Waugh agrees: “In the distant past, the effort was to not worry about what the contracts say, or how we’ll perform, but to be on the leading edge from a technology standpoint.” Today, he believes, finance has finally become a “change agent” in defense, focusing “on winning programs at the appropriate value.”
A Honda Instead of a Ferrari
The government played a major, if accidental, role in making contractors more finance-conscious. As the 1980s wound down, the United States encouraged new competitors to enter defense production, which increased capacity while hurting old-line contractors with already-thin margins. Then, with the fall of the Soviet Union, the federal arms procurement budget started a steady decline, and the United States began pushing for industry consolidation, creating a flood of mergers and acquisitions.
“There were 55 prime contractors in the 1980s, and we’re down to 5 now,” says Chris Kubasik, senior vice president and CFO of Lockheed Martin Corp. His own company, he points out, “comprises 17 of the heritage companies that would have been among those 55.”
Acquirers took on massive debt. But at the same time, the government funded less and less of companies’ research and development, helping heat up the corporate competition for capital. Suddenly, contractors found their finances being reviewed carefully by the investment community, which often didn’t like what it saw. The total defense budget, $462 billion at its Cold War peak in fiscal year 1985 (in today’s dollars), had fallen by a third in 1998, to $295 billion.
The Pentagon lowered the cost-ceilings on new weaponry, such as the F-35 Joint Strike Fighter (JSF). For the Air Force, the $37 million cost of each stealthy JSF is about the same price it pays for old-tech F-16Cs. Defense contractors began to get the message: find cheaper ways to produce high-tech arms and more efficient ways to merge, even if that meant reinventing the finance department.
“Today, cost is of the essence to the customer, because the customer doesn’t have the budget it used to,” explains Northrop’s Waugh. He views the change in U.S. weapons-buying as similar to how a wealthy family might react to a sudden plunge in income. “When you and your wife have lots of money, you go out to buy a Ferrari and a Rolls-Royce.” But in the aftermath, “you say to the wife, ‘I’m not even sure you need a Lexus. And wouldn’t a Honda be OK just to move the kids around in?’”
Contracting and Expanding
The industry’s newly empowered finance executives, eager to make the best of program shrinkage, also were instrumental in helping companies define their core operations and reshape themselves to fit the revised view — starting with the sell-off of noncore operations. The most dramatic early divestiture drive was by General Dynamics Corp., based in Falls Church, Virginia, which disposed of its huge fighter-plane, missile, and space-launch businesses, among others, and at one point seemed ready to liquidate completely. Finally, it decided to focus on tanks, ships, and electronics, and began acquiring again. Acquiring companies learned — the hard way — that M&A must be done selectively and carefully. Lexington, Massachusetts-based Raytheon Co. encountered severe growth pains after its buying spree, and only lately has seemed to regain its health.