Until defense contractors 10X their production capacity, everybody loses (including investors)
It's odd to say that in 2023, there are still supply chain issues persistent in certain industries. The industry where I find the supply chain issue to be the most severe is defense, where broken supply chains are preventing defense contractors from reaping profits at levels comparable to tech giants. These issues have made it difficult for countries like Israel, Taiwan, Australia, Japan, the Philippines, allies in Iraq and Syria, and European allies to build up their military at an unprecedented time. Most of the arms that have been sent to Ukraine weren't shipped directly from factories, but rather from the weapons inventories that nations have built over the past several years.

The support of Ukraine's defense against the Russian invaders has drained our ammo inventory levels. While people would like to think of the US as a massive superpower, a study by the CSIS would convey the opposite message as it found that the US would run out of munitions like long-range, precision-guided missiles, in less than a week of a Taiwan Strait conflict. There will be munitions that will take longer to drain, but those munitions are better suited for dealing with guerilla fighters, not large, professional armies like the PLA and the Russian military.

There are two reasons why we got to this situation:

1) Since the end of WW2, the US military has mostly been fighting guerilla fighters, not superpowers. From Vietnam to Afghanistan, the major wars that the US has been involved in consist of fighters that rely more on brains than brawn. This led the US to buy more weapons that allow its troops to match the brains of its enemies. The enemies might not all have PhDs or have access to the internet, but they are clever in the way they fight against a superpower like the US.

2) The reduction in military production capacity was immense after the Vietnam War. Those who've read the book called The Outsiders will find the General Dynamics $GD chapter to be an insightful read on the massive reduction in production capacity throughout the entire defense industry. Even with the War on Terror, the defense industry hasn't been matching the production capacity it once had.

Because of these reasons, we are seeing weapons like the Javelin missile launcher get depleted at a fast rate. It's staggering to see the US give seven years' worth of Javelin production to Ukraine from March 2022 to August 2022. It is astounding to witness the United States provide Ukraine an equivalent number of Stinger missile launchers to its non-US allies over the past two decades. And there are many more weapons that are dealing with similar phenomenons.

Here's a table that the CSIS has compiled on some of the most popular arms being sent to Ukraine and the inventory conditions they're in:

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It's fantastic to see the US and its allies go out of their way to help Ukraine. I'm grateful that the media is transparent about the supply chain issues that are happening within the defense industry. But this issue isn't something that we should ignore or replace with a false idea that this solution will magically disappear overnight, because overnight is impossible. Even if the US has decided to give numerous long-term purchase contracts with defense contractors to encourage them to expand their production capacity, the process of expanding production capacity takes time, and time continues to add as regulations make it harder for defense contractors to execute their plans from the start.

Until the US can build a strong industrial base, it can't sustain a protracted conventional war on one front, and it clearly doesn't have the capacity to endure two fronts, or even three, and so on. This strong industrial base should be able to produce a variety of arms as each front will require different types of weapons, vehicles, equipment, etc. The weapons that would be effective against Russian in the European theater isn't the same as the weapons that would be effective against China and North Korea in the Pacific theater.

Even as the US starts incentivizing defense contractors to expand their production capacity through the increased issuance of long-term production contracts, the defense industry has a labor and a supply chain security issue. For labor, it's hard to find people willing to work in factories and who have the skills to do things like welding. Majority of the factory workers in the defense industry are generally older. With many Baby Boomers retiring daily, the number of people that are capable of working in these missile factories continues to shrink. As for supply chains, some contractors are choosing to offshore their factories for cheaper labor. While defense contractors see wider margins on the things they sell, it exposes the US's defense production capacity to foreign adversaries. Some of those adversaries may even be studying or even stealing the technology as those factories produce arms for the US.

Surprisingly, China's monopolization of the rare earth metals industry is a concern for the Department of Defense (DoD). Rare earth metals are critical for the production of advanced weapons, but at least the US has $MP to accelerate plans to ramp up rare earth metals mining within the US and $TMC to mine rare earth metals on the Earth's seabeds. Even if we do secure adequate rare earth metals supply, if China were to invade Taiwan, the world will endure an unprecedented semiconductor shortage. $INTC is best positioned to provide the US and its allies with semciondcutors during the war but the production capacity of Intel is tiny compared to TSMC. Other chipmakers produce less advanced chips and many of the weapons needed to fight China and Russia require more advanced chips. Without TSMC, the West will have to learn to fight with less advanced weapons.

I don't think that the US should halt any foreign military sales because doing so will further disincentivize defense contractors from expanding their production capacity. Countries like Israel and Saudi Arabia provide defense contractors with steadier order flow, which is vital for creating an incentive for defense contractors to expand their production capacity. Encouraging more foreign military sales will also help with creating momentum for the rebuilding of the US industrial base.

Overall, the US needs to inspire defense contractors to build more production capacity. With the war in Ukraine becoming bloodier and China looking to seize the opportunity to invade Taiwan, the need to rebuild the US industrial base is bigger than ever. These are dangerous times.

Porchester ✳️'s avatar
The key for the defense sector is technology going forward, and a key reason for the ban on chips being sold to China.
Dissecting the Markets's avatar
@porchester we can’t buy time to delay China’s invasion plans. Technology will play a bigger role overtime as the US far surpasses China in innovation. For now, China and the U.S. have access to similar technologies.



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