understanding industry lesson 1: industry landscape · acq 315: understanding industry lesson 1:...

ACQ 315 Understanding Industry

Lesson 1: Industry Landscape

Version 1.0

ACQ 315: Understanding Industry Lesson 1: Industry Landscape Page 2

Progress in a World of Uncertainty


Introduction

Learning Objectives

Defense Industry Post WWII

Defense Budget Trends

Company Types and Differences

Key Issues and Future Uncertainty

Agenda


Industry Landscape Learning Objectives

Students will be able to explain how the scope and diversity of the current industry landscape influences companies’ methods of competing for defense contracts.

• Compare differences in business/market strategies, priorities, and processes between DoD large (first tier), medium (second tier), and small business.

• Compare differences in business operations and strategies between companies focused on weapons systems, commercial products, and IT.

• Describe macro issues that drive DoD industry strategy today.

• Explain how industry can be vulnerable to trends within the landscape, such as economic downturns, technology breakthroughs, workforce skill availability, energy issues, raw material supplies, etc.

• Differentiate between public and private companies and the implication to DoD.


American aircraft production

• Largest sector of the war economy

• $45 billion (almost a quarter of the $183 billion spent on war production)

• Employing more than two million workers

• And, most importantly, producing over 300,000 aircraft

One crucial example: B-29 Superfortress

• A highly sophisticated weapon that brought innovations such as bombsights, radar, and high-performance engines along with advances in aeronautical engineering, metallurgy, and factory organization

• Hundreds of thousands of workers at four major factories

• $3 billion in Government spending, the B-29 project required almost unprecedented organizational capabilities by the military, major private contractors, and labor unions

Aerospace Manufacturing WWII


Number of Military Aircraft Produced during WWII

613.5K vs. 206.8K Aircraft Manufacturing Dominance

Nearly 3 to 1 Advantage for the Allies over the Axis Powers


Three main externalities encouraged the development of a permanent defense industrial base centered on for-profit defense companies

• First and foremost: The Cold War

• Second: the determination of US post-war leaders to create an international system with American power at its center

• Third: The Korean War and its resultant globalization of the Cold War

Development of Defense Industrial Base


“Until the latest of our world conflicts, the United States had no armaments industry. American makers of plowshares could, with time and as required, make swords as well. But we can no longer risk emergency improvisation of national defense. We have been compelled to create a permanent armaments industry of vast proportions.

… In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex.”

President Dwight D. Eisenhower's Farewell Address to the Nation January 17, 1961

Creation of the Military Industrial Complex


The Cuban Missile Crisis


The End of the Cold War


During early/mid-90s, the Cold War was over and defense budgets were shrinking

Dinner with 15 defense industry chief executives in 1993 with Defense Secretary Les Aspin

• Subsequent events forever changed the character of the US defense industry

DoD was not going to solve industry’s overcapacity problem – that was up to industry

• DoD would strongly support industry consolidation and approve financial arrangements that benefited companies as long as they also significantly benefited the Government

Process of industry consolidation began – when the dust settled, only a few companies remained

“The Last Supper” (1993)


Consolidation from 1993 to 2007


The Top 20 DoD Contractors of the 21st Century

FY 2011

2012 Company Contracts

FY 11 ($B)

1 Lockheed 33.2

2 Boeing 20.1

3 General Dynamics 18.6

4 Raytheon 13.9

5 United Technologies 7.2

6 Amherst Systems 6.8

7 L-3 6.7

8 BAE 6.6

9 SAIC 5.3

10 Oshkosh 4.9

11 Miscellaneous Foreign Contractors 3.9

12 Northrop Grumman 3.8

13 ITT 3.5

14 Humana 3.4

15 Huntington Ingalls 3.2

16 Triwest Healthcare 3.1

17 Health Net 2.9

18 Veritas Capital 2.9

19 CSC 2.8

20 Fluor 2.7

Based on analysis of data from the Federal Procurement Data System – Next Generation. Covers 2011 Government fiscal year *Rankings IAW full corporate revenue may be found at

WashingtonTimes.com.


Commercial vs. Defense Companies

Commercial Business

Open Markets

• Multiple customers with individual transactions

• Anti-trust limits

Not subject to the Federal Acquisition Regulation (FAR)

Price-based business model

• Not required to comply with Government cost accounting standards

• Maximize sales and growth

• Upside/downside sales unlimited

• R&D investments recouped in product price

Government Business

Monopsony

• Single customer comprises multiple constituencies

• Industrial base policy limits

Subject to the Federal Acquisition Regulation (FAR)

Cost-based business model

• Truth In Negotiations Act (TINA)

• Maximize sales

• Upside/downside sales capped

• R&D investments funded or reimbursed by Government


Typically prime contractors on large contracts

Defense Company Comparison

Publicly traded on stock market

Driven by quarterly earnings

Typically focused on DoD/USG market

Large plants/manufacturing facilities and high overhead

Often composed of business units matching DoD mission areas

Large Public Companies

Often work as subcontractors, or as primes on smaller jobs

Privately held - stock does not trade

Driven by cash flow

Try to balance USG and commercial business units

One person does many jobs

Founders are often “all in”

Have to get across the valley of death to survive (first 5 years)

Private Companies


Most large defense contractors are publicly traded while many subcontractors and suppliers are privately held companies

Implications to DoD

• Company behaviors on new and existing contracts

• Financial risks/health

• Time value of money and financing

Public vs. Private Company

Public

Offers securities (stocks, bonds) for sale to the general public, typically through a stock exchange.

Can access large amounts of capital through securities sales; but under pressure to meet quarterly forecasts for sales and profit.

Private

Owned by a relatively small number of company members and does not offer or trade its company stock to the general public.

No requirement to disclose financial information; but more difficult to access capital.


Public Company Challenges

Significant implications of not meeting forecasts and of forecasting declining growth

• Stock prices

• Shareholder value

• Record sales

• Book orders

• Realize revenue

Knowledge of how corporate management decisions are made may enable DoD to influence

and/or leverage the process


A global mix of many diverse companies

What Does Defense Industry Look Like?

Public, Private, Commercial, Large, Medium, Small, and Foreign Companies


National Debt, Global Instability

Smaller DoD Acquisition Budgets

Available Workforce

Supply Chain Health

Access to Global Markets

Others ... ?

Key Issues for DoD Industry

UNCERTAINTY


What Is Our Debt and How Does It Compare to GDP?

OMB Adjusted Baseline

with BCA Caps

Recommendations to the

Joint Select Committee

Annual Deficits as a Percent of GDP Percent of GDP

10.0

9.0

8.0

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

OMB Adjusted Baseline

with BCA Caps

Recommendations to the

Joint Select Committee

Debt Held by the Public as a

Percent of GDP 90.0

85.0

80.0

75.0

70.0

65.0

60.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021


U.S. NATIONAL DEBT CLOCK

The Outstanding Public Debt as of 18 April 2013 at 10:12:39 AM EDT is:

$16,810,476,753,175

What Is Our Debt and How Does It Compare to Defense Spending?


Total Revenues and Outlays, 1973 - 2023


Quick Look Ahead and at Last Couple of Years:

US election dynamics

“Fiscal Cliff”: Debt Reduction – “Sequestration” Defense Cuts

Eurozone crisis

Tunisian Overthrow of President Ben Ali

Egyptian revolt; Islamic Brotherhood or Army running the country??

Japanese 9.0 Earthquake, Tsunami, and Fukushima meltdown

Yemen unrest, Syrian violence/Civil War

Air Strikes Against Libya … US/NATO … Gadhafi overthrown

US Credit Rating Downgrade by S&P

Chinese Stealth Fighter and Aircraft Carrier

Iran Nuclear Power

Unstable Global Environment

Implications for Defense Industry?


Department of Defense Budget

Base Budget Authority and OCO / Supplementals, Constant 2012 $ Billions, 1989-2017

“Even the full-blown sequester only brings the budget down to 2007 levels, which was in real money terms an all-time record.” Aviation Week January 7, 2012 (page 56)


Correlation of Stock Relative Returns to DoD Spending Is Hard to Escape

Budgets and Stock


DoD Budget By Company Size (FY11)

Source: OSD/AT&L Manufacturing and Industrial Base Policy

52%

22%

16%

10%

TOTAL

Large

Medium

Small

Unknown


US defense workforce has shrunk

significantly since the Cold War ended

Source: AIA Employment Database

DoD Industry Workforce

0

200

400

600

800

1000

1200

91' 92' 93' 94' 95' 96' 97' 98' 99' 00' 01' 02' 03' 04' 05' 06' 07' 08' 09' 10'

0

5,000

10,000

15,000

20,000

Professional

and Business

Services

Healthcare

and Health

Services

Retail Trade Non-Profit

and

Associations

Financial

Activities

Legal

Services

Aerospace

Legal professionals outnumber skilled aerospace workers

nearly 2 to 1

Source: Bureau of Labor and Statistics


Workforce Challenges

Baby Boomers getting to retirement age

Competing for engineering talent with other sectors (e.g., IT, energy, automotive)

Incentives to attract and retain recent university graduates

Layoffs: Many of the major US corporations are reducing their overall number of employees including General Dynamics (GD), Boeing (BA), and Lockheed Martin (LMT)

• Despite strong sales and many major programs, creating a leaner overall structure


Access to Global Markets

US contractors have historically relied on majority of sales to US customers

European firms rely more heavily on exports and business units outside of the parent nation

Tight US budgets and access to greater opportunities US companies to greater emphasis on exports

Increasing Relevance of

International Spending

Total FMS Notifications DoD Weapons Spending

CY95

CY96

CY97

CY98

CY99

CY00

CY01

CY02

CY03

CY04

CY05

CY06

CY07

CY08

CY09

CY10


Other Industry Challenges

Rising energy costs

Keeping overhead rates competitive with declining business base

Pace of technology advancements

Raw material shortages

Access to capital in market downturns

So How Does Industry Deal With All This Uncertainty?


“Globalization” of the planet has impacted the risk landscape

• May drive DoD’s suppliers to adopt different paradigms

• Reduction in investments

› Capital expenditures and R&D

• Product and customer diversification

› FMS, Homeland Security, commercial, services vice products

• Restructure

› M&A, divestiture

L-3 spinoff of Engility

In 2011, Lockheed Martin sold Pacific Architects and Engineers to New York-based Lindsay Goldberg without disclosing terms of the deal.

Northrop Grumman in 2009 sold TASC, its Government consulting unit, to a partnership of Kohlberg Kravis Roberts and General Atlantic for $1.65 billion.

Potential Direction of Industry

Individual Corporate Strategy Required to Guide the Way


Washington Post 26 November, 2012

“Defense contractors stockpile cash ahead of ‘fiscal cliff ’” Defense contractors led by Boeing and Lockheed Martin are stashing more cash…

The average cash holdings of the Defense Department’s five biggest contractors jumped 71 percent to $4.13 billion in the quarter ended Sept. 30 compared with the same period in 2010. That outpaces the 17 percent increase for companies in the Standard & Poor’s 500 Index.

“They have seen the storm clouds on the horizon for some time,’’ Howard Rubel, an analyst at Jefferies & Co. in New York … “Like the consumer, they’ve said, ‘I’m going to put an extra penny away in the kitty, because I don’t quite understand when things will get back to normal.’ ’’

Reduction in Investments

Company $ B

Boeing 6.58

Lockheed Martin 4.65

Northrop Grumman 3.52

Raytheon 3.03

General Dynamics 2.87


What is it?

Strategic Planning

Key Elements Addresses Key Questions

Vision/Mission

Market outlook/industry structure

Competitive strategies/positioning

Technology and core competencies

Organizational strategies

How to expand market opportunities and share?

Top 3 to 5 resource constraints?

Correct organization structure/skills and if not, how to obtain?

Geo location/facilities support requirements and potential changes?

What linkages/synergies with other firms/agencies are required?

ROI?

Process by which an organization determines its future direction and how to get there


FY13 DoD Emphasis Areas

Return to the Pacific

Counter-terrorism

• Special Operations Forces

• Unmanned Air Systems

• Sea-based Unmanned ISR

• Advanced ISR

Cyber Operations

Power Projection

Missile Defense

Space Systems

Counter Weapons of Mass Destruction

Science and Technology


Summary

Global uncertainty, fiscal crisis, and market downturn may drive significant changes in the industrial base

The defense industry is a national asset and part of our overall force structure

Many different types of companies and strategies are involved in defense contracting

New DoD emphasis areas have broad implications for industry investment and strategic planning

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