“In 2020, Lockheed Martin pocketed $76.8 billion, a whopping $48.6 billion more than No. 2 Raytheon’s $28.2 billion.
Atlantic Diving Supply (doing business as ADS Tactical) with more than $3 billion claims to be a small business. Both ADS and Fisher Sand & Gravel, which collected $2.5 billion, largely for its work on the wall along the U.S.-Mexican border have entries in the Federal Contractor Misconduct Database.”
“The General Services Administration is out with its annual list(PDF) letting us taxpayers know who got how much cash in fiscal year 2020, which ended last September 30.
The big news involves Lockheed Martin, which tightened its grip on the top spot of contractors across the federal government. In 2020, LockMart pocketed $76.8 billion, a whopping $48.6 billion more than No. 2 Raytheon’s $28.2 billion haul. In 2019, it eclipsed No. 2 Boeing by a far smaller $21 billion. And, in 2018, it topped No. 2 Boeing by “only” $11 billion. Lockheed’s boom is due primarily to several big F-35 contracts and a $15 billion deal to develop and produce C-130J cargo planes. Rounding out the top five were General Dynamics ($25.4 billion), Boeing ($23.2 billion) and Northrop Grumman ($14.6 billion).
As contractors have merged in recent decades, the dollars have become concentrated in a smaller number of firms, a trend we noted in the Military Industrial Circus in 2019. Raytheon moved up the chart last year after gobbling up much of United Technologies Corp. United Technologies sold off its storied Sikorsky helicopter division to Lockheed in 2015, plumping up Lockheed’s Pentagon business.
Beyond the traditional movers and shakers are a couple of relative newcomers. Clocking in at No. 23 is Atlantic Diving Supply (doing business as ADS Tactical) with more than $3 billion in Pentagon funding. The Project On Government Oversight recently took a look at the company and its claim to be a “small business.” And coming in at No. 31 was Fisher Sand & Gravel, which collected $2.5 billion, largely for its work on then-President Donald Trump’s wall along the U.S.-Mexican border. Remember: if you have concerns about any of these contractors, check out POGO’s Federal Contractor Misconduct Database.”
“Five of the nation’s biggest defense contractors — Lockheed Martin, Boeing, Northrop Grumman, Raytheon Technologies and General Dynamics — spent a combined $60 million in 2020 to influence policy, according to a new report from the Center for Responsive Politics.”
“The paper, “Capitalizing on conflict: How defense contractors and foreign nations lobby for arms sales,” details how a network of lobbyists and donors steered $285 million in campaign contributions and $2.5 billion in lobbying spending over the last two decades, as well as hiring more than 200 lobbyists who previously worked in government.
The amount of money at stake is immense, both at home and abroad, the center states on its website, OpenSecrets.org. Not only is a significant portion of the Pentagon’s $740 billion annual budget spent on weapons, the report explains, but American defense firms agreed to sell $175 billion in weapons to other countries over the last year. That includes deals to sell $23 billion in F-35 Joint Strike Fighters and drones to the United Arab Emirates, and billions more in sales to Taiwan and Saudi Arabia, it adds.
The practice appears unlikely to change significantly under the Biden administration. The report notes that while President Joe Biden issued an order restricting officials who leave the White House from quickly lobbying the executive branch or registering as foreign agents, several of his appointees have ties to the defense industry. Defense Secretary Lloyd Austin, for example, sat on Raytheon’s board before joining the administration.
And since Biden’s inauguration, the report states, the State Department has approved the sale of $85 million in missiles from Raytheon to Chile, and a $60 million deal between Lockheed Martin and Jordan to provide F-16 Fighting Falcons and services.
Foreign nations that are among the arms industry’s biggest customers also spend heavily to influence U.S. policy, often to the tune of tens of millions of dollars in spending covered by the Foreign Agents Registration Act. However, the report notes that some nations that spend the most, such as South Korea and Japan, focus more on trade and commercial issues than military spending.
Australia, the United Arab Emirates, Taiwan and Saudi Arabia are some of the other major buyers of American weapons.
Defense lobbyists are also among the best-connected in Washington, D.C., the report states. Of the 663 lobbyists working for defense contractors, nearly three-quarters used to work for the federal government — the highest percentage of any industry, according to the report.
“These connections make for cozy relationships and highly useful contact lists,” the report says. “Overworked and underpaid congressional staffers can also hope that lucrative lobbying jobs await them at the same companies who come to them pushing their own agendas.”
The so-called “revolving door” also exists on Capitol Hill, the report adds. Over the last 30 years, nearly 530 staffers have both worked for a member of the Armed Services and Foreign Relations committees of both houses of Congress or the Defense Appropriations subcommittees, and then as a lobbyist for defense companies.
The report highlights former Defense Secretary Mark Esper as an example of the revolving door in action. Esper worked for the Senate Foreign Relations and House Armed Services committees in the late 1990s and early 2000s, as well as an assistant deputy secretary of defense, before moving to Raytheon’s government relations office. After seven years in that job, President Donald Trump made him secretary of the Army and then head of the Defense Department.”
“A huge portion of U.S. defense spending is going to contractors and military personnel based in just a handful of states, according to data recently released by the Pentagon.
California, Virginia and Texas topped the list of recipients for overall defense spending,” said a press release accompanying the study. They received $181.3 billion, about one-third of the total allotted to all 50 states plus D.C.”
“Defense Department contract obligations and payroll spending in the 50 states and the District of Columbia totaled $550.9 billion in fiscal year 2019. Of those outlays, 73 percent was spent on contracts for products and services, while the remaining 27 percent paid the salaries of department personnel, according to the Office of Local Defense Community Cooperation’s latest report on defense spending by state.
The top five, which also included Florida and Maryland, received about 43 percent of the total, while the top 10 received approximately 59 percent, according to the data.
The top 10 states were: California, $66.2 billion; Virginia, $60.3 billion; Texas, $54.8 billion; Florida, $29.8 billion; Maryland, $26.1 billion; Connecticut, $19.7 billion; Pennsylvania, $18.1 billion; Washington, $17.8 billion; Alabama, $16 billion; and Massachusetts, $15.8 billion. That adds up to a whopping $324.7 billion.
The 10 states whose economies are most dependent on military outlays — measured by defense spending as a percentage of their GDP — were: Virginia, 10.6; Hawaii, 7.7; Alabama, 6.9; Connecticut, 6.8; Alaska, 6.4; Maryland, 6; Maine, 5.8; Kentucky, 5.7; New Mexico, 5.7; and Mississippi, 5.3.
“Some states received substantial funds for both contract and personnel spending, while other states received relatively high amounts in only one,” the report noted.
The top 10 states for defense contract spending were: California, $50.2 billion; Texas, $43.4 billion; Virginia, $41.6 billion; Florida, $22.3 billion; Connecticut, $19 billion; Maryland, $18.4 billion; Pennsylvania, $15.3 billion; Massachusetts, $14.7 billion; Missouri, $13.4 billion; and Arizona, $12.9 billion. That adds up to $251.3 billion, more than 60 percent of the total value of defense contract obligations across the nation.
Patrick O’Brien, director of the Office of Local Defense Community Cooperation, said: “State and local officials need to use this information to better understand the essential continuum of investments across people, equipment, weapons systems, real estate and services required to maintain our national defense. Across these areas, they should determine if there are opportunities to further develop workforce skills, enhance and improve innovativeness and buying power, and partner to strengthen the resilience of our installations and industrial base.”
“It was a striking passage in a Christmas Eve Washington Poststory about a company that helps small businesses get contracts from nearby big corporations. “These small suppliers have been heavily reliant on the health of big companies in their regions,” it read. “If you are in Houston, your business lives and dies with oil and gas. In the Midwest, it’s automotive. Boston caters to medical device companies. Washington is well known for its aerospace and defense.”
Well, it may be well known now, but that’s a relatively recent phenomenon. Defense-contractor headquarters tended to be where the factories were, far away from the decision-makers in D.C. Lockheed and Northrop were in California, for example, and General Dynamics was in St. Louis.
But General Dynamics moved to D.C.’s Virginia suburbs in 1991. “Winning contracts is not just a function of providing the necessary aircraft or submarine,” a St. Louis-based defense industry analyst said when the move was announced. “There also, sorry to say, are politics that get involved in a lot of these decisions. It’s something that’s difficult to quantify, but you know it does have a place in these decisions.”
Lockheed shuttered its California headquarters in 1995 after it merged with Martin Marietta. The deal reflected “Southern California’s dwindling role as a mainstay of the U.S. aerospace industrial complex,” the Los Angeles Times reported at the time. “Lockheed Martin chose Martin Marietta’s home of Bethesda, Md., for its headquarters, formally ending Lockheed’s long domicile in the San Fernando Valley.”
Northrop moved to Falls Church, Va., in 2010. “We think we’ll be able to do a better job for our customers and our company by having our corporate office there,” Northrop chief Wes Bush said back then. “
“POLITICO spoke with managers at eight defense companies of varying sizes to see how their response to the pandemic has changed seven months in.
From Zoom meetings to mental health check-ins during the work day to reconfiguring office spaces, most defense CEOs say the changes forced by the coronavirus will be permanent even after this crisis is over.”
“The pandemic upended the industry in March, sending most employees who could telework home and requiring additional safety precautions for those who still had to go to the office. Companies quickly adopted best practices, such as frequent hand-washing, deep cleaning, distance between employees and eventually wearing masks.
But over the past seven months, many companies have gone beyond these initial steps to protect the health of their employees and changed how they operate in other areas of their business. That includes adding benefits for the workforce, increasing the use of virtual communications and protecting supply chains.
“We need to first calm down any sense of a focus on getting back to normal,” said Karl Hutter, the CEO of Click Bond, a supplier to defense companies. “There’s not going to be a going back to normal.”
A top challenge CEOs cited is trying to maintain a company’s culture and community when at least some of the workforce is working from home full-time and it’s still unsafe to gather for morale-building events such as anniversary celebrations or holiday parties.
Industry leaders are also rethinking what their companies will look like in the future, including how many employees will continue to work from home full-time and how offices will be laid out.
POLITICO spoke with managers at eight defense companies of varying sizes to see how their response to the pandemic has changed seven months in.
Caring for the workforce
The coronavirus pandemic has heaped stress on employees, many of whom are trying to juggle a full-time job with full-time child care amid a crisis that can make it anxiety-inducing to step outside. As a result, industry leaders almost unanimously said they have prioritized caring for employees’ mental health in a new way to try to both give workers coping mechanisms and ease whatever stress they can.
Click Bond, for example, has launched a pilot program in which about two dozen staff meet weekly for a 12-week program on wellness, including a focus on mindful movement and meditations. Hutter said he hopes the pilot, which is being used by many different demographics from younger workers to “hard-boiled tool makers,” will become a broader, long-term initiative.
To help working parents, SAIC has given employees access to online tutoring help for their children to help ease the burden of working full-time while also helping children navigate the virtual classroom, said Amy Benson, SAIC’s vice president of government affairs.
United Launch Alliance and SAIC both established “leave banks,” which allow employees who won’t use all of their vacation to donate that time off to colleagues who may need it. ULA CEO Tory Bruno said this will become a permanent benefit at his company once the pandemic is over.
“It forces you to take on things like this, then you learn about them,” he said. “None of these benefits I just described will stop.”
Companies have contracted with services to provide employees 24/7 virtual access to medical professionals for some health concerns. Managers are also making sure employees have access to health care. Huntington Ingalls Industries, for example, gave new hires health insurance immediately instead of making them wait 90 days, said Bill Ermatinger, the chief human resources officer at the shipbuilding company.
Some companies are also regularly testing employees for Covid-19, both to keep facilities running by quickly diagnosing and quarantining any sick people and to ease the minds of those who report to work.
“Employees have been very very grateful we’re doing it,” said Mark Aslett, the CEO of Mercury Systems. “It’s the only way to deal with employees at scale and get results back quickly enough to manage business continuity.”
One of the top challenges for CEOs is making up for lost in-person interactions at company-wide events. Bruno has also gotten creative to try to replicate some of the morale boosting and team building that would come from a BBQ at a space launch, for example, by paying for employees to pick up meals from local small businesses.
Hutter also stressed the importance of maintaining the culture of Click Bond, and is planning a “drive in theater event” for the company’s annual holiday party as a way to safely gather and raise employees’ spirits.
Embracing virtual tools
The inability to safely fly to visit vendors has forced businesses to get comfortable doing more virtually, which industry leaders say they will continue doing because it’s more efficient. Anne Shybunko-Moore, the owner of GSE Dynamics, said her team can now check on the status of parts and address technical issues virtually.
“I can see that impacting the way I do business going forward,” she said. “Vendor visits and building relationships are still critical in our supply chain, but maybe it’s not necessary to fly to California. … I could meet with eight vendors a day if I had to, virtually, all over the nation.”
Some companies also had to overcome security concerns to use video meeting tools such as Zoom. United Launch Alliance did not allow employees to turn video on for virtual meetings before the pandemic out of a concern that something in the background, such as a model or a drawing of a rocket, would be either classified or controlled by international export laws.
But after months of no in-person meetings, Bruno said he’s instead issued workers rules for what can appear alongside them on camera. This is another practice that will continue after the pandemic is over, he said.
“I started to worry about new employees never seeing their coworkers and feeling disconnected … so we’re enabling video everything and giving guidelines asking them to be careful about what’s behind them,” he said.
Planning for future business
Heather Bulk, the CEO of Special Aerospace Services, said she is already knocking down walls at her company’s Colorado headquarters to reconfigure the office toaccommodate many who say they will feel safer coming back to work in a personal office with a door that closes. She also acknowledged she will need to update the break room, but is not yet sure what a space that is both communal and safe looks like now.
“I like the idea that you can have 75 people in one room and they can all share a coffee pot and chat, but I don’t foresee this pivoting back to the way it was in 2018 and 2019 for a while,” she said. “By making these changes and making them quickly, I’m able to move forward so in January of 2021, all these office changes should be up to date.”
Bulk also said she is taking steps to bring more capabilities in-house, a trend she expects to see across the industry as CEOs work to mitigate disruptions at small businesses that produce critical parts.
Many CEOs said they intend to keep some of the enhanced cleaning and distancing policies in place post-pandemic because they will keep the workforce healthy from diseases such as colds and the flu as well.
As to what the future of telework looks like once it’s safe to return to the office, CEOs are split over how much of their workforce is likely to remain at home. But most agree a hybrid model with some people in the office and some working from home at least part-time is likely to become the new normal.
“Productivity has been good. It’s been great in fact,” Bruno said. “If you’re working a five-day work week, why can’t one or two days be at home teleworking where you’re not interrupted by a bunch of meetings?”
“A surge of defense spending is prompting the Pentagon’s audit agency to triple the number of evaluations it will undertake in order to uncover or prevent unjustified profits based on incomplete, flawed or inaccurate cost data.
The Defense Contract Audit Agency intends to complete as many as 60 Truth In Negotiations Act reviews in the coming fiscal year, compared to about 20 in the year ending Sept. 30.”
“According to spokesman Christopher Sherwood. The agency completed 21 such audits in 2018 and 26 in 2017. About half the reviews focused on the top 25 defense contractors.
Efforts to bolster defense spending were aided by Congress’s decision to revise spending caps for the final two years of the 2011 Budget Control Act. That effectively added tens of billions of dollars potential defense spending to the Pentagon budget: $90.3 billion in fiscal year 2020 and $81.3 billion in the following year.
Congress has signaled its concern that the money could be misspent. The staff of Republican Senator Chuck Grassley, chairman of the Senate Finance Committee, as well as investigators for Democratic Representative Elijah Cummings, chairman of the House Oversight Committee, are already reviewing the Pentagon’s enforcement of the law intended to prevent unjustified profits based on incomplete, flawed or inaccurate cost and pricing data for military unique items.
“The committee is investigating whether defense contractors are providing complete and accurate cost data, as required by law,” Cummings said in an emailed statement.
The 1962 Truth In Negotiations Act sought to put government contracting officers on equal footing with company counterparts, requiring firms during negotiations to provide government buyers all the variables that influenced the final price of a product or service unique to the military. They must also legally certify that the information is accurate, complete and current.
The TINA audits are separate from Pentagon reviews that uncover instances of overcharging for basic spare parts such as nuts and pins. Those types of goods are considered “commercial items,” normally exempt from the law’s price data requirements since there is already publicly available data to compare them with.
Under the ramped up audit policy, the number of “work years,” or time devoted to compiling compliance audits, will increase by approximately 500%, Sherwood said.
Previous reviews show there’s reason to be concerned. As an example, Shay Assad, the Pentagon’s former director of defense pricing and contracting, said evaluations during his tenure showed that essentially 100% of the contracts examined at one top-25 defense contractor had suspect pricing.
“If one looks deep enough there is some element of fraud typically lurking,” he said.
Sherwood said the contracts most prone to significant risk of “excess profits” are large, firm-fixed price types. In 2015, the audit agency formed a specialized, 20-person unit to handle reviews of “high-risk” contracts.
Based on initial reviews commissioned before the team was formed, Assad said in a written statement that “it became obvious to us that we needed to step up defective pricing review efforts.”
“In a number of cases we expected profit outcomes of 12% to 15%,” Assad said, but they found levels of between 25% and 80% on some sole-source weapons contracts. “That does not happen by outstanding performance” but by faulty contractor cost estimating “or in the worst case, fraud,” he added. Assad retired this year.
Since 2015, the unit has conducted audits on 108 high-risk contracts totaling $74 billion. Of those, 79 — or nearly 75% — uncovered potential defective pricing of $589 million that could eventually translate into contractor repayments after the contested charges go through a negotiations process.
“If both parties arrive at a mutually agreeable settlement, the contractor will make a payment to the government,” Sherwood said. But if not, the government’s principal negotiator “issues a demand for payment, at which point the contractor may elect to make the payment or pursue legal action,” he added.
In that same period, the audit agency has referred 10 compliance audits with “suspected irregular conduct” to the Pentagon’s Defense Criminal Investigative Service. Eight of those 10 have resulted in active cases, Sherwood said.”
“The Pentagon is now buying technology instead of making its own.
The Department of Defense used to fund much of the basic defense tech research and development in-house. Now, the private sector fills that void with innovation fast outpacing what the government can produce.“
“Defense industry? You must mean the defense technology industry.
A new analysis of top government contractors from Bloomberg Government shows that technology was one of the biggest drivers of growth in the defense sector in fiscal 2018. It follows trends of recent years in both government contracting and global economics with tech being a leader in growth.
“Across the board, technology plays a greater role; but technology has always played a role in defense,” said David Berteau, president of the Professional Services Council, a government contractor trade group.
Bloomberg’s report analyzed and ranked the top 200 contractors in terms of unclassified contracts won across the government. Top contractors Lockheed Martin and Boeing, whose biggest market is defense systems, offer technology services as a part of their delivery of traditional aerospace and security products to the Pentagon. General Dynamics ranks third in overall government contract money, and its IT arm alone took in $3 billion last year. Technology, both in terms of services and equipment, grew by $8.3 billion, taking an $82.3 billion slice from the $559 billion overall contracting pie, according to the report.
The report did not distinguish defense-specific IT contracts from civilian ones, but it stated top IT contractors generated most of their income from defense contracts. The biggest growth in federal technology equipment came from defense giants Raytheon, Lockheed Martin and Northrop Grumman. Together the three companies generated $6.2 billion in federal technology obligations.
Old contractors turning a new leaf
Bell, a longtime manufacturer of helicopters and aircraft, is an example of this pivot of traditional defense contractors to provide technology hardware and services. The company now sees itself as a technology company that is a part of a technology-driven industry, its CEO, Mitch Snyder, said at a Center for Security and International Studies event last week. Bell even rebranded itself, trimming its name from “Bell Helicopter.”
Snyder said Bell is partnering with “Silicon Valley-type companies” to test and develop the use of AI in their aerospace products. The company is also developing an in-house core team that is focused on getting its products to be autonomy-first.
“The technology that we are using and the speed in which we are going, that is why we believe we are a technology company,” Snyder said.
Modernization is the name of the game
Beyond traditionally machine-focused companies embracing emerging tech, the big boom is in IT modernization contracts, according to the Bloomberg report. Billions of dollars have been poured into technology companies working on cloud modernization and legacy system maintenance, a trend that Bloomberg projects will continue.
“[T]ech spending included a $4.7 billion increase for services as agencies continued investing in modernization efforts to replace legacy systems,” the report states.
AI and machine learning are also on the Pentagon’s radar and prime technologies that could add to the technology spending push. Leaders at the top level of the Pentagon have said they are laser-focused on AI as a top technology priority.”
“When I began covering the U.S. military for the Fort Worth Star-Telegram in Washington 40 years ago, it was to report on the Texas contractors who built what the Pentagon bought. Tens of thousands of the paper’s readers cared a lot about the fate of the weapons rolling off their assembly lines. Cuts in production ordered by the Pentagon or Congress in faraway Washington could take food off their table; boosts could lead to overtime on the line and a fatter paycheck.
Back then, General Dynamics was building the Air Force’s agile F-16 fighter on Fort Worth’s west side. Vought was building the Navy’s A-7 attack plane nearby. And Texas Instruments (TI) was building the revolutionary High-Speed Anti-Radiation Missile—HARM—which could destroy enemy radars. But as the U.S. defense industry entered a post-Cold War contraction, a rash of mergers changed all those name plates. The F-16 ended up being built by Lockheed Martin. Vought was spun off from the LTV Corp., a once-powerful conglomerate, with pieces ending up in the arms of Northrop Grumman. And the HARM missile is no longer produced by TI, but by the Raytheon Corp.
The merger mania that surged as the Cold War wound down—when 51 aerospace and defense companies shrank to five—is making a comeback. The “military-industrial complex” that President (and five-star Army general) Dwight Eisenhower warned us of in 1961 has funneled down to a few “Walmarts of war,” as Daniel Wirls, a professor at the University of California, Santa Cruz, quoted defense researchers calling the surviving contractors in a June 26 Washington Postcolumn. Less competition can drive up costs while dampening innovation. Backers counter that efficiencies, job cuts, primarily, lead to lower costs that can save the Pentagon money—rarely—or let it buy more for the same price—also rare. And the middlemen—the lawyers and financiers who nurture these deals—do just fine, thanks.
Mergers’ merits are murky when it comes to costs and innovation, and haven’t been studied much. It’d be a good move, both for taxpayers and the government, if Congress and the Government Accountability Office took deep dives into the issue to learn enough to make smart decisions. The issue has been debated for decades. Back in 1997, Robert Pitofsky, former chairman of the Federal Trade Commission (FTC), told Congress that the FTC “strongly believes … that competition produces the best goods at the lowest prices and is also most conducive to innovation.”
The latest chapter in Pentagon-contractor consolidation is the June 9 announcement that Raytheon and the defense division of United Technologies Corp. plan to merge. And this announcement comes four years after United Technologies sold its Sikorsky helicopter unit to Lockheed Martin, the Pentagon’s biggest contractor, for $9 billion. The pending merger includes United Technologies’ booming aerospace business—jet engines (including those for the F-35, as well as the F-15, F-16, and F-22) and cockpit electronics—with Raytheon, builder of Tomahawk cruise missiles (acquired when it bought Hughes Aircraft in 1997, which acquired it when it purchased General Dynamics’ missile division in 1992) and ground-fired Patriot air-defense missile systems. The new company—to be known as Raytheon Technologies—would have annual sales of about $74 billion. The companies have set up a website to herald their union.
The Raytheon-United Technologies deal is just the latest in a series of mergers in the defense industry: Over the past year, United Technologies bought Rockwell Collins for $30 billion, defense companies Harris Corp. and L3 Technologies agreed to merge in a $34 billion deal, and Northrop bought rocket-maker Orbital ATK for $9.2 billion.
The Raytheon-United Technologies combo boasts 60,000 engineers and 38,000 patents. Both are generally “platform agnostic,” building pieces for aircraft, tanks, and ships built by others, and they rarely compete with one another for Pentagon contracts. That suggests the federal government won’t object to the deal, which is expected to close in the first half of 2020.
The Justice Department is the federal agency that reviews such mergers, with input from both the Pentagon and the Federal Trade Commission. The Pentagon’s Office of Industrial Policy is primarily focused on the national security impact of such consolidations that might reduce military might, while Justice and the FTC are more concerned with broader antitrust issues that could lead to military-hardware monopolies. Although the Obama Administration’s policy was that it would oppose mergers among the Big 5 defense firms, the Trump Administration hasn’t endorsed that view. (The five contractors doing the most business with the Pentagon in 2018 were Lockheed in the top spot, followed by Raytheon, BAE Systems, Northrop Grumman, and Boeing; United Technologies ranked 11th).
Still, the commander in chief is fretting about this merger nonetheless. “I am a little concerned about United Technologies and Raytheon because one of the things that I bring up all of the time, we used to have many plane companies,” President Trump told CNBC shortly after the companies announced their plan to join forces. “We used to have many, many. They’ve all merged. Now we have very few. … It is hard to negotiate when you have two companies and sometimes you get one bid.”
The pending Raytheon-United Technologies deal “would fall just below the previous policy’s formal redline but gets about as close to that line as possible,” an analysis of the proposed merger by the nonprofit Center for Strategic and International Studies said. While the Center said government approval is expected, “it is almost inevitable that the new company will be required to divest some defense capabilities, and potentially some commercial ones, that overlap between Raytheon and United Technologies to preserve competition.”
Defense mergers have accelerated recently, in part because of “early guidance from the new U.S. administration” that defense spending would be on the rise, consulting firm Deloitte said in a 2017 report. In fact, 80 percent of professionals in the aerospace, defense, and government services sectors are bullish on mergers. That’s according to a survey released in April by the independent investment banking firm KippsDeSanto in the heart of suburban Virginia’s defense-contracting nirvana. “We have been in a really good budgetary environment,” Managing Director Michael Misantone toldNational Defense in April, citing a “large increase in defense spending” as rocket fuel for military mergers.
Of course, it was only a generation ago that precisely the opposite was true. It was plummeting defense budgets that were making mergers all but inevitable—under orders from the Pentagon itself. Then-Defense Secretary Les Aspin and his deputy, Bill Perry, invited the top officials from the nation’s biggest contractors to a dinner at the Pentagon in 1993 to warn that they all wouldn’t survive the coming budget crunch. “We expect defense companies to go out of business,” Perry, who succeeded Aspin as defense secretary in 1994, said after what came to be called “the Last Supper” in defense-contracting circles. “We will stand by and watch it happen.”
In May, the Government Accountability Office (GAO) noted the dire effect of consolidation. Even though the Pentagon has cut four programs from its must-have list, the GAO said, its remaining 82 major programs had grown in cost by $8 billion, to a cool $1.69 trillion. “Portfolio-wide cost growth has occurred in an environment where awards are often made without full and open competition,” the Congressional watchdog agency added. “Specifically, GAO found that DOD did not compete 67 percent of 183 major contracts currently reported for its 82 major programs.” Nearly half of those contracts—47 percent—went the current Big 5: Lockheed, Boeing, General Dynamics, Northrop, and United Technologies (the numbers are even grimmer for taxpayers if supposedly “competitive” bids lead to only a single bidder).
Between 2008 and 2018, the average cost of a Pentagon weapons system—not including inflation—jumped by 13 percent, the report said. “We have reported that competition is the cornerstone of a sound acquisition process and a critical tool for achieving the best return on investment for taxpayers,” the GAO added. “Generally, a low competition rate can contribute to increased costs of goods and services and decreased buying power.”
We’ve heard similar refrains before. Then-Defense Secretary Ashton Carter said in 2015 that he worried about reaching a point “where we did not have multiple vendors who could compete with one another on many programs.”
The health of the defense-industrial base has been a perennial concern. The latest warning about the Pentagon’s shriveling supplier corps was issued by the Defense Department’s own Office of Manufacturing and Industrial Base Policy on May 13. While big defense-contractor profits remain juicy, many smaller Pentagon suppliers are struggling. And the number of contractors doing defense work is shrinking: 97 percent of the Pentagon’s missiles are built by Lockheed and Raytheon. And 98 percent of the lower-level subcontractors making parts for U.S. munitions are the only source for the military parts they make.
Worse, the Pentagon pipeline for missiles and munitions is plagued with problems, including “material obsolescence and lack of redundant capability, lack of visibility into sub-tier suppliers causing delays in the notification of issues, loss of design and production skill, production gaps and lack of surge capacity planning, and aging infrastructure to manufacture and test the products,” the report warns. “Production gaps for munitions and missiles directly reduce the U.S. capability to deliver kinetic effects against adversaries.” In October, a second report from the Trump Administration said the nation has an increasingly “fragile” defense-industrial base with “entire industries near domestic extinction” and growing reliance on foreign sources.
“There are currently only two domestic suppliers for solid rocket motors used in the majority of DoD missile systems, with a single foreign supplier making up the balance,” the report said. More than 80 percent of the Pentagon’s armored vehicles are built by a single manufacturer in a single plant. There is only a single company producing chaff, the foil-like fibers U.S. warplanes eject to distract incoming missiles.
And don’t count on mergers to spur innovation. Innovation requires the levers of competition to work. Competition drives the perpetual quest to get more bang for the buck by harnessing new technologies. The Pentagon acknowledged as much in 1998 when it succeeded in stopping Lockheed’s move to buy Northrop Grumman. But the shrinking number of contractors is leading to less competition, and therefore less innovation.
“Any shrinking in the number of these enterprises ought to be a matter of concern for the defense agencies and for government antitrust agencies,” William Kovacic, a professor at George Washington University Law School and former head of the Federal Trade Commission, said in the wake of the Raytheon-UTC announcement.
This merger trend isn’t likely to end well, at least for U.S. taxpayers and the military they support. “If the trend to smaller and smaller numbers of weapon system prime contractors continues, one can foresee a future in which the department has at most two or three very large suppliers for all the major weapons systems that we acquire,” Frank Kendall said in 2015, while serving as the undersecretary of defense for acquisition, technology and logistics. “The Department would not consider this to be a positive development, and the American public should not either.”
“There’s a phrase — the mid-market squeeze — that encapsulates a truism in defense contracting: If you’re not really big, and you’re not categorically small, then you’re going to have a harder time competing. “
“That is oversimplifying the issue, but there are practical reasons for this to be at least notionally true. Agencies and prime contractors both have set-aside goals that they’re expected to meet in terms of divvying a percentage of contract dollars to small businesses — goals they notoriously miss. That makes a small business designation for a company a valuable marketing tactic when competing to be on the team of a prime or to win a contract direct from a defense agency (less common, but it happens). I wouldn’t say it makes competition for small businesses simple, but it helps.
At the other end of the spectrum, you of course have the prime contractors, who have both the benefit of a direct relationship with the customer and, at least for the top tier, the sheer scale to meet more requirements at a lower cost.
That leaves the mid-tier suffering the Jan Brady effect.
And it stands to get worse as some of the biggest mid-tier players — cognizant of the squeezeand the benefit of scale — combine. The challenges of the midmarket were definitely a factor in the L3-Harris merger that closed July 1, Bill Brown, chairman and CEO of the newly formed L3Harris Technologies, told me during an interview ahead of the Paris Air Show.
The squeeze is driving consolidation and frankly is why there’s not many mid-tier players left, he said. “L3 and Harris were two; put them together and they become bigger.”
It’s a simple concept that nonetheless stands to redefine what a mid-tier company actually is — or, more accurately, to create a whole new category unto itself. L3Harris still doesn’t build platforms — Brown is quite adamant about that, as was Raytheon CEO Tom Kennedy when I spoke to him about the merger with United Technologies. That used to be a qualifier for the mid-tier — creating systems that often go in and on platforms built by the tier-one manufacturers.
But now, the fact that these merged companies are or will be large enough in terms of revenue to rival some of those tier-one defense manufacturers makes them quite different. What we have in L3Harris and the future Raytheon Technologies are companies with phenomenal scale and diversity.
We’ve watched a similar market shift among the IT services companies in the last few years, with medium companies combining to become mega providers that can price low, and offer more.
So where does that leave the other mid-sized defense companies? Probably looking around to see who they could perhaps merge with to leapfrog to that new category — or close to it. That’s not easy, though. As Brown noted, the pickings are becoming increasingly slim. And other factors matter: lack of market overlap, namely, to ensure a merger won’t raise antitrust issues and will promote diversity to put together more comprehensive systems.
If you look at this year’s Top 100 list, it’s hard to identify mergers that would fit the bill — though as Brown told me in June: “I wouldn’t have seen six months ago United and Raytheon.”
Plus, with big mergers come divestitures. L3Harris expects a “pretty significant” piece of business to be shed either as a sale or a spinoff in its first six months. One can figure the same from Raytheon and UTC, once the deal closes. That provides options for those mid-tier players looking to expand.
And down the road? Who knows. These things often happen in cycles, where an era of consolidation makes companies a whole lot of money, and then a couple years later they break up.
As Brown and L3Harris Chief Operating Officer Chris Kubasik told me: “It’s worked for bankers.”
“The additions have caused a reshuffling of positions relative to last year’s Top 100, but the absence of Chinese enterprises had painted an incomplete picture of the structure of the global defense sector. https://people.defensenews.com/top-100/
Some planners and analysts may scoff at the inclusion of Chinese firms, or for that matter enterprises of other countries that don’t have markets open to U.S. and European firms. But this raises the first of three lessons that can be learned from the Top 100: Pay attention to China.”
“The U.S. Defense Department and other defense ministries have been paying a lot of attention to China for more than a decade, and contractors have undeniably benefited from spending to counter China’s emerging defense capabilities.
The data listed in the Top 100 for eight Chinese enterprises raises a host of questions: Are these firms profitable? How much do they spend on research and development? What are management incentives and goals? How do these firms benefit from commercial enterprises that are often part of their business portfolios?
A recent McKinsey & Company study observed that the largest 100 Chinese firms in all sectors generated approximately 18 percent of sales internationally, compared to 44 percent for U.S. firms in the broad S&P 500 market index.
The same relationship may hold for China’s defense contractors. China’s major defense export customers have tended to be relatively small in number — Pakistan, Bangladesh, Thailand, Myanmar and some African states.
There are harbingers of change, however, with a Chinese firm selected in 2013 to supply Turkey with an air defense system (the deal fell through) and more recent UAV and ballistic missile sales as well as local development for Saudi Arabia. It’s likely that companies listed in the Top 100 will see more Chinese enterprises in global markets in the years to come.
The second lesson from the Defense News rankings is that it’s difficult for contractors to make significant moves on organic sales growth alone. Lockheed Martin has been the No. 1 ranked company since 2003; Boeing, Northrop Grumman, Raytheon, General Dynamics and BAE Systems have been ranked between No. 2 and No. 6.
There are two possible exceptions to this rule, however, in SpaceX and General Atomics, neither of which appear on the Top 100. There’s been a general dearth of new entrants in defense that have reached scale. Big moves in relative position have typically resulted from divestitures, or mergers and acquisitions .
For contractors that are on the list, this leads to a third lesson: The things you can’t see may kill you, or at least trip up your well-laid plans.
SpaceX is possibly an anomaly, as there are not that many billionaires with very different business models and goals targeting specific defense segments. But defense customers will continue to demand new and innovative products and services, and the number of potential competitors is far greater than those listed in the Top 100. The threats here may come from smaller firms that can rapidly scale up in new market segments — such as space, cyber or artificial intelligence — or protracted forays by large commercial technology firms into markets dominated by traditional contractors.
There are other companies not listed in the Top 100 that will play impactful roles in defense market segments. The initial public offering of Parsons raises its profile in defense. Kaman’s plan to sell its distribution business and concentrate on engineered products is another change, and the agreement between AeroVironment and Kratos announced in 2019 is another factor to weigh.”