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ACQ 315 Understanding Industry
Lesson 1: Industry Landscape
Version 1.0
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Progress in a World of Uncertainty
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Introduction
Learning Objectives
Defense Industry Post WWII
Defense Budget Trends
Company Types and Differences
Key Issues and Future Uncertainty
Agenda
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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.
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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
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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
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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
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“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
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The Cuban Missile Crisis
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The End of the Cold War
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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)
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Consolidation from 1993 to 2007
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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.
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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
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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
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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.
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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
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A global mix of many diverse companies
What Does Defense Industry Look Like?
Public, Private, Commercial, Large, Medium, Small, and Foreign Companies
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National Debt, Global Instability
Smaller DoD Acquisition Budgets
Available Workforce
Supply Chain Health
Access to Global Markets
Others ... ?
Key Issues for DoD Industry
UNCERTAINTY
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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
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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?
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Total Revenues and Outlays, 1973 - 2023
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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?
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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)
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Correlation of Stock Relative Returns to DoD Spending Is Hard to Escape
Budgets and Stock
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DoD Budget By Company Size (FY11)
Source: OSD/AT&L Manufacturing and Industrial Base Policy
52%
22%
16%
10%
TOTAL
Large
Medium
Small
Unknown
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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
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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
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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
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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?
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“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
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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
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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
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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
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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