How Defense Contractors Hope to Cope

The defense industry is often discussed as if it were a monolithic giant, but it consists of an estimated 40,000 companies across the nation that differ widely in their involvement in the arms business.

Although defense budgets have been dropping 2% annually since 1985 and their decline could accelerate during the 1990s, the market for weapons procurement and research still amounts to an awesome $120 billion a year.

“The defense industry in the United States does not have to be at its present peak size to be a very healthy, profitable, vital industry,” Hughes Aircraft Chairman Malcolm R. Currie said. “I felt very strongly that it would be far better to be somewhat smaller in size and be leaner, more competitive and to be profitable, than to go for size alone.”

Indeed, the defense boom of the 1980s left many companies weaker by the end of the decade than they were at the start. As defense budgets drop in coming years, the effects will vary widely, forcing some companies into mergers or closure and putting others into positions of strength. Here is a look at how major Southern California defense prime contractors are positioned for the coming shakeout.

Hughes Aircraft Co.

Hughes Aircraft has set a goal to double its non-defense business by the end of the 1990s, clearly the most ambitious diversification program in the aerospace industry.

Unlike past efforts by defense contractors to diversify, which in large measure have been business failures, the Hughes plan concentrates on extending Hughes’ existing, fast-growing line of commercial products.

“We are not jumping over the moon to another green pasture and hoping for salvation,” said Currie in a recent interview. “I would be naive as hell to say it is easy to capitalize on (defense technology) in commercial markets. That is a very, very difficult transition to make. We are making that transition where it makes sense, where we can put one foot in front of the other carefully and know what we are getting into.”

One key advantage that Los Angeles-based Hughes has is three decades of experience in building commercial communications satellites, in which it remains a world leader. During the 1980s, the company moved aggressively to extend its involvement in communications to ground-based networks and today has rapidly growing earnings in providing businesses such as Holiday Inns and Target retail stores with private communications systems.

Another major growth area for Hughes, a subsidiary of General Motors, will be in military training. A third new non-defense market will be in civilian air-traffic control. After losing a bid to build a massive new system for the United States, Hughes recently won a contract to supply a system to Canada, positioning the company for a major global market.

“There is a crying need in the world today for air traffic control,” Currie said.

By the late 1990s, Hughes could realize half its sales from non-defense business, up from 20% to 25% today, Currie said. The change in mix would occur through growth rather than loss of defense business, he added.

Hughes will close 1989 after having gone through a painful 6,000-worker reduction, prompted in part by the expectation that defense markets would shrink and by the company’s need to bring down its historically high costs. Its current work force of 65,000 is down from a peak of 80,000 a few years ago, and its backlog is large.

“I feel pretty good about our basic strength,” Currie said. “We are not going to get wiped out by any one or two or three cancellations, but almost anything that happens affects us in one way or another because we are so broadly diversified. There is just no getting around that.”

Rockwell International

Rockwell International Corp. has been perhaps the most fortunate prime military contractor in the nation during the past decade. It was big in defense when the going was good during the early years of the Reagan Administration buildup and has withdrawn sharply in the late 1980s when defense became far less profitable.

Today, defense programs account for just 28% of El Segundo-based Rockwell’s revenues, and that base does not contain any controversial programs that are at the forefront of the defense debate, notes company Chairman Donald R. Beall.

“From the narrow Rockwell view, the Department of Defense business has already over the last several years come down considerably, much more than I would expect would be affected by whatever the future budget situation will be,” Beall said.

Rockwell derives more than half of its sales from such non-government businesses as producing motor vehicle components, newspaper printing presses, industrial electronics and commercial electronics.

“I am very pleased to be in the position Rockwell is in to deal with the uncertain times ahead,” Beall said.

Even though the defense budget is coming down, Beall believes that the company’s government business will remain flat.

Rockwell is the largest contractor to the National Aeronautics and Space Administration, whose budget has long languished at around $8 billion annually but is now growing rapidly. In the current fiscal year, NASA’s budget jumped to $10.9 billion from 1988’s funding level of $8.9 billion. In 1991, NASA’s budget will be $12.2 billion.

The company, which employs 35,600 workers in Southern California, down from a mid-1980s peak of 42,000, is building another space shuttle in Palmdale and was just awarded a contract to build structural pieces for what could be a fifth shuttle. Its rocket engine business in Canoga Park is soaring on orders for expendable rocket programs.

At the same time, Beall said, the firm has a large number of defense electronics programs that are ready to go into production, systems that are unlikely to be cut even in the austere times ahead.

“On balance, we are more likely to grow than to not grow,” Beall said about the company’s government business. “Overall, I don’t see a major reduction in our Southern California work force.”

Northrop Corp.

With about half of its sales coming from the B-2 Stealth bomber program, Northrop will do well if that single program does well. But the risk is that a cancellation of the B-2 would decapitate the Los Angeles-based firm.

Northrop President Kent Kresa said a key test of B-2 support will be whether Congress authorizes and funds production of five of the bombers in the 1991 Pentagon budget. Defense Secretary Dick Cheney has thrown his support to the program.

“We are looking forward to getting on the path to reasonable rate production of the B-2,” Kresa said. “Right now, we are at very low rates. As we get to five and then hopefully to 10, we get into production.”

If that occurs, Northrop would increase its production work force while reducing staffing for development of the radar-evading bomber. There would be little net change in the current 12,000-member B-2 work force.

But Congress may delay B-2 production and order more flight testing. If that happens, a significant net reduction in the work force could occur.

Kresa projected that Northrop’s work force will be flat to slightly down in 1990, which depends on the already enacted 1990 Pentagon budget. The firm has 42,000 employes, 75% of whom are in Southern California. Northrop reduced its work force by 3,000 in 1989 to cope with reduced business and to cut overhead. In 1987, it hit a peak employment of 48,200.

The Air Force has planned to buy 132 B-2s for an estimated program cost of $70 billion or $530 million each, including already completed development. Northrop officials say the actual cost for production of the aircraft is about $274 million each.

Aside from the B-2, the company is competing for the giant $68-billion Advanced Tactical Fighter program, which is likely to be delayed by falling budgets. Northrop has 600 employes working on the program and recently delivered the first secret prototype aircraft to the Air Force.

Kresa rejects the idea of any major diversification out of the defense industry before the end of the 1990s. The only significant non-defense business that the company has is the production of fuselages for the Boeing 747 commercial airliner. That is growing but remains a small part of Northrop’s revenues.

Lockheed Corp.

While some aerospace companies are facing a difficult period of shrinkage, Lockheed has already undergone a considerable downsizing.

Lockheed’s current work force of 80,200, including about 18,200 workers in Southern California, is down from a peak of 99,300 in 1987, when its C-5B cargo jet program was in full production.

The company, headquartered in Calabasas, derives about 78% of its revenues from defense work and the balance from the space agency, commercial markets and weapons exports. Its non-defense segment is expected to grow, but Lockheed has not set a specific goal for it.

Lockheed Chairman Daniel M. Tellep said he believes that the company is well positioned to weather the coming defense cuts, even though Lockheed is not as well diversified outside defense as some other prime contractors.

“We are projecting moderate growth,” Tellep said. “Now, what we haven’t factored into that is what you might call a disaster scenario where the defense budget gets cut to $200 billion (from its present $291 billion). We don’t believe that is going to happen.

“For the most likely scenarios, which are declines in defense budgets, we think we are well postured in the defense market with systems like Trident,” he said, referring to the submarine-based nuclear missile that Lockheed builds for the Navy. “We know that our classified space systems look very healthy. Despite Strategic Defense Initiative cuts, we are postured in the strongest programs. We don’t see in the next several years major cuts in our SDI programs.”

Lockheed will deliver in 1990 the last of its F-117A Stealth fighters, the top-secret craft that has been in production at the firm’s Burbank plant since the mid-1980s. In the past year, the aerospace firm has also ceased production of the P-3C submarine patrol aircraft, C-5 cargo jet and the TR-1 reconnaissance plane.

Additional work force cutbacks are likely in Lockheed’s aircraft business, which is in Burbank, Palmdale and Rye Canyon, as well as in Georgia. But Tellep declined to speculate on those impacts.

The dearth of aircraft business at Lockheed makes winning the Advanced Tactical Fighter program all the more important. Lockheed is competing against Northrop for that Air Force program. The program, however, may come under severe budget pressure. The firm is also developing the P-7A anti-submarine patrol plane.

“I asked our people to put together the most pessimistic scenario possible,” Tellep said. “For the most part, we looked at the structure of Lockheed, and our big-ticket programs . . . enjoy high priority. Of the ones in the bag, the greater proportion of our revenue and income lie ahead of us.

“So, the common perception is that we are running out of gas and nothing lies ahead,” he added. “That is just not true.”

General Dynamics

General Dynamics Corp. is facing a continuation of the contraction of its missile business that has been going on for the past year. The St. Louis-based firm has two of its tactical missile production divisions in Southern California, as well as divisions for cruise missile production, airframe subcontracting and spacecraft work.

At the firm’s Pomona division, which builds the Navy’s Standard missile and Phalanx gun, employment is down to 5,200 from a peak of about 8,000 three years ago.

General Dynamics Executive Vice President Ralph E. Hawes, who oversees the firm’s missile business in California, said he expects that Pomona division employment could continue to shrink over the next two to three years by 30% to 40%. The reductions would result from the Navy’s decision to establish a second production source for Pomona’s systems as part of an initiative to increase competition and cut costs.

“Right now, the Navy is procuring one-half the number of Standard missiles and Phalanxes that they projected they were going to procure when they established second sources on those programs,” Hawes observed. “So, there is no question there is overcapacity.”

The outlook at the firm’s Valley Systems division in Rancho Cucamonga is somewhat better for the next several years. The division has about 3,400 workers and should be stable in the near term. But if a second source begins production on the Stinger missile, as expected, the division could have excess capacity, Hawes said.

General Dynamics’ electronics division and its Convair division, both in San Diego, should be stable, Hawes said.

“General Dynamics, overall, I won’t say we are in an excellent position, but it borders on that,” he said.

TRW Inc.

TRW, one of the most enigmatic defense companies, believes that its Space and Defense Sector in Redondo Beach, with 800 programs, should weather the upcoming defense downturn well.

“While we are uncertain about what the Department of Defense funding will be, TRW feels its programs in the arena of command and control, surveillance, intelligence and other high-priority systems should position us well for both the short term and the long term,” Vice President Julien Levine said.

Levine said TRW has a plan to expand its non-defense government business, which now amounts to just 10% of its space and defense sector sales, but has not established a goal for that growth. The sector comprises about 45% of the Cleveland-based parent’s sales. Automotive products sales make up 44% of TRW sales.

In the past year, the firm has had stable employment in Southern California of about 17,700, losing about 3,000 workers through attrition in the past year and hiring a like number. The diversified electronics and spacecraft company hit peak employment of 20,000 in 1987. In 1988, it laid off 1,000 workers after it was told by the Pentagon to stop work on a secret program.

Since so many of TRW’s programs are highly classified, it is difficult to assess whether they will be jeopardized by a plunging defense budget. One of the company’s biggest programs is serving as the systems engineer for the Air Force’s nuclear missile programs. That involves 1,200 jobs in San Bernardino.

McDonnell Douglas

McDonnell Douglas will exit the 1980s in one of the most enviable but financially risky positions in the aerospace industry.

While some other contractors will be scrambling to avoid calamity as defense budgets fall, the St. Louis-based firm’s Douglas Aircraft Co. unit in Long Beach has a massive commercial and military aircraft backlog that will extend production past the turn of the century.

But Douglas is going through a wrenching period of huge losses on those programs, coupled with a sweeping reorganization and an effort to create a new corporate culture emphasizing product quality.

It has fallen behind schedule on its Air Force C-17 jet transport, T-45 Navy training plane and MD-11 wide-body airliner programs and, during much of 1989, was plagued by production delays on its MD-80 series of jetliners. The unit has lost $227 million so far this year.

Just last week, the company announced that it would transfer production of the T-45 from Douglas to its McDonnell Aircraft Co. in St. Louis, a move that will affect 1,800 workers. But growth in other programs will not result in any job losses in Long Beach, Douglas officials said.

Douglas has 37,000 employees in Long Beach, 5,300 at a parts fabrication plant in Torrance and 1,000 at out-of-state facilities. That’s up from a trough of just 12,000 in Long Beach and 1,000 in Torrance in 1984. Company spokesman Don Hanson said there will be continued employment growth next year, but not at the 20% level recorded in the past several years.

The Air Force is planning to reduce production of the C-17 program, which employs 8,000, from the 10 aircraft previously planned to six. That will delay a production buildup at Douglas, as the Air Force decides whether it really wants the C-17.

Meanwhile, delays in development of the C-17 have resulted in Douglas overrunning its target cost on the program and nearing the so-called “contract ceiling,” over which it would have to absorb all expenses as a loss.