Defense contactors have several moves they can make to lessen the brutal impact of impending defense spending cuts, according to Loren Thompson, COO of the Lexington Institute, a think tank near the Pentagon focusing on defense and other issues.
Both Secretary of Defense Robert Gates and Sen. Carl Levin (D-Mich.), chairman of the Senate Armed Services Committee, are warning of major cuts in defense procurement programs impending in the fiscal year ending Sept. 30, 2010. (Please see full stories in this issue.)
"When you only have one customer and that customer suddenly finds itself spending a trillion dollars more per year than it is taking in, prudence dictates you should start developing alternatives to your current business plan," Thompson cautioned. "That’s the position the U.S. defense industry finds itself in today. Big cuts in weapons spending won’t happen quickly, but at some point the combination of a deep economic recession, receding threats and Democratic Party control of the government is likely to produce a downturn in the defense business. Fortunately, the industry has many options for coping with declining demand."
He advised companies to lower expectations, and wait for investors who are pushing defense stock prices lower to realize that other investments aren’t nearly as attractive.
Also, contractors enjoy huge backlogs of orders for defense hardware, and that can cushion coming cuts in Pentagon outlays. Contractors as well can trim overhead, knowing that big new contracts won’t be coming from the military any time soon.
Another move always has been an option: stealing market share from competitors. If one company can provide a platform more cheaply than a contractor currently holding the contract, seize the day, Thompson wrote. "Focused second-tier companies like Alliant Techsystems and ManTech International have the skills and flexibility to undercut bigger competitors on price and performance when affordability becomes a key discriminator. Some of the bigger companies, most notably Lockheed Martin, have also demonstrated a capacity to win business at the expense of rivals by being more responsive."
Contractors also can expand into adjacent markets, making products similar to those they already are producing. "Lockheed Martin is chasing a wide range of federal opportunities from logistics to healthcare to homeland security, leveraging its expertise in information systems and system integration," Thompson observed. "Boeing is bringing its commercial logistics skills to bear on military sustainment. Northrop Grumman is pursuing climate-change solutions and applying federal skills at the state and local levels."
And cash built up in the fat times of this decade can be used to make acquisitions useful in filling niches in a portfolio of products. "General Dynamics has proven especially adept at deploying capital in new properties that materially improve the company’s overall financial performance," Thompson noted. "As sector prospects moderate, the asking prices for many companies will fall to a point where they look like bargains for the right purchaser."
Finally, consider a merger of equals with another firm, especially if your company is in the second tier of contractors. "Even a big company like Raytheon might be able to merge with another defense major, since it has only modest business overlap with most platform producers," Thompson wrote. "The resulting synergies could improve the competitive landscape for both partners. A merger of equals could also help defense companies gain entry to commercial markets."
To read his paper titled "Defense Companies Have Many Options In A Downturn" in full, please go to http://www.lexingtoninstitute.org on the Web.
