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Defense Companies Must Do More Than Lobby Against Cuts

Posted by August Cole on

This time it’s different.

For more than a year, defense companies have taken measured steps to prepare for defense spending budget cuts. Many pruned corporate spending, sending fewer executives to foreign air shows. Some, like Lockheed Martin Corp., even offered sweeping buyouts. Others even sold off headache-causing businesses, as Northrop Grumman Corp. did by spinning off its shipyards. More acquisitions can be expected along the lines of United Technology Corp.’s offer for Goodrich Corp.

These are significant moves for an industry that’s had a strong financial run during the past decade but seems convinced it can hold its own as defense spending declines in the coming years.

It’s not going to be enough.

So far, what the big defense companies have been doing is keeping pace with, or just a whisker ahead of, the politics of the moment. The Second to None pro-defense initiative, backed by the industry, is a predictable move that might work in ordinary times. After all, there is no immediate advantage to doing anything rash, like getting out of the defense market entirely. At least not yet. It may come to that for some firms if we revisit the shameful politicking seen during the debt-ceiling debacle this summer.

The defense industry is standing on a very high ledge. Like the Beltway area itself, the industry has been through a post-9/11 boom that echoes the dot-com bubble era of 1990s San Francisco. If there’s any doubt, just count the number of European sports cars around the office towers in Tysons Corner or peruse Securities and Exchange Commission filings for the equity compensation of senior defense executives. The tech bubble burst quickly, given the nature of the equity markets at the time. The defense bubble is so far deflating slowly, not suddenly bursting given the nature of government contracting and the lock Washington lawmakers have on many weapons programs.
While Americans are clearly occupied with the flagging economy, and not whether the Marine Corps should get its own version of the Joint Strike Fighter, defense spending remains an important political club that Republicans can wield over Democrats. The two issues are intertwined because cutting hardware and research and development spending, as defense industry proponents keep pointing out, means losing jobs that are very hard or impossible to replace. Most major weapons programs count suppliers in all, or almost all, 50 states for a reason.

There is a very good chance the members of the deficit “Super Committee,” itself a product of this summer’s bare-knuckle political brawl, will succumb to these temptations and fail to come up with more than $1 trillion in broad federal budget cuts. Already, Ariz. Sen. Jon Kyl boasted he’d rather resign from the group than agree to more defense cuts. This kind of grandstanding will lead to certain chaos in the one area where fiscal sanity and political poise are needed most: defense. If the “Super Committee” failure triggers automatic cuts to government spending, what should have been a painful but necessary winnowing away of wasteful Pentagon programs and practices will become something ugly – and dangerous.

The defense industry is due for significant change, and it will take more than cutting corporate expenses or the sale of underperforming businesses to achieve it. Something more profound is underway and the fight over the country’s fiscal future may speed it along faster than anyone in the industry thinks is possible.

To remain strong as the defense bubble deflates, the sector’s companies must take some uncomfortable steps. One of the most important is to recognize that their primary customer, the Pentagon, is a terrible role model when it comes to efficiency and accountability – the very qualities that will be needed most during the next decade. The industry needs to be its own best role model.

Perhaps the toughest measure will be to back off from the costly lobbying and political influence in Washington that’s now a hallmark of the industry. This has become a liability beyond the Beltway, making the industry’s companies look like they can’t compete on the merits of their work. Another crucial step is rebalancing shareholder interests against those of government customers. That will upset some big investors, but this is an era where utility-like performance in the aerospace sector is going to be increasingly attractive. After all, taxpayers increasingly eye each dollar of contractor corporate profit, wondering how much of that money was once theirs. This is an era of zero-sum game political and economic outcomes in Washington. The defense industry is now no different.

The country needs a strong defense industry, but it is time to redefine where that strength comes from. It should be defined by stronger partnerships with the Defense Department, less Beltway acrimony and reliable and consistent contract performance. What’s needed most isn’t easily measured: a willingness to embrace the change at hand. If the industry does not, the hangover from years of wasted taxpayer dollars and excessive political influence will soon undo the industry’s fortunes — if draconian budget cuts don’t do it first.

August Cole is a fellow at the American Security Project, where he focuses on defense industry issues. The former Wall Street Journal defense reporter is based in the Boston area.

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