US defense industry girding for predicted slump

After years of predictions of a downturn that never materialized, US defense companies are now bracing in earnest for leaner times, lower profit margins and tougher negotiations about government contracts. Defense Secretary Robert Gates has launched a major efficiency drive to trim $100 billion out of the Pentagon's bloated overhead accounts from 2012 to 2016. The Pentagon expects growth of 1% after inflation in its 2012 budget, but much of that will be eaten up by rising personnel and health costs, leaving far less money for weapons programs than during years of double digit growth after the September 11, 2001 attacks. That has left industry executives with a growing sense of apprehension about the future, especially given the end of combat operations in Iraq and yawning deficits that have even some normally hawkish Republican lawmakers calling for cuts.

Recent news of delays in the U.S. Army's multibillion-dollar ground combat vehicle program and an even bigger US Navy warship program deeply unsettled industry executives. The Pentagon's efficiency and acquisition reforms are pressuring companies across the industry to make their organizations leaner and sell off unprofitable units. Many will also have to accept more risk and lower profits on the shrinking number of defense contracts that are up for grabs. Most companies have a solid backlog of orders from Bush administration years that would last for some time, although many companies are now trying to "mine the backlog". That means layoffs, tougher negotiations with suppliers and customers, and efforts to cut expenses across the board. Some companies like Lockheed Martin and Northrop Grumman have already taken more strategic steps to adjust their portfolios and sell off units that weren't a good fit in the current budget environment.

- It has been *quite* a while since my last post, but this is a little too big to pass up. Given the circumstances faced by the Singapore subsidiary of my former employer, some people have asked me how I could have seen this coming a couple of years ago. Naturally I couldn't really explain it in a sound-bite, but what I can say here is that it is not so much about having a crystal ball, rather, it is more like a matter of seeing the writing on the wall.

The writing was on the wall for the US defence industry quite a while ago. The soaring US government deficits meant that they were depending on the kindness of strangers (the Chinese, the Japanese, and other governments) to fund their own wars. The scope of their twin giant ongoing adventures in Iraq and Afghanistan meant that expenses were grinding away at the capital base - or whatever was left of it, if any. Historically it has always been expensive to fight wars on two fronts - and it has only gotten more expensive in the modern era.

I used to tell people, when times are bad, when the economy did not look too good, to look for positions in sectors such as defence, government, healthcare, education, utilities, and so on. That will have to change. The defence industry, especially the US military-industrial complex that I was once part of, is no longer what it once was. The world is changing. And we will have to change with it.

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