Contractors Advised to Focus Less On Stock Prices, More on Customers

Produce things faster. Lower the weight of weapon systems. Increase fuel efficiency. Stay on schedule. Cut your costs.

That sort of sums up the Pentagon’s marching orders to its contractors.

So, what else is new?

Apparently, quite a bit, according to the latest chatter in corporate boardrooms. While the military’s budget is so far being spared from the big knives, it is becoming more evident that Pentagon contractors will have to think differently about their business if they want to maintain or improve the financial performance they have enjoyed over the past decade, insiders say.

Company executives, for instance, may have to reconsider how much time they dedicate to efforts that boost their stock value, compared to what they spend taking care of their customers, says Steve Grundman, vice president of aerospace and defense at Charles River Associates, a Boston-based consulting firm.

During the Cold War, contractors talked obsessively about “the customer.” When the budget plunged in the early 1990s, companies still thrived by acquiring or merging with competitors. The shareholder became king. Now the pendulum may be swinging back to the middle, Grundman tells executives at a conference in Washington, D.C., hosted by Aviation Week.

“The Defense Department wants solutions to problems” and the Pentagon’s leadership does not see much help coming from the industry right now, Grundman says. The mantra of Defense Acquisition Chief Ashton Carter is to do “more without more.” Translation: He wants the cost curves that consumers enjoy at Best Buy. Besides cost, the other big problem that Defense wants solved has to do with innovation, but not in the traditional sense, Grundman says. It’s no longer about designing the shiniest or the sexiest widget. Military commanders worry about things like the weight of armor, the efficiency of batteries and how unbearably long it takes to analyze video streams from overhead drones.

Nothing on this wish list qualifies under what industry considers traditional products, says Stanley R. Szemborski, vice president of corporate strategy at Northrop Grumman Corp.

“Our customer has different needs. Industry has to change,” he tells the conference.

It used to be that unless a company scored a big manufacturing contract for new hardware, it was doomed. That is no longer the case, Szemborski said. In the past, contractors that got awarded “the big one” had a future, he said. The losers did not. Based on that binary worldview, most companies would be now facing extinction because there are hardly any new big production deals on the horizon, he said. “Over 50 percent of the investment accounts fund minor procurement — things that don’t get any headlines,” said Szemborski. “There are great opportunities for those who know how to pursue them.”

At Northrop Grumman, he said, “we talk about cybersecurity, logistics, unmanned systems, ISR (intelligence, surveillance, reconnaissance).” In these areas, “we see a lot of opportunities and also a lot of competition.” The secret to winning? Putting together a team of suppliers, including small businesses, that can provide “integrated solutions,” instead of ordinary stand-alone products.

Having a monopoly of a particular product line no longer guarantees a lifetime of contracts, analysts say. As part of his “buying smarter” strategy, Carter has directed project managers to be creative about promoting competition. If only one contractor bids on a program, the government should consider changing the requirements in order to encourage alternative proposals.

Executives and investors generally are confident that the industry can adapt to whatever the new reality might be. What they fear most is instability. And despite assurances from Defense Secretary Robert Gates that the investment accounts are going to be protected, Wall Street analysts and corporate chiefs harbor some level of skepticism about weapon-development and procurement budgets staying at today’s levels when other “must pay” bills such as military payroll, health care and fuel costs are growing faster than anything else in the budget.

The corporate world doesn’t respond well to unpredictability. And the budget standoff that has gripped Capitol Hill since the beginning of the year has been making industry edgy.

“For industry, the hallmark is going to be stability,” said Steven J. Cortese, senior vice president of Washington operations at Alliant Techsystems Inc. With some predictability, “medium- to long-term decisions are possible,” he said. “That’s critical for companies.” The funding rollercoaster witnessed in recent months — with Congress only approving temporary funding extensions — has been “damaging, threatening to management,” Cortese said. “It drives a volatile pattern of behavior in industry. And makes acquisition officials in the Defense Department wary of making hard choices.” Once everyone gets more visibility into what’s coming next, he said, “buyer and seller can think through how to meet needed capabilities.”

If decisions are made to cut the defense budget, industry can live with it, as long as there is a plan in place, he said. “I don’t think the top line poses a threat to the vitality of the industry,” said Cortese.

For now, what seems crystal clear is that the Pentagon, regardless of what happens to the budget, will expect more bang for the buck, Cortese said. “Everything I see in the 2012 budget demonstrates performance is at a premium.”

Topics: Defense Contracting, Defense Department, DOD Budget