Did Defense Contractors Escape the Axe in Latest Round of Cost Savings?

The big news last week for the government-contracting community was the update Defense Secretary Robert Gates provided on the Pentagon efficiencies.

But, along with his familiar refrain, voicing support for the $100 billion in cost savings, he also announced an additional $78 billion in budget cuts, including the cancellation of some weapons systems.

“Not every defense program is necessary,” the secretary said, “not every defense dollar is sacred and more of nearly everything is simply not sustainable.”

While the increased reduction was played up in the media, others see it having a more mixed, or modest effect.

The Proposal

Adding up to $78 billion:

• $54 billion — from reducing overhead costs, including a government civilian salary freeze

• $14 billion from lower-interest rates

• $6 billion in troop cuts for the Army and Marine Corps

• $4 billion from purchase and price changes for F-35 combat aircraft

Other announcements:

§         Staff support contractors will be cut 10 percent per year for three years, saving $3 billion

§         Cancellation of the Marines’ Expeditionary Fighting Vehicle

§         Two-year probation for the Marines’ Joint Strike Fighter to address production issues.

§         The Army will cancel procurement of the SLAMRAAM surface-to air-missile and the non-line-of-sight launch system

§         Modest increases in TriCare fees beginning in the 2012 fiscal year

What it means

When Gates announced the first round of Pentagon efficiencies last August, industry was all ears. “While previous plans to bring significant alterations to the defense-contracting budget were struck down by the private sector’s immune system of industry lobbyists and legislative challenges and clouded by logistical issues,” GovConExec magazine wrote shortly after the efficiencies were announced, “there is a prevailing sense across the business that Gates’ demands for cutbacks are not a drill.”

However, even with the new round of budget cutting and belt-tightening, defense watchers are counseling against hyperbole.

Loren Thompson of the Lexington Institute said the big story about this latest round of budget cuts is not what happened, but what didn’t happen.

“So if you were looking for an apt metaphor to describe what happened to makers of military hardware on Thursday,” he writes, “you might say they ‘dodged the bullet.’”

That’s because, while the projected DoD budget as advocated by the White House and adopted by Gates and the Pentagon’s leaders is about $13 billion less than what was projected in the previous year’s five-year spending plan, it still represents real growth, according to a Federal Times report.

Industry effect and response

While industry is remaining somewhat tight-lipped about the latest round of cuts, the Lexington Institute’s Thompson said defense companies will likely “fare well.”

While Gates did announce the cancellation of the EFV, that also means there will be plenty of other firms to  get a chance to compete for the replacement, which Gates also announced.

BAE Systems will be able to compete for such a replacement, and Thompson also writes the company also got a “shot in the arm” because of the announced modernization of the Amphibious Assault vehicle.

General Dynamics will also likely bounce back from the EFV cancellation, Thompson writes, because of increased spending on its tanks and communications gear.

For the complete prognosis from Loren Thompson of the Lexington Institute, click here.

For the best judge of how industry reacted, the marketplace may be the best place to look. When speculation began swirling earlier this week, The Washington Post reported investors in defense companies were “spooked.”

“Stock in government-services companies was hit especially hard,” The Post reported.

But, by the end of the week, stocks for defense firms had rallied, likely because Gates’ proposals “were not as severe as some had expected,” Reuters reported.

Reuters also reported that defense CEOs “generally welcomed the Pentagon’s budget forecast,” because they are already working on lowering costs and improving performance.

BAE, Inc.  CEO Linda Hudson told Reuters the company had undergone a restructuring last year to lower costs and speed up by process of bringing products and services to the market.