“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.”
“A whopping six Chinese companies have stormed into the top 15 global defense firms according to a new report by Defense News, which released its annual Top 100 list of the biggest defense companies in the world.
The burgeoning Chinese defense industry has blown past the majority of its US counterparts while leaving virtually all of Europe in the dust, according to a new study of the global defense market.”
“The top Chinese company on the list, Aviation Industry Corporation of China, boasts an estimated revenue from defense sales of $24 billion, pushing past traditional US defense giants General Dynamics and BAE Systems. The company has also inched within roughly a billion in revenue of fellow behemoths, Raytheon and Northrop Grumman, both of which pulled in just over $25 billion in 2018.
Two other Chinese companies, China North Industries Group Corporation Limited, and the China Aerospace Science and Industry Corporation, made the top 10.
Pentagon officials have long bemoaned the Chinese government’s ability to order industry to respond quickly — and completely — to its demands. The new report shines a spotlight on the gravity of those complaints while shining a spotlight on secretive Chinese defense industry.
During his recent nomination hearing to become the next chairman of the Joint Chiefs, Gen. Mark Milley said when it comes to military technology and doctrine, “China went to school on us,” telling the Senate Armed Services Committee, “they watched us very closely in the First Gulf War, the Second Gulf War. They watched our capabilities. And in many many ways, they have mimicked those, and they have adopted many of the doctrines and organizations.”
Some of the huge technological strides Beijing has made recently come as the result of rules that require foreign companies to share their technological expertise in exchange for access to China’s vast market. Using those technologies, combined with a willingness to spend, has allowed Chinese defense companies to grow at an astounding rate.
A Defense Intelligence Agency report released in January said that this state of affairs isn’t likely to change any time soon: “China has the political will and fiscal strength to sustain a steady increase in defense spending during the next decade, which will help support PLA modernization, develop an integrated military-civilian defense industry, and explore new technologies with defense applications,” the report concludes.
Given the poor transparency rules governing Chinese companies and China’s poor record of disclosing defense spending these companies could well be much larger than estimated. “
“Is fair competition achieved when one company has more cards to play than others and therefore walks away the winner? It doesn’t leave a clear path to victory for smaller competitors, particularly international ones that are inevitably at a disadvantage from the start.
Even a giant like Lockheed Martin, which has more than double the defense revenue of Boeing, has less than half the free cash flow.”
Image: Seeking Alpha.com
“It’s been about a month since the U.S. Air Force’s T-X trainer contract was awarded, providing plenty of time for industry and media alike to chew over the decision.
A lot of the conversations I had started out pretty much the same: “Were you surprised?”
I’m not one to place bets on major defense programs, but, yes, I was surprised.
And I was in good company. As the only firm offering a clean-sheet design, with no track record and presumably a whole lot of development and manufacturing costs ahead of it, a lot of people I spoke to saw Boeing as a long shot.
And yet the company won the $9.2 billion contract to produce 351 jets. Moreover, they won on price. And it’s not the only thing Boeing won: there was also the $2.4 billion UN-1N Huey replacement, and the Navy’s $805 million MQ-25 aerial fueling drone contract.
So why Boeing?
First, one could argue that Lockheed Martin might have been pressed by the Air Force to compete for the trainer but did not actually want to win. Not enough to really go bold, anyway. The company has a pretty demanding portfolio already.
Notably, Lockheed Martin CEO Marillyn Hewson said that matching the winning prices for Boeing’s trifecta of wins would have led to cumulative losses across all three programs in excess of $5 billion, “an outcome that we do not feel would have been in the best interest of our stockholders or our customers.”
Why would it be all that different for Boeing?
It won’t be, necessarily. Chances are that Boeing knows full well that it will see losses. It already has — announcing $691 million of new third-quarter charges for winning the contracts. But even billions in charges is palatable for a company that last quarter alone saw free cash flow surge 37 percent to $4.1 billion, and that number is expected to climb to $13 billion or more for the year.
That is the fundamental advantage of having a commercial business. Boeing has shown what appears to be the strategy for this program: Ride the wave, borrow from one business to offset losses in the other, keep the St. Louis plant humming and eventually see a major return, particularly when other buyers emerge. (Beyond international sales for T-X, Richard Aboulafia of Teal Group pointed to a few dozen planes procured for U.S. “red air” adversary training, and the prospect of a navalized T-X variant one day replacing the Navy’s T-45 carrier-based trainer, which could be good for 200 more.)
Obviously there’s risk involved. Boeing is counting on future opportunities to more than offset any overages it swallows. The commercial business may be booming, but that’s still a gamble, albeit a relatively safe one. In the meantime, though, Wall Street is pleased, particularly after losses of the Joint Strike Fighter program and Long Range Strike Bomber left some questioning Boeing’s future in combat aircraft manufacturing. This keeps the company squarely in the game.
It’s also an advantage that benefits the Department of Defense and the taxpayer. Looking at the trainer specifically, the Air Force is ultimately getting a more advanced aircraft, built to order, so to speak, for a deep discount. Cost overruns will happen, but the Pentagon won’t be on the hook for them. Perhaps it could bring some added oversight from congressional watchdogs, but that’s a small price to pay. This is a good deal.
But is that ultimately how the procurement game is meant to be played? Is fair competition achieved when one company has more cards to play than others and therefore walks away the winner? It doesn’t leave a clear path to victory for smaller competitors, particularly international ones that are inevitably at a disadvantage from the start. Even a giant like Lockheed Martin, which has more than double the defense revenue of Boeing, has less than half the free cash flow.
EDITORS NOTE: 10/2/2018 The Pentagon has now changed its position on this matter and backed off:Pentagon Backs Off
“The baseline performance- and progress-based payment rate for larger companies would be reset from 80 percent to 50 percent, with incremental increases or decreases based on new criteria proposed by DoD.
If a contractor, for instance, delivers end items on time, hits milestone schedules, or avoids serious corrective action requests, it would win 10 percent bumps for each. (Small businesses would have their own schedule of incentives.)”
“The Pentagon’s proposed plan to lower the rate of progress and performance payments some companies receive on defense contracts is sending shockwaves through the industry and invited a backlash from three large trade associations.
To incentivize defense firms to work more quickly and more efficiently for the taxpayer, Pentagon leaders want to create a tiered system that recognizes high performing companies with higher performance-based payments. Contractors, however, are balking at the Pentagon’s efforts to make them more accountable.
While obscure to the general public, the proposed rule changes have rattled government contractors, which argue they would choke off funding for innovation, shackle them with more bureaucracy, increase the cost of military equipment— and hurt profits.
The baseline performance- and progress-based payment rate for larger companies would be reset from 80 percent to 50 percent, with incremental increases or decreases based on new criteria proposed by DoD. If a contractor, for instance, delivers end items on time, hits milestone schedules, or avoids serious corrective action requests, it would win 10 percent bumps for each. (Small businesses would have their own schedule of incentives.)
The National Defense Industrial Association is calling on DoD to rescind the regulation and collaborate with industry to create a different rule. One objection it has is the proposed rule would determine payment rates based on companies’ overall performance, as opposed to contract by contract.
“The marching orders from Congress is we have to be faster, more innovative, to do better for the warfighter,” said NDIA Senior Vice President for Policy Wesley Hallman. But, under the proposed rule, a company that wants to take on a high-risk project that fails, “will later be judged on that thing the following December. They’re incentivized to take a low-risk approach.”
Though Section 831 of the 2017 National Defense Authorization Act encourages DoD to use performance payments, NDIA argues the rule violate’s the law’s intent and that lessening companies’ cash flow would slow payments to subcontractors and sap funding for independent research and development.
“We’re doing our best to let them know how this will hurt industry,” said NDIA Director of Regulatory Policy Corbin Evans.
The trade group’s comments were submitted at a public meeting Sept. 14 to consider changes the Pentagon proposed in August to federal acquisitions rules, the Defense Federal Acquisition Regulations Supplement. The Defense Department is holding another public meeting, Oct. 10, before the public comment period ends on Oct. 23.
Both the Professional Services Council and the Aerospace Industries Association, which more than 300 companies in the aerospace and defense industry, also offered presentations in opposition.
The move toward better stewardship of taxpayer dollars comes amid record Pentagon budget growth and amid a reorganization of the Pentagon’s acquisition, technology and logistics office, now due to finish in a few months.
The move falls in line with Under Secretary of Defense for Acquisition and Sustainment Ellen Lord’s efforts to halve the timeline of major defense acquisition programs, which are notoriously slow.
“I believe the lifeblood of most industry is cash flow, so what we will do is regulate the percentage of payments or the amount of profit that can be achieved through what type of performance they demonstrate by the numbers,” Lord said in a Defense News interview last week.
Hence, “we’re going to begin to reward companies through profit or through progress or performance payments, as a function of how they manage all of that, as well as quality and delivery and a variety of other things,” Lord said.
Though it’s unclear whether DoD will formally move ahead with the rule by a Dec. 1 deadline, investors have already responded negatively to a reports on the changes, according to aerospace and defense sector analysts at Cowen and Company.
“It will be a scramble for companies and DoD to compile the necessary data to evaluate the rate request. Under the current draft rule, DoD would need to evaluate the rate request in just one month for all its suppliers,” Roman Schweizer, of Cowen and Company, said in a note to investors Friday. “We suspect that will be very hard the first time and suggests this year may be too hard.”
Still, Cowen analyst Cai von Rumohr downplayed the near-term effects, especially beyond the major primes. He speculated the proposed rule change will have negligible impact on contractor results in 2019 since it doesn’t apply to any current contracts; it’s very unlikely to go into effect before 2020, if ever; it will not apply to time and materials and fixed-price commercial terms contracts, and because it will only apply to some cost-plus contracts.”
“The Army today has about 20 different software “baselines,” with different units and offices using inconsistent and often incompatible programs, often because their hardware is too old to handle anything better.
The resulting patchwork of networks is expensive to operate and difficult to secure against cyber attack. So the service wants to upgrade everyone to a single, consistent, up-to-date baseline within two years.
The Army’s long-term goal: a single unified network connecting everything from the home base to the battlefield, easy for the service to upgrade, easy for soldiers to use amidst the stress of combat, and hard for enemies to take down. The Army’s immediate question for industry: Can you build it?
Lt. Gen. Ostrowski, the director of the Army Acquisition Corps, wants you to write him if you want in on a series of roundtables the Army is holding with selected companies, hosted by the federally funded Institute for Defense Analyses (IDA). One roundtable was personally led by the Army Chief of Staff, the hard-charging, wisecracking Gen. Mark Milley, who is taking a hands-on role in the review he launched in May.
“What’s different is the involvement of the leadership,” said Army CIO Gary Wang, who’s leading the review for Gen. Milley. While the Pentagon bureaucracy does plenty of reviews, he told me, “oftentimes it’s delegated down to a much lower level.” This time, though, the severity of the Army’s “financial constraints” have gotten the Chief of Staff and Acting Army Secretary Robert Speer personally involved, Wang said.
There’s another reason Wang didn’t mention: the savage criticism in Congress of the Army’s flagship battlefield network, WIN-T. Gen. Milley himself said the network is too “fragile” and “vulnerable” for future battles against high-tech adversaries like Russia or China, because its transmissions are too easily detected and then jammed or hacked.
“WIN-T’s our current network,” Ostrowski said when I asked him about the system. “We’re an Army that has to fight tonight, and WIN-T will be very much part of that. Period. That gets that off the table.” Then he moved on to other topics — notably not saying what this review would mean for WIN-T in the future.
But this review goes well beyond WIN-T, Milley and Speer have emphasized. It covers all the Army’s networks, both for combat units and back-office business operations. The crucial issue, Ostrowski said, is “how do we simplify the network? Right now we have a lot of parts and pieces. We’ve gone out and bought a lot of stuff that’s incredible in terms of its capabilities. but we’ve got to simplify: We’ve got to make this soldier-intuitive; we’ve got to make it soldier-maintainable and soldier-operable.”
The Army today has about 20 different software “baselines,” with different units and offices using inconsistent and often incompatible programs, often because their hardware is too old to handle anything better. The resulting patchwork of networks is expensive to operate and difficult to secure against cyber attack. So the service wants to upgrade everyone to a single, consistent, up-to-date baseline within two years.
What’s more, cybersecurity in the narrow sense is not enough. The Army can’t just focus on hackers sending malicious code over the internet: It also has to worry about electronic warriors jamming, triangulating, or eavesdropping on radio transmissions. That’s a uniquely military problem. Yes, civilian mobile phones also rely on radio — that’s what “wireless” means — but only to reach the nearest cell tower, which is often plugged into fiber optic cable; battlefield wireless networks rely on long-distance radio, which is much more vulnerable.
A Daunting Task
So what does the Army want from its future network, and therefore from industry?
First and most fundamentally, Ostrowski told the AUSA conference, the review is driven by rapidly evolving threats, because the network needs to be ready to go to “fight and win our nation’s wars” against those threats. The Army must stand ready “to deploy rapidly, anywhere, anytime, to shape, prevent, and win, against any foe in any domain — domain being cyber, space, air, land, or maritime — and any environment — environment being megacity, desert, jungle, arctic.” So the network must be able to operate, and the soldiers using it must be able to reliably communicate, in all those conditions, under attack by any of those threats, and on the move, without stopping to set up radio antennas or lay fiber optic cables.
To that end, the network must be “simple and intuitive,” Ostrowski said, easy for soldiers to operate without extensive training or constant tweaking. Soldiers must be able to keep it running without relying on legions of industry Field Service Representatives (FSR), as was often the case in Afghanistan and Iraq.
The network must also be easy to upgrade as technology changes, without having to start the whole laborious procurement process over again, and without being locked in to one company’s intellectual property that no one firm can touch. “I will tell you up front, that if you’re going to bring proprietary solutions to the table, don’t come,” Ostrowski said. Instead, the network must be built on open standards, allowing any company to offer upgrades just as any company that meets Apple’s standards can sell apps for the iPhone.
Finally, the network must be secure against cyberattack, resilient to the damage of those attacks that do get through, and able to transmit its wireless signals in a way the enemy cannot easily detect. (The technical terms are Low Probability of Detection (LPD) and Low Probability of Intercept (LPI)).
This is a daunting list of desiderata, but engineers from both the Army and “numerous companies” are already “whiteboarding” how they would achieve them, Ostrowski said. “My name and number (are) up there,” he said, pointing to his slides. “I need you to let me know if you want to play.”
Who’s facilitating all this interaction? The Institute for Defense Analyses (IDA), a federally funded research & development cooperation that Congress had already chartered to study the Army network, said Maj. Gen. Peter Gallagher, who works for CIO Wang as director of architecture, operations, networks, and space. Gallagher told me he doubted if he’d ever seen a review this intensive, adding the full-court outreach to industry was “something Gen. Milley personally directed.”
“We rely on industry for everything we do,” Gallagher said simply.”
“The big winner, at least on the platform side, is Lockheed Martin, with an estimated $29.1 billion in potential sales.
That includes seven THAAD missile defense batteries ($13.5 billion), and three KC-130J and 20 C-130J aircraft ($5.8 billion), as well as four multi-mission surface combatant ships ($6 billion)
Now that details of the $110 billion arms package offered to Saudi Arabia are known, Lockheed Martin appears to be the clear winner among American defense firms.
First, a caveat: Defense News broke the details of the roughly $84 billion in unknown weapons offerings that President Donald Trump brought with him on a May 20 visit to the Kingdom. But by the nature of how foreign military sales are completed, dollar totals are best-guess estimations and likely represent the ceiling for what could be spent. The figures listed may well come down, and the timeframes listed may well change, based on final negotiations around the equipment.
the company’s Sikorsky arm also benefited, with two types of Black Hawk variants: 14 MH-60R Seahawk rotorcraft ($2 billion) and 30 UH-60 rescue helicopters ($1.8 billion). That could potentially grow. A statement from Lockheed, released after the visit to Saudi Arabia, claimed that a deal was being reached with Saudi company Taqnia to “support final assembly and completion of an estimated 150 S-70 Black Hawk utility helicopters for the Saudi government.”
A few other companies also fared well.
Boeing cashed in with an eight-year sustainment deal ($6.25 billion) for their F-15 aircraft, along with a relatively small $20 million deal to run a study on recapitalizing Saudi’s older fleet of F-15 C/D aircraft.
Raytheon’s big win came from an unknown type of enhancement for the Patriot missile system ($6.65 billion). BAE, meanwhile, hopes to bring in $3.7 billion worth of work on its Bradley vehicle, with a pair of contracts – one to modify 400 existing vehicles, and another to produce 213 new ones. (The company may also cash out on an order for 180 Howitzers, worth $1.5 billion.)
There is also a $2 billion order for an unknown number of Mk-VI patrol boats, produced by SAFE Boats International.
The previously unreported list includes roughly 104,000 air to surface weapons, including 27,000 GBU-38 designs ($1.24 billion, Boeing), 9,000 GBU-31v3 designs ($690 million, Boeing), 9,000 GBU-31v1 designs ($490 million, Boeing), 50,000 GBU-12 designs ($1.67 billion, Lockheed and Raytheon) and 9,000 GBU-10 designs ($370 million, Lockheed and Raytheon.)
But there is a chance for more growth, based on a set of unspecified aircraft and satellite programs. The list includes $2 billion for a light air support aircraft, type and quantity to be decided later. It also includes another $2 billion for four new aircraft to replace the Kingdom’s Tactical Airborne Surveillance System, which serves a similar role to the U.S. Air Force JSTARS.
The light air support seems to have a fairly small list of options: either Textron with it’s AT-6 (or, perhaps, its Scorpion jet, still in search of a first customer) or the Embraer/Sierra Nevada team’s A-29 Super Tucano. Both the UAE and Jordan have ordered the A-29, so buying the Super Tucano would give the Kingdom commonality with two of its closest allies.
The wildcard may be the U.S. Air Force’s OA-X experiment, which is holding a flyoff between the Scorpion, AT-6 and A-29 this summer. In theory, the Air Force is looking at replacing the A-10 with one of the three planes, but the service has been careful to stress this summer’s action is more of a fact-finding exercise than a downselect. At the same time, if the USAF shows a preference for one of the jets, the Saudis may look in the same direction.
As to the TASS replacement, the first question is whether the Saudis look to glom onto the JSTARS recapitalization, which should be awarded sometime in fiscal year 2018. If so, Boeing, a Northrop Grumman/L-3/General Dynamics team and a Lockheed Martin/ Bombardier team would benefit here.
However, the TASS and JSTARS setups are somewhat different, and it may be the Saudis would look for a custom solution.
Meanwhile, the Kingdom has been offered a clutch of satellites, with as-yet-unknown designs: two “Remote Sensing Satellites” estimated at $800 million and two satellite communications & space based early warning systems estimated at $4 billion.
Given the focus on missile defense, the space based early warning systems could well be a derivative of Lockheed’s Space Based Infrared System (SBIRS) missile defense satellite. If so, the U.S. may be able to seek an arrangement with the Kingdom on information sharing, which would widen the overall capability of the missile tracking system.
How quickly these contracts can be pushed through the system is an open question. Roman Schweizer, an analyst with Cowen Washington Research Group, wrote in a note to investors Friday that “precision munitions and missile defense remain top priorities for the Kingdom.”
“We think the elements of the package will probably go through as individual items, which could reduce opposition. We think some of the more easily defined items that have been either sold to Saudi before or to other countries could proceed quickly (such as THAAD, Patriot, precision munitions, helicopters, F-15, C-130Js, etc.),” he wrote.”