Defense firms publicly back budget effort

Major defense companies that have enjoyed banner revenue and profit for nearly a decade are publicly backing a new Pentagon effort to make contracts more affordable and eliminate unnecessary spending on weapons and services.

Pentagon acquisition chief Ashton Carter on Monday met with more than 200 defense company and trade-association executives to lay out the framework of the Pentagon’s plan to squeeze out as much as $60 billion over the next five years from weapon, product, supply and service contracts.

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The Pentagon spends about $400 billion on products and services out of a budget of about $700 billion a year, Carter said. Pentagon leaders are seeking 2 to 3 percent in savings of that $400 billion, Carter said.

Major defense companies such as Lockheed Martin, Northrop Grumman and the Boeing Co. have all said that they backed the new effort and applauded Pentagon officials for reaching out to industry to carry out the new endeavor.

“We understand the new reality of escalating demands on our DoD [Department of Defense] customers and increasing constraints on the resources available to achieve their missions,” said Robert Stevens, the chairman and CEO of Lockheed Martin. “We see the world through exactly the same lens as Secretary [of Defense Robert] Gates and Dr. Carter, and we intend to be relentless in focusing on program execution, on continuously improving our quality and on driving affordability into every process and every program.”

Northrop Grumman’s vice president for strategic communications, Randy Belote, said the company looks forward “to contributing to the discussion [to] … arrive at meaningful acquisition reform.”

Boeing, meanwhile, took the opportunity not only to back Carter’s efforts, but to tout its own efforts to reduce costs, such as the contracts for the Super Hornet fighter jet. Boeing has had significant congressional support for multiyear contracts for the jets.

Under the new initiative, the Pentagon acquisition corps will be tasked to find the proper contract types for both weapons systems and services. They will look to reduce costs with fixed-price contracts that require defense companies to bear cost overruns, and through encouraging “real” competition between contractors.

Carter said that the Pentagon wanted to see more small businesses enter the defense sector, as well as commercial companies that normally do not deal with the defense sector.

Carter’s effort is part of a sweeping initiative to find about $100 billion in savings over the next five years by reducing Pentagon bloat. The goal is to pour those savings into the fighting force and the modernization of weapons systems.

Jim McAleese of McAleese & Associates said Carter’s efforts equally target the military services and defense companies.

He acknowledged that the new endeavor would cause “concerns over potential reduction in defense contractor profits,” but said that there are plenty of costs to cut before contractor profits would be in danger.

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As a general rule, he explained that for each dollar of actual labor or material, hardware contractors often add another dollar for factory overhead and another 50 to 60 cents for corporate headquarters expenses “before profit is even considered.”

Nonetheless, some defense industry insiders are warning that companies will have to carry much of the burden to trim costs.

While the overall initiative makes sense and needs to happen at a time of flat budgets, it appears that the industry will have to shoulder the bulk of the pressure to reduce costs and liabilities, said one defense lobbyist.

Another defense insider cautioned that the Pentagon has a lot of work to do to remove the barriers to entry for many small businesses and other companies that now feel the rules are too prohibitive for them to compete and participate in defense contracts. Additionally, the scope of the effort should span well beyond the major defense contractors and offer a broader outreach through a public comment process, according to the defense insider.

Contractors could face significant risk as the Pentagon tries to move support and contracts for weapons in-house, according to Richard Aboulafia, the vice president of analysis at the Teal Group. He called Carter’s goals and guidance “quite sensible.”

“Given the prevailing fiscal climate, political mood and pressures on the defense budget, reducing overhead and other costs is necessary and inevitable,” said Aboulafia. “But the backdrop — the likely fall in sustainment funding and a potentially severe in-sourcing initiative at the Department of Defense — means that contractors have plenty of other things to worry about. It’s a serious double threat.”

Aboulafia said that many contractors have come to rely on weapons support and service contracts for profits. If the budget for so-called sustainment falls as the U.S. military leaves Iraq and Afghanistan and the Defense Department moves a significant level of the support work in-house, there would be a serious risk for many contractors.

“Many companies would need to modify their profit model and prepare for reduced revenues,” said Aboulafia.