For Defense Industry, Diversity Is Best Offense
A new era has begun in the aerospace and defense industry as defense contractors confront a declining defense budget. Combined defense spending for aircraft, space, ships and vehicles dropped to $61.9 billion this year from $84.7 billion in 1985 (in 1990 dollars). Spending for 1994 is projected at $50 billion to $55 billion for the same categories. Although expenditures for space flights and exploration are expected to increase, those for aircraft, ships and vehicles are sure to decline.
The trend among defense contractors is to respond by downsizing, which is necessary and addresses the cost side of the equation--but does not resolve the revenue side.
How, then, will contractors grapple with the need to expand the business base through diversification and leverage the technological expertise that is critical to their success? One possible approach, “painless diversification,” was coined by an industry analyst to describe the repackaging of defense-related products for applications within somewhat related, new outlets.
Four principal avenues come to mind: drug interdiction, commercial aircraft, NASA and foreign sales.
Drug interdiction is one of the fastest ways to diversify. The required equipment involves few product modifications, and companies such as Lockheed and Westinghouse have been able to move quickly and capitalize on the opportunity. However, it is not a cure-all. Although the market continues to grow, it is limited to about $1 billion a year in spending.
Commercial aircraft is big and booming. It appears that most of the large aerospace contractors are attempting to acquire portions of the commercial business from the two major domestic players, Boeing and McDonnell Douglas. But as McDonnell Douglas’ recent performance has shown, bulging commercial backlogs don’t necessarily translate into profit.
NASA is expected to be a growth market. In the three years or so, the National Aeronautics and Space Administration budget has shown significant increases. Fairly well-entrenched contractors such as Rockwell are taking advantage of the situation.
Foreign sales are the fourth relatively painless avenue. As the tension in Eastern Europe subsides, access to certain foreign markets may provide new opportunities for growth. The Mideast crisis is evidence that this situation is constantly evolving.
After painless diversification, what else is there? The opposite of painless is painful, an accurate description of the defense industry’s condition as it has attempted to move into commercial ventures. The reason: The military’s policy to pay for state-of-the-art technology is not applicable to the commercial market.
Armed services buyers tell defense contractors precisely what is needed, exactly how it is to be produced and how each step is to be documented. As an industry analyst once said: “The airplane flies when the weight of paperwork exceeds the weight of the airplane.” In the private sector, bureaucracy simply increases overhead and inhibits competitiveness.
In the military, one person generally controls the buys of a particular product. Not so in the commercial sector. In many cases, even identifying the ultimate buyer in the commercial sector is difficult. Trying to understand the criteria for the purchase of that buyer without extensive market research can be even tougher.
Despite the cautions, the search for commercial markets can be quite rewarding, as some contractors have discovered. Companies such as Raytheon have successfully diversified outside their core business for years.
The issue of broadening the business base by exploiting commercial opportunities will not go away. The question is not whether to adapt to change, but how.
