Northrop--a Company in Turmoil

As a financial and legal crisis looms outside, 4,000 Northrop workers in a windowless factory in Hawthorne are feverishly toiling to correct production problems on the MX missile guidance system.

The aerospace contractor has remained behind schedule on the program for five years and is still four months behind in its deliveries. In November, it made no new deliveries of its product.

Management considers that only a lull before a substantial improvement in delivery rates, but investors are worried. The price of Northrop stock has plummeted by 45% in recent months, in part the result of problems in the missile program. Financial analysts say the decline, which leaves Northrop with a market value of only $1.2 billion, has become a signal of vulnerability on Wall Street.

Meanwhile, a federal grand jury in Los Angeles is reportedly investigating allegations of criminal fraud in the missile program; the federal government has already charged Northrop with civil fraud.

Inside the Hawthorne plant, the financial and legal perils seem almost abstract, save for little red stickers that appear here and there on items, reminding employees in fine print, “Litigation materials, do not remove.”

Northrop Group Vice President David N. Ferguson, who is leading the recovery effort at the firm’s electronics division, said in a recent interview that the program is showing strong progress. Air Force officials readily agree.

“We will be back on schedule in the early part of next year,” Ferguson predicted. “The number one thing is to ship quality products and, by God, we have done that.”

But after more than a year of being the focus of unwanted attention for problems with its MX missile work, the damage to Northrop and the strain on the people involved are showing.

Moreover, the cumulative effect of Northrop’s MX problems, which have roots that extend back many years, may put at risk the company’s effort to move into the front ranks of the aerospace industry.

Although it is a well-known firm, Northrop ranked only as the nation’s 31st-largest defense contractor in 1986. It had been counting on explosive growth in the next few years as production begins on some big-ticket programs, such as the Stealth bomber and the Advanced Tactical Fighter, but some analysts have started to raise troubling doubts about the company’s capability of handling that growth.

‘Scary’ Stock Price

“There have been so many disappointments at the company,” aerospace analyst Joseph Campbell of the Paine Webber investment firm observed. “It has a base of disappointed shareholders and a low, low stock price.

“I am reviewing carefully the Northrop bylaws and certificate of incorporation to determine how vulnerable they could be to a hostile takeover. I want to at least be prepared if anything happens that would make Northrop precarious. There is not a lot of room in the stock price.”

Northrop stock closed at $25.375 Friday on the New York Stock Exchange, down 25 cents.

While the company is in no financial trouble, its profits are suffering due to the MX problems. Northrop was forced to take a writeoff against profits on the MX program in the most recent quarter.

David J. Smith, an analyst at Alex. Brown & Sons, terms the present low price of the company’s shares “pretty scary,” adding, “It is a dangerous position for the company if it wants to remain autonomous.”

Northrop Senior Vice President Les Daly said the company has had “standard defenses” against a hostile takeover for several years. He added, “Many analysts recommend the stock as a buy or a hold. We think the fundamentals of the company are sound. And we think it should be valued higher, as they do.”

Analysts also are not entirely reassured by the Air Force’s backing of Northrop. “The Air Force has been quite supportive, but it suits their purposes to say those things,” Campbell observed.

In fact, the Air Force is causing Northrop a good deal of financial stress by withholding $130 million in contract payments, more than 10% of the company’s net worth, because of the late deliveries of guidance devices. At current interest rates, the withholding of the payments costs Northrop almost $1 million a month to finance.

What cannot be measured yet is the potential for Northrop’s performance on the MX program to damage its chances to win future contracts. Under a new policy that is being formulated, the Air Force will weigh such problems against any division of the same company in future contract competitions.

“Any problem Northrop has had would to some degree affect any of the programs they will be bidding on in the future,” said Lawrence A. Skantze, the recently retired general who commanded Air Force procurement. “My visceral feeling is that Northrop still has a lot of work to do to straighten out their act.”

How the company got into this position is a story that has its roots in a long and arduous effort by talented Northrop engineers dating back to the 1950s to expand the firm into a major producer of precision guidance equipment.

Extraordinary Measures

But it is also a story of an embedded management at the firm’s electronics divisions that was unwilling to face up to its shortcomings for years on end as the company grew. It declined to take on the humanly difficult task of breaking up what had seemed to be almost a brotherhood.

What followed, according to some congressional critics, was a record of mismanagement and malaise that was tolerated for years. The crisis burst upon the company about a year ago, compelling it to take extraordinary measures, according to more than two dozen interviews with former military officials, industry experts and Northrop executives.

The Northrop case seems to show that defense contractors generally cannot painlessly grow into huge specialized manufacturing organizations in only a few years. Northrop’s electronics division attempted to go from being an organization of 600 employees mostly conducting research to a large manufacturing operation with 5,000 employees.

The problems the company has encountered also call into serious question Pentagon policies to foster competition to make very complex products that single companies have traditionally manufactured. Defense contractors are often called on to build up production capabilities for some of the highest-technology devices in the world, all within a few years and without any margin for error.

The MX guidance device, known as an inertial measurement unit or IMU, is among the most complex devices in the military world, containing 19,401 parts packaged in a device about the size of a basketball. An IMU could be compared to a compass and speedometer, telling a computer aboard the MX how to steer the missile to its target.

Rockwell Was Leader

When Northrop won a contract in May, 1975, to build the MX guidance device, the award represented a remarkable achievement in the world of missile guidance. In winning the MX program, Northrop unseated far-larger competitors with greater experience and stronger reputations. Northrop prevailed over competing bids by Rockwell International and Honeywell in 1975.

Rockwell International’s Autonetics unit in Anaheim had built 2,258 inertial measurement units and related guidance computers for the Air Force in the Minuteman I, II and III missile programs between 1961 and 1975 at a cost of $7 billion (adjusted to 1987 dollars), according to Air Force records.

Rockwell had the reputation of being the premier military guidance house in the nation. In addition to the missile guidance, Rockwell produced the very accurate systems that went aboard the Navy’s nuclear submarines.

What motivated the Air Force to change its source for nuclear missile guidance systems after what had been a highly successful history in the Minuteman III program at with Rockwell?

John Hepfer, now retired in Florida, was the Air Force general directly responsible for selecting Northrop over Rockwell in 1975. Hepfer said in a recent interview that the Air Force specifically wanted to knock Rockwell out of IMU production so that it would not have the job of both building the IMU and the guidance computer for the MX. Rockwell ultimately did win the job of building the computer and integrating the different parts of the MX guidance system.

“I was the guidance project officer on the Minuteman II and the Minuteman III,” Hepfer recalled. “When we got to the MX, we thought we would split the system up. And we did that by giving the integration job to Rockwell and the IMU to Northrop.

Problems Started in ’82

“Northrop had this gentleman by the name of Dave Ferguson, who had worked with the Draper Laboratory and had done good work. He had also worked with a division up in Massachusetts that built gyroscopes. We had confidence that he was aware of the technical difficulties.”

What Hepfer could not foresee was that Ferguson would leave the program by 1982 when he was promoted to group vice president. That year also marked the beginning of the problems cited in audits conducted by government inspection teams.

In June, 1982, the Air Force conducted a quality review of the MX program, found a number of things out of compliance with its standards and concluded that they were due to “an unorganized transition from a research and development environment to a production mode of operation.”

By 1985, the Air Force’s reviews had grown notably more acerbic. “Significant performance deficiencies were identified in your division which require management attention,” the Air Force wrote to a Northrop official. The review found such problems as a fragmented management organization at the company’s electronics division, poor workmanship in products, outdated engineering procedures and said up to 45% of IMU production required rework.

Conditions at the plant failed to improve. Earlier this year, an Air Force review gave the company only a “marginal” rating in such areas as product integrity, quality assurance and engineering. A second review scheduled for this fall was canceled.

It is difficult for investigators and even company officials to understand why Northrop did not react more quickly to these audits and other indications of problems.

‘Tough Times’

In a congressional hearing last October, Northrop Vice Chairman Frank Lynch said: “You ask me what went wrong. Well, frankly, I think it is a mind set or a mental attitude in management. . . . And that has been the biggest difficulty and that is the thing that has caused us to finally, after much effort, make the necessary changes in the top management of the division to get that mind set changed.”

The managers in the electronics division worked and socialized closely with one another and had gone through many lean years before winning the MX program. They had stuck with Northrop and made things work through personal relationships more than through the management system, according to a former manager there.

“The division was going through some tough times,” he recalled. “Management didn’t want to let engineering people go. They gathered everybody in a room and said, ‘We are going through some tough times, but we want you to stay.’ Those engineers who stayed became the branch, unit and section managers in the MX program.

“When they needed something done, they picked up the phone and said, ‘Hey, George, I need a resistor over in the avionics lab.’ And he got the resistor. It was a onesy, twosy system.”

But the system that had worked for the managers when they had a “onesy, twosy” operation, a reference to hand-making one or two products at a time, apparently broke down when it was used to try to control a 5,000-employee, high-technology manufacturing plant.

“When you transition from development into production, it requires a different mind set and discipline in your organization’s structure,” said Maj. Gen. Edward P. Barry Jr., commander of the Air Force’s ballistic missile office in San Bernardino. “You want to build an assembly line process and discipline so that every step is done exactly the same every time.

“Northrop was an organization that had not had a production line for some time. They were a development house that was not prepared, did not have the proper management team or the proper management discipline to transition into production.”

Emphasis on the Personal

An expert in the missile guidance business, who asked to speak anonymously, said he believes that the Air Force made a fundamental mistake in awarding the MX contract to Northrop, not because the company was incompetent but because no organization was likely to develop the expertise to produce such a complex item as a nuclear missile guidance system in only a few years.

“You just can’t build up an organization to do that kind of work overnight,” he said. “There is a (corporate) culture aspect that you don’t get quickly. There are certain things you just can’t write down in procedures. You have to have management that has learned the hard way and knows how to do it.”

Illustrative of the management’s emphasis on personal relationships was a management training system in which each supervisor was assigned a “buddy” to help resolve problems within the management fraternity.

Supervisors were given something called a “GOWI cube,” which stood for “Get on with it.” They also received a blue chip to carry in their pockets, which they could throw down on the table in meetings in a way analogous to throwing down the gauntlet.

The idea was: “Let’s prioritize what we have to do and get on with it,” explained Ferguson, a big promoter of the system. “It worked, to a degree. It was certainly better than if we hadn’t done it at all.”

But the training also symbolized the fraternity of management at the electronics division. In the minds of some, it became another aspect of management protecting management from the Air Force or from any other critic. It became an impediment to building a management system rather than relying on personal relationships.

“The system didn’t let them get from one step to the next,” a former manager said. “They could only work on what was in front of them. They never resolved a problem; they would work around them. If there was a defect, they would fix the defect, not what caused the defect.”

Fictitious Businesses

Indeed, the alleged tendency to fix the defect and not what caused it led Northrop into one of the most embarrassing blunders of its entire MX program. In 1985, the electronics division’s ordering system was hopelessly bogged down and required weeks or months to fill urgently needed orders for parts.

Rather than fix the system, division management decided to set up several fictitious businesses--the exact number is a subject of dispute--funded by the company with up to $4 million in petty cash.

The fictitious businesses, operating under names such as Liaison Engineering Services, purchased parts through a mail drop across the street from the plant, sometimes from non-approved suppliers. The parts would be delivered to the mail drop by United Parcel Service and then walked into the plant, circumventing the official receiving inspection process.

In congressional hearings, Northrop officials have acknowledged that they are not certain they can trace those parts and said at least some of them ended up in the Stealth bomber program. Lynch, the Northrop vice chairman, acknowledged that the system was “out of control.”

The fictitious businesses were closed down earlier this year after their existence was disclosed in a Times story. Extensive audits have been conducted by the government, the results of which are now reportedly before a federal grand jury weighing possible criminal indictments.

In addition, the grand jury has seen audits that allege improper time-card charging and evidence of falsification of test data on the IMU. In congressional hearings, Northrop has acknowledged time-card discrepancies and falsification of some tests.

Daly, the Northrop spokesman, said, “We take any investigation seriously. We will have to wait for the results to know the outcome.” He added that the potential damages in the federal civil case could amount to $1 million.

Top Management Distracted

Earlier this year, Ferguson cleared out a substantial portion of electronics division management when he replaced 30 managers and supervisors, including the division general manager, Gene Hauser.

“We had to put in different management,” Ferguson said. “That was not easy. That hurt.”

Asked why it was not done years sooner by managers under his command, Ferguson responded: “I really don’t know. I don’t know. I know what I had to do and I did it. Why it wasn’t done before, I don’t know.”

The problems were worsened by the distraction of top management. While the electronics division was trying to control explosive growth, the rest of Northrop was embarking on other ambitious projects, such as the Stealth bomber, the Advanced Tactical Fighter and a secret cruise missile. The biggest diversion was the ill-fated F-20 jet fighter program, which became an obsession with top management.

The explosive growth throughout the company was stretching management thin, and the relatively smaller MX program was pretty much left to run itself, according to insiders.

“My belief is that it was (Northrop Chairman Thomas V.) Jones’ problem,” said one person with intimate knowledge of the MX program. “He was never interested in anything but airplanes. Not enough attention was paid to the electronics division, which lacked experience in building up a program like this.”

In an interview earlier this year, retired Northrop executive Ross Miller agreed, saying that Jones “is an airplane man. He keeps very, very close control of the aircraft side of the business, but not nearly as much control over the rest of the company.”

Outside experts who have looked at Northrop have come away clearly disappointed.

Allen R. Stubberud, an electrical engineering professor at UC Irvine and a member of an Air Force Scientific Advisory Board that evaluated the MX guidance system earlier this year, said:

“We would have expected that, on a program this important, the people in charge would have made sure things were done right. The management structure and discipline didn’t get built as quickly as needed.”

Hepfer, the retired general, believes that Northrop used its time poorly. Congressional dickering over the MX delayed it for years and Northrop had “no excuse” for not being prepared for production, he said.

Price Driven Ever Higher

“The problem was that too much time elapsed between the initial development award and the final production contract,” he said. “The deliveries should have been four years after 1975, and instead things didn’t start until 1985. It happens every time. If you don’t have a set time on these systems, you start getting redesigns.”

The redesigns, the tardy deliveries and the management lapses drove the price of the IMUs through the ceiling.

“When I see the cost figures now, I am quite surprised,” Hepfer said. “We were originally talking about $1 million to $2 million maximum per IMU. I don’t understand why, if people want to complain about something, they don’t complain about the cost.”

The latest contract for IMUs was issued March 30, 1987, for a unit price of roughly $6 million, including certain gyroscopes and accelerometer instruments that are supplied to Northrop by the government. Northrop has received more than $1.6 billion for the program so far.

Although Northrop had never built a ballistic missile guidance system before the one for the MX, it did not walk into the program as a novice. The company entered the guidance business in 1950 and had experience that was critical to winning the MX contract.

The earliest operational guidance device produced by Northrop was a system for the Snark cruise missile in the 1950s, a program that had a big potential but was canceled when ballistic missile technology superseded it.

(In one of the curious footnotes to Northrop’s guidance system history, a Snark missile was found in the Amazon jungle by Brazilian authorities in 1983, some 26 years after it had gone 2,000 miles off course and crashed during an Air Force test.)

In the mid-1960s, Northrop built the navigation system for the SR-71 reconnaissance aircraft under the name of Northrop Astro-Inertial System, a largely classified program that is continuing today. The company performed well on the SR-71, according to knowledgeable sources, and ultimately was rewarded with a contract for a similar guidance system on the TR-1 reconnaissance plane.

‘Dismal’ Failure Rate

But not all of the company’s programs went as well as the SR-71. Northrop built the C-5A cargo jet’s navigation system, called the inertial Doppler navigation equipment (IDNE).

The IDNE, the technological forerunner of the MX in many key features, was installed in the C-5A between 1969 and 1973. By 1975, the Air Force was compelled to replace it because of its lack of reliability and high maintenance cost, according to half a dozen retired C-5A managers.

The system failed, on average, after every 20 hours of operation, a dismal failure rate, according to C-5A program officials who asked to remain anonymous. The cumbersome system had 11 boxes of equipment weighing several hundred pounds and required a huge aluminum casting that also weighed several hundred pounds.

Warner Newby, a retired general and the former manager of the C-5A program, recalled that the system “was difficult to maintain and it was very costly to maintain. To say it was a catastrophic program or a horrible program, I can’t say that. But I can’t say it wasn’t the best-run program I ever saw either.”

Northrop eventually delivered 200 of the systems, which were all scrapped by the late 1970s. “It was financially prohibitive to continue,” one Air Force Logistics Command expert said. It was replaced by a Delco Electronics system, which has a reliability rate about 500 times better.

As bad as the C-5A system was, it gave Northrop valuable experience in the technology that would eventually go into the MX guidance system. The key feature was the “floating ball.”

Floating Ball Concept

The MX system is an incredibly complex device in which instruments are packed into a beryllium sphere that floats inside another sphere in fluid fluorocarbon with the same specific gravity as the 126-pound ball.

The ball is not attached to the outer shell and its movements are not hindered by friction. It is something like an ice cube that remains stationary in a glass of water when the glass is quickly spun around. By constantly monitoring the position of the ball as the missile soars through space, the guidance computer can keep track of its position and give commands to its engines to steer it toward the target.

The concept of the floating ball originated in the 1950s with Charles Stark Draper, a scientist at the Massachusetts Institute of Technology who became the leader in inertial guidance systems. Draper founded the laboratory that bears his name and that continues to design all of the guidance systems for the nation’s nuclear missiles.

Ferguson, the Northrop manager who figured so importantly in the Air Force awarding Northrop the MX guidance system contract, started his career at the Draper Lab after graduating from college. Scientist Ken Fertig, a pioneer in floating ball technology, recalled that Ferguson worked on similar floating instruments while he was at Draper.

By the time the MX guidance program was ready for bidding, Northrop could boast experience in building such a floating ball system and the presence of Ferguson, who had spent four years at the Draper Lab working on floating inertial instruments.

And it is Ferguson, who helped Northrop win the MX, who now must extract the company from the national scandal that has enveloped its MX guidance program.

Despite the abrupt halt in deliveries last month, Ferguson said Northrop will deliver up to eight IMUs to the Air Force this month. So far, it has delivered one. Ferguson said he plans to be back on schedule by next March or April, two months later than he had projected in congressional hearings last June.

Lack of Discipline

The continued delays stem in part from negative findings by an Air Force-appointed scientific advisory board assigned to investigate allegations of technical flaws in the IMU.

While the board refuted many allegations of flaws and praised the company for its efforts to correct problems, it found that Northrop had been conducting “test station shopping,” in which electronic parts--called hybrid circuits--that failed on one test machine would be retested on others until they passed. It was taken as an example of the lack of discipline that has typified Northrop’s MX work for the last five years.

“These conditions understandably led to concern about the possibility of passing defective parts,” the report found. It went on to conclude, “Although the Northrop engineers participating in this review appeared competent, the level of engineering discipline in the hybrid engineering and production area at NED (Northrop Electronics Division) was not adequate.”

As a result of those findings, Northrop was forced to suspend all testing of important electronic parts. The company is now recertifying its test stations, operating shifts around the clock to restart testing of circuits. The shutdown has created a bottleneck on the entire program.

The late deliveries of IMUs have left the Air Force seriously short of guidance systems. At F. E. Warren Air Force Base in Wyoming, the Air Force has placed 28 MX missiles into silos. But only 19 have guidance systems. The other nine, holding 90 nuclear warheads, are what one congressman called “unguided missiles.”

The problem with test station shopping renewed concern in Congress over the reliability of the IMU and, thus, the accuracy of the missile. Northrop is being sued under the federal False Claims Act by at least five former engineers and other employees who have alleged during the last year that the IMU contains defective parts.

Such issues as the accuracy and reliability of the MX guidance system may never be fully resolved in the minds of critics. But over the next several months these and other missile guidance issues will be dealt with in a number of important legal actions, congressional hearings and military decisions that will determine how seriously the MX scandal will damage Northrop.

Return to Rockwell

The Air Force plans to buy billions of dollars worth of additional nuclear missile guidance systems over the next decade. In addition to fielding 50 more MX missiles, it plans to deploy 500 Midgetman missiles and to retrofit Minuteman missiles with new guidance systems, depending on congressional funding.

Northrop was virtually assured of most of this new business at one time, but its poor performance has caused the Air Force to go back to its old supplier, Rockwell International, to seek a second production source for IMUs. Now, Rockwell could possibly knock out Northrop out of the MX or take a significant share of the program. If it does, Northrop would suffer financial damage, according to Campbell, the aerospace analyst at Paine Webber. The Air Force is expected to announce contracts for fiscal 1988 soon.

The federal grand jury in Los Angeles is likely to act within the next several months, if it acts at all, according to sources in Washington. A number of key legal decisions also are expected in the civil suits pressed by the former Northrop engineers.

Aerospace analysts say Northrop’s low stock price makes the company such a good buy that a larger aerospace firm could easily swallow it up. In an era when defense markets are shrinking, Northrop has a backlog of $80 billion worth of government programs that could be bought for a mere $1.2 billion on the stock market.

Finally, Northrop is expected to be called again before the House Armed Services Committee, the fifth time that the company’s problems have been aired before Congress. Former Northrop internal auditor Terry Shielke is expected to testify, citing previous allegations that the company ignored the internal audits that he and others wrote, warning of serious operational problems that are now the subject of law suits.

One hopeful note for the company is that Armed Services Committee Chairman Les Aspin (D-Wis.) said in a recent interview that he is “feeling better” about the progress Northrop has made in recent months, though he is “not yet ready to declare the problem solved.”