COLUMN ONE : Defense’s Days of Reckoning : As the military budget shrinks, the aerospace industry struggles to adjust. The region’s economic future may rest on its ability to turn swords into plowshares.
At Dowty Aerospace, a small defense contractor in Arcadia, the business outlook grew so dire last month that its owners did the unthinkable: They gave the operation away in a cash-free deal that will eliminate 50 of the firm’s 130 electronics jobs.
Across town, another unlikely story is being played out. Aura Systems, a high-technology company in El Segundo founded by a group of Hughes Aircraft defense scientists, is hoping to hire 880 workers by 1995 to produce magnetic devices for commercial industry.
Somewhere between these extremes lies the future of California’s economy.
Will the fortunes of the state be characterized by Dowty, with a dwindling defense industry dragging down the economy through much of this decade? Or will the future bring an abundance of firms like Aura Systems, in which the brain trust of the military-industrial complex redirects its energies to the commercial marketplace, creating new industries?
This economic adjustment is a watershed for California. Either the aerospace industry and the people thrown out of defense jobs will redeploy their capabilities or a buttress of the state’s prosperity will be lost.
Except among liberal activists, wholesale conversion of defense industrial capacity to commercial production--the notion that missile plants can produce lawn mowers--holds little promise for stemming the losses. The failures of defense companies’ efforts to diversify are notorious.
Some firms are plowing into new markets nonetheless. Others are groping toward a better balance between defense and commercial business. Many seem to have their heads stuck in the sand.
“There is still a lot of denial out there,” said C. Donald Scales, director of the aerospace practice at the consulting firm Arthur D. Little Inc.
The wreckage from aerospace’s decline already has been substantial. Since 1988, California has lost 71,000 aerospace jobs and stands to lose an additional 95,400 by 1997, assuming that the Pentagon budget is cut only as much as President Bush has planned. Nationally, the toll of his proposed reductions will be at least 530,000 jobs, but if Congress forces deeper cuts, the numbers will jump to 920,000, according to estimates by the U.S. Office of Technology Assessment.
In previous aerospace busts--after the Vietnam and Korean wars, for example--the robust California economy handily bounced back, offsetting defense-related job losses through growth in commercial industry. Today, defense represents a smaller component of the state’s economy--accounting for 7.5% of the state’s economic output in 1990 compared to 14.3% in 1967.
But the current defense downturn is different.
It appears to be long-term, if not permanent. Defense workers trained for the industry’s specialized jobs may not be able to bridge the cycle as they did in the 1970s, for example, when they waited out the storm by driving cabs or selling real estate. This time around, California faces an exodus of companies disenchanted with regulations, taxes, housing costs, crime and education.
Even the potential for new high-technology firms such as Aura Systems arising to absorb displaced defense workers appears more problematic. Competition in the commercial high-tech fields, both nationally and internationally, is tougher than ever. In many respects, defense technology is less relevant to the commercial marketplace--and, in some cases, lags behind commercial technology.
Despite the seemingly bleak prospects, there are those who believe that California’s economic fears are overblown.
The massive layoffs and industry cutbacks of recent months are so painful mainly because they coincide with a national recession, said Stephen Levy, director of the Center for Continuing Study of the California Economy. He expects job growth in California to dwarf the defense losses, just as it did in past aerospace busts.
“The best transition policy,” the Palo Alto economist said, “is to run a booming economy.”
Many institutions tied to defense--including the state’s educational Establishment and a number of nonprofit research centers--are staying the course, confident that aerospace will come back.
At Cal Poly Pomona, the state’s largest source for engineers, the number of students in aerospace has changed little. Local research institutes, such as the Aerospace Corp., have no plans to change their mission. Although RAND is aggressively looking for new non-defense business, the Santa Monica think tank has its hands full analyzing what geopolitical changes mean for the military.
But a majority of economists, aerospace consultants and defense industry executives are pessimistic.
“It is difficult to envision a lot of people finding similar employment in related fields,” said David Hensley, an economist with the UCLA Business Forecasting Project. “It hasn’t worked so far and it doesn’t seem likely to happen in the future.”
Later this month, the Los Angeles County Aerospace Task Force, a group formed last year, will recommend statewide policies that could help in the adjustment.
But local government has limited policy options and financial muscle. “I don’t see an easy solution in the near term,” said William Gross, a former aerospace executive who is co-chairman of the task force.
At the national level, too, help will be limited. The Pentagon’s Office of Economic Adjustment is staffed by 20 workers with a $5-million annual budget--less than 0.002% of the defense budget. Eight metropolitan areas--including Los Angeles, Orange County and San Diego--have qualified so far for grants of up to $300,000 each to study their problems.
Ultimately, then, the success of California in recovering from the defense downturn will depend in large measure on contractors and their employees.
At the major defense firms, top executives are upbeat about bucking President Bush’s plan to shrink defense spending about 7% annually over the next five years.
“Very few defense companies are planning to get smaller,” said Robert Paulson, director of the aerospace practice at the consulting firm McKinsey & Co.
In their formal planning, defense firms have assumed--optimistically, given the environment in Washington--that they will capture substantial business from competitors or new defense programs, accounting in some cases for $1 billion to $2 billion in annual sales. That, Paulson notes, would be the equivalent of creating new Fortune 500-size companies out of nothing.
What is more likely for most firms is a shakeout. A major consolidation already has begun among defense subcontractors and one should begin in earnest in the next few years among the big contractors.
Dowty Aerospace, the troubled defense electronics operation in Arcadia, was acquired by Whittaker Corp., a Los Angeles aerospace firm that has been bargain-hunting lately. “Dowty was the first of the kind where we bought it without paying anything for it,” said Whittaker Chairman Joseph F. Alibrandi.
Dowty’s military contracts, which generate $10 million in annual sales, will be transferred to Whittaker’s existing defense electronics plant in Simi Valley--helping Whittaker use more of its plant capacity.
Since defense spending began to drop in 1986, the industry has been loath to cut excess factory capacity. In some sectors, the defense industry is producing at just 25% of its potential, reducing efficiency, eroding international competitiveness and driving up government costs, said John Harbison, who heads the aerospace practice at the consulting firm Booz Allen & Hamilton.
At some point, the excess capacity will be bulldozed--irrevocably ending an era, defense experts predict.
Facing that prospect, many aerospace firms are venturing again into fields outside defense. Lockheed has contracts with Los Angeles and other cities to perform data management chores, such as processing parking tickets. Meanwhile, Northrop is in preliminary talks with the Japanese firm Sumitomo Corp. about possible joint ventures in public transportation--aimed, apparently, at building rail cars for the Metro Green Line in Los Angeles.
Past efforts at diversification often ended in disaster. Grumman Corp., for example, bought Flxible Co., a producer of mass transit buses, in 1978, but quickly ran into trouble when bus frames began to snap apart. Grumman ultimately had to retrofit 2,900 buses; by 1983, it had sold the operation.
Virtually every major aerospace company made a run at the commercial computer industry during the 1980s, confident that commercial electronics was just like defense electronics.
McDonnell Douglas incurred combined operating losses of $361 million in its computer manufacturing and information processing business, parts of which it is now divesting. Northrop tried to market computer systems for medical offices, but ended up getting sued by doctors from around the country when the systems failed to live up to their billing. Boeing and Lockheed also flopped in such ventures.
“Frankly, sword makers don’t make good and affordable plowshares,” said Williams Anders, chief executive at General Dynamics, who recently rejected the idea of commercial diversification for his firm. A study conducted for General Dynamics by McKinsey found that defense contractors fail 80% of the time when they try to diversify into the commercial sector.
“The structure, the attitude and the thinking are all wrong,” said Aura Systems Chief Executive Zvi (Harry) Kurtzman, who formerly worked at Hughes Aircraft. “I don’t think you can change it. You cannot charge $100 million and take five years to produce something in commercial business.”
Some defense contractors--among them Seal Beach-based Rockwell International and TRW--are already well diversified. But many of their expanding commercial enterprises are based outside California.
Rockwell Chairman Donald Beall said that although his firm “has no hidden agenda . . . to de-emphasize defense,” it is putting relatively more of its investments these days into its growing commercial businesses--auto parts, electronics, newspaper printing presses and industrial control systems.
Hughes has set the most ambitious diversification course among the major defense firms. By the end of the decade, the company intends to increase its non-defense business to 50% of sales from 20% through expansion of its satellite-based telecommunications business and its aircraft simulator business.
“Telecommunications is exploding worldwide,” said Hughes Chairman Malcolm Currie. “We are creating new markets for the future.”
Weaning the economy from its Cold War footing is likely to generate an economic boom nationally by freeing resources for more productive investment. But many analysts say it is doubtful that the growth will sop up all the nearly 1 million California jobs that will be lost in defense.
The problem for California is that it receives about 18% of the nation’s defense spending but only about 12% of general federal spending. Though the state will share in the general economic growth resulting from any “peace dividend,” it will pay a disproportionately high price in defense cutbacks, said Hensley, the UCLA economist.
The best hope for overcoming that bias rests in the ability of defense scientists and engineers to apply their skills to new industries. It’s a wild card that California has played successfully in the high-tech companies of Silicon Valley, the San Fernando Valley, Orange County and North San Diego County.
Aura Systems, founded in 1987, is a paradigm of a successful defense spinoff.
At first, defense contracts funded virtually all of the firm’s research. But today, they account for just 10%, according to Kurtzman. The firm is trying to develop magnetic controls for industry, including plows built by Caterpillar Corp.
Aura Systems--in contrast to the practice of major defense contractors--has emphasized the use of small, multidisciplinary engineering teams aiming to achieve rapid product development. “It requires a whole new approach and a whole new orientation,” Kurtzman said. “People got too used to government regulation, paperwork, reports, memorandums, auditors, quality inspectors and on and on.”
A study last fall comparing small defense firms in Southern California and St. Louis found that contractors here were more aggressive in their efforts to find new business and international markets for their products. The survey by Carol Evans, a Georgetown University business professor, is believed to be the first detailed comparison of different regions’ responses to defense cutbacks.
“Companies in Los Angeles are more healthy and don’t have the same grim outlook,” Evans said. “On the West Coast there is a greater receptivity to trade and foreign linkages. L.A. firms are at least two steps ahead of St. Louis firms.”
Furon Corp., a $300-million Laguna Niguel aerospace manufacturer, is typical. When McDonnell Douglas announced its tentative deal last November to link up with Taiwan Aerospace, Furon’s executive vice president for international sales, Larry Hanson, was on the phone that same day to Taiwan.
“My thought was to get together with the key people in Taiwan,” said Hanson, whose firm wants to form a venture to export its plastic composite aircraft parts to Taiwan. “You need an infrastructure to support an aircraft industry, and we could be a part of it.”
Small contractors such as Furon stand the best chance of adapting to the declining defense market, because their technology and products tend to have dual uses. The military technology held by prime contractors, on the other hand, has become less applicable to the commercial marketplace in the last two decades, according to Jay Stowsky, a political economist at UC Berkeley who has studied conversion issues.
In the field of artificial intelligence, for instance, the Pentagon spent lavishly through the 1980s to develop technology for the Strategic Defense Initiative or “Star Wars.” But less generously funded commercial projects have surged ahead, Stowsky said. Similarly, a richly funded program to help the defense industry develop advanced computer chips dragged on for so long that commercial industry surpassed the technology by the time it was finished.
Indeed, defense technology spinoffs to the commercial world have dropped drastically since the 1950s, Stowsky said, arguing that it makes more sense today for the Pentagon to “spin-on” commercial technology to defense applications.
“The place where conversion is going to happen is at the level of materials and components manufacturing, where the technology really is dual use,” Stowsky said.
At best, he said, the Pentagon should stop distorting American research efforts and instead encourage more technology with both defense and commercial uses--an assertion broadly supported by defense executives and other experts.
But reallocating research funds and setting a national research strategy runs counter to Bush Administration policy, which rejects national industrial policies and favors current defense research spending patterns.
Without careful planning, some industry proponents fear, too much could be lost in the rush to economic adjustment. Aerospace--the spectacle of flight and the might of the U.S. military--has been a passion for U.S. society during most of this century and still can draw on vast public support.
Despite budget cuts, they note, defense remains a big business that well could rebound--if the history of human conflict is any guide. Moreover, the commercial aircraft market will continue to grow faster than the world economy; someday, visionaries add, space exploration will become a monumental enterprise.
“I don’t know why people think it is so bleak,” said Jason Spire, chairman of UCLA’s aerospace engineering department.
“Right now, people are getting laid off. But there are major opportunities in the future for aerospace in our nation,” Spire said. “We don’t have to say in this country that aerospace is going down the drain and this is another technology that we have lost. We will have constellations of satellites. There will be space exploration. A supersonic civil transport is right around the corner.”
Much will depend on the nation’s ability to muster the economic power to support large civil aerospace projects in coming decades.
“It is no time to be timid,” Spire said. “This is an important technology and we should preserve it and keep it on American soil. We can’t look at two or three years down the road. It is about time our society begin to look forward 10 years or 20 years.”
California’s Dependence on Defense
Defense spending peaked as a share of California’s economy at the height of the Vietnam War, then steadily dropped off through the 1970s until reviving as Presidents Jimmy Carter and Ronald Reagan launched the Pentagon on a historic build-up. The state’s defense sector has been declining again since 1987.
Defense spending in California as a percentage of gross state product:
1967: 14.3%
1979: 6.4%
1991: 7.5%
Source: California Commission on State Finance
Aerospace Market’s Ups and Downs
Three top Southland aerospace companies saw their defense work skyrocket during the military buildup of the early 1980s. By last year, however, the contours of their business exhibited stark contrasts.
Percentage of sales
Lockheed
U.S. Other U.S. Defense commercial government International 1981 71% 5% 3% 21% 1986 81% 5% 8% 6% 1991 70% 9% 15% 6%
Northrop
U.S. Other U.S. Defense commercial government International 1981 45% 15% 3% 36% 1986 81% 6% 2% 11% 1991 85% 10% .3% 5%
Rockwell International
U.S. Other U.S. Defense commercial government International 1981 21% 40% 20% 19% 1986 51% 25% 10% 14% 1991 27% 31% 17% 25%
Some figures are corporations’ estimates. Numbers may not add up to 100% because of rounding. How business was categorized may differ from company to company.
Source: Company reports
