DoD 5000.60-H

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DoD 5000.60-H, April 1996

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FOREWORD

DoD 5000.60-H, April 1996

TABLE OF CONTENTS
Page
2

FOREWORD
TABLE OF CONTENTS

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FIGURES

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TABLES

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PART I - FRAMEWORK

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CHAPTER 1 - INTRODUCTION

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CHAPTER 2 - THE PLANNING FRAMEWORK

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PART II - DEFENSE INDUSTRIAL CAPABILITIES ANALYSIS

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CHAPTER 3 - DECIDE IF AN ANALYSIS IS WARRANTED

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CHAPTER 4 - DEFINE THE PROBLEM

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C4.1. VERIFY THE NATIONAL SECURITY RELATIONSHIP
C4.2. DEFINE THE UNIQUE INDUSTIRAL CAPABILITIES
C4.3. VALIDATE THE RISK OF LOSING THE CAPABILITY
CHAPTER 5 - IDENTIFY AND EVALUATE ALTERNATIVE ACTIONS
C5.1.
C5.2.
C5.3.
C5.4.
C5.5.
C5.6.
C5.7.
C5.8.

NO ACTION
FOREIGN SOURCES
SUBSTITUTES
BUY-OUT TO MEET FUTURE DoD NEEDS
TECHNOLOGY SOLUTION
SMART SHUTDOWN
MAINTAIN THE CURRENT CAPABILITY
ADDITIONAL CONSIDERATIONS FOR DoD ACTION

CHAPTER 6 - RECOMMEND A COURSE OF ACTION

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18
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31
33
34
36
37
38
39
40
42
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APPENDICES
AP1. FINANCIAL ANALYSIS PROCEDURES
AP2. PROCEDURES FOR BREAK-EVEN ANALYSIS

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FIGURES
Figure
P1.C3.F1.
P2.C3.F2.
P2.C3.F3.
P2.C3.F4.
P2.C4.F5.
P2.C5.F6.
AP1.F1.
AP1.F2.

Title
Defense Industrial Capabilities Analysis
Decide If An Analysis Is Warranted
Verify the National Security Relationship
Define the Unique Industrial Capabilities
Validate the Risk of Losing the Capability
Identify and Evaluate Alternative Actions
Balance Sheet Example Format
Industrial Capabililty Financial Analysis Worksheet

Page
10
12
14
20
23
31
47
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TABLES
Table
AP1.T1.
AP1.T2.
AP1.T3.

Title
Page
Income Statement
46
Summary Table
49
Example of the CDE Widget Company Income Statement
50
and Profitability Analysis (in thousands)
AP1.T4. Internal Comparison
54
AP1.T5. External Comparison
54
AP1.T6. Peer Comparison
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DoD 5000.60-H, April 1996

P1. PART I
FRAMEWORK
P1.C1. CHAPTER 1: INTRODUCTION
P1.C1.1. Purpose. This Handbook provides the framework and guidelines for
evaluating, on a case-by-case basis, the need for Government action to preserve
industrial capabilities vital to national security. A defense industrial capability is a skill,
facility, process, or technology needed to design, develop, produce, repair, or maintain
products used by the Department of Defense. You should use this Handbook when
there is an indication that an important and unique industrial capability could be lost.
P1.C1.2. This Handbook is not intended to replace normal vendor management
procedures and authorities. There are many routine vendor problems that arise in
program and item management: components become obsolete when manufacturers
change models, companies stop making certain products, and other sources for the
products must be qualified. Those problems currently handled through routine vendor
management authorities are not candidates for this process.
P1.C1.3. What is the purpose of this Handbook? The Department of Defense
buys products and services -- not capabilities -- but every product or service represents
a set of industrial capabilities. This Handbook outlines the Department's analysis
process to answer:
P1.C1.3.1. What industrial capabilities are essential to making the products
and services the Department's needs?
P1.C1.3.2. Are these capabilities truly unique? Truly endangered?
P1.C1.3.3. What is the best course of action for the Department of Defense?
P1.C1.4. Philosophy. The Department of Defense relies on market forces to the
maximum extent possible to guide the development and sustainment of industrial
capabilities. We will only consider taking action in those exceptional cases where an
industrial capability, necessary to meeting defense requirements, is genuinely at risk of
being lost. Any recommendation for special action must be based on a thorough
analysis, using the guidance provided in this Handbook.

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P1.C1.5. Responsibilities:
P1.C1.5.1. Who should use this Handbook? When?
P1.C1.5.1.1. DoD managers or teams formed within and across the DoD
Components.
P1.C1.5.1.2. When there is an indication that a needed defense product or
service could be lost due to loss of industrial capability.
P1.C1.5.2. Analysis. Any DoD manager may initiate a Defense Industrial
Capabilities Analysis (see Part II) when there is an indication that a needed industrial
capability could be lost. Ultimately, the DoD Components are responsible for
analyzing industrial capabilities that may be at risk. When industrial capabilities affect
more than one defense program or user, the DoD Components should coordinate their
analyses and subsequent decisions within and across the Components.
P1.C1.5.3. Decision Authorities
P1.C1.5.3.1. For all Acquisition Category (ACAT) programs, all actions
or investments of less than $10 million annually to preserve a capability are approved
by the Component Acquisition Executive (CAE) or Defense Acquisition Executive
(DAE), as defined in DoD 5000.2-R, "Mandatory Procedures for Major Defense
Acquisition Programs (MDAPS) and Major Automated Information System (MATS)
Acquisition Programs," March 15, 1996, authorized by DoD Directive 5000.1, March 15,
1996.
P1.C1.5.3.2. For all other products or programs, all actions or
investments of less than $10 million annually to preserve a capability are approved by
the Head of the Contracting Activity (HCA).
P1.C1.5.3.3. For all programs or products -- ACAT and non-ACAT -- any
proposed action or investment to preserve a capability with an anticipated cost of $10
million or more annually requires the approval of the Under Secretary of Defense for
Acquisition and Technology (USD(A&T)) and coordination with the Deputy Under
Secretary of Defense for Industrial Affairs and Installations (DUSD(IA&I)).

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P1.C1.5.4. Policies and Procedures. DUSD(IA&I) is responsible for the
policies and analysis procedures that govern the Department of Defense's role in
maintaining industrial capabilities required to carry out the defense mission.
NEED HELP? If you need help in applying the procedures described in this Handbook, please contact the
DUSD(IA&I) Director, Industrial Capabilities and Assessments, the Pentagon, Room 2B322, (703) 697-1366
or 697-6833; DSN 227-1366 or 227-6833; e-mail [email protected].

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P1.C2. CHAPTER 2: THE PLANNING FRAMEWORK
We are operating in a defense environment that is very different from that of the past,
and defense policy has changed accordingly. The following is the framework in which
decisions on the preservation of defense industrial capabilities are made.
P1.C2.1. The Department of Defense is a smaller customer with changing
needs. Sharp reductions in the defense budget, particularly in the procurement account,
reflect our new security environment. Between 1985 and 1995, the Department's
budget dropped in real terms by 35 percent overall and by 67 percent in procurement.
The largest part of these cuts is being achieved by reducing the procurement of new
weapon systems. We are buying and developing fewer types of military systems and
purchasing smaller quantities of the systems we do buy. This has a direct effect on
industry.
P1.C2.2. Industry is downsizing. Consolidation and restructuring are the defense
industry's inevitable and natural responses to lower revenues. This consolidation is
essential to reducing the industrial capacity that exists in excess of defense needs, and
to lowering the overhead costs of the products we do buy. Such consolidation needs to
proceed primarily without Government intervention.
P1.C2.3. The Department of Defense is adopting new strategies. Our
challenge is to maintain superior technology and industrial capabilities at an affordable
price. To meet this challenge, we are pursuing two strategies.
P1.C2.3.1. Rely on commercial suppliers. The first strategy is to rely on a
technology and an industrial base sustained by commercial demand, but capable of
meeting defense needs. By using commercial products and services, we benefit from
the cost efficiencies and technological innovations available from a much larger
commercial market. We also capitalize on industry's investments in research and
development and more rapid pace of product improvements.
P1.C2.3.2. Buy from the global marketplace. The second strategy is for
the Department to take advantage of the cost and technology benefits offered by access
to the best global suppliers. We are pursuing cooperative international development
and production programs because they offer cost sharing of defense development
projects, access to new technologies, and access to an international industrial base.
With the proper selection of suppliers, we can gain from a significantly expanded use of
foreign sources without becoming vulnerable to those same sources.

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P1.C2.3.3. Reduce defense-unique industrial capabilities. While we are
seeking to eliminate business practices that drive industrial capabilities unnecessary
defense-unique industrial capabilities, capabilities that are needed solely, or
predominately, for defense products will remain. These capabilities may have no
commercial counterpart. For example, the Department of Defense will need
capabilities to produce defense products that can meet extraordinary performance
demands or operate in extreme environments. We must distinguish capabilities that are
truly defense unique from those that only appear unique because of past DoD
acquisition practices.
P1.C2.4. The Department of Defense will fund actions to preserve
capabilities only when necessary. In this period of downsizing and consolidation, our
objective is to ensure that industrial capabilities needed to meet national security
requirements will remain available. While an industrial capability resides in a company,
it is not a company, per se.
P1.C2.4.1. Analysis. We do not need, nor can we afford, to invest to
preserve every industrial capability or a capacity level greater than that needed to meet
defense needs. The Department of Defense will not take actions based solely on the
assumption that existing capabilities must be preserved. The Department of Defense
will base its decisions on a case-by-case analysis considering defense needs and all
possible alternatives.
P1.C2.4.2. Funding trade-offs. When the Department of Defense decides to
take a special action to preserve an industrial capability, we must include the costs in
our budgets, acquisition plans, and resource allocations. DoD dollars spent to preserve
capabilities leave fewer dollars available for other resource priorities, such as
readiness, modernization, and soldier quality of life.

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P2. PART II
DEFENSE INDUSTRIAL CAPABILITIES ANALYSIS

P1.C3.F1. Figure 1. Defense Industrial Capabilites Analysis

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PART 2

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This is a step-by-step guide to performing an industrial capability analysis. The analysis
process has four parts. These parts are not necessarily consecutive and you will have to
collect data to address the analysis issues of each part.
Analysis Process

Chapter

Decide if an analysis is warranted

3

Define the problem

4

Identify and evaluate alternative actions

5

Recommend a course of action

6

Each part provides flowcharts to help you understand where you are in the analysis
process and what you want to learn from each step. Figure 1 is a flowchart of the entire
Defense Industrial Capabilities Analysis process.
P2.C3. CHAPTER 3: DECIDE IF AN ANALYSIS IS WARRANTED
Your Objective is to determine whether there is sufficient cause to conduct an
analysis of the industrial capabilities that support the product or service of
concern. Stop your analysis at any point if you decide that no analysis or action is
necessary.
P2.C3.1. You should initiate a Defense Industrial Capabilities Analysis only, when
you become aware of a potential problem. Concerns may be raised because the
Department of Defense has stopped buying a product or service, or is reducing the
quantities it is buying. An analysis is warranted only if there is an indication that the
Department may lose the ability to obtain needed defense products and services. You
should distinguish between normal vendor management problems, handled routinely by
program and product managers within their normal authorities, and the exceptional
instance when an industrial capability might be lost. Figure 2 is a flowchart of the
process.
P2.C3.2. Routine vendor management problems do not require an analysis.
There are many vendor problems that arise in normal program and item management.
Usually these can be resolved within your routine procedures and authorities. In these
cases, you do not need to perform the analyses described in this Handbook.
P2.C3.2.1. Does another supplier exist? You have a normal vendor
management problem if another supplier exists that can, and is willing to, provide the
same product or service, given reasonable time and price.
P2.C3.2.2. Is a substitute available? You also have a normal vendor
management problem if a direct substitute product or service is available.
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P2.C3.F2. Figure 2. Decide If an Analysis Is Warranted

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P2.C3.5. Scenarios that require an analysis.
P2.C3.5.1. At least three scenarios call for an industrial capabilities analysis.
The first is when DoD managers are faced with a problem in getting a needed product or
service that they cannot resolve within their routine authorities and that may require
special action or investment to resolve.
The Army is faced with a problem in obtaining a special wire needed for the
production of a missile. The sole source manufacturer of the wire has advised that
the missile production rate is too low to sustain the capability and he will "close
shop."
P2.C3.5.2. The second scenario is when individual firms, industry
associations, or other responsible sources warn DoD managers that an industrial
capability is endangered.
Semiconductor manufacturers are reporting that they are not interested in making
products to meet certain military-defined integrated circuit requirements, such as
radiation hardening, unless they get a guaranteed volume of business.
P2.C3.5.3. A third scenario is when product development or manufacturing is
terminating either permanently or temporarily. Managers facing program termination
should assess the potential loss of industrial capability if a future DoD need for the
product or capability is identified.
A DoD Component is faced with a decision of whether to terminate production of
one of its missiles. The missiles are in adequate supply now, but will be needed
again within 3 to 5 years. The Component is considering awarding a low-rate
production contract to keep the production line intact.
P2.C3.6. Determine of an analysis has already been done. Before undertaking a
new analysis, determine if your Component or the Department of Defense has
completed other industrial analyses analysis has relating to the product, service, or
capability that seems to be at risk. You may find that your problem has been addressed
and there is no need for additional analysis. As a minimum, an already completed
analysis may provide useful input for your new analysis.
NEED HELP? If you need help determining if your Component or the Department of Defense has completed
other industrial analyses relating to the product, service, or capability that seems at risk, please contact the
DUSD(IA&I) Director, Industrial Capabilities and Assessments, the Pentagon, Room 2B322, (703) 697-1366
or 697-6833; DSN 227-1366 or 227-6833; e-mail [email protected].

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P2.C3.F3. Figure 3. Verify the National Security Relationship

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P2.C4. CHAPTER 4: DEFINE THE PROBLEM
Usually you will start an analysis because a product or service you buy or need is
becoming unavailable, or seems at risk of becoming unavailable. If you have already
identified a specific supplier or industrial capability -- for example, a skill or facility -that seems at risk, you will need to tie this supplier or capability to the defense product
or service it supports.
You are now ready to begin defining the problem. There are three steps to defining the
problem:
1. Verify the national security requirement

Section P2.C4.1.

2. Define the unique industrial capability

Section P2.C4.2.

3. Validate the risk of losing the capability

Section P2.C4.3.

P2.C4.1. Verify the National Security Relationship
P2.C4.1.1. Questions to ask. Figure 3 is a flowchart of the steps involved
in verifying the national security relationship. There are two basic questions to be
asked at this point:
P2.C4.1.1.1. Is there a national security requirement for the product of
service?
PC4.1.1.1.2. Who else uses this product or service?
P2.C4.1.2. Is there a national security requirement for the product or
service?
P2.C4.1.2.1. Your objective is to determine whether the product or
service that seems to be at risk is vital to meeting current and planned national
security requirements. If not, your analysis ends at this point. The Department of
Defense will only consider preserving a capability that is needed to support national
security. Start your analysis by identifying the defense product or service that seems
potentially at risk, then determine if the product or service is needed to meet defense
requirements. If a current defense requirement is ending, is there a known or likely
future need for the product or service? Define the timeline or schedule for the
product is required, even if it can only be estimated at this time.

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P2.C4.1.2.2. Broadly speaking, defense requirements -- current or future
-- fall into three categories:
P2.C4.1.2.2.1. Planned force structure and mission scenarios.
P2.C4.1.2.2.1.1. Is the product or service necessary to meet
planned military missions? In other words, is it needed to supply and equip the existing
or planned force structure of the Armed Forces? Refer to the President's Budget,
Future Years' Defense Program (FYDP), and the Defense Planning Guidance (DPG) for
information on the Department of Defense's planned force structure.
The Air Force requires satellites and associated launch vehicles to meet identified
threat and mission needs and schedules. These requirements are reflected in their
FYDP input.
Nerve gas antidote auto injectors have little peacetime requirement; however, the
Department of Defense must have the capability to surge production to meet
wartime or contingency demand. Surge requirements are included in Component
Operations Plans based upon the DPG.
P2.C4.1.2.2.1.2. Additionally, individual DoD Component plans
identify long-range needs that may be outside the FYDP.
Minuteman III solid rocket motors must be rebuilt in a planned cycle of 20 years.
While in a given time period there work may not appear in the Component's budget
or FYDP, there is a need for the capability to rebuild the motors when the time
limitation is reached.
P2.C4.1.2.2.2. Readiness and sustainment. Is the product or
service needed to meet readiness or sustaiment requirements? Will its absence affect
the Department's ability to support defense systems, assemblies, or other components
over the life cycle? When defense products go out of manufacture, the Department
requires post-production support for the useful life of the product. Readiness and
sustainment requirements are determined based upon product repair histories and
planned overhaul schedules. Refer to DoD Component inventory and weapon system
program managers for this type of data.
The B-52 and B-1 bombers are out of production. However, both are still in
operation and require spares, repair parts, test equipment support, data, and
sustaining engineering.

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P2.C4.1.2.2.3. Next-generation defense capabilities. Is the
product or service needed to support the design, development, or manufacture of
next-generation defense equipment? Would its loss limit our ability to develop or field
new systems? Is it needed to modernize systems or make mission-driven upgrades?
The Department of Defense is interested in developing increasingly advanced
"smart " munitions, missiles, and other weapons. Capabilities such as specialized
engineering and software skills and sophisticated modeling and simulation are
essential to their development of affordable but superior "smart" weapons.
NEED HELP? If you don't know what products or services are funded or required by the President's Budget,
FYDP, or how to otherwise determine national security requirements for your product or service, contact your
activity or Component headquarters.

P2.C4.1.3. Do others use this product or service? Your objective is to
identify all users for the products and services of concern. If appropriate, you
should establish a DoD team to participate in or coordinate the analysis. Industrial
capabilities needed to support one product, service, or program are very often needed by
others. The Department of Defense cannot afford to make duplicate investments to
preserve identical or very similar industrial capabilities. To understand the full national
security requirement, you need to identify the users and their demand for the product or
service. When the product, service, or capability of concern supports more than one
defense program or user, you should establish a cross-DoD analysis process.
P2.C4.1.3.1. Define total demand. Define total demand, including DoD
and world-wide demand. If you initiated this analysis with a specific capability as a
focus, you again need to tie it to the product or service it supports. Is the defense
capability in question needed to support other products, services, or programs?
P2.C4.1.3.1.1. DoD Demand. This includes other defense users of
the product or services, both within and across Components. What is the total DoD
demand for the products or services, in terms of total quantities required, quantities on
order, dollars, and development or production timelines?
P2.C4.1.3.1.2. World-wide demand. What is the Department of
Defense's relative share of the global product or service market? Who are the
non-DoD users? If the Department of Defense is not the only or predominant user,
then the capability is most likely not at risk. If the Department's product is a variation
of a more widely-used product the capabilities needed to provide both products are
usually very similar.

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P2.C4.1.3.2. Establish a cross-DoD analysis. Establish a cross-DoD
analysis by either coordinating a team of representatives from all affected DoD
managers or by designating a lead Service or Agency. (For assistance in designating a
lead Agency, see the Help box below.) If you can identify other Government users,
such as the National Aeronautics and Space Administration or the Department of
Energy, coordinate your analysis with them.
The Navy and the Air Force have a need for high accuracy intercontinental ballistic
missile (ICBM) guidance systems. Any analysis of the capabilities to manufacture
ICBM guidance systems should be coordinated between the two Services. Further,
the industrial capabilities needed to produce guidance systems for ICBMs may be
similar to those needed for other defense missile guidance systems. These "similar"
capabilities should be explored in the joint-Service analysis.
NEED HELP? If you are unable to identify the other defense products or other users, elevate the need for
analysis to a higher level of management. You may also call the DUSD(IA&I) Director of Industrial
Capabilities and Assessments, (703) 697-1366 or 697-6833; DSN 227-1366 or 227-6833; e-mail
[email protected].

P2.C4.2. Define the Unique Industrial Capabilities
P2.C4.2.1. Questions to ask. Figure 4 illustrates the steps that should be
taken to define the unique industrial capabilities. The two questions you need to ask at
this point are:
P2.C4.2.1.1. What capabilities are needed to provide the product or
service?
P2.C4.2.1.2. Do any of these capabilities require further analysis?
P2.C4.2.2. Define the capabilities needed to provide the product or
service.
P2.C4.2.2.1. Define the many capabilities that are needed to provide the
product or service of concern. In some instances, defining all the capabilities may be a
relatively easy and limited task. For example, if a company advises the Department of
Defense that it will no longer provide a particular minor assembly, you may be able to
rapidly identify the small set of capabilities that are needed to develop or produce the
product.

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P2.C4.2.2.2. However, in many cases the product in question will be a
very complex end item, subsystem, or set of assemblies. In these cases you will need
to do much more extensive work to define all of the capabilities involved. A work
breakdown structure, commonly used in acquisition programs, is a good starting point.
The Department of Defense has been using a particular type of engine that is
similar to a commercial engine design. However, the DoD engine incorporates
subassemblies (e.g., hot section) uniquely adapted for defense applications. The
DoD production contract is ending. In assessing the capabilities that may be lost,
the DoD manager delineates the types of capabilities used to develop, produce, and
support the engine.

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P2.C4.F4. Figure 4. Define the Unique Industrial Capabilities

P2.C4.2.2.3. Type of Capability. Moreover, you need to define
capabilities in terms of type of capability (skills, knowledge, facilities and equipment,
processes, or technologies).

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The production of solid rocket motor fuel depends on certain human skills that are
difficult to document and to precisely replicate. Proper execution of the fuel mixing
process is critical because of the highly explosive nature of the materials. These
skills are an important capability for producing the fuel.
P2.C4.2.2.4. Kind of Activity. Other considerations are the kind of
activity the capability supports (design, develop, produce, repair, or maintain defense
products at the system, subsystem, or component level) and the amount of capacity that
exists in private or public activities for the product, service, or industrial capability you
are assessing.
P2.C4.2.2.5. Amount of Capacity. Capacity is the volume or level of
output -- or the potential for a level of output -- that exists for a given product or
service. Loss of industrial capacity that is excess to defense needs is not the same as
loss of a capability, and in fact may be desirable in reducing contractor costs.
P2.C4.2.3. Is the Capability Truly Unique?
P2.C4.2.3.1. Your objective is to determine those industrial
capabilities that are truly unique and irreplaceable for providing a product or
service required for national security. Narrow your analysis truly unique
capabilities. Many capabilities that exist today in support of defense products or
services seem unique.
P2.C4.2.3.2. However, their existence in a unique form does not
necessarily mean that they are the only capabilities that could meet defense needs.
Many capabilities required to support defense products and services are available, or
similar to those available, in the commercial marketplace.
The DoD manager of the engine that is adapted from commercial engine designs
finds that many of the DoD engine's components, materials, and processes are
identical or very similar to those of the commercial engine. These are eliminated
from the analysis. The analysis will focus only on those capabilities needed to
support the defense-unique adaptations (e.g., hotsection).
P2.C4.2.4. Questions to determine if the capability is truly unique. In
this part of the analysis, you should:

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P2.C4.2.4.1. Identify current suppliers of the product or capability of
concern. Does the product or capability exist today only in a single product line, or in a
single or very limited set of suppliers? NOTE: Suppliers can include private or public
sources.
P2.C4.2.4.2. Identify suppliers of related defense and non-defense
products or services. Do these suppliers use industrial capabilities similar to the
capability of concern? Is it at all feasible for the design or production of your product
of concern to be carried out using these similar capabilities? Analyze projected
demand for the related products to assess future availability of these similar
capabilities. You may not be able to fully address this factor until you have completed
some comparative analysis of substitutions. (See section P2.C5.3.)
P2.C4.2.4.3. Is the capability so unique that defense needs or missions
cannot be met without it? Will its loss cause the development or production of certain
existing defense items or defense product areas to be time or cost prohibitive?
P2.C4.3. Validate the Risk of Losing the Capability
P2.C4.3.1. Your objective is to determine whether a capability, uniquely
required to provide defense products and services, is truly in danger of being lost.
If it is not truly unique, or if it is not in danger of being lost, further analysis is
unnecessary. Once you have determined that an industrial capability is needed to
provide a defense product or service, and is truly unique, you must determine if the
capability is really at risk of being lost. Figure 5 illustrates the steps involved in
validating the risk of losing the capability. There are two basic questions to address:
P2.C4.3.1.1. Will the capability be lost due to supplier financial
performance or product line profitability?
P2.C4.3.1.2. Will the capability be lost if development or manufacturing
is reduced or interrupted?

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P2.C4.F5. Figure 5. Validate the Risk of Losing the Capability

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P2.C4.3.2. Will the capability be lost due to supplier financial
performance or product line profitability? A needed capability could be lost
because the current supplier is leaving the market. If a supplier is warning that he may
exit because the product line or the business unit is not profitable or sufficiently
profitable, you will need to perform an analysis of either the product line's profitability
or the supplier's financial viability.
P2.C4.3.2.1. Follow a four-step financial analysis. The financial
analysis should answer the following questions:
P2.C4.3.2.1.1. Is the specific product line profitable?
P2.C4.3.2.1.2. Is the business unit's financial performance so poor
that the activity may not be continued?
P2.C4.3.2.1.3. Is profitability expected to improve due to likely
future sales (including proposed government contracts), internal restructuring, ongoing
corporate mergers and acquisitions, or other changes in circumstance?
P2.C4.3.2.2. To answer these questions and gain a bottom-line
understanding of a business activity, follow a four-step financial analysis as summarized
in this section. Appendix 1 provides the detailed procedures you should use in
performing each of these steps.
P2.C4.3.2.2.1. Step 1. Collect Financial Statements. Gather the
relevant financial statements that accurately reflect the current financial health of the
company. You will collect Income Statements and Balance Sheets, which the company
can provide at your request. These documents provide the company's financial results
of operations for a given year, along with an accounting for the resources of a business,
and the claims against those resources by lenders and owners. Since the expressed
concern is about the financial contribution of the product that the Department of
Defense purchases, you should collect these documents at the corporate and business
unit or product level. Follow the steps outlined in Appendix 1 to obtain the data you
need.
P2.C4.3.2.2.2. Step 2. Calculate Profitability. Use the financial
data you have collected to perform a preliminary profitability screen and determine
whether the company is profitable, i.e., making money. The results of this screen will
help you determine whether any further financial analysis is necessary.

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P2.C4.3.2.2.3. The primary measure of profitability for your
financial analysis is Operating Profit Margin. Operating Profit Margin is simply the
company's operating income divided by its sales; this result is then multiplied by 100 so
that it is stated as a percentage. Use the procedures in Appendix 1 to determine the
company's Operating Profit Margin for a 5-year period: the past 2 years, the current
year, and two projected (future) years. Appendix 1 also provides a sample profitability
analysis, and defines Return on Assets (ROA), an additional measure of profitability.
P2.C4.3.2.2.4. After calculating the Operating Profit Margin, use the
following two criteria to evaluate the business unit's or product's profitability:
P2.C4.3.2.2.4.1. The Operating Profit Margin is a negative
percentage in current or future years; or
P2.C4.3.2.2.4.2. The Operating Profit Margin is positive in
current and future years, but has declined by more than 50 percent over a 3 to 5-year
period.
P2.C4.3.2.2.4.3. If the answer in either case is true, the
company's financial viability merits further analysis to determine the causes of its
weakening performance. Proceed then to Step 3.
P2.C4.3.2.2.4.4. If neither criterion holds true for the company,
no further financial analysis is generally needed.
P2.C4.3.2.2.5. Step 3. Perform a comparative analysis.
Compare the financial performance of the business unit or product with those of other
companies or with other business units within the same corporation. At this point you
may want to seek assistance from a more experienced financial or cost analyst. You
will be using the two measures of profitability that you have calculated in Step 2,
Operating Profit Margin and ROA, as a basis for this comparison.
P2.C4.3.2.2.6. From the company's perspective, the question is
whether its operations are earning an adequate return. Such a determination requires
judgment. You will compare company returns across a number of dimensions (e.g.,
overtime, between divisions of the corporation) as the basis for this judgment. Follow
the procedures in Appendix 1 to compare profitability measures for the company with
internal, external, and peer business unit measures.
P2.C4.3.2.2.7. Step 4. Identify the problem. Use the information
obtained in Step 3 to identify the specific financial problem that the company is
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encountering, as well as potential solutions. Having compared the measures of
financial performance across a number of important dimensions, you should now be able
to assess the company's financial viability. There are three potential outcomes from
your assessment, as follows:
P2.C4.3.2.2.7.1. No real financial problem. The following
examples are typical situations where there is no risk or minimal risk to financial
viability.
P2.C4.3.2.2.7.1.1. The company is making profits that are
acceptable when compared with other business units, firms, or similar industries.
Profits may well have declined but still should not represent a major concern. This may
happen for a number of reasons, such as:
P2.C4.3.2.2.7.1.1.1. The business unit could still be
performing well compared to the corporation as a whole or to other companies in the
same market; or
P2.C4.3.2.2.7.1.1.2. The entire market may be at a
cyclic low point.
P2.C4.3.2.2.7.1.2. While there is a short-term profitability
problem, the situation is temporary and future sales should be sufficient to sustain the
company. For example, a new contract is about to be awarded.
P2.C4.3.2.2.7.1.3. The business may be experiencing a
downturn from which recovery is expected (e.g., a cyclical industry). Sales and revenue
are expected to turn around due to natural market forces.
P2.C4.3.2.2.7.2. Company should take action. The following
are situations where the financial problem is real, but within the company's
responsibility to correct.
P2.C4.3.2.2.7.2.1. As sales volume has decreased, the
company has not adequately controlled the ratio of indirect to direct costs, thereby
reducing profits. Assess whether indirect cost reductions can be achieved to reduce the
high overhead costs and increase profitability.
P2.C4.3.2.2.7.2.2. The company has not upgraded its
facilities, modified its processes, or applied available new technology to reduce costs.
Investment may have to be made in more efficient production processes, and older
production lines may have to be shut down.
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P2.C4.3.2.2.7.2.3. The company is seeking, investment,
loans, or cost reimbursement from the Department of Defense prior to exhausting
corporate and outside sources. If future profitability is contingent on refinancing,
ascertain commitment of lenders for a bank loan or underwriters for financing.
Confirm that the cost of debt will be lower and will enable the company to become
profitable. See the next Help box, below.
P2.C4.3.2.2.7.3. Government action should be considered.
If the financial problem is real and Government action should be considered to maintain
the company's desired capability, use Chapter 5 of this Handbook to assess potential
alternatives available for Government action.
NEED HELP? If you need help in performing the financial analysis, contact your Budget/Accounting or
Comptroller organization, or call the DUSD(IA&I), the Pentagon, Room 2A318, (703) 695-0121 or 695-7915;
DSN 225-7915 or 225-0121; e-mail to [email protected].

P2.C4.3.3. Will the capability be lost if development or manufacturing
is reduced or interrupted?
P2.C4.3.3.1. Many capabilities can be interrupted and restarted.
Very complex and finely tuned industrial capabilities -- processes, skills, and equipment
-- are often needed to make defense products. However, because of their very
complexity, these capabilities are often documented, automated, and tightly controlled
by statistical and other precise process metrics. Highly skilled employees in such
specialized areas are usually capable of working on related products or processes. Thus
many industrial capabilities can be duplicated or restarted -- with acceptable
performance -- despite some lapse in development or production activity.
P2.C4.3.3.2. A few industrial capabilities may be such intricate
combinations of science and art that they must be sustained continuously to be viable;
however, these are exceptional instances.
A major DoD product area has three large prime contractors that build very
different types of the same product. An in-depth DoD analysis determined that
despite the unique and complex industrial capabilities needed to make the different
product types, any of the manufacturers could build the others' products. This is
possible because all three primes have basically equivalent engineering
competencies and manufacturing capabilities, and there are sufficient
documentation and process knowledge to produce the different types.

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P2.C4.3.3.3. Evaluate the technical risk for each capability of
concern. You need to perform a technical analysis to determine whether your
capability will be degraded unacceptably, or effectively lost, if the development or
manufacturing activity it supports was not sustained continuously or at some minimal
rate. Your analysis objectives are to determine:
P2.C4.3.3.3.1. Whether a specific skill, process, or piece of
equipment is affected by changes in the activity rate or level.
P2.C4.3.3.3.2. Whether these rate sensitive capabilities are driven by
a product performance specification (e.g., specifications that are extremely complex or
narrow in tolerance).
P2.C4.3.3.4. Work with the organization currently performing the
development or production activity. Answer the following questions for each product
component or capability of concern to discern or disprove the risk of loss.
P2.C4.3.3.5. Can workforce proficiency be maintained by other
activity? Before answering, you should investigate:
P2.C4.3.3.5.1. Maintaining qualified, certified, or licensed skills by
full or part-time work on other product lines. Can any restrictions on cross-training and
job repetition (e.g., union requirements) be altered?
P2.C4.3.3.5.2. Expanding workforce idle span times. How much can
idle span time, relative to "time on task"' be expanded and yet still maintain proficiency?
P2.C4.3.3.5.3. Reducing the minimum repetition frequency needed to
meet current proficiency requirements for repetition sensitive tasks. What is the
lowest level that engineering estimates support as necessary to sustain viable skills?
P2.C4.3.3.5.4. Using simulation, testing, and other exercise
techniques to supplement process or product line experience requirements.
P2.C4.3.3.6. Skilled workforce. Can a skilled workforce be
reestablished? Before answering, you should determine:
P2.C4.3.3.6.1. The minimum number of workers from the highest
skill level needed to sustain the capability. What is the lowest number of "highest
skilled" workers used historically?

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P2.C4.3.3.6.2. How personnel losses are normally accommodated.
Can the hiring, training, and certification time or process for new employees be altered?
P2.C4.3.3.7. Proven process. Can the process provide quality
products at various rates? Before answering, you should investigate:
P2.C4.3.3.7.1. The effects of dramatically reduced rates on process
and product performance. Project these effects using historical process metrics. Is
the process mature and repeatable? Have process output or product yield and quality
remained acceptable across historical variations in activity rate?
P2.C4.3.3.7.2. Specific effects on product performance when the
"sensitive" process has been altered or replaced with a new process (historically).
P2.C4.3.3.7.3. Is Statistical Process Control in place?
P2.C4.3.3.7.4. Whether the process is documented in a drawing
package. Has the package been used by other firms in competitions, spares buys, or
maintenance? Does the Department own, or can we buy or license, these data?
P2.C4.3.3.8. Usable equipment, tooling, and material. Will the
equipment, tooling, and material be available when needed? Before answering, you
should investigate:
P2.C4.3.3.8.1. Keeping equipment ready by extra maintenance or
calibration. How sensitive is equipment tolerance and performance to interruption in
operation? What time lapse or condition of equipment would necessitate
refurbishment or replacement?
P2.C4.3.3.8.2. Equipment down-time history. What has happened
during previous interruptions in equipment operation due to down time (maintenance,
equipment changes, changeout, etc.)? How has equipment been brought up or taken
down to match production rate?
P2.C4.3.3.8.3. Advance actions to ensure availability of exotic raw
materials.
P2.C4.3.3.9. Restart history. Has the activity been restarted after
previous interruption, however brief? Before answering, investigate:

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P2.C4.3.3.9.1. Whether there have been previous activity breaks and
restarts for this product, or for a product that employs very similar capabilities.
Include interruptions for delayed contract awards, product or process modifications, or
equipment or personnel changes.
P2.C4.3.3.9.2. Why there would be a risk of losing the capability
now. Previous restarts should provide insight into how the capability might be sustained
across activity breaks. Revisit the above analysis questions based on this insight.
P2.C4.3.4. If your analysis or product restart history shows that you can
maintain or reestablish a skilled workforce, a proven process, and usable
equipment, your capability will likely not be lost or unacceptably degraded by a
lapse or reduction in activity. You can terminate any further analysis step for that
item or capability.

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P2.C5. CHAPTER 5: IDENTIFY AND EVALUATE ALTERNATIVE ACTIONS
P2.C5.F6. Figure 6. Identify and Evaluate Alternative Actions

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Your objective is to determine and compare the cost, lead-time, consequences,
and risks of pursuing the alternatives available to the Department of Defense. If a
needed capability is determined to be truly endangered. You must examine and compare
all reasonable alternatives for DoD action, including the option of taking no action.
Figure 6 illustrates the sequence of events in this phase of the analysis.
The Department of Defense will only take action to maintain an industrial
capability if the time or cost to regenerate that capability, once lost, would prohibit the
Department from meeting its mission needs. You have already established an estimated
DoD requirements timeline for the product or service this capability supports. Your
goal in this evaluation is to determine which alternative or alternatives best meet the
Department's needs, given time and cost. The following paragraphs describe
alternatives and the considerations for analysis, and provide examples of situations
where the alternative is an appropriate choice.
This list is not exhaustive; consider other alternatives.
Alternative

Section

No Action

P2.C5.1.

Foreign Sources

P2.C5.2.

Substitutes

P2.C5.3.

Buy-out to Meet Future DoD Needs

P2.C5.4.

Technology Solution

P2.C5.5.

Smart Shutdown

P2.C5.6.

Maintain the Current Capability

P2.C5.7.

Additional Considerations for DoD Action P2.C5.8.

Examine each of the alternatives using the procedure outlined below. If a given
alternative is unrealistic, identify it as such.

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Evaluating Alternatives
1. Perform a cost-risk-benefit analysis to compare alternatives. Determine:
-- The cost and lead time to achieve the alternative, including the costs to qualify or requalify products.
Identify life-cycle costs and effects. Use established DoD cost-estimating techniques. Where costs are
uncertain, provide cost estimates in ranges, along with the basis for estimates. DoD Instruction 7041.3,
"Economic Analysis for Decisionmaking," November 7, 1995, provides procedures for performing economic
analysis. This should be available from your budget or Comptroller organization.
-- Consider risks in terms of effects on performance, quality, mission capability, and readiness for each
alternative. Work with the user to determine the acceptable flexibility of performance requirements.
2. Identify any assumptions made in analyzing alternatives.
3. Use reprocurement data. More alternatives are feasible when you have access to the technical data for
the capability or product that the capability supports. The Department typically owns the data rights for
products developed with defense funds. When a manufacturer owns the data rights, it may be willing to
sell, license, or release the rights, particularly if it has terminated production.

P2.C5.1. No Action
P2.C5.1.1. If DoD takes no action to preserve the capability, is it feasible
to regenerate the capability? What will happen if the Department of Defense takes
no action? This alternative literally means choosing to take no action and make no
investment to extend or preserve any part of the capability. This alternative may be
particularly appropriate in product areas for which the DoD near-term requirement is
terminating and future requirements are unclear, or would likely be met by a much
altered configuration.
P2.C5.1.2. Considerations:
P2.C5.1.2.1. Restart cost, time, and technical issues. The analysis of
this option should identify and quantify the cost, time, and technical implications of
regenerating (or restarting) the capability at some point in the future, given that all DoD
programs or funds have stopped. Since capabilities exist in support of products, you
probably need to assess restarting the capability as part of an activity, e.g., engineering
or production of a given product.
P2.C5.1.2.2. Useful life. Estimate the rate at which the capability is
expected to decline. When will the capability be completely lost? You also should
consider the utility of the capability given the pace of technological change and changes
to the DoD mission. When will the capability begin to become outdated?

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P2.C5.1.2.3. Retaining future product capability. If production is
terminating, you need to examine future research and development (R&D) capabilities.
Are there DoD R&D programs or commercial product demands that will sustain
engineering skills and knowledge?
P2.C5.2. Foreign Sources
P2.C5.2.1. Does any foreign supplier offer a product or capability that
can be substituted for the one at risk? Although the original manufacturer may have
been domestic, viable alternative sources may exist if the market is more broadly
explored. Reliable foreign suppliers are usually acceptable, and in fact are encouraged
to allow the Department to obtain a wider competitive cost and technology base.
Foreign dependence does not mean foreign vulnerability. The Department of Defense
seeks to use foreign sources wherever advantageous and within the limitations of the
law. The Department has reciprocal procurement agreements with many nations in
which each party agrees to consider the other as a potential supplier for defense
purposes.
The Department of Defense relies on foreign suppliers to play a major role in
many weapon system acquisitions. Foreign suppliers are acting for the Department
both as major subsystem providers (e.g., an Israeli firm is providing the air vehicle
for the Tactical Unmanned Aerial Vehicle program) and as primes (e.g., all prime
teams bidding on the new Joint Primary Aircraft Training System Program include a
foreign prime member).
DoD contractors rely on foreign sources for many strategic and critical materials,
for example, cobalt, chromium, manganese, and tungsten. Currently, the only
remaining sources of fibers needed to make certain types of composite materials are
foreign. Both commercial and defense firms are successfully using these foreign
sources to support composite manufacturing.
P2.C5.2.2. If you have not used or even solicited foreign sources for your
product or service in the past, you may have to research potential feasible firms. Work
with your procurement officer to perform this research and to analyze this alternative.
P2.C5.2.3. Excluding foreign sources requires special approval. If you
believe that foreign sources should be excluded from a solicitation for mobilization
base reasons, you must obtain approval for the exclusion before proceeding with the
solicitation. The decision to use other than competitive procedures, or to exclude
foreign sources from acquisition solicitation for mobilization reasons (that is,

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exclusions under FAR Part 6.302-3(a) and FAR Part 6.202(a)(2), must be approved by
the official prescribed by FAR Part 6.304 and by the USD(A&T) for contracts over $50
million. Each CAE has instituted a process requiring formal approval of domestic
source restrictions for procurements less than $50 million.
P2.C5.2.4. Domestic Source Restrictions. What exceptional conditions
might warrant excluding foreign suppliers?
P2.C5.2.4.1. Foreign sources may pose an unacceptable risk when there is
a high "market concentration" combined with political or geopolitical vulnerability. A
sole-source supplier existing only in one physical location and vulnerable to serious
political instability may not be available when needed. Note: Market concentration
alone is not a reason to exclude foreign sources; there-must also be a credible threat of
supply disruption due to political instability. Sheer physical distance from the United
States is not by itself a risk that merits foreign source exclusion.
P2.C5.2.4.2. Suppliers from politically unfriendly or anti-American
foreign countries, as defined by statute or U.S. Government policy, are not used to meet
U.S. defense needs.
P2.C5.2.4.3. A U.S. source may be needed for technologies and products
that are either classified, offer unique warfighting superiority, or could be used by
foreign nations to develop countermeasures. However, the Department has agreements
with many allied and friendly nations for safeguarding classified military information.
Foreign sources cannot be automatically excluded on the basis of a need to protect
classified or unique technologies or products; this must be determined by individual
circumstance.
Stealth technologies involve control of radar, infrared, or other signatures to
reduce an adversary's detection of U.S. weapon systems. Technology or product
transfer to foreign firms could jeopardize U.S. superiority in stealth technology.
There are a number of statutory restrictions on the Department that prevents it from
buying particular products from non-U.S. sources, for example, textiles, food
products, and specially metals.
P2.C5.2.4.3.1. Suppliers that cannot or will not provide products for
military applications for political reasons are not feasible sources.
P2.C5.2.4.3.2. The Department of Defense is required by law to
purchase a particular product from U.S. sources only. The Department is required by
law to purchase a particular supply only from U.S. sources.

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P2.C5.3. Substitutes
P2.C5.3.1. Is there a substitute for the industrial capability, or for the
product the capability supports? Simple, direct substitutes for a common part or
material are typically adopted as a matter of course as a part of a DoD manager's routine
"vendor management." This alternative examines finding a substitute when a simple part
or ready source substitution is not an option. You should determine if other DoD
programs, or industry products, employ a different capability or produce a product that
could serve as a substitute to meet your needs. You should consider at least three
approaches to substitution:
P2.C5.3.1.1. A substitute for the industrial capability. Even if the
capability at risk appears to be unique, investigate the possibility that another industrial
capability may be substituted for the current capability. Look beyond the industrial
capability as defined today and try to find a capability that might replace it.
A particular defense transport vehicle is projected to go out of production. The
Department is concerned that the skills and materials needed to manufacture the
unique, heavy-duty transmission will be lost. The DoD manager finds that
manufacturers of some commercial heavy transport vehicles employ the same
technical skills and materials in manufacturing transmissions as those needed to
manufacture the DoD vehicle transmission.
P2.C5.3.1.2. A substitute for the product. Investigate the possibility
that a replacement product could provide the same defense mission capability. Try to
find a substitute for the product levels of assembly; i.e., if you cannot find a substitute
component can you find a substitute for the next higher assembly?
The manufacturer of a certain type of gyroscope used by the Department of
Defense is warning that he may have to terminate his defense product line due to
low quantities. If production ceases, this particular type of gyroscope technology
will be lost. The DoD manager determines that a different type of gyroscope, based
upon laser technology, can be used as a substitute for the gyroscope technology
that is threatened.
P2.C5.3.1.3. A modified or nearly perfect substitute. Investigate the
possibility of modified or nearly perfect substitute for the capability or the product the
capability supports. Most substitutes for the product or capability will require some
alteration to meet DoD requirements, or some compromise in meeting form, fit, or
functional requirements. Determine if a modified capability or product, or a nearly

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perfect substitute offering different but sufficient performance, could satisfy your
need. These substitutes may be more cost effective than other options, even though
they may entail longer delivery times, additional cost for qualification or logistics, or
some performance degradation from the current product.
A landing gear used on a DoD cargo aircraft is built to a DoD specification and
has some unique performance requirements. The landing gear production is
ending but the Department of Defense will need to procure them again in low
quantities in the future. Working with the user and the product engineers, the DoD
manager is able to revise certain of the unique performance requirements so that
another existing landing gear can be used with minor modification. The
Department pays to modify and requalify the new gear.
P2.C5.3.2. Evaluating substitutes. You must determine whether the
Department's requirements can be met by a substitute industrial capability or product.
This requires a technical assessment in which you:
P2.C5.3.2.1. Analyze performance criteria. Perform an engineering
analysis of the technical drawings, data, and performance specifications of the product
currently in use. Using performance parameters that describe or drive the current
capability, identify how similar capabilities or products might meet, or fall short of
meeting, DoD needs. Work with the military user to determine where changes in
performance parameters would be acceptable.
P2.C5.3.2.2. Qualify the substitute item. After identifying a potential
substitute, you may also need to demonstrate the performance of the substitute
capability or product in factory and operating environments.
P2.C5.3.2.3. Compare costs fairly. Be sure to compare the cost of the
proposed substitute product to the likely future cost of the product it would replace.
Product costs frequently begin to rise when capabilities are at risk. Costs to test or
qualify the new substitute product for use should also be included.
The DoD manager estimates the price for the laser technology gyroscope and the
expected price of the next buy for the gyroscope going out of manufacture. (The
old gyroscope has been increasing in price as the production quantities have been
decreased over time.) The analysis includes the cost of tests to qualify the new
gyroscope's performance.
P2.C5.4. Buy-out to Meet Future DoD Needs

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P2.C5.4.1. Is it economically or technically feasible make a
"life-of-type" buy of the product? A life-of-type buy is the purchase and storage of
anticipated lifetime to quantities of the product that the capability supports. To analyze
this option:
P2.C5.4.1.1. Determine technical limitations. First, determine if a
life-of-type buy is a practical alternative and is legally authorized. It is not practical for
products that have shelf-life limitations or other technical characteristics that make
long-term storage or delayed consumption undesirable.
Nerve gas antidote injectors, needed to support some types of military conflicts,
have a limited shelf life due to drug and packaging degradations over time.
Therefore, they cannot be purchased in "lifetime" requirements quantities. A viable
supply source must be when needed.
P2.C5.4.1.2. Determine requirements and costs. Work with all DoD
users of the product to project a realistic requirement quantity. It is very difficult to
accurately project the lifetime quantity requirement for a capability; try to understand
the users' assumptions in defining their demand. The cost of this option includes not
only the direct cost to procure the total quantity, but the cost of long-term storage,
management, and the time value of money.
P2.C5.4.1.3. Address fiscal limitations. The Under Secretary of
Defense (Comptroller) (USD(C)) considers making life-of-type buys as "buying in
advance of needs," a fiscal practice that is strongly discouraged. However, completing
the analysis outlined in this Handbook provides the type of data required by the USD(C)
to authorize making a buy of at least some portion of the lifetime quantity.
When an electronic piece part becomes unavailable and no substitute item or
source can be found, Defense Electronic Supply Center inventory control managers
work with users to make a lifetime requirements computation. When properly
justified, they seek Comptroller authorization to buy some portion of the lifetime
quantity, for example, 2 - 3 years' worth. During the subsequent 2 - 3 years, they
work to find another solution to the problem.
P2.C5.5. Technology Solution
P2.C5.5.1. Is there a viable R&D or technology-based alternative?
Could a technology or product under development provide a substitute for a
capability or product? A new technology solution might offer a feasible alternative to

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preserving an existing capability, even if it only partially meets the current need. A
technology solution could be a substitute for a capability, for example, an advanced
technology approach to manufacturing an item that promises to replace the current "at
risk" manufacturing process. It could also be a replacement for the product or system
that the current capability is used to support.
The type of integrated circuits used on the electronics boards in the F-15 radar
were becoming obsolete in increasingly large numbers. The F15 weapon system
manager chose to employ a technique where a special type of new technology part
emulated the old parts' functions. This eliminated the need for making life-of-type
buys of the old parts.
P2.C5.5.2. Analysis considerations. Work with the R&D community -inside or outside the Department of Defense -- to explore and evaluate potential
solutions. Determine whether a proposed technology solution adequately addresses
DoD performance specifications. Since the technology capability probably requires
development and risk, the military user must help determine if the cost, schedule, and
performance implications of the technology solution are acceptable.
A raw material used to build a very high-energy propulsion system is becoming
unavailable. An analysis of the capability (the raw material) determined that no
other material was available that could meet the performance requirements. The
DoD manager works with DoD materials laboratory personnel to assess whether a
new technology material might be available that, with demonstration, could meet the
projected need.
P2.C5.6. Smart Shutdown
P2.C5.6.1. Should the Department of Defense invest in a "smart
shutdown"? If we do, will restarting the needed production or development
activity at a later date be faster or more effective? Smart shutdown means
purposely preserving certain elements essential to reproducing a product or service,
while allowing the current development or production activity to stop. Examples of
actions to preserve certain elements include storing and maintaining equipment and
tooling, cataloging and tracking personnel skills, videotaping and photographing
processes, stocking critical raw materials, and creating computer-based models of the
product to be reproduced.
P2.C5.6.2. DoD programs are usually terminated because there is no longer a
requirement for the current "version" of the product. Often, the Department of Defense
will want to buy a significantly altered, next-generation version in the future.

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The Navy's torpedo production requirement is ending soon. There is no
anticipated requirement for full production for at least 10 years. The Navy
evaluated investing $15 million in "smart shutdown" actions, including buying
production process specifications and video taping processes. They ultimately
decided not to invest the $15 million because the next torpedo designs will be very
different and use few of the current processes.
P2.C5.6.3. However, if the current or a similar product or capability may be
required in the future, smart shutdown investments should be considered.
P2.C5.6.4. Analysis considerations. There are two important analysis
issues for smart shutdown and restart.
P2.C5.6.4.1. Can you reasonably expect to successfully restart the
activity to meet a future defense requirement in time, and at an acceptable cost?
P2.C5.6.4.2. Is investing to preserve certain elements more effective than
simply taking no action at all? Assess the costs of actions relative to the projected
benefits of preserving these selected elements. Define how investing now to preserve
certain elements will make restarting the activity later either less costly or more
technically feasible.
The estimated time to go from a completely "cold" Abrams tank production base to
a full-surge production rate is roughly 56 months. Based upon analysis, DoD
managers determined that this lead-time could be reduced from 56 months to
potentially as low as 36 months by employing "smart shutdown." Smart shutdown
elements applied in the analysis included storing production equipment,
maintaining registers of uniquely skilled personnel, and stockpiling certain tank
components.
P2.C5.7. Maintain the Current Capability
P2.C5.7.1. Should the Department of Defense invest to sustain a current
development or production activity in order to preserve a capability? In this
option, you will assess taking an acquisition action to preserve a capability by preserving
the development or manufacturing of a current product or service. You should only
consider this alternative if you have a known or projected future requirement for the
current product or service. Possible actions include special DoD acquisition actions to
sustain the following:

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P2.C5.7.1.1. Unique production capability that is at risk, such as:
P2.C5.7.1.1.1. Issuing a "bridge" contract to maintain a predetermined
production rate across a "requirements gap."
P2.C5.7.1.1.2. Stretching out production quantities to keep a
production line going at a production rate just sufficient to keep it "warm," that is, to
keep critical capabilities intact.
P2.C5.7.1.1.3. Directing spare parts or maintenance procurements to
the production supplier to keep certain types of production skills intact.
P2.C5.7.1.2. Engineering or research capability at risk, such as:
P2.C5.7.1.2.1. Initiating new technology development or prototyping
programs.
P2.C5.7.1.2.2. Continuing or initiating sustaining engineering
contracts, system updates, or a modification program.
In trying to determine whether to fund a special "bridge contract" to support a
missile that will be needed again in 3 - 5 years, the DoD manager is considering a
contract for production of only those components needed to support truly unique
capabilities. He may buy the highly crafted nozzles with unique coatings, as they
are not required by any other product. He is not considering buying the entire
missile.
P2.C5.7.2. Scope of action needed. The capabilities at risk may only be a
few among many capabilities that make up a product. Any special acquisition action
being considered needed should be focused on how best to preserve the needed
capability. This may not necessitate production or engineering work for the entire
product, or for the same product that the capability currently supports.
P2.C5.7.3. Determining the needed level of effort. You need to perform an
analysis to determine the appropriate pace (e.g., rate of production, level of engineering
activity) required to sustain the needed capability, given the constraints of DoD
resources.
P2.C5.7.3.1. Technical analysis. Is the needed capability endangered
because any reduction or interruption in the capability will lead to its loss? If your
near-term requirements are too low to sustain the technical viability or accuracy of the

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capability, you need to perform a technical analysis. This analysis must examine the
specific technical aspects of the capability that make it volume, rate, or time sensitive.
Try to define the risk that is associated with variations in this rate. You need to
determine the lowest possible rate or level of effort that can be performed and yet still
maintain the viability of the needed capability. Paragraph P2.C4.3.3.provides details of
this type of analysis.
P2.C5.7.3.2. Break-Even analysis. If the capability is endangered due
to supplier financial performance or product line profitability, you will need to
complete a Break-Even analysis. A Break-Even analysis examines a business operation's
fixed and variable costs relative to volume to calculate the point at which there is
neither profit nor loss. The results of this analysis will help you to understand the rate
or level of activity that the Department may want to consider funding if the current
capability must be maintained. Appendix 2 describes how to perform a Break-Even
analysis. You will probably also want to call on skilled cost or financial analysts for
assistance.
NEED HELP? If you need help in performing the financial analysis, contact your Budget/Accounting or
Comptroller organization, or call DUSD(IA&I), the Pentagon, Room 2A318, (703) 695-0121 or 695-7915; DSN
225-7915 or 225-0121; e-mail [email protected].

P2.C5.8. Additional Considerations for DoD Action. The analysis has thus far
focused on comparing the costs and risks of feasible alternatives, once you have
determined that a needed capability is endangered. There are other types of actions that
might aid in preserving a capability, but that are more difficult to quantify or control. In
some cases these actions require work with individual suppliers. Others are global
actions to address an entire product area. Can you preserve the needed capability by
one of the following measures.
P2.C5.8.1. Contract changes. Can the Department of Defense make a
contract change to alter delivery, payment, or other conditions such that the supplier's
business problems are eased? Is it possible to use multi-year contracts or other
purchase planning tools to provide the supplier a more stable operation?
P2.C5.8.2. Procurement relief or restriction. Can the Department
eliminate procurement restrictions that may be exacerbating the loss of capability? Or
impose a restriction that limits DoD procurement of certain products from endangered
suppliers?
P2.C5.8.3. Export assistance. Can a capability be preserved by increased
sales by the current suppliers of the same product or similar products to users other

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than the Department of Defense? If foreign sales are blocked due to a Government
action, e.g., a trade barrier or an export license, could the Department help?
P2.C5.8.4. Policy relief. Can the Department eliminate policy that may be
exacerbating the loss of capability? For example, are policies preventing you from
soliciting from a wider set of potential sources of supply?
NEED HELP? If you need help in defining or assessing any of these alternatives for DoD action, contact your
Component headquarters, or call DUSD(IA&I) Director, Industrial Capabilities and Assessments, the
Pentagon, Room 2B322, (703) 697-1366 or 697-6833; DSN 227-1366 or 227-6833; e-mail [email protected].

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P2.C6. CHAPTER 6: RECOMMEND A COURSE OF ACTION
P2.C6.1. If you want to recommend an action or investment, take the results of
your analysis, in the form of a Summary Report, to the designated decision authorities.
Decisions to take actions or make investments of less than $10 million annually to
preserve industrial capabilities are made by the CAE or DAE for ACAT program, or by
the HCA for all other program. USD(A&T) approval and DUSD(IA&I) coordination are
required on actions valued at $10 million or more per year. DUSD(IA&I) will also
ensure appropriate OSD staff coordination for proposed investments.
P2.C6.2. Your Summary Report should address cost, schedule, effects on
performance and pertinent qualitative considerations. You need to define how and when
the action would be incorporated into the budget and, if possible, identify budget
offsets. A copy of your Summary Report must be provided to DUSD(IA&I).
P2.C6.3. If you recommend action or investment for more than one year, you will
need to revalidate your analysis each year. As time passes, DoD requirements and
defense industrial capabilities change. Given these changes, you may not need to take
action in future years after all.
COMMENTS? This Handbook must be continuously updated and improved to remain current and
meaningful. Please help us by providing your comments, suggestions for improvement, and current
examples from the field. Contact the DUSD(IA&I) Director, Industrial Capabilities and Assessments, the
Pentagon, Room 2B322, (703) 697-1366 or 697-6833; DSN 227-1366 or 227-6833; e-mail [email protected].

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AP1. APPENDIX 1
FINANCIAL ANALYSIS PROCEDURES
AP1.1. STEP 1. COLLECT FINANCIAL STATEMENTS
AP1.1.1. You will need to collect two types of financial statements, the Income
Statement and the Balance Sheet, from the company. These statements provide the
financial results of operations for the company's fiscal year, an accounting for the
resources of a business, and the claims against those resources by lenders and owners.
AP1.1.2. Since the expressed concern is about the financial contribution of the
product that DoD purchases, you should collect these documents at the corporate level
and business unit or product level.
AP1.1.3. Statement Types:
AP1.1.3.1. Consolidated Income Statement (corporate level).
AP1.1.3.2. Consolidated Balance Sheet (corporate level).
AP1.1.3.3. Income Statement (at the lowest appropriate level, product or
business unit).
AP1.1.3.4. Balance Sheet (at the lowest appropriate level, product or business
unit).
AP1.1.4. Time Span:
AP1.1.4.1. Collect Income Statements for a 5-year period:emsp;Historical
(the past 2 years), Current (the current year), and Projected (the next 2 years).
AP1.1.4.2. Collect Balance Sheets for a 3-year period: Historical (the past 2
years) and Current (the current year).
AP1.1.5. Both types of financial statements are discussed in the following
sections, with calculations given for the information needed, and example worksheets.
AP1.1.6. Income Statement Description. The Income Statement summarizes
the financial performance of the firm over a period of time, normally 1 year. A
standard format is usually maintained in accordance with the matching concept in which
sales (revenues), or the amounts received from selling goods and services, are matched
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DoD 5000.60-H, April 1996

against the associated expenses and costs incurred while operating the company. Table
AP1.T1. depicts the calculations you need to make for the Income Statement.
Table AP1.T1. Income Statement
(January 1 through December 31, 19XX)
Sales

The revenue obtained for the product or service delivered.

- Cost of Goods Sold

All costs associated with converting raw materials into finished products.

= Gross Income

Income generated directly from the sale of products or services.

General and Admin
Expenses

The cost of office space, support staff, and other such expenses.

- Depreciation

The estimated cost associated with or degree to which an asset is used up in
producing a product (e.g., land is not depreciated).

=Operating Income 1

The earnings generated from units sold minus expenses (costs of goods sold,
selling, general and administrative expenses).

+ Non-Operating Income

Income that is not derived from the core business (e.g., interest income).

- Non-Operating
Expenses

Expenses that are not derived from the core business (e.g., a one-time
restructuring expense).

Earnings Before Interest
& Taxes (EBIT)

Income before financing expenses and income taxes.

- Interest

Financing expenses on debt.

= Earnings Before Taxes

Taxable earnings of the firm.

- Taxes

Corporate income taxes.

= Net Income

The "bottom line" income generated for the period.
1 Operating income represents the core earnings of a business before
financing, taxes, and other non-operating income and expenses are taken into
consideration.

AP1.1.7. Balance Sheet Description
AP1.1.7.1. The Balance Sheet provides a "snapshot" of a firm's financial
position on a given day while the Income Statement covers a period of time. The
Balance Sheet lists the assets, liabilities, and owner's equity on the date stated in the
heading.
AP1.1.7.1.1. Assets, which represent future economic benefits, are listed
in descending order of their liquidity, i.e., how quickly they can be converted into cash.
AP1.1.7.1.2. Liabilities, which represent obligations, are divided into debt
and equity.

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DoD 5000.60-H, April 1996

AP1.1.7.1.2.1. Debt is listed in order of priority, i.e., which
obligations need to be paid first or who would be paid first in the event of a liquidation.
AP1.1.7.1.2.2. Equity is derived by subtracting liabilities from
assets. In other words, equity equals the value of assets after subtracting obligations
owed to debt holders.
AP1.1.7.2. Figure AP1.F1. depicts an example of a format for a Balance Sheet.
Figure AP1.F1. Balance Sheet Example Format
Balance Sheet
(December 31, 19XX)
Assets

Liabilities

Current:

Debt

Cash

Current:

Marketable Securities

Accounts Payable

Accounts Receivable

Notes Payable

Inventory

Current Maturities on Long Debt
Long-Term Liabilities:

Fixed:

Long-Term Debt

Property, Plant & Equipment
Land

Equity

Buildings

Common Stock

Machinery

Retained Earnings

AP1.1.7.3. The Balance Sheet tells you how healthy a company is at a
particular time. You can ascertain whether the amounts listed for current assets (the
first items on the Balance Sheet, such as cash, marketable securities, accounts
receivable, which will shortly be turned into cash) exceed the current liabilities, or
claims on the business that need to be paid in the near future. By looking at the fixed
assets (property, plant, and equipment) and corresponding accumulated depreciation, you
can see whether the company's production equipment is old or relatively new. If
accumulated depreciation is a high percentage of fixed assets, production equipment may
be obsolete; a lower percentage may indicate newer production equipment.

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AP1.1.7.4. The Balance Sheet also shows you how the company is capitalized,
or how it funds its growth, e.g., whether there is a high level of long-term debt or equity
(common stock) financing. When contrasted with a Balance Sheet from an earlier
period, you can identify problem areas or trends that may require additional evaluation
or inquiry.
AP1.2. STEP 2. CALCULATE PROFITABILITY
AP1.2.1. Perform a Profitability Screen Using Operating Profit Margin
AP1.2.1.1. In Step 2, using the financial data collected, you will now perform a
profitability screen and determine whether the company of concern is profitable. The
results of this screen will help you determine whether any further financial analysis is
necessary.
AP1.2.1.2. The best measure of the financial viability of a firm is the degree
to which it is profitable (i.e., making money). The primary measure of profitability for
the purposes of our financial analysis is Operating Profit Margin:
Operating Profit Margin (%) = Operating Income / Sales x 100
AP1.2.1.3. Operating Income represents the company's core earnings. It is
equal to Sales minus Operating Expenses. Operating Income excludes interest
payments and extraordinary items.
AP1.2.1.4. You will need to calculate the operating profit margin for the
company of concern for the 5-year period mentioned in the Step 1 section. Completion
of the following summary table, Table AP1.T2., will allow you to compute Operating
Profit Margin and analyze profitability trends from the income statement. NOTE:
Remember that you need unconsolidated divisional data, that is, data from the Income
Statement at the lowest appropriate level, product or business unit. You will have to
ask the company for this data.

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Table AP1.T2. Summary Table
Historical

Year

-2

Current

-1

0

Projected

+1

+2

Units
Sales (revenue)
- Costs of Goods Sold
- General & Admin Expenses
- Depreciation
= Operating Income (OI)
Operating Profit Margin (%) = OI / Sales x 100

AP1.2.1.5. At the corporate level, Operating Income can be determined from
the consolidated Income Statement, which typically is provided in the format previously
described. However, when determining the effect on profitability of a specific product
being purchased by the Department of Defense, you need to calculate Operating Profit
Margin at the lowest appropriate level, i.e., at the product or business unit level.
Sometimes the Operating Income is not provided or cannot be obtained directly in the
standard Income Statement format at this low level within the corporation. When this is
the case, use the following to obtain Operating Income, which you can then use to
compute Operating Profit Margin.
Operating Income = Sales - Direct Costs - Indirect Costs - Overhead - General and
Admin Expenses
AP1.2.2. When Is a More Detailed Financial Analysis Necessary? After
calculating the Operating Profit Margin, use the following criteria to evaluate the
business unit's or product's profitability:
AP1.2.2.1. The Operating Profit Margin is a negative percentage in current or
future years; and
AP1.2.2.2. The Operating Profit Margin is positive in current and future years,
but has declined by more than 50 percent over a 3 - 5-year period.
AP1.2.2.2.1. If the answer in either case is true, the company's financial
viability merits further analysis to determine the causes of its weakening performance.
Proceed then to Step 3.

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DoD 5000.60-H, April 1996

AP1.2.2.2.2. If neither criterion holds true for the company, no further
financial analysis is generally needed.
AP1.2.3. Profitability Analysis Example
AP1.2.3.1. An example of a profitability analysis is provided for the mythical
CDE Widget Company (Table AP1.T3.).
Table AP1.T3. Example of the CDE Widget Company Income Statement and
Profitability Analysis (in thousands)
Historical

Year

-2

Current

-1

Projected

0

+1

+2

Units

2,000

1,750

1,250

1,000

900

Sales (Revenue)

100,000

87,500

62,500

50,000

45,000

- Cost of Goods Sold

40,000

35,000

25,000

20,000

18,000

- Selling Expenses

40,000

35,000

35,000

20,000

18,000

- General & Admin Expenses

7,000

8,000

8,000

9,000

10,000

= Operating Income

13,000

9,500

9,500

1,000

(1,000)

Operating Profit Margin

13%

11%

11%

2%

- 2%

AP1.2.3.2. Looking at the Income Statement in Table AP1.T3., we see
numbers indicating there may be a financial problem with this company.
AP1.2.3.2.1. Unit Production is declining, as is Sales (Revenue).
AP1.2.3.2.2. Operating Income is projected to be negative in Projected
Year 2, and is steadily declining.
AP1.2.3.2.3. As we calculate percentage decrease,
(Projected Year 2 - Historical Year 2)
Historical Year 2
(-1,000 - 13,000)
13,000
= - 108%

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DoD 5000.60-H, April 1996

AP1.2.3.2.4. Operating Income decreases by 108 percent, which is far
greater than 50 percent. Look up the Standard Industrial Code (SIC) for widgets, and
obtain the same data from companies (with the same SIC) similar to CDE Widget
Company. While the industry is experiencing a downturn in operating income, the
average decrease is 42 percent over the same period.
AP1.2.3.2.5. Likewise, Operating Profit Margin has a negative number in
a projected year and has declined by more than 50 percent across the period.
AP1.2.3.3. Therefore, you should continue the analysis. The sample
worksheet depicted in Figure AP1.F2. may be provided to the Government's financial
representative or the contractor as a guide to obtain this required profitability
information.

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Figure AP1.F2. Industrial Capability Financial Analysis Worksheet
Contractor:

___________________________________
___________________________________
___________________________________

Point of Contact:

___________________________________

Phone:

_____________________

Fax:

_____________________

Action Requested:

___________________________________
___________________________________
___________________________________

Agency Office:

___________________________________
___________________________________
___________________________________

Point of Contact:

______________________________

Phone:

_____________________

Fax:

_____________________

Summary Table
Historical

Year

-2

Current

-4

0

Projected

+1

+2

Units
Revenue
- Cost of Goods Sold
- General & Admin Expenses
- Depreciation
= Operating Income (OI)
Operating Margin (%) = (OI / Revenue) x 100

AP1.2.4. Calculate Return on Assets
AP1.2.4.1. So far you have used the Operating Profit Margin from the Income
Statement as a primary indicator of a financial problem within the business. In addition
to the Operating Profit Margin, other measures of profitability may be used, depending
upon the specific business situation. For example, you can compute the company's
Return On Assets (ROA) by adding information available from the Balance Sheet:
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DoD 5000.60-H, April 1996

ROA (from primary opertions)2 = Operating Income / Total Assets
AP1.2.4.2. In this case, ROA indicates the amount of profitable return from
the firm's primary operations being generated by the assets being used.
AP1.2.4.3. For the corporation as a whole, you can easily calculate ROA using
numerical values taken directly from the Income Statement and Balance Sheet. To
determine the profitability contribution by the product to the corporation, you should
also calculate ROA at the product or business unit level:
ROA (product) = Operating Income Derived from the Product / Total Assets Used To
Produce the Product
AP1.2.4.4. ROA presents another view of a company's financial health by
gauging how efficiently the company's assets are being used to produce the product or
service. It measures how much the company's assets are earning in Operating Income.
AP1.3. STEP 3. PERFORM A COMPARATIVE ANALYSIS
AP1.3.1. Compare the financial performance of the business unit or product with
those of other companies or with other business units with same corporation. At this
point you may want to seek assistance from a more experienced financial or cost analyst.
AP1.3.2. Operating Profit Margin and ROA are two measures of performance that
provide a means to evaluate the company's financial performance. From the firm's
perspective, the question is whether its operations are earning an adequate return. Such
a determination requires judgment. Comparison of returns across a number of
dimensions (e.g., over time, between divisions of the corporation) provide the basis for
this judgment. Formats in Table AP1.T4. through Table AP1.T6. are examples of how
to compare profitability measures for the company with internal, external, and peer
business unit measures.
______________
2 The standard formula for ROA is Net Income divided by Total Assets. This standard definition is not as useful for
our analysis because it does not focus on the firm's primary operations or products.

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DoD 5000.60-H, April 1996

AP1.3.2.1. Compare numerical measures calculated at the product or business
unit level with similar calculations obtained at the corporate level to determine the
importance of the product or business unit to the corporation (Table AP1.T4.).
Table AP1.T4. Internal Comparison
Status

Operating Margin

ROA

Corporate
Business Unit (BU)
Item of Interest

AP1.3.2.2. Use these measures at various levels within the firm to compare
the product or business unit performance on the DoD program of interest with other
customers, e.g., commercial, other Government organizations, the DoD program of
interest and other DoD customers outside program of interest (Table AP1.T5.).
Table AP1.T5. External Comparison
Sales

Operating Margin

ROA

Corporate
Business Unit (BU)
Item of Interest
Department of Defense
Item of Interest

AP1.3.2.3. Compare the product or business unit performance being measured
to consistent calculations for similar products or business units (Table AP1.T6.). For
example, competitors or related businesses may produce products that are similar or
can be directly substituted for the item of concern. You may have to ask other DoD
managers in other programs or product areas for information on similar products or
business units.
Table AP1.T6. Peer Comparison
Sales

Operating Margin

ROA

Item of Interest
Substitute Product
Similar Product

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DoD 5000.60-H, April 1996

AP1.4. STEP 4. IDENTIFY THE PROBLEM
Use the information obtained in Step 3 to identify the specific financial problem that
the ompany is encountering, as well as potential solutions. Having compared the
measures of financial performance across a number of important dimensions, you
should now be able to assess the company's financial viability.

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DoD 5000.60-H, April 1996

AP2. APPENDIX 2
PROCEDURES FOR BREAK-EVEN ANALYSIS

AP2.1.1. Appendix 2 provides procedures for the Break-Even analysis called for in
Section P2.C5.7., Maintain the Current Capability.
AP2.1.2. A Break-Even calculation shows the level of operations (in units
produced) at which revenues just cover costs (i.e., neither profit nor loss). The
Break-Even volume is computed by dividing fixed costs to produce the product by the
contribution margin. The contribution margin is the selling price per unit minus the
variable costs per unit, which are assumed to be constant in this discussion.
Break-Even = (fixed Costs) / (Contribution Margin)
Contribution Margin = Selling Price - Variable Costs
Where
Fixed Costs:

Costs that remain constant regardless of changes in the level of production (e.g.,
supervisor's salaries, lights and heat for the factory);

Variable costs:

Costs that vary directly with changes in activity (e.g., direct labor and materials used to
produce the product);

Contribution
Margin:

Selling price per unit for the product less the variable costs per unit; and

Break-Even
(units produced)

The level of operations at which there is neither profit not loss.

Example:
Unit Selling Price
Unit Variable Costs
Unit Contribution
Margin
Fixed Costs

$91.43
- $25.71
$65.72

$230,000
Break-Even = $230,000 / $65.72 = 3,500 units

AP2.1.3. If a company were exiting DoD business for higher returns elsewhere, and
had a target profitability (operating income), you would simply add operating income to
the numerator in the above equation to determine the amount of business that the

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DoD 5000.60-H, April 1996

Department of Defense would need to provide the company to give the company
incentive to remain in the defense business.
Fixed Costs + Target Operating Income =

$230,000 + $20,000 = 3,804

Unit Contribution Margin

$65.72

3,804 units needed to produce the target operating income

AP2.1.4. It may not be possible to prepare a Break-Even analysis using only
information from the financial statements. Usually these financial statements do not
have clearly distinguished fixed and variable costs, nor do they show unit production
data. Hence, this data must be obtained from the contractor. Once obtained, the
information can be linked with the financial data for the same period to prepare the
Break-Even analysis.
The DoD Components may obtain copies of, this Handbook through their own publication channels and
through the following World Wide Web site: http://www.acq.osd.mi]/
Authorized registered users may obtain copies of this publication from:
Defense Technical Information Center
8725 John J. Kingman Rd., STE 0944
Fort Belvoir, VA
22060-6218
(703) 767-8274
Other Federal Agencies and the public may obtain copies of this publication from:
National Technical Information Services
5285 Port Royal Road
Springfield, VA
22161
(703)487-4650

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APPENDIX 2