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Defense Contractors Basically Have Two Years To “Yank China Out” Of Its System

October 15, 2020

By Kenneth Rapoza, CPA Industry Analyst

If you want to do business with the Department of Defense and NASA, for example, you will now have to make sure there's not a hint of Chinese telecommunications equipment and video surveillance equipment anywhere in your building, or used by your vendors. 

Made in China components and key Chinese companies like Huawei and ZTE are getting forced out of the offices of US companies that contract directly with, or indirectly with, the US government. Have a Lenovo laptop you use to do business with Lockheed Martin? Better hope its internal camera isn’t made by Hikvision. 

Two months ago, the Departments of Defense, NASA and the General Services Administration, some of the biggest government procurement agencies around, amended the Federal Acquisition Regulation (FAR) of Section 889 of the John S. McCain National Defense Authorization Act (NDAA). It went into effect on August 13, though companies have until around August 13,2022 to get in compliance.

You can find all the details here.

“It’s a smart first try,” said Michael McKenna, a lead member of CPA’s China Task Force. “This isn’t going to change no matter who is president. It’s a secular trend. The military and the intelligence community have decided that China is our next great power rival and getting key pieces of equipment from them is crazy.”

Over the last week, companies have come out of the wood work in articles complaining about how hard this is going to be to find out where they source key telecommunications equipment, the main target of the amendment.

“Saying ‘I don’t know’ where it comes from is no longer an acceptable option,” McKenna said.

If you’ve asked most Americans if Department of Defense contractors should know where their supply came from, chances are 300 million of them would say they think it’s a good idea.

The amendment is precise. It only covers certain telecommunications equipment and services produced or provided by Huawei, ZTE or any subsidiary or affiliate of those entities, as well as video surveillance products or telecommunications equipment and services produced or provided by Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, or Dahua Technology Company and its affiliates.

The Section 889 contract clause was amended to prohibit agencies “from entering into a contract, or extending or renewing a contract, with an entity that uses any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system,” unless an exception applies or a waiver is granted. Translation: any China equipment, system, or services from those aforementioned companies is a DoD deal breaker.

An organization's failure to submit an accurate representation to the Government constitutes a breach of contract that can lead to cancellation, termination, and financial consequences.

Direct suppliers and subcontractors now have roughly a year to figure out if the telecom systems, service providers and the video surveillance equipment they use was made by those Chinese entities. If they find them, defense contractors either have to dump those service providers and find “clean providers”, or in the case of the equipment being something they have in-house (think security cameras), will be required to yank out the China component and install one from someplace else.

CPA believes this opens the door to optical equipment manufacturers to develop new business catering to companies that will have to be China free or lose their relationship with the DoD and NASA. Some 387,967 unique vendors are impacted by Section 889 changes.

“This ruling now opens up opportunities for US based enterprise networking providers like Cisco, Arista Networks or Fortinet and on the video surveillance side the opportunities are even larger because we have no American brands anymore that make video equipment,” said CPA chief economist Jeff Ferry. “It opens up opportunities for them to make video surveillance cameras. I don’t think companies should be required to share their supply chain information with the public or with the market, but they should be required to share it with the government because supply chain security is a national security issue. And China is a national security issue now.”

Oculus co-founder Palmer Luckey and his company Anduril Industries said his drone making business is going to be all Made in the USA. He is making them for military contracts, suggesting that in the future, the best way to get lucrative, long term government deals is to make sure the bulk of your critical components are made here. If not, CEOs will have to know exactly where those parts came from, and who made them.

Zach Mottl, chief alignment officer at Atlas Tool & Die Works, a precision manufacturer that has about 40% of its business tied to the defense industry either as a contractor or subcontractor, said he is fine with the amendment. The 100+ year old company used to make housing and brackets for phone switching equipment before that industry was taken over by China competition. Atlas then switched to defense to make up for that loss. And now China once again is having a real world impact on Atlas Tool.

Mottl has had to send letters to his vendors, as well, because the FAR amendment also applies to them. AT&T got a letter from Atlas recently to make sure Atlas phone conversations and data isn’t flowing through transponders with Chinese equipment, for example.

“Ultimately, I have do this with all of my vendors,” he said. “I started with my IT department and they will have to deal with video security companies who will have to do their own due diligence on this. They will have to be compliant, like us, if they want to keep their businesses with us and we have to do it if we want to keep our government contracts,” he said. “These rules are good. DoD knows what they are doing.”

The Washington Post published an article on this recently, citing companies complaining about having to rummage through the complexity of a global supply chain. The American Trucking Association said yanking out Made in China IoT and GPS equipment will be too costly.

UPS said companies like theirs might abandon future bids for government work.

“The costs associated with ensuring ongoing compliance with Section 889 across the entire corporate family could outweigh the opportunities that come from the contracts held by the one legal entity that performs government work,” they said.

The government’s not backing down. This is the future. It may be the tip of the iceberg, with more companies to be added down the road. Or new additions, like microchips that can be used to ping back information and data to China.

According to the FAR update, contractors using 5G wireless and IoT equipment from companies covered by this rule “could become reliant on China equipment that may be controlled by Chinese intelligence services and the military in both peacetime and crisis.”

National security is becoming the main means of going after China. That includes using tariffs to protect industries deemed important to the US, whether its solar panels or pharmaceuticals.

The amendment stated that “threats to the US posed by China are becoming more complex. Foreign intelligence actors are employing innovative combinations of traditional spying, economic espionage, and supply chain and cyber operations to gain access to critical infrastructure, and steal sensitive information and industrial secrets. The exploitation of key supply chains by foreign adversaries represents a complex and growing threat to strategically important US economic sectors and critical infrastructure.”

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