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US: Pentagon's Changing Priorities Challenge Lockheed

by Renae MerleWashington Post
February 23rd, 2004

Lockheed Martin Corp. at first seems almost as invincible as the fighter jets and missiles it makes.

Bethesda-based Lockheed, the largest defense contractor in the world, collected almost $22 billion of the $209 billion the Pentagon spent on prime contracts last year, widening its lead over its next biggest competitor, Chicago-based Boeing Co., to $4.6 billion. Many people in the industry expect Lockheed to dominate the fighter-jet market for the foreseeable future. It had orders for five commercial satellites in a dismal market last year, the most of any company. And President Bush has proposed increasing defense spending 7 percent, to almost $402 billion, next year.

So what could possibly worry Vance D. Coffman, the taciturn engineer who has led the company since 1997?

Plenty, experts say.

Lockheed's stranglehold on the military aircraft market is based on two planes, the F/A-22 Raptor and F-35 Joint Strike Fighter, both frequently lambasted by members of Congress for their technological problems and growing budgets. While Lockheed dominates the fighter market, it is not secure with unmanned drones, which many experts consider the future of military aviation. And the Pentagon is thinking about radical new ways of changing warfare that could threaten Lockheed's dominance.

Then there is the growing federal budget deficit, expected to top half a billion dollars this year, which could crimp Bush's plans to boost military spending. "If Congress has to choose between eliminating tax breaks, between repealing health care reform or cutting the defense budget, what do you think they're going to do?" said Jeffrey P. Bialos, who was a deputy defense undersecretary for industrial affairs in the Clinton administration.

When Coffman took over six years ago, Lockheed Martin, product of the merger of Martin Marietta Corp. and Lockheed Corp., was still in its infancy. The deal was not unusual: As defense spending fell after the Cold War, many defense contractors merged or bought one another to survive. Lockheed and Martin Marietta said the combined companies would be hugely efficient and save the government billions of dollars.

But soon the new company was in trouble, disappointing Wall Street by missing financial goals, blowing up rockets trying to launch satellites and making the ill-fated decision to join the telecommunications boom. Lockheed spent $2.6 billion for Comsat Corp., a global telecommunications company, and took a $1.7 billion charge when it left the business a few years later.

Business has improved. Coffman purged upper management and reorganized the company. Chief Financial Officer Robert J. Stevens quickly charmed Wall Street. Lockheed reduced its debt to $6 billion last year from $12 billion in 1999. It doubled its stock dividend and this month reported its largest backlog ever, almost $77 billion.

"Our goal is not to be big, our goal is to be good," said Stevens, who now is president and chief operating officer. "There is no complacency. It's a highly competitive marketplace."

Yet complacency is often a problem when you are the biggest company in your business.

"Lockheed's problem is that they're number one, so they have less incentive for across-the-board innovation," said Robbin F. Laird, a defense industry analyst. "These are challenges."

This is a bad time to be complacent. Beginning in the 1990s, the Pentagon rejected as too simplistic the traditional idea of building better ships, tanks or fighter jets. The new focus was on how to connect those weapons through satellites and computer networks, creating a "virtual battlefield." A soldier, for example, could access a satellite picture of a battlefield on a handheld computer and go into combat with an unmanned vehicle trailing with supplies. But just how to create smart battlefield technology can be difficult for defense giants accustomed to requests simply to make weapons faster, lighter or more lethal.

In 2002 Lockheed lost what many people in the industry considered one of the first real tests of whether contractors could adapt to the Pentagon's new manifesto. Boeing Co. won a contract to replace clunky Army tanks with high-tech, lightweight armored vehicles, and to connect soldiers through satellite and computer networks. The deal could be worth $90 billion over the next 20 years.

"Senior Army officials have said Boeing won because it has a vision, a framework under which all soldiers would work," said Loren B. Thompson Jr., a defense industry analyst for the public-policy think tank Lexington Institute. "You can't develop a credible vision unless you can bring everything together -- aircrafts, computers, everything. You have to be able to leverage every part of your capability to stay competitive."

Lockheed reacted to the trend by creating a new unit, Integrated Systems and Solutions, which looks across the company's businesses for opportunities to cooperate and merge expertise. When pursuing a contract, for example, the unit can pull together an aeronautics engineer in one unit with a software technician in another.

The unit's effectiveness will be tested in several competitions this year, including one for a piece of the Joint Tactical Radio System, which will replace thousands of single-band military radios used for voice communication. There are 25 brands and the Pentagon wants to replace them with one "family" of equipment that could be used for voice, data, imagery and video communications.

Lockheed's core business, though, remains fighter jets. Last year, aeronautics re-emerged as the company's largest unit, with the 25-year-old F-16 responsible for much of the increase. But the unit's future is tied up with two next-generation fighters: The F/A-22 and Joint Strike Fighter. The F/A-22 is an Air Force plane; the Joint Strike Fighter would be used by the Air Force, Navy and Marines.

The F/A-22, developed to confront forces of the Soviet Union, has been endangered for more than a decade as skeptics wondered whether the stealthy, supersonic fighter is necessary and whether the military needs two new fighters instead of just one. Lockheed has struggled with some of the plane's software. Some of the plane's functions, such as the flight-control screen in front of the pilot, have shut down during test flights. Restarting that program can take several minutes. Recently the federal Office of Management and Budget asked for another review of the fighter.

Rep. John P. Murtha (D-Pa.), ranking minority member of the House Appropriations Committee's subcommittee on defense, said he thinks there is no chance the fighter will be canceled. But there is room for concern.

"I think there is a chance they may not get the number of airplanes they want," Murtha said. The Air Force has already cut the number of planes it plans to order to 277 from about 700, although it says it needs 381. The plane, which was to have been delivered in 1996, is now scheduled for next year.

The Joint Strike Fighter is already expected to cost $7 billion more to develop than had originally been expected. It is expected to be sold widely overseas, but as Lockheed struggles to keep the planes from getting too heavy, the Pentagon decided to delay introduction of the fighter by a year.

While Lockheed dominates the fighter market, its position is not so secure with unmanned aerial vehicles, which many consider the future of military aviation.

It's a market from which Lockheed has been largely absent since 1998, when the Pentagon canceled the company's Dark Star, a high-altitude surveillance drone. The Pentagon is expected to spend almost $2 billion on such technology next year.

The company's only unmanned aerial vehicle is the low-flying Desert Hawk, which is used for surveillance, while Northrop Grumman Corp.'s Global Hawk and the Predator made by General Atomics have been stars of the wars in Iraq and Afghanistan.

"Lockheed, the premier fighter company, needs to participate in that market," said Philip Finnegan, director of corporate analysis at Teal Group, a defense industry research group.

Coffman is vague about his intentions -- possibly, a spokesman said later, because any plans the company has might be classified. "We obviously want to be a player in the market," Coffman said, not just a subcontractor.

Hanging over Lockheed's business prospects is the question of whether defense spending will decline. Bush's budget doesn't include the $50 billion that many experts expect the Pentagon to need in Iraq and Afghanistan, said Thompson, the defense industry consultant.

The Office of Management and Budget wants to limit the supplemental budget to fund operations in those countries to $30 billion and force the Pentagon to absorb the rest, Thompson said. That would mean cuts in budgets for research, development and procurement, which fuel the defense industry, Thompson said. That could hurt defense contractors, including Lockheed.



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