Finance on the Front Line

Defense contractors are benefiting from new controls their CFOs have installed.

Among the functions redesigned to report directly to Kubasik was that of independent cost evaluation (ICE), in which as many as 75 analysts evaluate program costs. “It’s a key control in this industry, and we’d always had an ICE function, but before, the reporting was to the leaders of each business area, which often didn’t reach the CFO,” says Kubasik.

Lockheed is lavishing its cost-control efforts on a program that may offer the largest potential: JSF. To fill the needs of the three services, the United States plans to purchase 2,852 aircraft, potentially for $200 billion. Building the plane under strict cost controls is a challenge for Lockheed, but one it feels ready to meet. In addition to the early warning system of ICE, Kubasik and Stevens have instituted “continual assessment” programs and a process called anchor point management (APM), to track progress by closely examining certain pre-identified elements in development, spurring “prediction reports” that go to the CFO. APM relies on a series of tests that use a so-called critical item network — about 3,000 activities “that have the potential of being on the schedule critical path for some major program milestones, such as first flight,” now scheduled for 2005, with delivery scheduled to begin around 2008.

JSA Research analyst Nisbet says Lockheed’s closer attention to detail may help account for the company’s apparent ability recently to avoid losses on a range of programs. “They were ignoring such things as early warnings when they were in a consolidation mode,” he says. “Until Bob Stevens, there was nobody with the authority to make it happen.”

Saving Our Ship

When most commercial manufacturers find ways to cut production costs, they can pocket the savings through higher margins. But that’s rarely true for defense contractors, which must return any savings to the customer when they are operating under the typical cost-plus-incentives arrangements. Under such contracts — as opposed to the fixed-price arrangements that more closely resemble commercial production terms — arms makers accept a certain margin rate and the government picks up costs, within agreed-upon limits.

But as is true in any industry, says Northrop’s Waugh, “to get costs down, we have to incur costs. And those costs we incur hit those same programs.” That’s not all. “Our projected savings, from conducting our business more professionally, is put into the pricing,” so future margins on programs don’t reflect cost efficiencies, either.

Why work to cut costs on weapons systems? In the new industry environment, says Waugh, “we are all terribly concerned about the affordability of our products,” the increasingly high-tech weapons systems the military relies on. Even if a bigger return on investment doesn’t result from Northrop spending on plant and equipment improvements and thus reducing overall costs, “it makes sense if you think you’re going to lose the program without that investment,” he says.

Northrop has made cost reduction its mantra. And the approach has reshaped the finance departments, too, at acquired companies like Litton Industries, purchased in 2001. Litton, for example, hadn’t assigned a business manager to each of its five separate programs, choosing instead to have one manager for an entire location. “Quite frankly, you don’t get the insight and analysis you need unless you have one for every program,” says Waugh. “There was too much ‘smoothing’ of information” among discrete programs, robbing finance of insights into problems and successes.

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