Sea worthy: government action needed to fix troubled shipbuilding sector.

Shipbuilding is critical to both national security and global stability. This industry, however, is not globally competitive in the production of large oceangoing vessels and depends on government procurement and a protected domestic market to remain viable.

The limited commercial market, combined with a decline in Navy orders, has resulted in excess production capacity, underused larger shipyards and high vessel costs. The combination of high costs and limited budgets, in turn, threatens the Navy's ability to meet its stated goal of a 313-ship fleet by 2020.

There are no easy solutions to the dilemma, but there are a number of steps the U.S. government can take to bolster this critical component of the defense industrial base, concluded a team of military and civilians students at the Industrial College of the Armed Forces.

The group visited 15 U.S. shipyards, as well as several shipbuilders in Taiwan and Hong Kong.

U.S. shipbuilders make up less than 1 percent of the international market. Because they are not able to compete globally, they rely on domestic military and commercial markets which are protected from international competition by law and regulation. About 80 percent of the U.S. shipbuilding and repair market focuses on military vessels, and the remaining 20 percent concentrates on commercial vessels.

Six major U.S. shipbuilders are owned by two large defense suppliers, General Dynamics and Northrop Grumman. Five of the six shipyards make strictly military vessels. Only General Dynamics' National Steel and Shipbuilding Co. in San Diego, has contracts to build Daewoo designed commercial ships.

Besides the "Big Six," there are numerous small and medium sized shipyards which focus on manufacturing commercial vessels and compete for government contracts to repair warships. There are also five public shipyards in the United States, four of which are operated by the U.S. Navy--one is run by the Coast Guard--which repair or upgrade existing ships. This industry also relies on thousands of subcontractors and suppliers.

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Shipbuilding is a heavily regulated business. Laws affecting this industry date from the earliest sessions of Congress. The Jones Act is probably the most significant legislation. It requires ships that engage in domestic U.S. trade be built and flagged in the United States, and crewed by U.S. citizens.

The market for smaller vessels is at a peak. Several small and medium shipyards have extensive backlogs for ships. Much of the demand is driven by high oil and gas prices and the concurrent boom in the offshore petroleum industry. While the outlook over the short term is healthy, the longer term demand may be tied to the economics of oil and gas exploration and development in the deeper Gulf of Mexico.

Asian shipyards, particularly South Korea, Japan and increasingly China, have concentrated on producing large ocean going commercial ships--container ships, tankers and bulk carriers--at very competitive prices, mostly because of economies of scale and typically larger, more efficiently designed shipyards. European shipyards, on the other hand, particularly those in Finland, Italy and Spain, have focused on commercial and high-tech civil ship construction including ferries, research vessels, large cruise ships and medium-sized naval vessels.

The market for new U.S. built oceangoing vessels, however, is less robust. It is limited primarily to replacements for the existing Jones Act fleet. With a Jones Act fleet of approximately 120 ships, and an average life of 20 to 30 years, replacement should provide a modest, but relatively stable, market over the next several years.

As a result of labor shortages at U.S. yards, domestically built ships will become more expensive, which makes it even less likely the United States can recapture a major market share of global shipbuilding. According to shipyard executives, companies are having difficulties finding younger workers who are interested in providing the manual labor required to build ships, at the current wages that the industry pays.

Maintaining the country's shipbuilding industrial base will probably not be achieved unless domestic shipbuilders can maintain a certain threshold level of industrial activity. When a country stops building a certain class of vessel, it can rapidly lose its intellectual ability to resuscitate the industrial capability.

One major challenge is the cost/quantity paradox with respect to building warships. Ships cost more today because of low volume procurements. This is a significant factor that drives up costs because of increased overhead expenses to maintain the country's shipbuilding industrial base. The current Navy fleet consists of 276 ships--the lowest since 1929. The Congressional Budget Office in 2006 concluded that unless shipbuilding budgets increase significantly in real terms, or the Navy designs and builds much cheaper ships, the size of the fleet will fall substantially.

Another concern is the uncertain budgetary climate. The outlook for the Navy's shipbuilding budget is not bright. The Navy requested and received $9.4 billion and $9 billion for fiscal years 2006 and 2007, respectively, for the construction of new ships. The budget increased to $14.1 billion in 2008. But that may not be enough to meet the Navy's goal to build and maintain a 313-ship fleet. The Congressional Budget Office believes it may take as much as $20 billion per year.

Even if the Defense Department budget grows, there is no guarantee that the Navy's share of the budget will remain constant given the pressing needs of the Army and Marine Corps. Navy planners, additionally, have trouble estimating future fleet needs.

Warships are large, complex platforms that take 10-plus years to design and build and have a 30 to 40 year service life. Given the changes in threats and technology since the end of the Cold War, the Navy's requirements for battle force ships has varied significantly. These changes have led to congressional inquiries regarding the Navy's continual shifting priorities.

The escalating cost of ships is a significant problem. The Navy's Littoral Combat Ship, initially budgeted at $220 million, is now estimated to cost nearly $500 million. The secretary of the Navy has cancelled the contract for the third LCS because of cost growth concerns. The first-in-class amphibious assault vessel, the USS San Antonio--commissioned in January 2006--experienced cost growth of $804 million above its initial budget, an increase of 84 percent. The Virginia class submarine will need approximately $300 million during the next three years to cover projected cost increases.

To begin to address these issues, the ICAF study recommends that Congress establish an interagency shipbuilding board to seek synergies across departments and agencies. The defense secretary should designate the chairman, and the board should also include representatives from the services, Coast Guard, and other agencies such as the National Oceanic and Atmospheric Administration and the National Science Foundation.

The group also suggests that Congress require the bi-annual submission of a long-range U.S. shipbuilding plan. The Navy secretary would coordinate the service's 30-year shipbuilding plan with the Army, Coast Guard, National Oceanic Atmospheric Administration, and other agencies to develop a government-wide blueprint. The Navy's 30-year shipbuilding plan is a valuable first step, but Congress should request a more comprehensive plan that incorporates anticipated needs of other agencies.

The secretary of the Navy also should institute a government-industry forum to review shipbuilding plans in concert with industry and other government organizations before the plan's submission to Congress.

The study group also recommends Congress and the Navy establish longer-term funding strategies such as the use of "multiyear" and "block-buy" procurements. Such long-term funding would bring stability and could reduce the cost of ships.

The undersecretary of defense for acquisition, technology and logistics and the secretary of the Navy should develop procurement strategies promoting greater competition for modules, blocks and subassemblies. Promoting competition could mitigate the current low-volume and overcapacity situation by employing contract award criteria and other measures to encourage bids that involve multiple shipyards. Alternatively, modules, blocks and sub-assemblies could be openly competed from both private and public sources and provided as government furnished equipment to the prime contractor for final integration.

If other measures fail to increase competition, the Navy should consider building vessels in public shipyards, under a government-owned, contractor operated arrangement.

EDITOR'S NOTE: The complete ICAF study on the shipbuilding industry can be found on the National Defense Magazine website www.NationalDefenseMagazine.org.

Alan L. Gropman is a distinguished professor of national security policy at the Industrial College of the Armed Forces, National Defense University. The views expressed in this article are solely those of the author and do not represent those of the Defense Department or the U.S. government.