More Bang for the Byte

The Pentagon's spending on info tech is soaring

In the back of the vehicles used by the U.S. Army's mechanized cavalry scouts, there's a laser-based viewfinder that helps scouts get a lock on enemy positions without getting too close. The enemy location is then passed to a central command unit. The system is built by defense contractor Raytheon Co. (RTN ) But it contains special high-tech sensors originally designed for commercial use by tiny Crossbow Technology Inc., a 50-employee company.

Why did Raytheon turn to Crossbow? The answer reflects the U.S. strategy to build a digital military that is powered in many cases by the same cutting-edge information technology and sophisticated networking the private sector uses. Crossbow engineers originally designed its sensor technology to replace the mechanical altimeters used in commercial aircraft. Raytheon approached Crossbow in 1999 because it figured the technology could help gauge such mundane but crucial details as how high or low a vehicle is sitting on the ground. Even better, Crossbow's digital sensors are designed to feed data directly into a computer network.

The transformation of the U.S. military to a networked fighting force is changing the role of companies that supply weapons and technology to the military. Defense contractors such as Raytheon, Boeing (BA ), and Northrop Grumman (NOC ), best known for making powerful fighter jets and missiles, have been building up their information-technology capabilities, expanding into such areas as software development and electronics systems design. That is setting the stage for a brawl among systems integrators such as CACI International (CAI ) and Computer Sciences Corp. that have specialized in building complex systems for the government. These second-tier high-tech firms will be battling for subcontractor roles on teams with the big defense contractors as they vie for huge network deals. "This market space is a very challenging one today," says CACI CEO J.P. "Jack" London.

But that makes it an opportunity for the tech industry. A Defense Dept. drive started in the late 1990s to buy off-the-shelf technology rather than pricey, custom-built systems is opening doors at the Pentagon. Companies ranging from giant Hewlett-Packard Co. (HWP ) to security specialist Symantec Corp. (SYMC ) and tiny startups like Crossbow are finding new customers in the military. Software maker Sybase Inc. (SY ), for example, just installed a logistics program in nearly every U.S. Navy ship. While it had to make its program more secure for the Navy, "it's not as customized as you might think," says Jim White, head of federal sales.

The federal government is the one sector of the economy that's shelling out the dough for tech like the good old days -- pre-bubble, that is. Merrill Lynch estimates federal spending will jump 12%, to $59 billion, in the next year. Defense spending on information technology, meanwhile, is expected to grow at an even more rapid pace, up 19% within the next year, to $27.8 billion. With overall tech spending expected to increase just 5%, from $875 billion, in 2002, the federal government is proving a powerful lure to tech companies.

But don't expect military spending to be a panacea for what ails tech. Defense spending is still a fraction of the tech economy. For now, defense sales are more like a salve. Take database giant Oracle Corp. (ORCL ), which is providing a svelte version of its software for use on the battlefield. Oracle says that while defense dollars are good for business, it can't make up for the triple whammy of lost sales to dot-coms and telecom companies and for the poor economy. The company doesn't break out federal sales, but says they have held steady over the past two years. Overall revenues have dropped 11%, to $9.6 billion, during the same period.

Certainly, high-profile success on the battlefield can provide a powerful boost for new technology that carries over to the commercial world. In 1990, for example, tiny Trimble Navigation Ltd., based in Sunnyvale, Calif., sold 10,000 handheld devices with global positioning systems to the military for the first Gulf War. The battlefield success of those devices was a boon to Trimble and the commercial GPS market. Today, Trimble is a $466 million company, with just 3% of its sales from the military.

That's the trick: translating success with the military into commercial staying power. Execs at privately-held Crossbow execs say the military accounts for less than 25% of sales, and they would like to keep it that way. Why? Huge contractors such as Raytheon can survive the feast-or-famine of government contracting, but little companies can't. "It's not a year-in, year-out business that you can count on," says venture capitalist Gary J. Morgenthaler, who has invested in three defense-related startups, including Crossbow. Indeed, Crossbow President Michael A. Horton is more excited that the Federal Aviation Administration recently cleared its digital guidance systems for use in commercial airplanes. That opens the $148 billion aviation market up to the startup.

Still, the Defense Dept.'s digital doctrine is opening plenty of doors for commercial tech companies. Take the Land Warrior. In the mid-1990s, the U.S. Army project promised to turn soldiers into high-tech fighting machines with laser-guided rifles and a computerized display of battlefield conditions embedded in their helmets. But the prototypes, built by Raytheon, weighed more than 80 pounds and cost $90,000 apiece. The General Accounting Office squawked about cost overruns.

Brushing aside traditional defense contractors, the Army called on Exponent Inc., a Menlo Park (Calif.) consulting firm, to head a new consortium. Using off-the-shelf parts such as Intel Corp. chips that they bought from retail stores such as Fry's Electronics, the team produced a unit 25 pounds lighter and $80,000 cheaper. Defense contractor General Dynamics recently got the contract to build the units for delivery in 2005. Nonetheless, there's a new guiding principle for future military gear, says Hugh Duffy, former chief executive of PEMSTAR Pacific Consultants, which worked on the new unit: "Just go to Fry's."

By Jim Kerstetter, in San Mateo, Calif., and Stan Crock in Washington, with Robert D. Hof in San Mateo and bureau reports

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