Fears of the incredibly shrinking defense budget may be overblown.

• Author: Erwin, Sandra I.
• Position: Defense Watch

Here's a defense budget nugget that should scare the bejeebers out of Pentagon contractors: If there is a 2 percent annual decrease to the defense budget's top line for the next decade, without other changes, the acquisition budget will fall to zero.

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As everyone awaits the recommendations of the debt-reduction "Super Committee," no sector of the government contracting community is as anxious about the future as Pentagon suppliers.

The extent of the cuts to defense is still unknown. This irritates industry leaders because they see their biggest customer paralyzed by indecision, and putting off the investment planning decisions by which contractors live and die. In this defense downturn, the "bottom is not defined," said Sean O'Keefe, CEO of EADS North America.

Compounding industry's fears are the cataclysmic forecasts about the Pentagon's procurement budget. The aforementioned scenario that has acquisition funds evaporating over the next decade is extreme, but not inconceivable, given the current trends. A 2 percent cut from the top line may not sound like much, and would not significantly affect the Pentagon's operations. But it is the consensus view among budget experts that the bigger menace to procurement spending comes from within the Pentagon's budget. Investment accounts--procurement, research and development--are being eaten alive by the budget "hogs"--personnel, operations and maintenance.

If funding for the Pentagon begins to decline in the next several years, that pressure will fall disproportionately on the acquisition budget, noted a study by the Institute for Defense Analyses. The usual noise that often is made about the importance of preserving the defense industrial base tends to fall on deaf ears if the political winds blow in favor of spending cuts. "In the past, such arguments have not been entirely successful; the biggest defense cuts have been in acquisition," the report said.

Budget watchers will point out that this trend is nothing to panic about. This is what happens every time there is a defense downturn, and the industry should weather the storm just fine, as it has in the past. Investments inevitably take a hit because they are the most discretionary portion of the defense budget.

But even if the industrial base manages to adapt to smaller budgets, an environment of shrinking resources only means that dark days are ahead, analysts warn. Alpha Capital, a firm that advises industry investors...