Less Bang from the Pentagon's Bucks

Just a few big programs are sucking up the entire weapons' budget. Long term, that's bad news for contractors -- and investors

By Stan Crock

For years, military experts of all stripes have worried that a defense budget "train wreck" was waiting to happen. They pointed to the widening disparity between all the weapons plans in the Pentagon's long-term blueprints and the money budgeted to pay for them. At some point, something would have to give -- or so the argument went.

Liberals argued that the problem was too many weapons. Conservatives shot back that there was too little money to pay for weapons crucial to national security. The billions now being lavished on the Pentagon, which may be creating irrational exuberance about defense stocks, provided little ammunition to either side. While some of the money has gone for weapons procurement, most of it has been going for operations and maintenance, medical care, pay hikes, and the like.

Turns out both sides may have the argument all wrong. In fact, very few big weapons programs are being built or are in the works anymore. The Army, Navy, and Air Force each have one major program in the planning stages right now. On the other hand, there's plenty of money for procurement, roughly $70 billion in 2003. The trouble is that the few programs that remain are extravagantly expensive. The trick will be to spend the cash more wisely.


  Credit former Lockheed Martin Chairman and CEO Norman Augustine for seeing this coming. Back in 1983, he looked at the trajectory of per-unit costs for jet fighters and the trajectory of increases in the defense budget and formulated something he dubbed "the First Law of Impending Doom or the Final Law of Economic Disarmament." He wrote back then: "In the year 2054, the entire defense budget will purchase just one aircraft. This aircraft will have to be shared by the Air Force and Navy 3 1/2 days each per week except for leap year, when it will be made available to the Marines for the extra day."

Sure, he was being puckish. But as usual, the always thoughtful Augustine captured an underlying truth that's becoming evident two decades later. Just look at the plans of the Air Force, Navy, and Marines to buy nearly 3,000 Joint Strike Fighters for $225 billion. The JSFs are supposed to be cheap at about $70 million a pop, but I'll believe that figure when I see the planes on the runway.

The costs of such systems have reduced the services to just a few big weapons programs. The Navy has one big shipbuilding program for the future: the DD(X), a family of small ships coordinated through a communications network. A General Dynamics-Lockheed Martin team is competing for the contract against a team of Northrop Grumman, Raytheon, and United Defense, with a selection due next month. In the meantime, the Navy is on a timetable of building five ships a year, buying them at what is the lowest per-unit rate since 1932.


  The Army has one major program, the Future Combat System. Boeing, which is the lead systems integrator, hasn't yet picked who will bend the metal for the program. The Air Force is starting to produce Lockheed Martin's F-22 Raptors, but the Big Kahuna is the company's Joint Strike Fighter, two-thirds of which will be bought over the next 25 years by the Air Force under existing plans.

Some companies may have to exit the defense business

Contrast this with the Cold War. In the 1980s, the Navy was building 19 ships a year, and the Pentagon had seven fighter programs going. Today, with so much riding on the small number of competitions, the losers have to think about exiting the business. When the production line for Boeing's current Navy fighter, the Super Hornet, winds down in a few years, Boeing will be out of the fighter business for a generation if it doesn't get some work on the JSF. The already shrunken defense industrial base will get even smaller -- a trend the Pentagon leadership is struggling to address.

The signs of budget stress are already evident. The Navy and Marines are said to be mulling a plan to cut the number of JSF they would buy from 1,089 to 680. The number of Super Hornets also may shrink, from 548 to 460. This is the worst of both worlds for contractors. Not only are there so few programs but the Pentagon is likely to buy fewer units of the ones that remain.


  One major reason for the possible Navy-Marine cutback is money. It won't be there is a few years as pay, health-care, and infrastructure costs rise. Another reason is strategic. Short-range fighters don't make a lot of sense if the U.S. doesn't have close access to the battlefield. And carriers would be sitting ducks for cruise missiles if they got too close to enemy territory. Long-range bombers might be more effective.

The war in Afghanistan provides a tactical rationale for the cuts. With the munitions now so precise, fewer sorties and thus fewer planes are needed to achieve a goal. And you may not need glitzy new fighter planes if old war horses such as F-15s and B-52s can exploit the precision weapons.

Pentagon acquisitions czar Pete Aldridge acknowledged as much at a recent press briefing, when he discussed the possibility of JSF cuts. "It is the ability to destroy the target they're after, and [in that case, it's] the munition, not the carrier, that's important," he told reporters.


  So instead of a vast number of JSFs and 300 or so of the more expensive F-22 Raptors, the Defense Dept. could buy just a few of the new generation of weapons and purchase more proven -- and less expensive -- planes, such as the F-15 and F-16. With new avionics and munitions, they could be highly capable.

What does this mean for the defense industry? In the near term, profits should continue to rise for contractors, simply because procurement money is increasing. The longer term is a different story. If you make smart bombs, as Boeing and Raytheon do, or unmanned aerial vehicles, like Northrop Grumman and General Atomics, you will have a steady business, if not a hugely profitable one. In a dozen years or so, some company might do well making a new bomber. But for those who make fighters, like Lockheed Martin and Boeing, the horizon will begin to darken.

Will the Pentagon buy just one plane a year? No. But a downward flight path for big weapons purchases seems inevitable. Augustine, who retired from Lockheed Martin in 1997, has always been a prescient guy. He knew enough to get out of Lockheed Martin and the defense industry before the wheels came off. Will investors be so savvy with their timing?

Crock covers national security and foreign affairs for BusinessWeek from Washington. Follow his views in Affairs of State twice a month, only on BusinessWeek Online

Edited by Douglas Harbrecht

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