An industry reinvents itself
America's defence companies are turning dualpurpose
Jul 18th 2002 | From the print edition
THE 1990s were an eventful time for America's defence industry. With the cold war at an
end, the number of big American contractors came down from 15 to five (Lockheed Martin,
Boeing, Raytheon, Northrop Grumman and General Dynamics) within a decade. That was a
dramatic consolidation, but as budgets shrank, it was not unexpected.
The other, more surprising development was that the defence industry turned into a kind of
ghetto, despite considerable efforts to make doing business with the Pentagon easier and less
bureaucratic. Barriers to entry were removed in the hope of turning defence into something
more like a normal business, but instead of an influx of new blood, a mass exodus followed.
IBM, General Motors, Ford, Chrysler, General Electric (except engines) and Texas
Instruments all sold or closed their defence companies. As Merrill Lynch's Byron Callan put
it, “The defence industry became detached from the rest of the economy.”
The reasons are not hard to find: the federal government is a demanding customer; defence
profit margins are often tighter than in the private sector; and strict rules on procurement have
in the past caused some defence companies to lose money on fixed-price development
contracts. Many companies decided the defence game was not worth the candle.
With just a handful of big American companies and a trio of European ones, each of which
dominates its home market and competes in places such as the Middle East and Asia, proper
globalisation (in the sense of a number of transnational companies competing worldwide)
seems out of the question. But that does not mean that globalisation will have no part in the
defence industry at all. Because electronics and computing software play an increasing role in
defence systems, the core defence companies have to ensure they have access to a wider pool
of technology.
What remains to be seen over the next decade is whether the ghetto model will survive, or
whether defence will eventually move closer to commercial business. The more it does, the
more global it could get at the level of the second- or third-tier suppliers, who make
components or equipment for the prime contractors. Lawrence Freedman of King's College,
London, who has written on the implications of RMA, sees the ghetto walls coming down as
the civil sector develops more technical dynamism. The trend towards increased use of IT and
systems integration in warfare should accelerate this trend:
The old defence sector was based on dedicated programmes with only a limited civilian spinoff. This now exists side by side with a more dynamic industry, which can pass through two
generations of technology while the official defence-procurement machinery is still working
its way laboriously through its bureaucratic mechanisms. Although the electronics and
computing sectors originally took off on the back of military investment, they have now
developed their civilian markets to such an extent that even the military is a minor player.
Underlying this is a worry that the defence industry, having consolidated so much with a loss
of competition on both sides of the Atlantic, might begin to lag in innovation, and might not
be up to supporting the transformation of the armed forces it serves. Even though America's
military might and technology is streets ahead of anyone else's, the country cannot afford to
be complacent. A recent study by RAND's National Defence Research Institute looked at
military revolutions throughout history and found that, by and large, new ways of waging war
were usually developed by a country or a group that was not dominant at the time.
Indeed, it could be argued that the most revolutionary military development to happen in
recent times was the hijacking last September of four kerosene-laden jetliners to use as guided
missiles in New York and Washington, DC. Modern electronic technology in the form of emails and the Internet played a big part in the planning of this venture.
By contrast, the traditional defence industry grinds away slowly, with mighty systems
immutably determined by defence-department contracts. To take one example, the Joint Strike
Fighter could well go into service with electronics systems that, although state-of-the-art in
2006, will be getting long in the tooth in 2012, unless something is done to update them.
Jerry Daniels at Boeing, which lost the JSF contract, points to the dangers that engineering
teams will scatter and expertise will be lost when Lockheed Martin eventually becomes the
only company making fighters. “Twenty years ago we had 50-odd defence contractors; today
we have a handful. Then there were many rapid opportunities to bid, there was always a new
programme coming along.” By contrast, he explains, the trend now is towards fighters that
combine many functions and can be ordered in bulk. His (perhaps not entirely disinterested)
suggestion is that it might be better to go for upgrades every five years and put the work out to
competitive bids. To some extent, this is already being done. Boeing has recently won a
contract to rethink and upgrade the avionics on the C130 transport plane manufactured by its
arch-rival, Lockheed Martin.
One reason why the defence department encouraged the mergers of the early and mid-1990s
(see chart 6) was that it was worried about the financial health of the industry as budgets
shrank. But by 1997, when a weak Northrop Grumman thought its best hope was to become
part of the much larger Lockheed Martin, the government had had enough and blocked the
merger on competition grounds. According to Pierre Chao of CSFB, an investment bank, the
defence department then got into a panic about the collapse of defence shares as consolidation
ended.
One concern in the Pentagon was that the defence contractors might have increasing trouble
attracting capital and talent for which other high-tech firms are also competing. Mr Callan
points out that a high-tech company such as Intel has a market capitalisation of over $100
billion, whereas the top three defence groups together add up to only half that. The concern is
that top engineers will turn their back on defence companies and work for high-tech firms
where they can make more money through stock options.
The irony is that Silicon Valley itself evolved from defence contracts, and that civilian jet
aircraft, from the Boeing 707 to the jumbo jet, owed a great deal to military programmes. The
same was true of computers. The defence industry pioneered the management of complex
systems that have now become routine in civilian applications, such as air-traffic control or
telecommunications. It is no accident that the world's leading (non-American) company in airtraffic control is Thales, a Paris-based defence-electronics company that specialises in dualuse technologies which can be applied to the commercial market.
According to Mr Krepinevich at the Centre for Strategy and Budgetary Assessment, the
American government will have to improve its policy towards the defence industrial base if
America is not to lose its technical lead. He thinks too much of what goes under the name of
R&D is really devoted to the engineering and manufacturing development of incoming
products. That may provide a nice cash cushion for companies, but it means they do little
innovative research of the sort needed to develop entirely new products. He would like the
Defence Department to take a hard look at future requirements to see which areas of
technology could best meet them. Money for this could be found by chopping expenditure on
mature technologies where extra R&D produces marginal gains.
Two-way traffic
Commercial input into the defence industry is not a one-way process. Leading defence
companies such as Boeing, Lockheed Martin and Northrop Grumman have been changing
their profile too, turning themselves into something more than makers of fighters, missiles and
rockets. It is no longer simply technologies that spread from military to civil applications, as
they did in the 1950s, when only the defence sector had big money to spend on R&D. Instead,
the defence companies themselves are moving into the commercial field, using the expertise
they have developed in the military sector.
An obvious example is Lockheed Martin, a conglomerate that three years ago was losing
money and staggering under a debt burden of $12 billion. Integrating the various businesses
from Lockheed's takeovers of companies such as Martin Marietta was proving difficult.
Nothing was going right. The company's space rockets kept blowing up on the launch pad, the
update of its C130J transport plane was hitting problem after problem, it lost a key satellite
surveillance contract to Boeing, and losses kept piling up. Now it is climbing back into profit
and has slashed more than $4 billion from its debt by selling parts of its business to BAE
Systems, the British contractor which is becoming more American by the day (of which more
in this article). Lockheed's shares look good largely because it beat Boeing for the JSF (F35)
contract, which will ensure an inflow of billions of dollars even if the order is trimmed from
3,000 to 2,000. Its main partners in this deal are Northrop Grumman and BAE.
But there is more to Lockheed than big defence deals. About 30% of its sales are now in the
civil sector (although admittedly civil work for the government far outweighs its private
work). Lockheed buys in components and software from the electronics industry, but it is
itself a huge IT company, employing some 20,000 systems and software engineers on top of
its 50,000 mainstream scientists and engineers. The same “system of systems” needed for
digital battlefields has commercial applications in organisations such as America's postal
service, the FBI, Medicare and the Social Security system.
Boeing offers an even more striking instance of cross-fertilisation between the commercial
and military sectors. It became big in defence when it bought McDonnell Douglas in 1996.
McDonnell had put itself up for sale after it was excluded from the JSF competition in an
earlier round, leaving Boeing and Lockheed in the final shoot-out. But Boeing had also
acquired North American Rockwell with its space business, and later gained satellite expertise
by buying parts of Hughes's electronics business.
Once Boeing's boss, Phil Condit, and his then number two, Harry Stonecipher (who had been
McDonnell's last boss), had bedded down the mergers, they realised they were sitting on a
collection of assets that could be used to sprout all sorts of businesses aside from jetliners,
rockets and satellites. Using military technology, Boeing is developing so many new
businesses in the commercial market that the share of its civil jet sales will soon fall from
60% of the group's turnover to around half. For instance, the same technology that guides
missiles can be repackaged to provide satellite-based air-traffic management systems. And a
military radar antenna is the key piece of kit in a system to bring broadband communications
to passengers in commercial jets.
The mergers have also made it easier for Boeing to ride out the loss of the JSF contract. Its
space and communications division, based in Seal Beach, California, is the lead contractor
working on America's national missile-defence system, as well as the provider of the future
combat system that is part of the integrated battlespace system for the army. Like Lockheed,
Boeing sees itself as an integrator of “systems of systems”. But these established giants face
competition at the electronics-systems end of defence contracts.
Meanwhile, Northrop Grumman is still remaking itself. Its boss, Mr Kresa, says that Northrop
saw the rundown in bomber production coming in the early 1990s and started to shift its
emphasis to technology and systems. By acquiring Grumman, it got into the big JointStars
aerial surveillance plane contract. With its purchase of Logicon, it got into information
warfare. Brushing off the collapse of its planned merger with Lockheed Martin, Mr Kresa
continued to build up the group. With Westinghouse, it bought electronics and radar; with
Ryan, Global Hawk. Since then it has bought Litton Industries and Newport News to become
the world's largest naval shipbuilder. It has successfully bid for TRW, an aerospace and carparts group, against several competitors, including BAE. If the deal is approved, Northrop
will sell off the cars-parts division and hold on to the missile and space business, which brings
satellite know-how with it.
Other defence companies are still trying to clean up their acts. Raytheon, a missiles and radar
group, is plugging on with reducing its huge debts by selling off some businesses, though its
cashflow is still negative and its civil business-jet subsidiary is suffering. General Dynamics,
which is big in ships, was blocked by the defence department in its bid for Newport News,
which allowed Northrop Grumman to sweep up that firm. Northrop has also dealt General
Dynamics a blow by winning a $2.9 billion contract to design the navy's new DDX destroyer,
which is expected to be the basic platform for a range of ships that might produce contracts
worth up to $60 billion.
The one newcomer that has dared venture into the defence ghetto is known as L-3
Communications, a company founded only five years ago by Frank Lanza, the former
president of Loral, a defence outfit that merged into Lockheed Martin in 1996. Having
supervised the integration, Mr Lanza persuaded Lockheed to sell him ten electronics
companies. L-3 puts together guidance and intelligence devices. It enjoys revenues of $2.3
billion and is forecast to grow at 30% a year. It has also moved smartly into the newly
burgeoning field of homeland security, with baggage screening devices and systems. Such
civil business accounts for a quarter of its sales.
Despite some travails, Wall Street's glowing verdict on their shares gives a good indication of
American defence companies' financial prospects. European companies, by contrast, face flat
budgets and, except for the Anglo-American BAE, can hope to get little more than crumbs
from the world's biggest defence market.
From the print edition: Special report
The defence industry
War on new fronts
Different tactics are needed to profit from a
slowdown in defence spending
Nov 4th 2010 | From the print edition
AS DEFENCE budgets come under fire, defence companies are deploying new tactics to
protect their profits. Britain is cutting military spending by 8% over four years and Germany
has similar ideas. And after growing by more than 10% in recent years, America's annual
budget of some $700 billion—nearly half the world's total—is unlikely to rise after 2011. It
might even fall. Robert Gates, America's defence secretary, said in May that “the gusher has
been turned off,” and recently announced that $100 billion would be cut over five years from
“overheads” at his department.
Defence companies have to cope not only with reduced budgets but with a shift in policy and
technology, which will also mean fewer orders for expensive pieces of kit. Last year Mr Gates
cut some badly performing big projects. And America may yet change from “cost plus”
contracts, in which the government shares the risk of financing big projects, to more fixedprice awards, like the deal for a new airborne refuelling tanker, shortly to be awarded to either
Boeing or Europe's EADS.
Some big programmes are still going strong. The F-35 multi-role fighter jet is worth over
$380 billion in America and should contribute around 15% of the profits of Lockheed Martin,
its main contractor. But such projects are exceptions. So defence companies will be looking
harder abroad for military budgets that are still growing. Many of those budgets will belong to
countries with deep pockets and neighbours to fear. A restive Iran and plenty of petrodollars
should ensure that the Gulf states continue to buy lots of weapons. The Obama administration
has been seeking congressional authority for Boeing to sell Saudi Arabia $60 billion-worth of
jets, including F-15 fighters. Boeing, which makes the F-15, wants to increase its overall
export sales from 16% of its defence business to 25%. The military budgets of India, Japan
and South Korea are tempting, too. Brazil is also keen to bring its armed forces up to date. But
Harry Nourse of HSBC, a bank, points out that as more firms head abroad the competition
will get hotter.
There will be some opportunities in the shifting priorities of defence budgets closer to home,
especially when the supplanting of older weapons systems is being deferred. Britain's decision
to delay replacing its ageing nuclear submarines, for instance, means more cash will go into
keeping them going. BAE Systems, Britain's biggest defence contractor, already earns half its
revenues from support services, such as maintenance and upgrading, and sees them growing
in importance as more defence services are outsourced.
Newer threats to national security also hold out the hope of fresh sources of profit. Defence
companies, using technological know-how gathered from work in communications,
surveillance and reconnaissance, are moving rapidly into security services, where budgets are
rising. Cybersecurity is the area with most promise. David Strauss, an analyst with UBS,
another bank, reckons increased spending on cybersecurity will mean reduced defence
spending in other areas. Nevertheless, firms specialising in security software believe the
business will boom as the rest of the rich world attempts to catch up with Britain and America
in cybersecurity. But that race will attract plenty of competition from civilian software giants
with more developed distribution networks and vast sales forces. The defence companies are
banking on their high levels of security clearance and experience of dealing with defence
departments to keep ahead.
Companies will buy or sell assets as they adjust to the new requirements. Northrop Grumman
is considering a sale of its low-margin shipbuilding unit. And Boeing and EADS are looking
to buy smaller firms in areas like cybersecurity and robotics.
More collaborative programmes are likely too. Before a summit in London this week between
David Cameron, Britain's prime minister, and Nicolas Sarkozy, the French president, BAE
Systems and France's Dassault urged the two leaders to support collaboration on developing a
new generation of combat aircraft and unmanned surveillance drones, which are increasingly
replacing some helicopters and aircraft because they are much cheaper to buy and to operate.
Britain and France are already planning to share aircraft carriers.
Yet the mega-mergers that defined previous defence cuts, like Boeing's takeover in 1997 of
McDonnell Douglas, are unlikely to be seen again. Governments may be looking for a greater
bang for their buck, but none will want to reduce competition by blessing a grand alliance
among the half-a-dozen or so big defence contractors left in the world which are capable of
handling large weapons programmes. The defence chiefs will always have some big-ticket
items on their shopping lists.
From the print edition: Business
Turkey and its army
Erdogan and his generals
The once all-powerful Turkish armed forces are
cowed, if not quite impotent
Feb 2nd 2013 | ANKARA AND ISTANBUL | From the print edition
IMAGINE a country with NATO’s second-largest army that counts Iraq, Iran and Syria as
neighbours and is encircled by the Aegean, the Black Sea and the Mediterranean—but has
nobody to command its navy. Just such a situation looms in Turkey after this week’s
resignation of Admiral Nusret Guner, the number two in the navy who was expected to take
over when its incumbent head steps down in August. There are no other qualified candidates,
not least because more than half of Turkey’s admirals are in jail, along with hundreds of
generals and other officers (both serving and retired), all on charges of plotting to oust
Turkey’s mildly Islamist Justice and Development (AK) government.
Admiral Guner’s resignation came after prosecutors claimed that 75 naval officers being tried
for allegedly running a sex-for-secrets ring had planted a spy camera in his teenaged
daughter’s bedroom. In an emotional speech the admiral said he believed in his colleagues’
innocence.
The series of cases known as Ergenekon has left Turkey’s once omnipotent armed forces
weak and divided. At last count one in five Turkish generals, including Ilker Basbug, a former
chief of the general staff, was behind bars. This ought to be a triumph for Turkish democracy.
But the trials are dogged by claims of spiced-up evidence and other discrepancies.
The families of over 250 defendants given long prison terms in September 2012 in another
alleged coup plot, Sledgehammer, are taking their case to the UN Human Rights Council.
They insist the evidence was doctored. Independent forensic experts back their claims. Jared
Genser, a lawyer based in Washington, DC, who has worked for such luminaries as Vaclav
Havel and Desmond Tutu, says he agreed to act for the Sledgehammer defendants because he
“firmly believes” in their innocence and because the evidence against them “was
demonstrably forged”.
Some point fingers at a powerful Muslim group led by Fethullah Gulen, a moderate Turkish
cleric living in self-imposed exile in Pennsylvania. The generals hounded the Gulenists after
they ejected Turkey’s first Islamist prime minister, Necmettin Erbakan, in 1997. The
Gulenists have made a comeback under AK and are said to have infiltrated the police and
judiciary.
Turkey’s prime minister, Recep Tayyip Erdogan, shares some doubts, even though he has cut
down the generals’ influence during his decade in power. “These operations against the army
are affecting morale. There are 400 serving and retired officers in jail. At this rate we will
have no officers left to appoint to command positions,” he complained in a recent interview.
As clashes with the Kurdish separatist PKK continue despite new peace talks and the conflict
in Syria threatens to spill over the border, Mr Erdogan is right to be worried.
Yet even as the prime minister seeks to distance himself from the Ergenekon case, some claim
that he has struck a cosy alliance with the army. The chief of the general staff, Necdet Ozel,
who owes his rise to the resignation in 2011 of his predecessor in protest at Ergenekon, is
fiercely loyal. Mr Erdogan rushed to his defence in December 2011 after the Turkish air force
had rained bombs on Kurdish civilians who were apparently mistaken for PKK rebels as they
slipped into Turkey from Iraq. Some 34 Kurds, mostly teenagers, died. A parliamentary
commission investigating the affair has run into claims of a cover-up. Not a single head has
rolled.
It may be that the still-popular Mr Erdogan feels that the army is fully under his control. The
National Security Council through which the generals used to bark orders to nominally
civilian governments has been reduced to a symbolic role. After constitutional reforms were
approved in a 2010 referendum, soldiers began to be tried in civilian courts. “Erdogan sees the
army as his boys,” comments Henri Barkey, a professor of international relations at Lehigh
University in Pennsylvania.
Yet for all their recent setbacks the generals still retain considerable sway. The defence
budget remains largely immune to civilian oversight. The chief of the general staff is not
subordinate to the minister of defence. And an internal service law that allows the army to
intervene in politics remains in place.
Indeed, the idea that some officers may have been conspiring to topple the AK government is
not far-fetched. In 2007 the army tried unsuccessfully to stop Abdullah Gul, a former foreign
minister, from becoming Turkey’s president because his wife wears the Islamic headscarf. In
2008 the generals egged on the constitutional court to ban AK on flimsily documented
charges that it was seeking to impose sharia law. In the event the case was dismissed by a
single vote. As for Ergenekon, “even in the absence of tampered evidence, there is sufficient
proof of coup plotting to send scores of generals to jail,” argues Orhan Kemal Cengiz, a
human-rights lawyer who has studied the case.
Turkey’s army has overthrown no fewer than four governments since 1960. The bloodiest
coup came in 1980, when 50 people were executed, 500,000 were arrested and many
hundreds died in jail. Yet millions of Turks, who have long revered the armed forces as
custodians of Ataturk’s secular legacy, cheered the coup. Its leaders are now at last facing
trial; opinions are belatedly shifting amid gruesome revelations of the army’s misdeeds. A
recent poll suggests that, for the first time, the presidency has supplanted the army as the
country’s most popular institution. And a report by the Platform for Soldiers’ Rights, an
advocacy group, detailing abuse of conscripts, has dealt a further blow. Some 934 soldiers are
said to have committed suicide over the past decade, surpassing the number killed while
fighting the PKK. Were the conscripts killed by their superiors? Their parents want to know.
From the print edition: Europe