Will Defense Consolidations Impact Efforts to Eliminate Sole-Source Contracting?

Dennis Muilenburg

Defense industry experts are bracing for a major consolidation after public comments last Tuesday from Dennis Muilenburg, CEO of Boeing’s defense, space and security division, fueled rumors that the company might consider a merger with Northrop Grumman.

However, a Boeing-Northrop merger would put almost half of all defense work in the hands of one giant company, which would severely complicate the Pentagon’s efforts to eliminate sole-source contracts.

“We continue to see acquisitions as an opportunity area for us,” Muilenburg commented at the Reuters Aerospace and Defense Summit in Washington.  “It’s one of the tools that we use to grow.”

He added that Boeing was targeting acquisitions in sectors including unmanned aircraft, cybersecurity and intelligence and surveillance systems, markets in which Northrop is a key player.

“I’m not going to rule out or rule in any options,” Muilenburg said on Tuesday. “Obviously, as we see defense budget pressure, that does at times lead to potential consolidation.”

However, the same political forces driving Robert Gates’ major cuts to defense could complicate a Boeing-Northrop merger, since sole-source contracts have become a political liability.   Since Northrop already subcontracts on Boeing’s F/A-18 Super Hornet fighter and the E/A-18 Growler electronic warfare aircraft, a merger would mean sole-sourcing most of those aircraft’s components, which could be problematic given the recent controversy over the sole-source contract for the F-35’s engine.

David Hess, President of Pratt & Whitney, said of the controversy:

“Every platform in the [military] inventory, whether it’s a helicopter or fighter or a tanker, has a single engine because of the economics, because of the cost of developing a second engine, and because of the cost of maintaining two engines.”

Hess attributes the push for a second engine to political pressure from GE and Rolls-Royce, who will design it, and a legislative environment where Congressmen can dabble in aeronautical engineering makes a Boeing-Northrop merger seem risky.

In fact, every one of Northrop’s business units except shipbuilding plays some role in the F-35 Joint Strike Fighter’s production, and while the aircraft was designed primarily by Lockheed Martin, consolidating the production of any portion of the largest defense contract at the Pentagon could provoke a political backlash.

Aside from domestic politics, a Boeing-Northrop merger could affect international trade relations. In October 2006, the day after the United States filed a WTO complaint that EU governments provided illegal subsidies to Airbus, Brussels filed a counter suit alleging the United States did the same with Boeing. The EU complaint alleges the U.S. government illegally funneled $26 billion in military research funds into Boeing’s commercial air sector. If Boeing and Northrop Grumman merge and almost half of DoD’s discretionary funds wind up at the new conglomerate, an already tense climate of international trade might grow downright hostile.

Talks of a Northrop Grumman-Boeing merger remind many in the defense industry of the legendary “last supper” in 1993. As former Lockheed Martin CEO Norm Augustine wrote in DoD Buzz: “The invitation received by about 15 defense industry chief executives in 1993 to drop by the Pentagon for dinner was signed by Defense Secretary Les Aspin. It was, as the saying goes, an invitation one simply couldn’t refuse. The events that took place that evening forever changed the character of the U.S. defense industry.”

What happened next? “General Electric Aerospace merged with Martin Marietta, which combined with Lockheed. McDonnell Douglas joined Boeing. Grumman joined Northrop. When the dust had cleared, there were only a few firms left standing.”

Industry experts agree a Boeing-Northrop Grumman merger would make sense: Projected cuts in defense spending always spur talks of industry consolidation. Loren Thompson of the Lexington Institute writes that weapons spending fell by 50 percent during the last two downturns, and the same could happen again this time.

“That means that at least one of the big players will have to exit if we are facing a similar downturn in the years ahead,” he writes.

Thompson agrees, writing that such a merger would require major divestitures in strategic growth areas like space operations to satisfy federal antitrust regulators, which would make the transaction less attractive.

“In addition, there is little evidence at present that Northrop Grumman CEO Wes Bush or his board is interested in being bought,” he writes.

But, despite all these potential hurdles, Boeing is still a motivated buyer, since Robert Gates recently cut 330 billion from future defense spending plans.  Thompson writes that maintaining revenues based on a surge in commercial aircraft demand is “a hard thing to accomplish” when your defense customer “is terminating everything from the Army’s Future Combat System to the Air Force’s C-17 transport to the Missile Defense Agency’s interceptor complex in Europe.”

While a Northrop-Boeing merger might seem far-fetched, given Lockheed’s move this week to trim its executive workforce by almost 25 percent and cut almost 10,000 total jobs and similar cuts in the works for Boeing and Northrop, it’s clear that big changes are coming.  In the words of Yeats, “Things fall apart, the center cannot hold.”

Something’s got to give in the defense industry. Hopefully, the defense industrial base can emerge intact from budget cuts and political quagmires.

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