Why The Pentagon Can’t Count: It’s Time to Reinvent the Audit

This article previously appeared in War on the Rocks.

In the past, headlines about the Pentagon failing its financial audit again would never have caught my attention. But having been in the middle of this conversation when I served on one of the Defense Department’s advisory boards, I understand why the Pentagon can’t count. The experience taught me a valuable lesson about innovation and imagination in large organizations, and the difference visionary leadership – or the lack of it – can make.

With audit costs approaching a billion dollars a year the Pentagon had an opportunity to lead in modernizing auditing. Instead it opted for more of the same.

Auditing the Department of Defense
By law, the Department of Defense has to provide Congress and the public with an assessment of where it spends its money and to provide transparency of its operations. A financial audit counts what the Department of Defense has, where it has it, and if they know where its money is being spent.

Auditing the Department of Defense is a massive undertaking. For one thing, it is the country’s largest employer, with 2.9 million people (1.3 million on active duty, 800,000 in the reserve components, and 770,000 civilians.) The audit has to count the location and condition of every piece of military equipment, property, inventory, and supplies. And there are a lot of them. The department has 643,900 assets, from buildings, to pipelines, roads, and fences located on over 4,860 sites, as well as 19,700 aircraft and over 290 battle force ships. To complicate the audit, the department has 326 different and separate financial management systems, 4,700 data warehouses and over 10,000 different and disconnected data management systems.

(BTW, just like in the private sector, financial audits and audits of contracts are separate. While the DoD Office of Inspector General is responsible for these financial audits of trillions of dollars of assets and liabilities, the Defense Contract Audit Agency is responsible for auditing the hundreds of billions of dollars of acquisition contracts. They have the same issues.)

This is the fifth year the Department has undergone a financial statement audit – and failed it. The audit was not a trivial effort, it required 1,600 auditors – 1,450 from public accounting firms and 150 from the Office of Inspector General. In 2019, the audit cost $428 million in auditing costs ($186 million to the auditors along with $242 million to audit support) and another $472 million to fix the issues the audit discovered.

Let’s Invent the Future of Audit
The Defense of Department’s 40-plus advisory boards are staffed by outsiders who can provide independent perspectives and advice. I sat on one of these boards, and our charter was to leverage private sector lessons to improve audit quality.

With defense spending on auditing approaching a billion dollars a year, it was clear it would take a decade or more to catch up to the audit standards of private companies. But no single company or even entire industry was spending this much money on auditing. And remarkably, the Defense Department seemed intent on doing the same thing year after year, just with more people and with a few more tools and processes to get incrementally better. It dawned on me that if we tried to look over the horizon, the department could audit faster, cheaper, and more effectively by inventing the future tools and techniques rather than repeating the past.

Nothing in our charter asked the advisory board to invent the future. But I found myself asking, “What if we could?” What if we could provide the defense department with new technology, new approaches to auditing, analytics practices, audit research, and standards, all while creating audit and data management research and a new generation of finance applications and vendors?

The Pentagon Once Led Business Innovation
I reminded my fellow advisory board members that in 1959, at the dawn of the computer age, the Defense Department was the largest user of computers for business applications.

However, there was no common business programing language. So rather than wait for one, the Defense Department led the effort to create one – the COBOL programming language. And 20 years later, it did the same for the ADA programming language.

With that history in mind, I proposed we lead again. And that we start an initiative for the 5th generation of audit practices (the Audit 5.0 Initiative) with machine learning, predictive analytics, Intelligent sampling and predictions. This initiative would also include automating ETL, predictive analytics, fraud detection, and a new generation of audit standards.

I pointed out that this program wouldn’t need more funds since the Department of Defense could allocate 10% of the $428M we were spending on auditors and fund SBIR (Small Business Innovation Research) programs in auditing/data management/finance to generate 5-10 new startups in this space each year. Simultaneously we could fund academic research, to incentivize research on Machine Learning as applied to Audit 5.0 challenges in finance, auditing and data management.

In addition, we could create new audit standards by working with existing government audit standards bodies such as (The Generally Accepted Government Auditing Standards (GAGAS), Yellow Book, the GAO’s Standards for Internal Control in the Federal Government, Green Book and the Federal Accounting Standards Advisory Board (FASAB). We could collaborate with civilian audit standard bodies (ASB (Auditing Standards Board) and PCAOB (Public Company Accounting Oversight Board). Working together, the defense department could create the next generation of machine-driven and semiautomated standards. Furthermore, it could help the Independent Public Accounting firms (KPMG, EY, PwC, Deloitte, et al) create a new practice and make them partners in the Audit 5.0 initiative.

By investing 10 percent of the existing auditing budget over the next few years, these activities would create a defense audit center of excellence that would fund academic centers for advanced audit research, standup “future of audit” programs that would create new 5-10 startups each year, be the focal point for government an industry finance and audit standards, and create public-private partnerships rather than mandates.

Spinning up these activities up would dramatically reduce the department’s audit costs, standardize its financial management environment, and provide confidence in their budget, auditability, and transparency. And as a bonus, it would create a new generation of finance, audit and data management startups, funded by private capital.

The Road Not Taken
I was in awe of my fellow advisory board members. They had spent decades in senior roles in finance and accounting in both the public and private sectors. Yet, when I pitched this idea, they politely listened to what I had to say and then moved on to their agenda – providing the DoD with Incremental improvements.

At the time I was disappointed, but not surprised. An advisory board is only as good as what it’s being chartered and staffed to do. If they are being asked to provide a 10 percent incremental advice, they’ll do so. But if they’re asked for revolutionary i.e. 10x advice, they can change the world. But that requires a different charter, leadership, people, innovation, and imagination.

In the end, the Department of Defense, the largest purchaser of accounting services in the world, whiffed a chance to be the leader in creating the next generation of audit tools and services, not only for financial audits, but for the hundreds of billions of dollars of acquisition contracts the Defense Contract Audit Agency audits. By now the department could have audit tools driven by machine learning algorithms, ferreting out fraud by vendors or contractors and anticipating programs that are at risk.

Lessons Learned

  • If you only get what you ask for you haven’t hired people with imagination
    • America’s defense leaders ought to ask and act for transformational, contrarian and disruptive advice
    • And ensure they have the will and organizations to act on it
  • Move requests for advice for incremental improvements to the consulting firms that currently serve the Defense Department
  • Defense leaders need to consider whether spending a billion dollars a year for an audit is causing the department to become appreciably more efficient or better managed
    • Or whether there might be a better way

The 6th Lean Innovation Educators Summit – Education and Innovation in the Age of Chaos and Disruption

Join Jerry Engel, Pete Newell, and Steve Weinstein for the sixth edition of the Lean Innovation Educators Summit December 14, 1-4 pm Eastern Time, 10 am-1 pm Pacific Time. Register here.

This virtual gathering will bring together entrepreneurship educators from around the world who are putting Lean Innovation to work in their classrooms, accelerators, venture studios, and student-driven ventures.

The summit topic is “Education and Innovation in the Age of Chaos and Disruption.

Our students will be facing the challenges of a world that’s rapidly changing, chaotic and uncertain. A world undergoing climate change, supply chain disruptions, political instability and continual technology innovation and disruption. It’s incumbent on us as educators to provide the next generation of innovators with the tools and mindset to meet these challenges.

Among the questions we’ll address in this short summit:

  • How do we as entrepreneurship and innovation educators best prepare the next generation?
  • What role should our institutions help us do this?
  • What are the other systems and partnerships that we need to take advantage of?

We will have concurrent breakout sessions so participants have the opportunity to choose their own path to explore. We’ll then going to pivot to hear from colleagues across three broad categories of innovation:

  • Curriculum – We’ll discuss how best to equip educators with the tools they need to cultivate and guide student teams around solving mission-driven problems.
  • Ecosystems – We’ll explore partnerships that engage and inform positive student engagement and outcomes and how to support diversity of thought, background.
  • Trends – The rate of technological disruption shows no sign of slowing down. Climate change was a hypothesis for our generation but will be the facts on the ground for our students. The struggle between great powers and a fluid global landscape will accelerate. All of these will shape what future curriculums our students need and educators must deliver.

Alexander Osterwalder, the creator of the business model canvas and Strategyzer co-founder will join the discussion about the intersection of education, innovation and entrepreneurship

During the breakout sessions, you will have the opportunity to contribute to the conversation via Chat, Q&A, and an online community bulletin board. We will close out the Summit with Alex Osterwalder’s fireside chat moderated by Dr. Jerry Engel.

How to register

When you register, you will receive a link to an online collaboration space where you can submit questions, challenges and feedback. This feedback will inform the content of the presentations, post-event white papers, and the curriculum delivered to our educator community.

This session is free but limited to Innovation educators. Register here and learn more on our website: We look forward to gathering as a community of educators to shape the future of Lean Innovation Education.

The Three Pillars of World-class Corporate Innovation

My good friend Alexander Osterwalder, the inventor of the business model canvas (one of foundations of the Lean Methodology) has written a playbook (along with his associate partner Tendayi Viki,) From Innovation Theater to Growth Engine to explain how to build and implement repeatable innovation processes inside a company. 

Here’s their introduction to the key concepts inside the playbook.

Over 75% of executives report that innovation is a top three priority at their companies. However, only 20% of executives indicate that their companies are ready to innovate at scale. This is the challenge for contemporary organizations: How to develop a world-class ecosystem that can drive repeatable innovation at scale.

The playbook describes the three pillars of corporate innovation: Innovation Portfolios, Innovation Programs and a Culture of Innovation. Under each pillar, the playbook describes three questions that leaders and teams can ask to evaluate whether their company has the right innovation ecosystem in place.

Innovation Portfolio: what are your company’s portfolio of innovation projects?

  • Are your company’s innovation efforts exploring or exploiting business modes?
  • Does your company have a balanced portfolio of projects that cover efficiency, sustaining and transformative innovation?
  • What is the health of your innovation funnel or pipeline?

Explore: Search for new value propositions and business models by designing and testing new business ideas rather than execution. 

Exploit: Manage existing business models by scaling emerging businesses, renovating declining ones and protecting the successful ones.

Innovation Programs: how are your company’s innovation programs are structured and managed.

  • Do your leaders get excited about the wrong innovation programs?
  • What results are your innovation programs producing?
  • Are your company’s innovation programs interconnected in a strategic way?

To close the innovation capability gap, companies can evaluate their innovation programs by asking whether they’reinnovation theater or producing tangible results for the company.

  • Value Creation: Creating new products, services, value propositions and business models. These programs invest in and manage innovation projects that create value by producing new growth or cost savings.
  • Culture Change: Transforming the company to establish an innovation culture. This may include new processes, metrics, incentive systems, or changing organizational structures. These transformations help the company innovate in a consistent and repeatable way.

Innovation Culture: What are the blockers and enablers of innovation in your company –

  • How much time does your leadership spend on innovation?
  • Where does innovation live in your organization and how much power does it have?
  • What is your kill rate for innovation projects?

To overcome the innovation capability gap, companies need to create a culture that enables the right behaviors to produce world-class innovative outcomes. A reliable indicator of the quality of your innovation culture is how innovation teams would describe it. Is it a culture that is dominated by blockers of innovation or enablers of innovation?

  • Leadership Support: How can corporate leaders have the biggest impact on innovation in terms of time spent, strategic guidance, and resource allocation.
  • Organizational Design: How to give innovation legitimacy and power, the right incentives, and clear policies for collaboration with the core business.
  • Innovation Practice: How to develop people’s innovation skills and experience and acquire the right innovation talent. How to ensure that we are using the right tools, processes, and metrics to test and adapt ideas in order to reduce risk.

 Lessons Learned

  • The three pillars of an innovation ecosystem:
    • Innovation Portfolios
    • Innovation Programs
    • a Culture of Innovation
  • Download the Osterwalder Playbook here

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