Cuts Force Defense Sector to Adapt

The resounding success of U.S. weapons systems in the Gulf War is a towering tribute to the U.S. defense industry. However, rather than celebrating their achievements and toasting a bright future, defense executives are sounding dire warnings about the health of their sector.

The warnings contain many elements of truth. The defense budget has fallen steadily since its peak in 1985, and the procurement account has been cut the deepest. As a consequence, defense industry employment has declined more than 10% since 1988 and is expected to drop another 10% in the next two years.

Some firms have been hit especially hard and are on their second or third round of layoffs. Stock prices are low, and heavy debts are common. Many of these problems were exacerbated by questionable Pentagon policies in the 1980s, such as fixed-price R&D; contracts and slower payment schedules.

But many of these procedures have since been abandoned or modified. And the fact is that the industry’s current predicament can really be traced to a fundamental change in the Pentagon’s buying patterns that dates back several decades. As the sophistication--and cost--of weapons systems increased, the military commissioned fewer and fewer new designs, purchased fewer units of each new model and began extending the service life of weapons in the field, often by buying new on-board electronics equipment to improve performance.

Despite its own gloomy forecasts, the defense industry--especially the aerospace sector--has had an impressive record of adaptation to this long-run trend. Some companies within the industry have merged, others have been absorbed by firms from other industries, and still others have shifted successfully to major subcontractor roles. Airframe manufacturers have added electronics capability and developed significant modification and refurbishment facilities. Some firms have become adept at marketing their products overseas. Others have adapted by developing or expanding proficiency in designing new types of defense systems, such as satellites and rocket boosters. Additional firms, particularly those with roots in electronics, have emerged as defense powerhouses.

The track record of attempted cross-overs to the commercial world has not been good. And although theories abound, the real explanations are elusive. Defense firms are said to have poor marketing and distribution skills and to lack a tradition of dealing with quality-price trade-offs. They typically have large overhead cost structures stemming from government and military supervision and the need to maintain surge capability.

Nevertheless, the future will see even more attempted cross-overs. For example, a firm that supplies advanced voice-recognition equipment to the military is attempting to apply the technology to automated teller machines and home security systems. Another that makes rocket propellant is shifting to automobile air bags. Radar-absorbent coatings for sports cars and interstate truckers are probably around the corner.

There is no escaping the fact that the paucity of new programs and the decline in procurement spending will require further adaptation and streamlining. In addition to the work force reductions that have taken place, we could well see one or two traditional prime contractors leave that tier of the industry--perhaps as a result of absorption by another firm.

This consolidation is occurring frequently in Europe as well, however, and people who remember onetime prime contractors such as Vultee, Curtiss, Temco, Stearman, North American, Taylor, Ryan and Stinson know that it has happened often in our own history.

This future environment will continue to test the adaptive capabilities of the industry and will require weapons buyers to adapt as well. The Pentagon will have to make it easier for non-defense firms to do business with it and will have to assure that surviving design teams have adequate opportunities for innovative research and prototyping.