within the company to work on the same bit of technology or mission or what have you.  You will get multiple plants for good reasons.  Boeing, for example, when it was producing a hell of a lot of B‑17s and then B-29s, needed multiple plants to carry the production load.  General Dynamics had one at Fort Worth and one at San Diego.  In an earlier period, this made sense to have some duplication simply because, if you've ever seen Convair’s old plant at Fort Worth, [you know that if] you make it any bigger than it was was to make it too damn big.  Or look at Boeing in Everett, [Washington].  That's an absolutely huge plant.

DR. FOX:  And you've pointed out—and I think it was one of several important observations in The Weapons Acquisition Process—profits are a positive function of costs.  So when you say, “Look, you could reduce your costs very substantially by merging all of these laboratories that you have,” you've got to be willing to shoot yourself in the foot because you're going to be reducing the basis for calculating costs with your Defense Department contractor who, because of perverse reasons, thinks profit ought to be a function of costs. The higher the cost, the higher the profit.

DR. SCHERER:  Yes. Because—I think we'll get to this on your question list—all of your major systems acquisition contracts are in one way or another, until you get to a very late stage in the procurement cycle, all cost-based. 
They're not always 100-percent cost-based.  The Pentagon has, on occasion, been able to use its leverage to get the contractor to swallow some of the early phase costs, but basically they are cost-based.  Yes?

DR. CONVERSE:  If you extended this chart back, it was even more drastic because by 1980, a lot of the aircraft companies are gone.  Does it trouble you that we are basically a country that depends upon maintaining a technologic advantage for its security—and has since World War II—and that we have really five big companies here that are responsible for that?  I'll get into deep water quickly here, but it seems to me that these big companies are no different than any big institution in that the bigger it gets, the less innovative it probably tends to be.  There was this RAND study done about five years ago, about combat aircraft industry. [Mark Lorell, The U. S. Combat Aircraft Industry, 1909-2000: Structure, Competition, Innovation (RAND, 2003).] [The author] was very cautious in there about drawing conclusions, but he did—

DR. SCHERER:  He did the bomber study, too. (Mark A. Lorell with Alison Saunders and Hugh Levaux, Bomber R&D Since 1945: The Role of Experience (RAND, December 1995).)

DR. CONVERSE:  Yes.  What he suggested was that periods of innovation took place when there were numerous competitors.  I think the extent of defense industry consolidation is troublesome.

DR. SCHERER:  Well, it is troublesome.  On the one hand, you want as much diversity of sources as you can feasibly have.  On the other hand, you are constrained when the cost of a single program is a big chunk of your procurement budget.  So you've got to kind of make a trade-off there.

Three is not a bad number.  Two is a very bad number, I think.  Three is not such a bad number.  You'd like more, if you could.  If you can't because of the cost, you want to do other things.  You want to make it possible for an upstart company—they may happen rarely these days, given the scale of things—  You want to give them a fighting chance to come up with a superior concept and get established, if they really have a better mousetrap.  How often that happens these days, I don't know. 

I read some stuff recently about SpaceX and this proposed merger between the launch operations of Boeing and Lockheed.  SpaceX seems to have a quite different concept for getting payloads into space.  That's the kind of company I would try somehow in my procurement policy to encourage. I don't want to say sustain, but at least encourage.  I want to buy some stuff from them, and if they really do have a better mousetrap, I want them to grow.  So I want to be on the lookout for guys like that.  I suspect they're rare these days, but that's one thing I want to do to maintain openness to technological change.

The other thing I want to do is have a very good scientific advisory group, which is providing me with ideas about where the science base is taking us militarily and proposing new concepts.  The most striking example of this is, of course, the genesis of the Polaris, where you had a whole bunch of missile systems coming along, but the ideas for a submarine-launched missile, I mean, they just didn't make any sense.  The missile was too damn big to put on a submarine.  They had a winter study group or a summer study group out at Woods Hole and brought together a bunch of academic scientists and the Livermore Labs people and the like and talked about—[Vice Admiral] Red Raborn (Vice Adm. William F. Raborn directed the U.S. Navy’s Fleet Ballistic Missile Program from its inception through the development of the Polaris missile.)was [among them], I think—this problem.  Wouldn't it be nice if we could hide these missile launchers out in the ocean somewhere?  But the trouble is the missile's too damn big for the submarines.  It may have been [Edward] Teller, but I'm not sure, who said, “Gentlemen, you're not thinking forward.  We're going to be able to develop hydrogen warheads that will fit in a space this size.  When we do that, you can make the submarine-launched missile very small and get a bunch of them on a submarine, and this is going to begin to make economic sense.”

You want to maintain that.  That was completely divorced from the decisionmaking processes of the contractors.  This one originated out of the scientific advisory base, and it was a revolution, an important revolution.  You want to sustain that kind of thing, if at all possible, where you've got independent sources of ideas and if one looks good, you're going to put a contract out, a study contract, and see if you can make something of it.  So yes, it's a problem to have the initiative base shrink to, say, three enterprises, but there are things you can do to combat the blindness that might follow from that.  Yes?

DR. SHIMAN:  Kind of following on to that, I noticed you commented, in Peck and Scherer, about, I guess at that time, the barriers to entry for new firms into the weapons business were low because twenty-five years later, all the talk was on the high barriers to entry and it was very difficult for innovative companies, you know, such as high-tech companies and companies like Motorola, to get into the defense business because of these barriers, all of the peculiar requirements and mil specs and what have you.  How did that change in the, about, twenty-five years from when you had written that, and why did it change?  Has it been corrected at all, in your view?

DR. SCHERER:  Well, you did have, after World War II, a fair amount of entry of really new firms into the business.  Sanders Associates is one.  Hughes was a relatively latecomer in a sense.  I mean, Howard Hughes built, what was it, the Spruce Goose. You had a few new entrants, but actually very few at the systems level after World War II.  Raytheon got in relatively late.  They weren't doing any systems.  They were just doing radars during the war. 

We had a few new entrants, but very few.  What happened is two things. One, it got too damned expensive to come up with and carry through a new systems idea.  I guess companies like Thiokol and—who was the other solid rocket producer?—Aerojet General, those were new entrants, too.  But it got very expensive to do it.  It got to be a more specialized kind of activity with its own routines, its own bookkeeping, its own procedures, and all the rest.  A lot of the companies that might have entered simply said, “Hey, we don't need this complication.  Our civilian business is difficult enough.  Let's stay out,” or in some cases, get out.  It became more specialized.

DR. SHIMAN:  So it sounds like you're saying that it's partly a function of the government, as it had a declining role in the economy, that these companies had many other choices, that they didn't really need government business to—

DR. SCHERER:  Let's look at it a different way.  When I got started in this business forty-some years ago, I used to compute the statistics.  More than half of all industrial research and development was supported either by NASA or by the Department of Defense.  I haven't looked at it lately, but it's probably 15 percent now.  There's just a world of opportunity for high technology out in the civilian world.  That has been growing much more rapidly, despite growth of the military budget, and it's been growing much more rapidly than the military space part of the R&D enterprise.  There are just a lot of guys out there who say, “Thank you very much, I'm happy with what I'm doing as a civilian vendor, and I don't want to mess with this different world of military contracting.”

Why is military contracting different?  Is it just with the government?  Is it just this?  Is that why?  I think the answer is no.  I think the message of Peck and Scherer is that these programs are so big and they are so risky, you really can't do it any other way.  Burt Klein used to say—Burton H. Klein was a towering giant at the RAND Corporation—that the only private enterprise company in the aerospace systems business these days is Dassault.  What drives Marcel Dassault forward to continue doing business the way he does is fear of nationalization.  If he performs well as basically an independent vendor with a lot of support from the French government, selling very well in the Third World, as long as he succeeds there, he's not going to be nationalized.  As soon as he fails, they're going to nationalize him.  I think he's been nationalized.  I haven't followed, but I think Dassault is now part of one of the European aerospace giants. 

It just isn't a business that lends itself—and this is a central message of Peck and Scherer—to doing it the private enterprise way.  Now, to repeat it, it's a business that relies very much on component-type technology inputs from the private sector.  Intel is not considered a defense vendor, but it has contributed enormously to the performance of our weapon systems.

DR. LASSMAN:  So, at the time that you're writing in the early '60s and we'll say the twenty-five-year period afterward, I was under the impression that a lot of private sector firms functioning primarily in the commercial businesses actually were finding the defense business as a way to smooth out their commercial cycles.  You have firms that have either gotten into the defense business because of the war and so they make bombs and torpedoes and are moving into electronics because they had divisions that were related to that and they stayed in it after the war, or  you have new entrants that come and see the growing defense industry and say, “Hey, let's get a piece of the pie and we're going to jump into it.”

DR. SCHERER:  That kind of diversification was big in the '60s and early '70s. I have not seen much of it since.

DR. LASSMAN:  You mean as part of the conglomerate movement?

DR. SCHERER:  Yes.  There was a philosophy that diversification is good in its own right.  There have been success stories, but there have been more failure stories than success stories.

DR. LASSMAN:  When I've been looking through issues of Aviation Week, for example, I've seen a lot of advertisements for firms that didn't have any military experience, like General Mills up in Minneapolis or AMF [American Foundry and Machine Co.].

DR. SCHERER:  [General Mills] was big already in the '50s.

DR. LASSMAN:  But General Mills had a mechanical division that was doing defense work during the war and then they kept pushing that.

DR. SCHERER:  I think they're out of it now, aren't they?

DR. LASSMAN:  They are. They sold that division.  I guess I was trying to figure out to what extent that diversification then was as broad. It wasn't much more broad, as you're saying.  It's much smaller.

DR. SCHERER:  Well, when Peck and I wrote and for some years thereafter, this diversification into defense to balance things out was viewed as a very good thing.  I think if you could get the data, you'd find that there's been a big movement away from that since then.

DR. FOX:  But I think it's also clear—and you're not saying anything contrary to this—that there are hundreds, if not thousands, of companies that don't appear on this list here, many of which are small companies.  I think of one that I just became acquainted with this past week called Sensis Corporation, that has developed a way of keeping track of aircraft on the ground, something that the Air Force has lacked both in the military services and in commercial airports.  Amazing number of near collisions and, in fact, collisions that can be avoided by just keeping track of these. 

Now, they would like to have a big DoD contract.  They already have a big FAA contract and a number of commercial airport contracts around the world, but what they've done is because they need some of the political clout—they do have some competitors—they have gone and partnered with Northrop Corporation. They maintain their separate identity but they get Northrop to do the things Northrop can do best, not the least of which is some political support from districts around the country.  They maintain their identity in their unique contributions to this emerging new technology.

DR. SCHERER:  It's not unlike pharmaceuticals.  There's a close analogy here.  The most innovative companies in the pharmaceuticals industry, broadly defined these days, are biotech companies, most of them start-ups.  They don't have the resources to deal with clinical trials and getting stuff through the FDA and detail men to get into the physicians’ offices and sell the stuff once they've got an FDA approval.  So they partner with or sell out wholesale to a big pharma company, and that's a winning business strategy. 

My daughter is one of those.  She's research director of a small biotech start-up.  I've asked her, “What are you going to do if you go into Phase II trials?” She said, well, her first best would be to partner with a big pharma company, but we can't do it ourselves, we don't have the resources to get through what FDA requires of us. So, our second-best is to sell outright to a big pharma company.

DR. BERLAGE:  I have a question that relates to what we were just talking about and when you said that the applications of private industry just aren't very useful, and to what you started out talking about, the sources of innovation and where that comes from and where the drive for innovation comes from as applied to technology.  I wanted to ask you about the sources of innovation when you're talking about managerial innovation because presumably that's also been a part of the acquisition process.  The search for better ways of managing the process, the program, in order to somehow achieve a better economy, production, etc.  I wanted to ask you a bit about where the sources of that kind of knowledge comes from.  Has that come from the outside, from social science type of knowledges?  From the business series, managerial series?  Has that impacted the way that the acquisition process has changed or been managed?

DR. SCHERER:  I guess I'd start by saying that in management as in technology, necessity is the mother of invention.  The new managerial forms that have evolved in the defense sector, I think, have been a great contribution, much as Edison inventing the light bulb—which he didn't do. It was inventing the whole system of providing electric lighting.  So it really goes back more than a century.

The idea of requiring systems management—and I can't pinpoint exactly where that started; certainly the services had what you might call today systems integration offices in their management structures.  Wright-Patterson Air Force Base in the Air Corps/Air Force, various Army arsenals, the Navy shipyards, the Bu-Ships and the Bu-Ord.  They had their program management offices.  After the war, as somebody has already said, that approach to the problem faded, but it certainly wasn't nonexistent.  Contracting out to do the systems integration job or the program management job or both really—they're somewhat different—became more and more important.  Part of it was political in the sense that the companies proved to be more effective champions of new weapon systems than the military program offices were, given the limitations on the lobbying that they could do, although [Admiral Hyman] Rickover (As head of the Naval Reactors Branch of the Bureau of Ships and concurrently the head of the Division of Reactor Development of the Atomic Energy Commission (AEC) starting in 1949, Admiral Hyman G. Rickover shaped and guided the nuclear Navy for more than three decades.) was a supreme master of lobbying.  Part of it was simply that the companies could hire, given government pay scales, superior talent, and you needed superior talent to do this systems integration job. 

There's a lot of confusion over this, and I would want to differentiate at least two aspects of systems integration, which I think I made clear in my Nike studies.  One aspect is simply having somebody looking over the whole collection of parts and saying, How do these guys fit together?  Who gets what parameter?  Who has to take a reduced specification so that we can have an enhanced specification somewhere else in the system, given constraints on size and payload and electrical power and all that stuff?”  Somebody has to oversee the process of doing this.  Over time, it became clear that the traditional military program offices usually did not have the technical talent to carry out this tough job effectively.
There's another aspect of systems integration, or program management ,or whatever you want to call it that I think is at least as important, but that has been achieved less uniformly.  That is having someone sit down right at the outset of a program and saying “What does the state of the art allow?  What does the state of the component art allow?  What does the state of the physical parameters art allow?  What can we reasonably achieve at reasonable cost on a reasonable time frame?  What is just too difficult?”  I think the Nike/Ajax program was the supreme, early manifestation of bringing this kind of approach to a weapons program.

Contrast that to the Bomarc. You haven't seen our Bomarc study.  Bell had really, really good people, and they put them to work for a while on the Nike, asking these kinds of questions.  It wasn't so much: “How many notches in the umbilical does Douglas get for the missile part and how many notches do we get for the guidance part?”  That had to be done, but that was relatively low-level. Simply asking what does the state of the art allow on the kind of schedule we want to maintain— Bomarc was a very different kind of program.  

It is always a shame that my alma mater had a lot to do with screwing up Bomarc at the outset.  A lot of the studies for the Bomarc were done under the GAPA [SAM-A-1] program that preceded Bomarc. They were done at the University of Michigan, Willow Run Laboratories, and they just did not do a competent study of what was feasible, given ramjet technology at the time and given radio communication technology and given guidance system technology.  Bomarc was an $800 million flop, back when $800 million was a lot of money. 
I think you needed these things.  By and large, industry was able to acquire better capabilities to carry out these functions than the traditional military program offices were. 

Now, there were exceptions.  Polaris was, I think, an exception.  To the Polaris project were drawn some of the brightest minds in the United States Navy for Red Raborn's program management office.  They knew what they didn't know, too, which is an important thing, and so they brought in Applied Physics Laboratory to help them out and they brought in somebody else to help them out.  There was a big fight over who was really going to run the Polaris program.  Was it going to be Lockheed, because Gene Root, the general manager of Lockheed Missile and Space Division, wanted to develop a supreme program management capability at Sunnyvale?  Were they going to run the show?  Were they going to tell General Electric what parameters it had to meet in the guidance system?  Or was Special Projects Office going to do it?

In the end, it was very clear that Special Projects Office called the shots.  It's because, again, the Navy gathered some of the very top technical people it had to staff the Special Projects Office.  The Air Force Ballistic Missile Division in Inglewood, California, did the same thing.  Bennie Schriever (General Bernard A. Schriever was commander of Air Research and Development Command (1959-1961) and Air Force Systems Command (1961-1966).) put together a very, very good staff.  They recognized their limitations, too, and they got Ramo-Wooldridge to assist them and CalTech and put together the shop that did the kinds of things that had to be done for a successful program management.

DR. FOX:  Isn't this really a discussion of the whole emergence of systems engineering and systems engineering management firms, like TRW?

DR. SCHERER:  Yes.  Well, TRW evolved out of Ramo-Wooldridge—the merger of Ramo-Wooldridge with Thompson Products, who didn't know anything about weapons development.

DR. FOX:  So that today, I think most program offices in the Army, Navy, Air Force of any size would have a significant systems engineering office within them.  Now, how much systems engineering they do versus having a contractor do would undoubtedly vary from one program to another.

DR. SCHERER:  And it certainly did vary in the period we looked at, from the programs like B-58 and F-4 Phantom, where almost all of the program management was done within the contractor, to Polaris and Atlas or Jupiter.  Well, Jupiter was an arsenal system development.  Almost all the program management was done in the government office.

DR. CONVERSE:  Let me just add: I wasn't as tuned into this when I was writing it as I am now, and when I go back and revise, I'll have a little more certitude.  In any case, you can really see this in the development and production of the B-47. In 1952, the Air Force and Boeing engaged in bitter exchanges over responsibility for development and integration of the aircraft’s component systems.  The Air Force was saying, “Boeing, that's your job,” and Boeing was saying, “No, we thought you would go out and get government-furnished equipment and provide it to us and it would be integrated into the air frame.” The Air Force expected Boeing to integrate the system, but the company didn’t have the capability at that time.

DR. SCHERER:  And Wright-Pat didn't have the capability either.

DR. CONVERSE:  Exactly, exactly.  The Air Force didn't either.  So that's where the need for something like Ramo-Wooldridge Company, you can just see it so clearly—

DR. SCHERER: The necessity is the mother of invention, managerial invention.

DR. CONVERSE:  What's even more interesting is how sharp these people were, Ramo and Wooldridge, to see that need and to fill that.

DR. SCHERER:  Well, they were out in that environment.  I forget the people movements, but they were out there.  RAND had developed a substantial capability at doing some of the kinds of thinking, not the hands-on management, but doing the conceptual thinking needed to put together a weapon system.  One or another of the Ramo-Wooldridge people, I think, spilled over from RAND. I forget the exact history.  Dean Wooldridge, I forget where he came from.  Maybe CalTech.  I'm not sure.

DR. CONVERSE:  They came from Hughes.

DR. SCHERER:  You know what happened to Hughes?  Now that's an interesting story.  How Hughes really got to be a big factor in the electronics systems and surrounding missile systems business was they staged raids on Bell Labs and hired away at very generous salaries a lot of Bell Labs’ top people.  [Hughes] put together an absolutely first-rate technical team.  I don't know who was the guiding genius.  It couldn't have been Howard Hughes.

DR. CONVERSE:  Generals Eaker [Lt. General Ira C. Eaker] and George [Lt. General Harold L. George] played important roles.  Hughes hired them in 1947 after they retired from the Air Force.  Eaker had been the AAF’s deputy commander and George had run the Air Transport Command during World War II.  It was a classic case of the revolving door.

DR. SCHERER:  I know the Bell Labs people were really sore because they were a very bureaucratic operation.  They thought they were so damn good, they didn't need to pay people to work for them.  Hughes just raided them something fierce.

DR. FOX:  They didn't understand the method of defense contracting.

DR. SCHERER:  Well, they did. They actually did a lot of defense contracting.  They built the B-52 bombing and navigation system.

DR. FOX:  That's true.  I was referring to the fact that I think Ramo-Wooldridge was able to pay them substantially more money because it was chargeable to defense contracts. [Bell] had been operating in a different kind of world.

DR. SCHERER:  Well, they had to worry.  At the time when I was there, they had two facilities, one at Murray Hill and one at Whippany.  Although Whippany was mainly military and Murray Hill was mostly civilian, these places were only a few miles apart and there was exchange of personnel back and forth.  They couldn't screw up their salary structures to accommodate the needs of a maverick competitor like Hughes driving up individual star salaries.

DR. CONVERSE:  Why don't we take a ten-minute break and come back at five after 3 and we'll resume?

DR. SCHERER:  Fine. (Recess.)

DR. CONVERSE:  While we're resuming, maybe you want to go over the next question, Dr. Scherer.
[Question 3 inquires about the role of small business in defense acquisition. … Has its share of the weapons acquisition market increased?  And if so, have the innovative capabilites of small firms increased as well (through, for example, the instutionalization of R&D) to meet the technological requirements of the military services?  Of particular interest are the major forces of change here—either through government policies and technical assistance programs (which, historically, have been unsuccessfull) or through responses to the massive restructuring of the U.S. manufacturing sector over the last few decades.]

DR. SCHERER:  Well, it's a small business question.  I'm not sure we've dealt with that all the way.  Basically, this is a data problem, and I frankly don't know.  I would guess that they're still collecting such data. 

There was one important thing that I think has probably changed it and this is something I have not followed at all, although I should have.  In the mid-'90s, the procurement regulations were changed, actually at the behest of Steve Kelman, (Steven Kelman is the Weatherhead Professor of Public Management at Harvard University's John F. Kennedy School of Government. From 1993 through 1997, Dr. Kelman served as Administrator of the Office of Federal Procurement Policy in the Office of Management and Budget.) my colleague from the Kennedy School.  Steve became head of the White House Office of Procurement or something like that, and he said, “Hey, do we really need all this stuff that requires you to put out bids and specifications and qualify contractors and all that?  Is this really necessary for the nuts and bolts and the toilet plungers and all that stuff?”  The regulations were rewritten in such a way that for a whole big range of items, you could just go out to Home Depot and buy the stuff.  I suspect that opened up big opportunities for small business, but I really have not seen anything written about it.  You might talk to Steve about it, but he wrote a book about it later on.

DR. FOX:  Yes. I think that's largely non-defense, too.

DR. SCHERER:  But there's a lot of stuff that defense buys that you could do in a very complicated way or you could do in a simple way.  What Steve tried to do was make it simple.

DR. SHIMAN:  He was actually working very closely with the acquisition reformers in DoD to get legislation, like the Federal Acquisition Streamlining Act or the Federal Acquisition Reform Act, passed. That was 1994 or 1995. He wrote a book saying that it's worked.

DR. SCHERER:  The other thing on this question is that at the subsystem level, usually you're talking about such technical complexity and size, it's just beyond the reach of most small businesses.  Occasionally you'll have a small business—like Sanders Associates started as a small business—that will come up with some bright idea and grow very rapidly to meet the needs.  By and large, the subsystems, if they're spun off as government-furnished equipment—and I don't know whether they are or not these days—the main impetus has probably been the attempt by DoD to get out the profit margins that the prime contractors were collecting on subsystems.  With the small nuts and bolts, when you're buying microprocessors from Intel or DRAMs from Micron or whatever, your prime contractor's going to do that business. It's just too nitpicky for it to be done as government-furnished equipment.

I guess the point is that it disappears as a statistic because nobody has, to my knowledge, ever systematically collected data on where prime contractors are spending their dollars.  I assume that the Pentagon still collects data on prime contracts with small business, but to the extent that all the nuts and bolts are procured by a contractor to DoD, that disappears in this statistical noise.  There's probably a lot of it, always has been.  I remember trying to get data on this and you just couldn't do it. 

We talked about Systems Analysis.

DR. FOX:  That's a good question for you, Number 4.

[Question 4 reads: In light of the experience of defense acquisition since 1962, what observations do you have on the contribution Systems Analysis has made to defense decision-making?]

DR. SCHERER:  We really talked about that, beginning with Edison and zooming forward to the various ways people have been experimenting on how to manage these programs and how to do the systems integration in a lot of different ways.  The Bell Labs management of Nike/Ajax was one of the pioneering changes.  The other defense contractors were picking up this kind of capability and the emergence of people like Ramo-Wooldridge and Applied Physics Lab and JPL and Space Technologies and the like, all have contributed to the solution of this problem.

DR. FOX:  I read this question a little differently.  I thought it was referring to the work of Systems Analysis in the Pentagon.  Beginning in '62, and in particular, what was the contribution of Alain Enthoven's (Alain Enthoven was assistant secretary of Defense (Systems Analysis), 1965-1969.  In 1965, the office was established as a new assistant secretariat.  In April 1973, the office became director, defense Program Analysis and Evaluation (PA&E).  In 1974, the office was re-designated assistant secretary of Defense (PA&E); in 1976, it became Director for Planning and Evaluation.  In 1977, it again became assistant secretary of Defense (PA&E) until 1981, when it became a directorate again.  In 1988, the office once again became an assistant secretariat in the Department of Defense.) organization in the Pentagon?  I think that's a slightly different question.

DR. SCHERER:  That's a very different question.  Well, I looked at the organization chart the other day.  I can't find any remnants of Enthoven's shop. They now call it PA&E, Program Analysis and Evaluation.  I couldn't find it and so it's not at an organizational level.

DR. FOX:  David Chu, (Dr. David S.C. Chu served as director and then assistant secretary of Defense (PA&E) from 1981 to 1993.  In 2001, he was sworn in as under secretary of Defense for Personnel and Readiness.) [PA&E], has been in and out of the Pentagon for decades.

My own sense is that Systems Analysis first came in with Enthoven and McNamara as a big splash.  Then subsequently, because of the reaction of senior military officers, I think, in particular, it was downplayed.  I think Systems Analysis has endured and is today one of the big players at OSD and in the services today in defense acquisition.  I think the services someplace along the line got the message that either they were going to be experts in Systems Analysis and have a Systems Analysis that out-Enthovens Enthoven or they were not going to be around here to talk about it. 

DR. SCHERER:  I've heard Enthoven talk about what he did—basically asking very simple-minded, Economics 1 questions about the big picture with an economic slant:  Just what are you trying to accomplish here?  What's it going to cost us?  What are the alternative ways of doing it?  [He was] asking those kinds of questions, which somehow frequently fell between the cracks before such an entity existed.

DR. FOX:  —Or just never were asked, like:  If we build the C-5A, how many of those are you going to need to build, and is there any other way of accomplishing that mission?  And what would it cost with C-5As versus other aircraft or other means of accomplishing that same mission?  I think, as you pointed out earlier, you don't need to get beyond Economics 1 before you are dealing with those concepts.  On the other hand, gathering that data, certainly at the OSD level, largely did not occur before Alain Enthoven.

And today, I think, right up through the '90s and the 2000s, you wouldn't go forward with a program or wouldn't propose a program by one of the services unless you had that information at your fingertips and could present it in a way that would stand up under critical analysis by the OSD PA&E office. 

DR. SCHERER: You want people in there who understand economic concepts, who are willing to ask really hard, nasty questions that will make them enemies. 

You know, RAND diversified. They began their diversification effort by going into municipal systems, such as fire protection and the like.  Since then, they've diversified quite successfully over into health economics.  You know why they initially began diversifying?

DR. MOODY:  They were making the Air Force mad?

DR. SCHERER:  Oh, boy, did they make the Air Force mad!  They shot down the B-1.  They did a cost analysis that shot down the B-1, or rather, the RS‑70. That was the predecessor of the B-1.  The Air Force was absolutely furious and threatened to cancel their contract.  That's when RAND first started their diversification effort.

On this whole question of this kind of analysis, there's a really great book.  I think it's Analysis for Military Decisions by Ed Quade. ( Edward S. Quade, Analysis for Military Decisions (Rand McNally, 1964).)  Quade is, I believe, the way he appears on the cover.  It's really a great book, published probably in the mid '60s or thereabouts.  It shows the kinds of ways that RAND approached these problems.

The approach that was pursued by Enthoven really came out of RAND.  I'll tell you an anecdote that Joe Peck told me from his experience as Enthoven's deputy.  There was a big decision to be made between two weapon systems, fighter aircraft.  I forget who the contenders were. One of them was McDonnell, I think, and I forget who the other one was.  Several people from Enthoven's shop went in to brief McNamara on the choice that was to be made between these two different contenders for a particular mission. 

McNamara was, as usual, superb.  He knew all the specs of each aircraft, how long it took to run before it would clear a twenty-foot barrier, what its payload was, what its range was, what its max speed was.  He had all the numbers in his head.  Then at one point, he turned to Joe and said, "Now who's the contractor for that one?"  That was the most important unk-unk.  This contractor had an absolutely miserable reputation for delivering on the promises that McNamara had memorized, and McNamara didn't know it.  Now, it was the job of Enthoven's people not only to know how long you had to roll before you could clear a twenty-foot barrier, but also whether this was a contractor who had any reputation for delivering on its promises and a lot of other stuff like that.

DR. SHIMAN:  If I may add something, my impression is that, in my period anyway, PA&E was the office in OSD that the services most feared because PA&E was impervious to the kind of arguments that backers of programs were used to making.  I mean emotional arguments and promises and optimistic arguments and claims that couldn't be verified.  PA&E wanted hard numbers.  They weren't interested in anything that couldn't be analyzed in that way, and they were not afraid to stand up and say no, whatever pressure was put on them.  So they were actually feared, whereas other OSD offices were not so much.

DR. SCHERER:  I don't know how you develop that kind of a tradition, but it was done.

DR. SHIMAN:  It takes high-level support, I imagine, to obtain that independence.

DR. SCHERER:  Hitch and Enthoven had very good backing from McNamara.

DR. MOODY:  Well, it was interesting because Laird, (Melvin R. Laird served as secretary of Defense from 1968 to 1973.  The DAHP interview of Melvin Laird was conducted by Dr. Walton S. Moody on 18 November 2004. ) came in. He had been sitting in Congress watching all of this stuff and he understood the institutional opposition to analysis.  He walks in, and the first thing he does is to make sure that the analysis shop is going to continue to function.  I mean, I saw the one where, when Ivan Selin (Ivan Selin was acting assistant secretary of Defense (Systems Analysis) from January 1969 to January 1970.) was the acting head.

There's this telegram from Barry Goldwater, (Barry M. Goldwater was then a Republican senator from Arizona.) who has just read somewhere that Selin was still there and has just made some outrageous statement about an Air Force program.  He says, "Dear Mel, I thought you fired [Selin] months ago. Why is he still around?"  Laird comes back and says, "You know, he really is helpful."  In the end, of course, Selin has to resign.  To me personally, that seems to be the problem. 

In the '70s, it appears that they got into a lot of things on cost analysis and so on.  I think that much of that was to continue to have a function.  Even if there were people who wanted to abolish them, [the analysis office] had something where they could really get into some of the nuts and bolts of what they could really do and use it as cover to keep on looking at programs in their totality.

DR. SCHERER:  I'm not sure what the timing of this was, but they may have been compensating for the atrophy of the cost analysis division at RAND.  It did atrophy, and I'm trying to remember.  I think it was in the '70s, Dave Novick was still there but delegated most of the work to Eugene Fisher, as I recall, and it kind of went downhill.

DR. FOX:  Gene Fisher was cost analysis.  I cannot tell you about RAND at the time that Enthoven was there, but I have the impression that Enthoven's focus at RAND was considerably broader than cost analysis.

DR. SCHERER:  Oh, absolutely, Yes.  He was in a different division of RAND.  Enthoven was in the economics division, and there was a separate cost division headed by Dave Novick.

DR. FOX:  Yes, and that's where Fisher was.

DR. SCHERER: Burt Klein was head of the economics division.

DR. FOX:  That may be. I don't know him.

DR. SCHERER:  … Which was one of the best Economics departments in the United States, when Burt was head of it.

DR. FOX:  I think that Laird did a very interesting thing.  I was working in the Pentagon at the time, both with his office and with the Army's office.  OSD wanted to downplay the cosmetics of the powerful role of Systems Analysis, but they wanted firmly to retain the capabilities and everything that office wanted to do.  If you had to change some people, which they did, that's one thing, but there was no doubt in OSD or in the Army, Navy, and Air Force that that Systems Analysis capability was here to stay.  No more was somebody going to go ahead and promote a new aircraft system just because General X said, “We want that particular aircraft,” just because that aircraft system is cost effective at any cost.

DR. SCHERER:  The B-58 had a lot of technical problems, but one of the reasons it was not well received by SAC was that the co-pilot sat behind the pilot.  Curtis LeMay (General Curtis E. LeMay was commander of Strategic Air Command,1948-1957; Air Force Vice Chief of Staff 1957-1961; and Chief of Staff, 1961-1965.) thought this was the worst way to fly an airplane.  They ought to be sitting side by side.

DR. MOODY:  He fought that on the B-47.  Of course, the big thing on the B-58 was when Joe McConnell (General John P. “Joe” McConnell was later Air Force  Chief of Staff, 1965-1969.) was on the SAC staff and said the B-58 is a fine airplane if your enemy is Canada.

DR. SCHERER:  They're pretty fierce.

DR. FOX:  That's quite picturesque.

DR. MOODY:  That was why their comment on the FB-111, when that was being proposed, was if the B-58 is a strategic bomber, the FB-111 is a strategic bomber.  The unstated premise being that actually the B-58 was not the plane for the job anyway.

DR. FOX:  Why don't we move on to Number 5, unless there's something else here.
[Question 5 reads:  According to a 1969 article in Harvard Business Review, fixed-price incentives and total packaging failed in good part because contractors could not or would not adjust their own management practices, choosing to “run programs out of their heads” and acting as “fire fighters” instead of instituting formal planning and control systems needed to make the new approaches work.  Does this strike you as a fair impression of how things were at that time?  Do you see any evidence that contractors have since changed and “got religion”?]

DR. SCHERER:  I frankly didn't see this at all. I didn't see the article.  I hope, Ron, you didn't write it.

DR. FOX:  No, I didn't.

DR. SCHERER:  Because I'm just not impressed by it.  I don't think that was the problem at all.  It's true that so-called Total Package Procurement failed.  Total Package Procurement, which was McNamara’s initiative, involved two things.  It was an attempt to deal with the bidding and lying problems, the bad decisions that came from wildly understated program costs, and the idea was you would have the contractors bid for a whole series of units produced and bid not under the traditional cost-plus-fixed-fee contract—where, okay, you lie, so you don't get quite as big a fee at the front end but you make enough later.  Rather, you took some kind of an incentive contract where, if you were off by 100 percent on your bid, it swallowed all your profit plus some.  So you put it on an incentive contract and you bid a substantial part of the package.  To my memory, the C-5A was one of those Total Packages.  The F-14, I believe, was another, and maybe the Cheyenne helicopter was.

DR. FOX:  Yes, the Cheyenne helicopter was also one.

DR. SCHERER:  I think there were three flagship Total Package Procurement programs.  All three came to grief, and it wasn't because the contractors were incapable of doing this stuff.  The Navy pilots used to say, “Grumman gets us home.”  Grumman was a damn good contractor.  It's just that it isn't suitable to the uncertainties that you've got to face in this thing.  The C-5A was the worst disaster of all.  To make it stick, you had to have, among other things, fairly clear specifications on the beast that the contractor was going to deliver.  The contractor negotiated the fixed-price incentive contract on a well-specified beast.  Lockheed was having big troubles meeting the specs. 
One of the most troublesome parts was that they had agreed to a weight maximum.  The

hole logic of Total Package Procurement was that, okay, you've agreed to have a fly-away weight of so many hundred thousand pounds.  Lockheed was something like 30,000 pounds over or 15,000 to 30,000 pounds over the specifications it had agreed.  This was the Air Force, I think.

It went to the Air Force and said, “Look, guys, we just can't pull it in at that weight.  You've got to waive the spec on this.” …  “Damn it, we're not going to.  This is a Total Package Procurement.  We're not going to give you any leeway on this.”  You cannot develop a good weapon system without flexibility, and Total Package Procurement was antithetical to that.  So the Air Force said, “You’ve got to meet this weight spec.” 

So Lockheed went back and redesigned the wing structure.  They had already built some of the spars.  They chemically milled the spars to take weight out of them and a whole bunch of other stuff.  Then when push came to shove, the wings were falling off. 

So they had to go back once again—at the cost of a couple hundred million dollars—and waive the weight specification, rebuild the wings to a heavier weight and more structural durability.  All this cost a half billion dollars or something like that, which very nearly bankrupted Lockheed.  If they hadn't agreed on a repricing arrangement that basically bailed out of the fixed-price incentive contract with an open ceiling—not a cap on Lockheed's share but an open ceiling for Lockheed to absorb.  They basically had to bail Lockheed out of this.

I don't know the F-14 story, but if you want to hear it, you should talk to Joe Cosgrove. We had a brief conversation about it.  Joe's my across-the-street neighbor and was Navy program manager for that.  Nor do I know the Cheyenne, but these were more ambitious developments than the C-5A. 

What I would conclude out of this is that the uncertainties as to what you can achieve are just such that you cannot, you should not, agree to rigid specifications at the beginning of the program.  You cannot feasibly drop all the price risks on the contractor at the beginning of the program.  We clearly learned our lesson on this, if you look at the Advanced Tactical Fighter and the Joint Strike Fighter.  I think, was it— who's the guy from Hewlett-Packard?  David Packard?  Defense secretary.  Whoever brought in “fly before you buy.”

DR. MOODY:  That's David Packard. (David Packard, co-founder and former president and CEO of the Hewlett-Packard Company, was deputy secretary of Defense from 1969 to 1971.)

DR. SCHERER:  The fact is that those two programs were done the right way when you were really pushing the state of the art.  They had a dozen or so contractors for paper design phases.  They had a half dozen or so for—

Now, why did they go to three?  They had gone to pretty detailed engineering before they reduced to three.  I forget exactly what stage McDonnell was cut out, but then there was a fly-off between Lockheed and Boeing.  I think the first hardware contract was for three units or something like that from each of the two.  They flew them off.  Only then did they put out the kinds of contracts that were used in Total Package Procurement. 

That's the right way to do it.  Total Package Procurement was Ford Motor Company at its worst.

DR. FOX:  In light of what Mike [Scherer] has just said, you’d think, well, didn't the contractors know that?  I mean, they were the people.  Didn't the contractors know?

DR. SCHERER:  They were under huge pressure.  It was the only game in town.

DR. FOX:  That's right. The only game in town and the contractors knew that.  But the contractors mistakenly thought that the Air Force on the C5-A and the Army on the Cheyenne would play the game as they had played it in the past—that is, have a thousand or more contract changes a year on the program as a means of increasing the price.

DR. MOODY:  Alter the spec.

DR. FOX:  “Want us to sign that?  We'll sign it.  We know how you play this game.”  It's called contract changes.  All of a sudden, that was not the game that was playing here.  I couldn't agree with Mike more:  You don't write fixed-price contracts for things you've never done before and you don't know how they're going to turn out.

DR. SCHERER:  You didn't have a more competent aircraft design group than Kelly Johnson's group at Lockheed.  These guys were not inadept at designing airplanes.  They were not inadept at managing the development of airplanes.  They were just put in an impossible economic situation.

DR. FOX:  And I think the people closest to Lockheed from the Air Force would have agreed.  They would have loved to go through the contract changes, just as the people in the Navy on the A-12 program were all ready to sign off on all the contract changes, but their superiors—in the case of the Air Force Bob Charles (Robert H. Charles was assistant secretary of the Air Force for Installations and Logistics from 1963 to 1969.) —were not willing to do that.  That's where the arrangement fell apart.

DR. CONVERSE:  Incidentally, although Packard is attributed with “fly before you buy,” that was actually the policy of the [Secretary of Defense Charles E.] Wilson Defense Department after '53.  That's why Trevor Gardner resigned as assistant secretary of the Air Force for R&D.  That's what he was reacting to. 

I think one of the differences is that Wilson's Defense Department's hand was not as heavy as when Packard was in there.  OSD was much stronger then than they were, say, in the mid-1950s.

Under Wilson, OSD was trying to discourage entering a system into quantity production before it had been thoroughly tested.  But it did not require the services to do that.  The approach was more persuasion or encouragement than a mandate.

DR. SCHERER:  I'll tell you a story that at least indirectly reflects on this change.  McNamara came in as Defense secretary and I was hired as a consultant.  They were having a Woods Hole or something like that summer study of McNamara's procurement reforms, and I was hired as a consultant to comment on the agenda.  I remember getting all the materials for the agenda and to whoever my keeper was, after reading it over, I said, "Well, Yes, all this is really interesting stuff.  It seems to imply the fundamental assumption that all the decisionmaking is going to be centralized within the Pentagon."  I said, "Shouldn't you have a session devoted to the question:  Is this centralization a good idea?"  My keeper's answer was, "That's already been decided."  A couple of weeks later, I got a letter saying:  “Your services are no longer required.”

DR. FOX:  I think what we need to do is get to at least Questions 6 and 8.  I think Question 7 may have been covered, but if the person who's the author of 7 feels that it's not been covered, then please speak up.  Why don't we move on to 6 now?

[Question 6 reads:  If you were to update Economic Incentives, taking account of changes in the business world, what observations would you add?  Are you still pessimistic about incentivizing?]

DR. SCHERER:  I have to confess a lot of uncertainty about this.  My impression, having got out of the business immediately after writing that book, was that it went nowhere.  A couple decades later, as I got back into the business briefly, mainly in connection with the proposed Lockheed-Northrop merger, it appeared to me that actually a lot of the recommendations had been put into effect.  It was not exactly in the way I proposed them, but the spirit of the proposal was put into effect in the sense that systematic performance evaluations were made.  Some contracts—I don't know how many—were issued that had specific clauses for payment in proportion to the quality of the performance.

I think I just read that [Dick] Cheney's (Richard B. Cheney served as secretary of Defense from 1989 to 1993; in 2001 he became vice president of the United States.) former firm, Halliburton, got nailed in Iraq on a performance clause for the stuff they had agreed to do.  But even in source selection, performance actually came to play a significant role in determining whether a contractor was given a new program or not.  So I'm going to have to say that in hindsight, I have the impression that in a broad way, the changes I advocated there were implemented, not just exactly the way I proposed, but who would ever expect such a thing?  The broad spirit of them was at least brought into play and that this had created some problems, indeed a problem that I warned of in a later chapter of the 1964 book.

One of the things I learned in the Lockheed-Martin/Northrop Grumman merger deliberations was that Northrop was in big trouble.  They couldn't get any new program awards.  Why couldn't they get any new program awards?  They would participate in one source selection competition after another, and regularly they would get knocked out.  The deciding factor, as it turned out, in their turn-down was the bad performance they had exhibited on the B-2 bomber.  They were trying to do something very, very difficult with the B-2 bomber.  Strategically, it was probably just the right thing at the wrong time, so you had a technical problem and you had a mission problem.  Northrop had a huge overrun and lots of problems with stuff peeling on the wings and having to be fixed up and a lot of other difficulties.  So they got a very bad performance evaluation, and that haunted them for the next half dozen or ten years and made it difficult for them to survive. 

And here's what I had warned against.  I said that if it turns out, as a result of these performance evaluations or anything else, that you winnow down to a very small number of contractors, you may kill a contractor who's actually a good guy to keep around.  You may kill him on the basis of performance evaluations, when actually you'd like to have him around.  That's what happened that caused Northrop to want to sell out to Lockheed. 

I remember after these deliberations were concluded and the merger had been abandoned, I wrote to Jacques Gansler and said, "Jacques, you had better learn a lesson from this."  We need Northrop as an independent source of ideas in the manned systems field and actually, by that time, it had been expanded to include unmanned systems, too.  I wrote to Jacques and said, "If you want that, you had better just wash out Northrop's bad past performance evaluations and consider them a new source selection competition with a clean slate rather than with the albatross of the B-2 hanging over their head."

So that's all I can say about this.  Things have happened and they haven't all been good.

DR. FOX:  I think one of the things that you proposed, which was not adopted right away but which was subsequently adopted and remains today as a very effective recommendation was the section where you say, rather than having profit be the result of a cost-sharing calculation based on the level of cost, where what the contractor would gain or lose would be a relatively small amount of profit for varied swings in cost, what you said was that the Defense department ought to consider making an after-the-fact evaluation of the performance of the contractor and then awarding profits based upon that retrospective look on the contractor.  The organization that adopted your recommendation first was NASA.  NASA pioneered that under the heading of "cost-plus-award-fee contracts"  (CPAF).  CPAF was not subject to the disputes clause of contracts. The Defense department subsequently went on board, again finding the CPAF arrangement quite satisfactory.  To this day, DoD considers cost-plus-award-fee contracts in very high regard.  I haven't seen the footnote, in the weapons acquisition process, but I think they ought to do that.

DR. SCHERER:  That's alright.  If it works, I'm happy.

DR. FOX:  Well, it's working.  What about Number 8 here?  That's really kind of an open-ended question.  You may or may not have any further observations on it.

[Question 8 reads:  What is your assessment of the state of defense acquisition today?  Are you concerned about the trend lines regarding the rising costs and lengthening cycle times?]

DR. SHIMAN:  If I can add to my question?  Maybe I should give a bit of background to it.  You know, you've been talking about the trend lines, for example, of unit costs.  Obviously the basic trends of costs and schedule have been continuing to climb fairly steadily over the years.   Periodically people think, oh, the acquisition system's in big trouble.  Fifteen years ago, people thought it might be on the verge of collapse.  Well, it didn't, but the trends have continued, and it takes forever now to get a program through, and the costs are skyrocketing.

What I'm wondering is, is there a point at which we can no longer sustain the acquisition system as it's currently structured?  Is there a point where its utility to the country becomes less and less because it's not producing weapons when we need it to do what we need?  And the costs are getting so high just to produce weapons, let alone to repair damaged programs and fix problems that come up, that the defense budget can't keep skyrocketing to keep pace with this? I guess I'm kind of wondering, at what point does something have to give?  Is that a correct analysis of this or are you more optimistic about the system?

DR. SCHERER:  I'm reminded of what economists say about the trade deficit.  When something is unsustainable, it can't go on forever.  I worry about the same kinds of things you do.  On the other hand, I am just awestruck by the quality of what has been achieved.  I was awestruck initially when we succeeded in sending men to the moon.  I was awestruck with the Iraq War of 1991.  I mean all these GPS-controlled missiles.  And they finally got the ramjets to work.  We have cruise missiles that can fly 600 miles and hit within a couple of hundred meters.  There have been really mind-boggling achievements here that have been very, very effective.

The other thing is that the strategic situation has changed radically.  It could change again.  I don't deny that at all.  I worry about Russia coming back, the Russian threat coming back.  It's not altogether vanished, and it could come back.  I'm delighted to say that Henry and Vladimir (On 6 June 2006, Russian President Vladimir Putin met with former U.S. Secretary of State Henry Kissinger at Putin’s Novo-Ogarevo residence near Moscow. ) got along well yesterday or the day before, but I worry a lot about China.  So it could be that we'll revert to the kind of Cold War that we experienced during the 1960s and 1970s and that really didn't phase down until the early '90s, in which case we will want these same kinds of capabilities redoubled in brass.

Our problem now is it's hard to start new programs because they're so expensive.  It's hard to procure many units because the individual units are so expensive.  These UCAVs and all this other stuff suggest new ways that we may go.  I suspect we can produce UCAVs for a fairly minor—  We can make a whole lot of safety trade-offs and get the prices down.
I don't know.  I haven't seen any data on it, but my general impression is that although we are very much constrained by high costs and limited budgets, we're doing very, very well, thank you.  I don't know what NSA has up its sleeve, but I think, relative to the current strategic environment, we are doing extraordinarily well.  I do worry about the strategic environment of twenty or thirty years from now, if Russia decides it wants to become a superpower again or use the stuff it's already got, which is wearing out, and/or if China decides that it wants to be the world's leading superpower. Then we’ve got a problem.  But we also have a very rich nation.

DR. CONVERSE:  What I was going to say was if you wanted to sum up U.S. defense acquisitions since World War II, isn't it amazing what an unlimited amount of money can do?

DR. SCHERER:  Yes.  It's not just that, because when I got started in this business, which was when the Korean War had phased out and the space race had started.  As I recall in the late '50s, we were probably spending about 10 percent of gross national product on defense.  Give or take a percentage point, we were spending 10 percent on defense.  What are we spending now, 3 percent?  So we’ve got a very big economy from which we could expand defense production if we really needed to.

The other thing that goes to, I think, a different question is that it's a smaller world now.  British Aerospace is heavily involved in the F-22 program.  I think we're finally realizing that maybe it makes sense for us to buy German Leopard tanks rather than develop our own.  Maybe someday we might even—I wouldn't recommend it, but we might—buy European fighter aircraft.  We really have a potential supply base that consists of the United States and Western Europe and probably also Japan.  We have a lot of potential if the need arises.  Let's hope it doesn't.

(End of Audio.)

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