Defense Contractors Demand Better Inflation Handling from DOD

The head of the largest aerospace lobbying firm warns that thinking inflation is mostly over is premature. He believes the worst is yet to come because the Pentagon tends to delay addressing problems, and the industry is becoming more cautious in its bids.

Former U.S. Army secretary and interim U.S. Air Force secretary Fanning claims that the defence industrial base has historically served as a "shock absorber" for inflation, seeing its effects years before the government does. Although the general public believes that inflation is being handled since, for instance, grocery prices have decreased, a flood of new issues is about to arise. "At first, the industry was kind of put in charge of figuring out labour rates, how to make this work because the government holds all the cards, and margins fall down. The contracts are with them," adds Fanning. Nevertheless, new contracts, order volumes, and competitors will inevitably arise. The Pentagon will ultimately discover they only receive two if the platform's pricing is changeable and they were expecting three instead of properly accounting for inflation.

"That's my theory, that the '26 budget is where we're going to start to see the accumulated effect because the Pentagon [is] very good at pushing things out into the future.” “I learned from someone when I was younger that year six of the five-year plan is the most fascinating since that's when everything is hidden. You just pushing into year six, but eventually it just accumulates and eventually it has to be dealt with.” – Eric Fanning on May 16.

As the House and Senate began discussing the budget proposal for the fiscal year 2025, Eric Fanning, chairman of the Aerospace Industries Association (AIA), introduced a set of new legislative goals. These proposals aim to address the persistent inflation issues that the aerospace industry is grappling with. Despite the significant impact of inflation, the Defense Department has largely avoided openly discussing these challenges. The AIA’s recommendations are designed to confront the inflation problem head-on, highlighting the need for legislative action to support the industry’s stability and growth amidst rising costs.

The '26 budget may be the starting point for this shift in the dynamic, but ultimately, once the additional expenses are revealed and data is available, I believe they have been able to strike a compromise and let industry absorb part of it. Because of declining buying power due to inflation, the budget for 2025 is up 1% over the previously approved $895 billion maximum set by Congress. Not only the main primes who usually take on the contracts, but other parties will also be affected if it is not resolved.

Every step of the supply chain is involved. According to Fanning, the reason why products are more expensive isn't the only one; businesses will also bid with less risk as a result of past experiences and current situation.  For arms, for instance, the Pentagon is giving multiyear contracts first priority in order to ensure reliability; nevertheless, certain suppliers may find this challenging due to inflationary pressures.

Requesting a proposal from a small supplier chain firm five years ahead of time typically results in extremely cautious projections that account for significant inflation, according to Fanning. Therefore, the worst of inflation may not even have hit us yet. Representing three hundred and thirty-three enterprises, Fanning observes that while some of the larger companies are coping with the immediate effects, they are probably waiting for the next round of contracts, when they will have greater negotiating leverage.

“We are able to display the data in a way that makes evident the notable shifts in labour and material costs—a problem that still needs to be solved. I'm attempting to warn individuals who believe that just because some costs are going down, like those of eggs, it means that everything is well and we are safe. Nevertheless, a lot of people ignore the fact that we're only delaying issues, which makes them worse over time”, Fanning cautions. The AIA's legislative recommendations encompass several critical measures aimed at addressing the rising costs associated with defense trade. One key proposal is to increase the threshold for congressional notifications, a move prompted by the escalating expenses of defense-related goods. Additionally, the AIA suggests restricting the use of fixed-price contracts for low-rate initial production lots. This limitation is intended to mitigate the financial risks that come with inflation, ensuring that contracts remain fair and manageable for suppliers. These measures collectively aim to provide a more sustainable framework for dealing with the economic pressures facing the defense industry.