Achieving growth is a complex and difficult equation.

Only a small minority of

companies succeed in their attempts at sustained growth, and for three major
reasons:
For one, too many companies leave money on the table in their core
businesses, failing to optimize for cost and revenue opportunitiesor to
seek nearby adjacencies to expand the core;
For another, companies selling into mature markets need to expand their
horizons. We help them look for new sources of revenues, or adjacencies,
via new distribution channels, customer segments or geographies, and
avoid taking a step too far;
Finally, some companies will hit a wall in their traditional business lines and
need to renew their core. We help such firms find successful platforms,
often within their own businesses, along with new customer insights and
capabilities to renew their business model.
Growth through adjacencies
Additional growth also requires that a company relentlessly pursue business
adjacencies that strengthen its core, that foster the ability to anticipate and react
quickly to the competition and that develop processes to eliminate or circumvent
the inherent organizational inhibitors to growth. Adjacency moves offer one of the
most effective ways for companies to achieve repeated bursts of new growth.
Two common mistakes derail adjacency moves:
First, companies try to build on top of a weak core business;
Second, they overreach into new businesses that aren't truly related to
their core.
Our tools help clients determine accurately which adjacent businesses will add
the most growth and value. Companies can assess an adjacency's relationship to
the core business by evaluating shared customers, channels, technologies,
products and other factors.
Growth beyond the core
In the case when a company's core formula has run its course, or faces industry
upheaval, we help executives renew company strategy and capabilities. This
work entails looking deep within their organizations to find undervalued,
unrecognized or underutilized assets that can serve as new platforms for
sustainable growth.
Finally, successful growth relies heavily on management execution. That last
imperative is particularly challenging in many organizations, which is why Bain
works to generate consensus within management by jointly developing and
prioritizing growth strategies. Read more about our Results Delivery approach




Most defense company executive teams are spending a lot of sleepless nights
these days. Their worry: how to create shareholder value in a market with a
gloomy long-term outlook. Defense and security budgets are heading south.
Sequestration looms large on Capitol Hill. New program starts are few and far
between. Internally, most companies cost structures are bloated from a 10-year
growth cycle, and organizational complexity is rampant.
With that backdrop, how does a defense contractor make itself an attractive
investment for shareholders? So far, we see A&D companies undertaking familiar
strategies. They are reducing costs by streamlining their organizations. They are
acquiring more companies in hopes of strengthening core businesses, filling
capability gaps or gaining access to new customers. They are pursuing adjacent
markets by chasing international contracts and new end markets such as health
care.
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These strategies can create significant value if executed well, but each has
limitations. Then there is another, newer strategy: business model innovation.
This involves developing innovative offerings or delivery models to meet
customers needs at less expensean urgent objective, given the governments
struggles to achieve its diverse objectives with fewer dollars. So far, we have
seen four primary types of business model innovations emerge:
Managed services. Providing a product or offering based on customer
usage, allowing the government to avoid owning the asset. Example: the
power-by-the- hour model used by engine OEMs.
Commercialized offerings. Investing internal capital to develop an offering
that can be sold off-the-shelf, such as Harris Corp.s radio business.
Exploiting hidden assets. Finding untapped capabilities to create
alternativesan MRO services company uses its internal demand-
forecasting tools to provide other companies spare parts more rapidly.
Creative partnering. Looking outside the industry to non-traditional sources
of innovation. Consider Raytheons adaptation of Googles Android
platform as an experimental battlefield handheld device for soldiers.
So why are we not seeing more business model innovations take hold? Part of
the reason is that launching one is not a natural act for most defense contractors.
Managers are often conservative, more accustomed to decades-old standards
for competing on new businessstandards that are no longer affordable.
The business model successes we have studied or helped to implement all
required significant change in business processes, management talent, capital
allocation and governance. They often relied on a great deal of collaboration with
trusted customers, because there were always hiccups along the way.
But contractor reticence is not the main challenge. The biggest barrier:
government. At a time when the customer should be encouraging innovation, it is
loading on new requirements, more auditing and tighter rules around
competitions.
This should be a time when the government defines its most important mission
needs and then asks contractors to provide innovative ideas. Let the contractors
take on some of the inherent risk associated with business model innovation and
reap the rewards if they deliver. For instance, if L-3 Communications can rapidly
meet an airborne intelligence, surveillance and reconnaissance need using
surplus aircraft, its shareholders should be rewarded. Of course, certain defense
systems will not and should not ever be candidates for anything but the strictest
developmental specifications and process standards. But that leaves a lot of
room for innovation.
The path to more successful business model innovations mostly involves a
change in mindset. Start with trust: Pursue market areas where suppliers and
customers have an established business history and where joint
interdependence exists. Take a few calculated risks. The government should
encourage less of an audit-based culture. Contractors should find a few more
uses for cash other than share buybacks. And think of it as talent development:
At a time when both government and contractors are at risk of losing talent,
deploying high-potential people to new business models is a great way to retain
them.
Contractors need new avenues of growth, and the government needs a healthy
industrial base. They both agree on the importance of partnering to find creative
ways to fill unmet needs. What would happen if they opened up the aperture and
let some new business models see the light of day?



Aerospace & Defense
Optimizing portfolio strategy
In a time of decreasing government spending, aerospace and defense industry
players need to engage in decisive portfolio management if they are to continue to
create shareholder value. We have significant experience in helping companies
optimize their product and R&D portfolios from supporting exhaustive analyses
of current investments and identifying divestment opportunities, to developing
strategies to redeploy capital and resources to new, high-potential segments,
products and service offerings and technologies.
Driving growth
In light of the current economic cycles and pricing pressures from customers,
aerospace and defense prime and sub-contractors need to make bold efforts to
identify growth opportunities. We help companies identify international markets
in which to extend their traditional capabilities, develop services in adjacent
sectors, and expand within the aerospace and defense verticals. Working with
functional and industry experts from across the firm, we can help companies
identify attractive white space areas in the defense and security industries and to
capture these new business opportunities.
Improving program a!ordability
Aerospace and defense contractors face an affordability imperative. This requires
strategies to weather the retrenchment in government spending in the short-term
while building capability to be competitive in the long-term. We help companies
achieve both objectives, with the overall goal of improving their agility and
market responsiveness.
Our current work includes developing processes for significantly reducing costs
of direct labor, direct material, and indirect costs to achieve lean, cost-efficient
operations. We help organizations to improve affordability by adopting design-
to-value principles and redesigning critical processes and capabilities, including
product development and production models, supplier relationships, and
program operating models and risk management.
Transforming operational performance
We help clients design and implement manufacturing processes to increase plant
performance and improve supplier coordination. This includes in-depth
evaluation of network configuration, capital productivity, and plant-level
information and communication flow. Working with McKinsey experts in
operations and supply chain logistics, we help aerospace and defense
manufacturers build their capabilities in areas such as modular manufacturing,
green manufacturing and IT-enabled manufacturing to reduce cost, increase
efficiency, and enhance growth opportunities.
Increasing supply chain agility
Commercial aircraft and defense contract manufacturers are continually looking
for ways to reduce the cost of inventory and increase responsiveness. McKinsey
supports manufacturers by bringing best practices in supply chain management
and lean manufacturing. Our work extends from performing basic scenario
evaluations to complex optimization analysis of entire value chains, including the
impact of achieving different economies of scale and employing varied
production technologies.


The defense value chain is on the precipice of significant change
triggered by severe budget pressures. The Department of
Defense is at a crossroads. Successes in the commercial sector
offer the industry a way forward, but they also beg a key question:
Can defense value chains respond similarly?
Budget cuts are increasing pressure in every direction along the U.S. Department of
Defense (DoD) value chainfrom customers (PEOs, SPOs, war fighters), prime
contractors, and sub-tier suppliers, to funding providers such as those on Capitol Hill
and Wall Street. The pressure is forcing the government and its suppliers to dramatically
challenge the status quo.
A.T. Kearney interviewed 18 defense-sector senior officers and executives from various
areas along the defense value chain (see sidebar: About the Study). They presented a
wide range of perspectives on improving affordabilitysuggesting that defense
acquisition (buy side) and development, production, and sustainment (sell side) are ill
equipped to meet today's new realities. For example:
Acquisition processes are cumbersome
The acquisition workforce lacks critical affordability-mandated skills and tools
Customer requirements are fragmented with little or no portfolio commonality
Prime contractors' bureaucracy mirrors that of their government customers, and
they have grown accustomed to cost-plus economics
Sub-tier suppliers face tremendous uncertainty and challenges in bringing new
technology to market
In addition, defense faces a number of other changes that demand greater
transformation of its value chain. Among them are a general decrease in requirements
for mass firepower and support of large-scale wars against nation-state adversaries;
more need for agility, situational awareness, interoperability, and pinpoint precision to
succeed in asymmetric warfare; and a faster development-to-delivery product cycle time
putting single-purpose technology in the hands of the war fighter quickly rather than
resorting to complex, costly products that require years to make their way into the fight.
Finally, if meeting affordability needs is not a big enough challenge, other values must
be considered concurrently while cutting costsfor example, social goals in contracting,
building the supply chain for congressional support, and trying for zero-risk instead of
balanced-risk management.
Challenges, Choices, and Consequences
Faced with these challenges, the Department of Defense has a choice of two possible
courses of action:
Reduce scope. The historical path, and most expedient one, is to reduce scope, which
may include targeting specific programs to reduce volumes or capabilities, or outright
cancellation. An even more draconian measure is mandating a percentage cut across
the board. This path, particularly if it is the principal means to accomplishing severe
budget cuts, implies increased operational risk to military personnel, reduced readiness
and responsiveness, more costly recovery decisions later, and erosion of the industrial
base.
Maintain scope. A better course is to change the way business is conducted to realize
more value per dollar expended while maintaining readiness, capability, and
performancein other words, drive affordability. If successful, combat effectiveness,
development and production processes, and support for critical industrial base
capabilities should continue uninterrupted.
In view of the prevailing budget pressures, the "reduce scope" path is faster and
arguably easier to implement because new conditions can be unilaterally imposed (see
figure 1). The "maintain scope" path implies significant business process and
organizational change, requiring cooperation and collaboration among many
stakeholders across the value chain in an environment that typically exemplifies rigidity.
1


Our perspective, nonetheless, is that while the United States may be forced to pursue
both paths, the defense industrygovernment and suppliersmust pursue the
affordability path with a vengeance. It is hard to imagine there will ever be a more
urgent need than now to undertake the transformational changes that real affordability
requires. Throwing money at challenges is no longer an option. Given the magnitude of
the cuts, pursuing both paths may be necessary, but changing the business approach
and maintaining as much scope as possible is far preferable from a national security
perspective.
Observations and Options
Our study indicates that the rigidity of the defense value chain is a pervasive
impediment to improvement. In fact, this inflexibility, which is largely imposed by the
government and reinforced by its own resistance to change, drives a host of related
barriers to increasing productivity or redefining solutions. As a result, the defense value
chain is neither as agile nor adaptive as those of other industries.
This inflexibility was made clear by our study findings and by our own perspective
developed from years of helping businesses transform their commercial value chains in
the face of daunting customer issues, changes in the nature of demand, a declining
market, or other concerns. In these situations, successful organizations displayed
flexibilityalbeit sometimes painfulthat enabled them to transform their value chains
and thrive in the face of austerity. Commercial value-chain flexibility has been a source
of value creation and competitive advantage, as outlined in the sidebar: Taking a Page
from the Heavy Equipment Industry.
In spite of the challenges and impediments, our study suggests two compatible
approaches to maintaining scope through improved affordability (see figure 2).

Increase productivity. This means delivering specified product or service level
performance by better leveraging of labor or capital across the value chain than is
reflected in current business processes and organizationsin short, delivering existing
products or services more efficiently.
Redefine the solution. Here, a new paradigm is implemented to meet a capability
need. The new paradigm may include developing and deploying a new product or
service solution, new technology, or new adoption or adaptation of existing technology
in short, changing the nature of the "game" through innovation.
Arguably, a third option for maintaining scope existsattacking supplier profit margins.
However, we summarily rejected this option as a short-sighted, short-run strategy that
ultimately results in "lose-lose" outcomes if the supply base enterprises fail to earn their
cost of capital, leading to exits or underinvestment. While pockets of "excess profits"
may exist in the U.S. defense industry, government will not materially meet its budget
challenges by striving to reduce profit margins. Correctly, in our opinion, the Under
Secretary of Defense for Acquisition, Technology, and Logistics explicitly opposes an
attack on supplier profit margins.
To make significant inroads against defense budget cuts, increasing productivity and
redefining the solution must encompass more than incremental approaches, which, with
reference to our earlier point on value-chain rigidity, means significant change must
occur for all value-chain participantsgovernment, primes, and sub-tier suppliers.
These changes cannot be unilaterally mandated. Rather, they will require an
unprecedented degree of collaborationa new government and business relationship
and way of doing business.
Attributes of Top-Performing Value Chains
As indicated in our heavy-equipment industry case study, and in numerous examples
from other industries, value-chain transformation is possible and can have dramatic
results. In charting a path forward for government and the defense industry,
understanding the characteristics or attributes of top-performing commercial value
chains represents a good starting point. These commercial organizations leverage the
contribution of all participants to improve productivity and generate innovation. Their
value chains consistently exhibit the following three attributes (see figure 3).

Efficient execution. Efficient value-chain execution is a source of significant cost
reduction and, when combined with high quality performance, provides a critical driver
of superior value creation, competitive advantage, and ultimately improved market
share. Value-chain partners with clearly defined roles and responsibilities operate as a
collaborative, synchronous network. Particularly in monopoly and monopsony or
oligopoly situations, the collaboration includes the customer.
Maximum contribution from supply markets. Commercially, value-chain
configuration is considered a source of competitive advantage. The scale and scope of
the extended enterprise are leveraged to achieve cost advantage and operational
complexity management. Suppliers are empowered to provide their best solutions to
deliver requirements as opposed to responding to rigidly defined requests for proposals
(RFPs). Visibility, alignment, and engagement exist beyond the customer or prime level.
Speed, agility, and adaptability. Product development, production, and delivery cycle
times are critical competitive factors. External innovators are identified and brought into
the value chain early in the product development process. Commercial-off-the-shelf
(COTS) technologies are quickly adopted. Open-system architectures enable external
developer contributions rather than heavy or sole dependence on sequential internal
development. Value-chain configuration has the flexibility to meet changing customer
requirements, exploit new opportunities, and mitigate emerging risks.
These three attributes suggest solid principles for defense value-chain transformation in
both government and industry.
Drawing on input from our study participants and our work in the commercial sector, we
identified 10 improvement levers for government and suppliers pursuing value-chain
transformation. Five of the levers fall under the banner of "increase productivity" and
three under "redefine the solution," with two levers sharing characteristics of both (see
figure 4).

The following outlines all 10 levers and some of the activities required in a value chain
transformation.
Attribute 1: Efficient Execution
"In general, primes are reluctant to collaborate closely with peers or subs .... They don't
want them in their backyard." program manager, tier 1 supplier
1. Improve collaboration among all participants (government, prime contractors, and
sub-tier suppliers).
Maintain open dialog across the value chain throughout the product life cycle
Raise the level of transparency between the government and suppliers across
the value chainthis requires accompanying "rules of engagement" and, likely,
non-traditional forms of program governance
Engage in joint process improvement initiatives in all major cost, schedule, and
performance areas; the initiatives should be focusedin terms of scope,
objectives, work plans, timelines, metrics, and accountability
2. Reconfigure the value chain to reduce costs and improve performance.
Regularly evaluate make-or-buy decisions
Engage in supplier development with key value-chain partners to ensure
capabilities grow with changing requirements and enable technology
developments
Maintain value-chain flexibility to incorporate new participants that provide cost,
schedule, or performance innovation; and new capabilities
Attribute 2: Maximum Contribution from Supply Markets
"By the time I get the RFP, there is no room for new technology, or the lag in getting the
RFP out is so long that technology has moved beyond that anticipated in the RFP."
CEO, tier 3 supplier
3. Leverage buying power across the portfolio.
Leverage government-buying scale and scope to enable mega-buyer and mega-
supplier sourcing and relationship management.
Establish a government portfolio view to capture economies, synergies, and
commonality opportunities across programsparticularly where programs share
facilities and workforce.
4. Use incentives to boost productivity.
Establish risk-reward opportunities to encourage improved performance.
Align profit opportunities with program-specific, long-range annual performance
improvement targets.
Make rewards sufficiently substantial to warrant attention and provide incentive
for change and urgency.
5. Optimize the stability of production volumes.
Establish business case economics recognizing trade-offs of stable production
volumes and economic order quantities versus flexibility.
Improve funding stability through sanctioned management reserves.
6. Enable competitive market forces to shape best solutions.
2

Modify the RFP and source selection process to enable the use of collaborative
optimization and expressive bidding as opposed to rigidly defined, prescriptive
RFPs.
Attribute 3: Speed, Agility, Adaptability
"The private sector is able to deliver capabilities and improve those initial deliveries on a
12- to 18-month cycle. Defense IT systems typically take 48 to 60 months to deliver."
IT developer
7. Reduce development and production cycle times.
Adopt a modular "good, better, best product development" mindsetset targets
and criteria early and embrace the relative difference in each.
Empower program managers on both the government and supplier side to
reduce multiple layers of low-value oversight and "obstruction by the multitude of
minions."
Provide critical path transparency and adjust resources accordingly.
8. Lower barriers to new or non-traditional entrants.
Actively engage non-traditional suppliers and streamline the certification process.
This implies understanding the real cost of risk as opposed to using it as a
convenient excuse to prevent change.
Facilitate access of non-traditional entrants through venture capital or incubator-
like models such as DeVenCI and In-Q-Tel.
Go beyond passive solicitation postings on fed-bizopps to actively facilitate
access to buyers via B2B websites.
Establish a chief innovation officer position in the DOD similar to that in the
commercial sector.
9. Streamline adoption of COTS solutions.
Establish tailored procurement processes for rapidly changing technology.
Adopt commercial best practices to leverage COTS information technology.
Develop technology road maps recognizing overlapping multi-program capability
requirements.
Limit tailoring of COTS solutions to a minimum.
10. Adopt open system architectures.
Outline common standards for systems and sub-systems to be universally
adopted and enforcedwhere appropriateacross the DoD. While many
contractors and services already define native open-architecture standards, the
real bang for the buck lies in taking a department-level view.
Encourage independent parties, large and small, to design and develop
interoperable modular components that all work together under specified
standardsthereby lowering overall development, modification, and operating
costs across the life cycle.
Get the architecture right the first time. This requires not only defining and
adopting an open-architecture philosophy, but also building out government and
contractor system engineering capabilities to understand the planned
architectures' inherent trade-offs.
Focus on the OpportunitiesTogether
In the new environment of significantly reduced defense funding, the value chain status
quo is unsustainable, pressuring virtually all participants on both the buy and sell side of
the equation to act differently. There are challenges and opportunities ahead. Those that
focus on the opportunitiesspecifically, the value-creation opportunities to improve
productivity and accelerate innovationcan maintain and even improve their profit
margins. But none of this can be accomplished alone. All players in the defense
industry, from sub-tier suppliers to government customers, will have to make significant
changes to their value chains. The good news is that the commercial sector already
offers a "how to" perform a value-chain transformation. Following the three guiding
principles outlined in this paper, combined with prioritized affordability plans, will help
ensure that the "maintain scope" option prevails over the "reduce scope" option as the
most expedient, long-term remedy for the defense industry.




Optimizing portfolio strategy
In a time of decreasing government spending, aerospace and defense industry
players need to engage in decisive portfolio management if they are to continue to
create shareholder value. We have significant experience in helping companies
optimize their product and R&D portfolios from supporting exhaustive analyses
of current investments and identifying divestment opportunities, to developing
strategies to redeploy capital and resources to new, high-potential segments,
products and service offerings and technologies.
Driving growth
In light of the current economic cycles and pricing pressures from customers,
aerospace and defense prime and sub-contractors need to make bold efforts to
identify growth opportunities. We help companies identify international markets
in which to extend their traditional capabilities, develop services in adjacent
sectors, and expand within the aerospace and defense verticals. Working with
functional and industry experts from across the firm, we can help companies
identify attractive white space areas in the defense and security industries and to
capture these new business opportunities.
Improving program a!ordability
Aerospace and defense contractors face an affordability imperative. This requires
strategies to weather the retrenchment in government spending in the short-term
while building capability to be competitive in the long-term. We help companies
achieve both objectives, with the overall goal of improving their agility and
market responsiveness.
Our current work includes developing processes for significantly reducing costs
of direct labor, direct material, and indirect costs to achieve lean, cost-efficient
operations. We help organizations to improve affordability by adopting design-
to-value principles and redesigning critical processes and capabilities, including
product development and production models, supplier relationships, and
program operating models and risk management.


To understand how regional shifts might affect the nature of global competition,
we questioned executives about the decline in defense spending in established
markets and the rise in emerging markets. Would this shift in spending be
accompanied by a commensurate shift in the structure of the industry? Would
new globally competitive players emerge, using their lower cost structures as a
springboard to global prominence? Almost two-thirds of respondents
admittedly, mostly from more established marketssaid they did not expect to
see a new competitive global player emerge; instead they thought that companies
in emerging markets would continue to function mainly as low-cost
manufacturers or suppliers.
The survey results make it clear that defense industry leaders believe their
companies must change the way they do business; the question is how to do it.
Almost all survey respondents believe that defense customers will change their
focus from procuring the systems with the highest possible performance to ones
that are more affordable. However, only two-thirds of the defense-industry
executives surveyed think that defense suppliers will be able to change their
internal processes to deliver more affordable, rather than exquisite, products.
hoped that government would make it simpler in the specifications, recognize
the fragility of the industrial base and allow consolidation to occur, and drive
harder bargains. One executive said a desired change would be more open
collaboration between industry and departments of defense early in the
requirements and acquisition process.
Industry leaders also shared their apprehensions about the challenges of
international growth. Many voiced concerns about export controls and
regulations, and about International Traffic in Arms Regulations, suggesting
these are a significant barrier to growth. Others noted their struggle with
decreasing budgets. Respondents also cited cultural issues, such as lack of
management experience working outside the local country, a similar lack of
understanding of local context or cultures, and the need for a change of mind-
set from top management, including human-resource management, as potential
barriers to international growth.
Each of these growth opportunities comes with unique challenges and concerns.
With respect to commercial aerospace, one of the largest potential areas of
growth for defense companies, executives cited concerns about cyclicality, slow
GNP growth, pricing pressure, displacing incumbents on Boeing/Airbus
narrow-body aircraft, capital constraints, and production ramp-up. One
executive noted the Asian footprint and consolidated machining in Asia as a
challenge, while another stated having a decent business case for investment
would be an issue.
Services, the second most anticipated source of growth, was cited by three-
fourths of respondents to generate a larger share of their companies revenues.
Executives note challenges for service growth include recruiting, how to create
value, the procurement process, competition from government, insourcing by
military customers, and customer resistance.
One area of varying opinions was unmanned systems. While about two-thirds of
survey respondents say their companies will seek unmanned-systems growth,
only a little over half say they will diversify outside of defense. Yet that is where
growth will come, according to most of those who plan to diversify. Executives
see several challenges for growth in unmanned systems, including airspace
utilization, a lack of clear requirements from customers, no common
architecture, and pilots as decision makers. One respondent noted that the
sector is littered with small to medium players and far too many in-country
development programs. Our company will focus on the larger platforms (such as
the unmanned carrier-launched airborne surveillance and strike system, or
UCLASS) where there is more value and more synergies with our scale and
capabilities.
In another acknowledgment of the questions around unmanned systems, two-
thirds said they believe that the Joint Strike Fighter program will not be the last
major manned-aircraft development program.
For cybersecurity, an area in which only half of survey respondents are
interested, executives foresee challenges, such as acknowledgement of the
problem and the prospects of dealing with it, a lack of agreement on what
cybersecurity encompasses and on what, exactly, the customer can buy to have
more of it, and the industrys competence to offer effective solutions.