I received a question the other day from a major trade publication in the business as to whether I saw “a major debacle coming" for the defense industry. After taking some time to study the possibility, and to think about what would constitute a debacle, I responded. What follows is my response.
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I'm not sure, for example, that I'd call the fates befalling Ford, GM, and Chrysler a debacle. Dénouement might be a better term, as long as their collective demise has been in the works. A more sudden and less predictable failure—if financial failure is required—might better fit the meaning. The defense business has been short on those for some time. Lockheed famously faced bankruptcy in the 1970s after huge cost-overruns on the fixed-price C-5 Galaxy development program and its own L-1011 project. So, management exacted a $500 million unilateral price increase from the government for the C-5, and a loan guarantee for the L-1011, which also famously failed to live up to what Lockheed claimed in its pleas to the congress. The latter is a classic case study by Uwe Reinhardt ("A Breakeven Analysis for Lockheed's Tri-Star: an Application of Financial Theory," Journal of Finance, September 1973). General Dynamics was in similarly bad shape with the Los Angeles class submarine program, and extracted its cash from the government as well. There's a pattern, I think, in convincing the federal government of the importance of current management and ownership, regardless of performance.
I'm also not certain that the contraction in defense spending in the early 1990s would qualify as a debacle for anyone. That was seen coming for some time, and everyone had plenty of time to prepare. General Dynamics made a fortune for its shareholders by shrinking; until recently, sellers have made more than buyers from mergers in the long run, and the evidence from the last few years is not completely in. Perhaps oddly, the Pentagon was sufficiently stressed about a bankruptcy at any given large contractor at the time that it commissioned RAND to study the question. That it took the authors 26 pages to conclude that bond yields were the best predictor is an indication of how unsophisticated the Defense Department's financial analysts, hired or otherwise, must have been back then. That was a basic lesson in my introductory graduate finance class.
At this stage, it seems to me that a financial debacle—if not bankruptcy, then a serious contraction in the size of one of the larger contractors—is possible, if unlikely. Two things would have to come to pass. First, Obama's people at Defense would have to get serious about reconfiguring the US armed forces for the more probable fights, and the ones that really matter to them. Second, those same folks would have to get ruthless about terminating programs that were not meeting financial expectations or security needs. I am not advocating a change; as a consultant in the business, I merely observe what would happen. That said, since the overall level of defense spending might not crash, any debacle could work out very well for someone. I'm not really in the predictions business, but I'll hazard a few guesses that might be relevant.
You mentioned shipbuilding; we might consider what could happen if someone took a serious look at real needs for air defense ships. Enough people questioned the need for a 14,000-ton Zumwalt that the class is almost dead. Since the Navy has 62 Arleigh Burkes afloat, under construction, or planned, one might ask why it needs more of those as well. The Burke herself is just 17 years old, so it's barely conceivable that the government might decide to take a capital ship holiday of sorts. That would be extremely bad for shipbuilders in Maine, where the Bath Iron Works builds literally nothing but Burkes. The possible addition of landing ships could salvage the situation for Northrop Grumman. The money that would free up for Littoral Combat Ships and Joint High Speed Vessels would constitute a bonanza for Austal.
This talk of expanding the ground forces will likely come to nought, because people are very expensive, and that quantity of troops just isn't necessary if the incoming crew is so skeptical about invading countries the size of Iraq. As the Army will emerge from that campaign with a fully rebuilt and modernized fleet of Abrams, Bradleys, and Paladins, interest in the FCS, apart from the sensors and UAVs, will be collapse. The MRAP business may continue for some time, as long as casualties continue to be primarily caused the big three threats: mines, rocket grenades, and Kalashnikovs. However, since BAE Systems and General Dynamics have hedged their bets well between big war and small war vehicles, they should both handle the slide decently. Some of the electronics specialists who are more committed to FCS than the MRAPs may have some problems.
The most intriguing question lies with the air arms. Bell would be in a world of hurt were the V-22 not performing so well in Iraq. Boeing's helicopter business (even apart from Bell-Boeing) will continue to sell Chinooks for decades, it seems. General Atomics, whatever the Navy said about its performance on USAF contracts, will be building drones for some time. This is because these are airplanes that actually get used in combat these days. It's notable, then, that over half of the aircraft that the USAF requested in the 2009 budget are drones. The F-35, however, could be in for some deep reductions in procurement quantities. It's rather difficult for me to see how the CTOL version would be brought to bear against the Chinese, and why very many of them would be needed against anyone else. Lockheed Martin would hate that, of course, but Saab could greatly benefit from additional sales of new or refurbished Gripens.
All that said, I don't really expect this to happen. The likelihood of something like this would have been greater had John McCain gotten himself elected, for only Nixon could go to China. Obama's people may conclude that they must essentially bunt, and do less than Clinton's people did for restructuring. They had some big successes with the JDAM, the F-18E/F, and ultimately the Stryker, but at the end of the 1990s, the armed forces were mostly a scaled-down version of what stood on the line during the Cold War. Following that plan again would leave most of the long-term business relationships intact.
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