Industry recalibrating strategies for a declining defense market.

Author:Erwin, Sandra I.
Position:Defense Watch

* The defense market is shaping up to become a Darwinian world where winning contracts will be a matter of life or death for many companies.

Not only is the Pentagon cutting back on weapons purchases but Defense Department buyers also are under strict orders to squeeze every dime they can from every program, which should translate into less money for industry.

"If you are not succeeding you are very vulnerable in this environment," says Frank Kendall, undersecretary of defense for acquisition, technology and logistics.

The spending spree of the past decade kept alive many underperforming companies, he says. "We don't live in that world anymore. If you're not executing successfully, you're in trouble." Analysts say industry is faced with several choices: Exit the market, double down on defense by buying up competitors, or try to weather the storm until the next military buildup.

But in the current climate, those who choose to stay in the business will have to step up their game or industry shareholders will lose patience.

Doug Belair, senior vice president of strategy and planning at BAE Systems Inc., says companies tend to guard themselves by protecting franchise programs, improving earnings and delivering cash to shareholders. That may not be enough to survive the coming age of austerity, he tells an audience of corporate executives at an Aviation Week conference. "In the last downturn, companies that hunkered down did the worst in delivering shareholder value."

Defense companies need to do more than just muddle along, he suggests. They need to develop disruptive products. Just like Apple sold the world the iPod, weapon manufacturers have to invent the next big thing that the Pentagon ultimately will not want to live without. "Figure out what they need that they don't have," Belair says.

Take a page from the commercial corporate playbook and impress the customer with forward-looking products, Belair suggests. Companies, he says, should work hard at anticipating the military's future needs, and invest in technology so they get ahead of the customer and have something ready when the need arises.

Pentagon suppliers also need to develop thicker skin, as contractors will continue to be blamed, fairly or otherwise, for budget overruns and mismanagement of weapon programs, another analyst warns. "Many companies have not yet figured out how to adjust to an environment where they are treated as bad guys," says Steven Grundman, a former


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