Reorgs and Layoffs as Defense Industry Prepares for New Budget Squeezes
We’ve been predicting this
situation for over a year, talking about DOD funding shortfalls and budget cuts at Federal
agencies, leading to a downturn affecting
the entire aerospace and defense industry. The future is now the
present, and A&D companies are making the necessary adjustments to
retain their market share in the face of industry challenges. As we reported in September 2009, some industry insiders expected company
leadership to be smarter about making downsizing decisions this time
around, hopefully having learned painful lessons from the last round of
cuts in the 90’s. In fact, we even noted
that a couple of defense companies (including Lockheed Martin) were
adding to their executive ranks under the assumption that an enhanced
focus on strategy, execution, and customer relationships would lead to
better results. We could go on, listing and linking to more articles on
this topic, but we believe we’ve made the point—times are getting
tough, and the tough times were predictable.
Companies continue to make adjustments in response to market
pressures, which now include a new DOD initiative to slash contractor overhead. In mid-June 2010, BAE Systems announced a reorganization designed for “better delivering our strategy
in an increasingly cost-conscious marketplace.” The reorganization
details were not provided but, as part of the realignment BAE reportedly
will close down its operating headquarters of Electronics, Intelligence
and Support divisions (EI&S) effective July 1, 2010.
In addition, Lockheed Martin announced on July 6, 2010 that it was “offering incentives to thin out
its executive ranks in a move to lower overhead costs” (according to the
Wall Street Journal article, link above). The WSJ article also reports
that—
‘Our customers are facing
increasing demands with constrained resources, and they're relying on us
to give them the very best value within these constraints,’ Chairman
and Chief Executive Bob Stevens said Tuesday. He specifically mentioned
recent comments by Pentagon officials regarding productivity and
cost-savings programs.
His
comments echo others he made recently about how the defense giant is
bracing for belt-tightening at the U.S. Department of Defense. The
company also has undergone a business reorganization and has cut back
its participation in international trade shows, and it plans to sell two
units.
The company is reportedly offering
Directors and Vice Presidents a “Voluntary Executive Separation
Program,” which consists of “financial incentives” if they leave the
company by February, 2011. While Lockheed Martin declined to specify a
target number of employees it hopes will accept the VESP incentives,
reports indicate that a reduction of 7 percent would not be out of line.
Meanwhile, DOD Comptroller Robert Hale said in a recent interview that “U.S. spending on weapons through 2016 likely will grow
faster than the overall defense budget, which will have annual increases
of only about 1 percent above inflation,” according to an article at
Bloomberg Businessweek (link above). The article reports that—
‘Procurement and research are in the ‘gaining’
portion of the budget,’ Hale said. ‘The goal would be to move money from
support-type activities -- operations and maintenance, military
construction -- into acquisition.’
The
foregoing was seen as “good news for defense contractors,” according to
one industry analyst quoted in the article.
What
is one to make of these seemingly contradictory statements—i.e.,
stating that overhead must be cut and programs must become more
“affordable” while concurrently stating that weapons spending (and
indeed the entire DOD budget) will continue to grow? Quite candidly,
readers of this site should have seen it coming. We reported that “current Defense budget levels are nearly double what they were a decade ago, even
after adjusting for inflation.” We also opined that, “if Obama Defense spending is reaching a
plateau, that plateau is at least 5 percent higher than recent history
in inflation-adjusted dollars.” We provided a link to a study by the
Project on Defense Alternatives (PDA) that probed the seeming
contradiction between real budget growth and the need for more budget.
One of the causal factors the PDA study mentioned was DOD spending per
uniformed service member, which had increased by nearly 50 percent per individual over the decade between 2000 and 2010.
The study reported that, “the increase was
enough to bring total personnel expenditures back up to Cold War levels –
for a military only 69% as large.”
To sum up,
it appears as if DOD spending—and not
contractor spending—is driving the need to develop weapon systems more
efficiently, and certainly less expensively, than has been the historic
norm. Whether that is possible or not remains to be seen. But in the
meantime, defense contractors are reorganizing and cutting overhead in
an attempt to be seen as part of the solution, rather than part of the
problem.
FAR Revised to Eliminate Profit on Cost of Direct-Charged Equipment
In August,
2009, we reported on a proposed FAR rule
that looked very much as if it would have required Contracting Officers
to exclude from profit consideration “all contractor-acquired property,
unless an item is expressly called-out as a contract deliverable,” when
establishing pre-negotiation profit objectives. Well, the final rule was published on July 2, 2010 and, while it contained some
changes from the proposed rule, it still contained some troubling
language.
First, as we noted in our article,
the location of the proposed profit language seemed illogical. We were
pleased to note that the FAR Councils relocated the profit language from
15.404-4(a)(3) to 15.404-4(c)(3).
Several
commenters disagreed with the elimination of profit on
contractor-acquired property. The FAR Councils heard the objections and
modified some aspects of the proposed rule. But they left intact the
elimination of profit/fee on items that the contractor acquires, where
those items are not part of a deliverable.
The
final rule now states—
15.404-4 Profit.
* * * * *
(c) * * *
(3) * * * Before applying profit or fee
factors, the contracting officer shall exclude from the pre-negotiation
cost objective amounts the purchase cost of contractor-acquired property
that is categorized as equipment, as defined in FAR 45.101, and where
such equipment is to be charged directly to the contract. * * *
The term “equipment” is defined as—
Equipment means a tangible item that is
functionally complete for its intended purpose, durable, nonexpendable,
and needed for the performance of a contract. Equipment is not intended
for sale, and does not ordinarily lose its identity or become a
component part of another article when put into use. Equipment does not
include material, real property, special test equipment or special
tooling.
Why did the FAR Councils take this
approach? As they wrote in the promulgating comments—
While the application of this policy tended to be
obfuscated by the term ‘facilities,’ the underlying principle was
clear--that when the contractor buys equipment or acquires real property
on a ‘pass through’ basis, i.e., when not part of a deliverable, it is
the Government--not the contractor--who assumes the risk. Moreover, it
is generally held that upon contract award, contractors are required to
furnish all property necessary to perform Government contracts (FAR Part 45.102) as well as all
the necessary resources needed for contract performance (FAR 9.104-1(f),
General standards).
Accordingly, it is not appropriate for the Government to include the
cost of contractor acquired property (equipment) when calculating the
Government's pre-negotiation profit or fee objective. Including such
costs would unduly compensate the contractor for obtaining equipment it
should already have; and for risks it did not
incur. This is a long held view; however, up until the publication of
the proposed rule FAR Case 2008-011, it had not been adequately
addressed in the
FAR.
This policy does not exclude the otherwise
allowable cost of depreciation under FAR 31.205-11.
Accordingly, contractors now have a clear disincentive to
direct-charge costs of purchasing equipment to their Government
contracts. Instead, we should expect them to include such costs in
their overhead rates, as depreciation. However, given DOD’s recent emphasis on curbing contractor overhead, this strategy has its own
pitfalls.
The new rule contains much more
than the policy statement noted above. But this is the one that caught
our eye. Interested readers should follow the link above and review the
multi-faceted rule in its entirety.
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KC-X Aerial Tanker Update—The Russians Are Back!
When last we looked at this problem-plagued plane procurement, President Obama
and his Pentagon “indicated it would welcome” a bid from a foreign
manufacturer—which at the time everybody thought would be EADS. But
then a wildcard was introduced into the game, as a Russian aircraft firm
reportedly was gearing-up to offer a variant of the Illyushin-96
widebody jetliner, to be designated Il-98. We smirked, picturing the
face of Boeing executives, who had worked so hard to turn the
competition into a “low-price, technically acceptable” game in which
there was almost no chance for the other side to win—and forcing
Northrop Grumman to concede. Given the
huge gap in labor and material costs between the two entities, we opined
that there was essentially no chance for Boeing to beat the Russians on
price. The only way for Boeing to beat the Russians, and to secure
what has been called the largest Pentagon contract ever, would be to
change the game and, if that happened, there were many European nations
prepared to cry “foul”.
But almost immediately the reports
were denied, and the competition settled down to Boeing versus EADS.
But quite recently (July, 2010) reports surfaced that yet another bidder had entered the field—and this time it
was Antonov out of the Ukraine. Employing a strategy similar to that
reported for Illyushin, Antonov has executed an agreement to sell
through a Southern California.-based defense contractor, U.S.
Aerospace, Inc. According to the article at
AirForceTimes (link above)—
Under
terms of a “strategic cooperation agreement” signed July 1 in Kiev,
Ukraine, “final assembly” of an U.S. Aerospace-Antonov tanker would take
place on U.S. soil. Defense News obtained a copy of the agreement. The
American company would oversee that stage of production.
U.S. Aerospace would coordinate the bidding
process, negotiate with the Air Force, coordinate with subcontractors,
ensure conformity of aircraft to requirements of RFP for KC-X Tanker
Modernization Program,” according to the agreement.
Antonov would integrate components into the
aircraft, work with its U.S. partner on preparing the aircraft for
certification and testing, and “manufacturing and delivering to [U.S.
Aerospace] specified aircraft and components,” states the pact.
What is Antonov offering the U.S. Air Force? According to
that same article—
The source said U.S. Aerospace
and Antonov plan to enter the four-engine AN-124-100, and a two-engine
variant of that airframe known as the AN-122. In a further twist, the
U.S.-Ukrainian team plans to enter “a new plane designed to meet the
[KC-X] specs, dubbed the AN-112,” the source told Defense News. The
AN-112 would be, if eventually entered, the only plane in the race
designed specifically for the Air Force’s tanker requirements.
Bids were due to be submitted by July 9, 2010. But at least
one source has reported that the new bidder has requested a 60-day
extension in order to prepare its bid. As of this date, it is not clear
whether the Pentagon will agree to the extension.
This Reuters article notes that—
John Kirkland, a Los Angeles-based attorney for
U.S. Aerospace, [said] the [Antonov] team would offer the Pentagon a
‘dramatically’ lower price for a far more capable plane.
Kirkland said Antonov, maker of the world's
largest cargo planes, had modified an existing military cargo plane to
meet U.S. specifications. Unlike the commercial derivative planes
offered by rival bidders, the plane had a rear cargo door, a more stable
airframe, and could land on dirt runways.
(We
should note that Mr. Kirkland was also involved in the Illyushin bid as
well.)
Some commenters dismissed the tardy
bid as a “waste of time” (according to the Reuters article) because of
various issues—among them the financial troubles of U.S. Aerospace,
Inc. The company, which trades over-the-counter (as USAE), “reported a
net loss of $14 million in 2009,” according to Reuters. The article
also had this to say about the U.S. face of the Antonov team—
The company told investors in May it was in
default on several notes and had an accumulated deficit of $28 million,
which raised substantial concerns about its future unless it was able to
secure additional debt and equity financing.
It’s an old adage that, if the RFP is the first
time a bidder learns of an opportunity, it shouldn’t bother
bidding—because it has already lost. We wonder if the Antonov team
(including Mr. Kirkland) has heard of that adage, or believes it applies
to this situation. Time will tell.
Manned Space Exploration—Where Do We Go From Here?
The National Aeronautics and Space
Administration (NASA) has been treated like a red-headed stepchild over
the past few Presidential administrations. Sure, Presidents talk a good
game—return to the Moon, human exploration of Mars, et cetera—but we
all know that the budget needs of the agency have taken a distant back
seat to the needs of other Executive agencies, including the Department
of Defense. After all, fighting a Global War on Terror clearly takes
precedence, as do the needs of the
Department of Homeland Security.
Even if
NASA had been given all the funding it needed, there is some question as
to whether they could have spent wisely.
In any case, things look bleak for the beleaguered agency. We have
posted before about findings from the Augustine panel or Augustine
Commission or The Review of U.S. Human Spaceflight Plans Committee (or
whatever you want to call it). See, for example, this post or this one.
The Augustine Commission told President Obama—
The U.S. human spaceflight program appears to be
on an unsustainable trajectory. It is perpetuating the perilous practice of pursuing goals
that do not match allocated resources. Space operations are among the most demanding and unforgiving
pursuits ever undertaken by humans. … Space operations become all the
more difficult when means do not match aspirations. Such is the case today. … Once the Shuttle is retired, there
will be a gap in the capability of the United States itself to launch
humans into space. … The Committee did not identify any credible
approach employing new capabilities that could shorten the gap to less
than six years. The only
way to significantly close the gap is to extend the life of the Shuttle
Program.
There are some who have called for
NASA to get out of way, and let private industry tackle the problem.
For example, this blog entry asserted that
the Government simply can’t oversee space
exploration. Conquering space? Sure. But exploring it? Not a
chance. The Government needs to get out of the way of the entrepreneurs
who have the necessary vision and passion to lead the exploration of space. The author, Jim Wright, said—
Governments don’t explore.
Governments conquer. Governments grandstand
and stage stunts. Governments argue and bicker and wage war. Some are
good and some are bad and some are indifferent.
But they don’t explore.
It is human beings who explore. Individuals of
courage and daring and burning passion and enterprise. …
The Constellation
program has been doomed from the start. Hell, the Constellation program
has been doomed since July 20th, 1969. We’ve been there, we’ve done that –
and America as a nation wasn’t interested
in continuing when we had the hardware and the
resources, what makes you think we’ll do it now when we have to recreate
the entire infrastructure at a hundred or a thousand times the cost?
Access to space hasn’t gotten cheaper or less complex, just the opposite
in fact. The age of daring, of the test pilot astronaut is over – it’s
the age of the bean counter. Constellation has always been underfunded, organized by committee after
endless committee, awash in adminstrivia and paperwork and government
bullshit – and really, it was never more than a political gambit by an
uninspired and uninspiring twit of an anti-science President who tried
to pull a do-over of JFK but couldn’t motivate his own Administration
let alone galvanize the nation…
Constellation has always been doomed.
Constellation has always been doomed because governments don’t
explore. Bean counters and bureaucrats don’t explore. Because when
Congress runs your space program, indeed any program, you are doomed
from the start. …
It is
private corporations who explore, hunting profit and new markets and
assets and resources. …
Governments
don’t explore, but if they do the job right their citizens do.
We have
discussed several private industry initiatives that would advance the
state of space exploration technology. For example, we reported on the VASIMIR© plasma propulsion engine and the company
developing the promising technology, the Ad Astra Rocket Company. We also reported on ALICE
(Aluminum/ICE) propellant that would drastically lower launch expenses
because it could be manufactured on the Moon or Mars instead of being
transported there. So President Obama’s recent call to NASA to “jump-start development of a commercial space
industry” instead of focusing on the Constellation program is not as
far-fetched as it may at first seem.
Here is a
link to details of the Obama Space Plan, over
at Space.com.
One of the private companies best
positioned to capitalize on the Obama Plan is SpaceX (Space Exploration Technologies). We have written about
SpaceX before—notably here, where we noted
its aim of reducing launch costs “by a factor of ten.” The company is
also linked to VASIMIR©, as we reported it was in negotiations to
deliver Ad Astra’s VX-200 model to the International Space Station for
testing in space.
Here is a snippet from Elan Musk’s
statement on the Obama Space Plan, as found on the company’s site.
In 2003, following the
Columbia accident, President Bush began development of … the Ares I
rocket and Orion spacecraft. It is important to note that this too would
only have been able to reach low Earth orbit. Many in the media
mistakenly assumed it was capable of reaching the Moon. As is not
unusual with large government programs, the schedule slipped by several
years and costs ballooned by tens of billions.
By the time President Obama cancelled Ares
I/Orion earlier this year, the schedule had already slipped five years
to 2017 and completing development would have required another $50
billion. Moreover, the cost per flight, inclusive of overhead, was
estimated to be at least $1.5 billion compared to the $1 billion of
Shuttle, despite carrying only four people to Shuttle's seven and almost
no cargo.
The
President quite reasonably concluded that spending $50 billion to
develop a vehicle that would cost 50% more to operate, but carry 50%
less payload was perhaps not the best possible use of funds. To quote a
member of the Augustine Commission, which was convened by the President
to analyze Ares/Orion, ‘If Santa Claus brought us the system tomorrow,
fully developed, and the budget didn't change, our next action would
have to be to cancel it,’ because we can't afford the annual operating
costs.
Cancellation was therefore
simply a matter of time and thankfully we have a president with the
political courage to do the right thing sooner rather than later. We can
ill afford the expense of an ‘Apollo on steroids’, as a former NASA
Administrator referred to the Ares/Orion program. …
Thankfully, as a result of funds freed up by
this cancellation, there is now hope for a bright future in space
exploration. The new plan is to harness our nation's unparalleled system
of free enterprise … to create far more reliable and affordable
rockets. Handing over Earth orbit transport to American commercial
companies, overseen of course by NASA and the FAA, will free up the NASA
resources necessary to develop interplanetary transport technologies.
This is critically important if we are to reach Mars, the next giant
leap in human exploration of the Universe.
… For the first time since Apollo, our country will have a
plan for space exploration that inspires and excites all who look to the
stars. Even more important, it will work.
On
June 7, 2010, SpaceX reported that its
Falcon 9 launch vehicle had successfully launched “and achieved full
Earth orbit right on target.” As the company announced—
SpaceX currently has an extensive and diverse
manifest of over 30 contracted missions, including 18 missions to
deliver commercial satellites to orbit. In addition, the Falcon 9 launch
vehicle and Dragon spacecraft have been contracted by NASA to carry
cargo, which includes live plants and animals, to and from the ISS. Both
Falcon 9 and Dragon have already been designed to meet NASA’s published
human rating standards for astronaut transport, allowing for a rapid
transition to astronauts within three years of receiving a contract to
do so. The critical path item is development and testing of the launch
escape system, which would be a significant improvement in safety over
the Space Shuttle, which does not possess an escape system.
Yes, we are heartsick at the United States Government’s
abandonment of its commitment to manned space flight. But so long as
the future of the program is in the hands of companies such as Ad Astra
and SpaceX, we are not overly despondent. To put it another way, we’d
rather have Elan Musk and Franklin Chang
Diaz running the show, instead of the current
NASA administrator and his team.
PHOTO
CREDIT: The Russian Progress resupply craft on track to
dock with the International Space Station. The first attempt was
aborted, but the second attempt was successful. Photo courtesy of NASA.
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