Defense Industry Goes With Guns, Not Butter

Recent merger of two defense companies fits growing trend

RAYTHEON Company's acquisition of a military-electronics firm this week fits a pattern in the US defense industry: Though faced with fewer orders from the Pentagon, defense contractors aren't converting from tanks to toasters.

Instead, most firms remain heavily involved in defense work while aggressively cutting jobs, closing plants, and pursuing mergers and acquisitions.

''The cancellation or culmination of several existing or projected major-weapons systems has had, and will continue to exert, a profound effect on the defense industrial base,'' says a recent report by the Defense Budget Project, a nonpartisan research group in Washington.

Last year saw more than a dozen major mergers and acquisitions, a dramatic increase over years past, the report states.

The latest consolidation in the industry, a $2.3 billion deal between Raytheon, a defense contractor in Lexington, Mass., and Dallas-based E-Systems, a leader in military intelligence technology, will create a conglomerate with more than $12 billion in annual revenue.

Defense industry consolidation is about 60 percent complete, analysts say, and will continue for several more years.

''By the year 2000, fewer than half of the current aerospace/defense firms will remain as independent companies or as leaders in their field,'' says John Harbison, a vice president of Booz Allen & Hamilton, a management consulting firm in Los Angeles.

As much as ''75 to 80 percent of contractors will be swallowed up by more aggressive industry leaders or simply exit the market entirely.''

The end result, experts say, could be a dozen or so massive companies controlling the entire industry. In such sectors of military production as fighter jets, main battle tanks, armored vehicles, and nuclear submarines, there are already only one or two firms.

This hits defense workers hardest. Employment in defense-related firms has declined 26 percent since 1987, dropping from approximately 3.7 million workers to 2.7 million, according to the Defense Budget Project report. By the turn of the century, that number will drop another one million, estimates Richard Bitzinger, defense industry analyst for the DBP.

As the merger rush continues, the creation of additional mega mergers such as NorthropGrumman and Lockheed-Martin Marietta is what will be interesting to watch, Mr. Bitzinger says. Last year's $10 billion Lockheed-Martin merger is the biggest in the industry's history.

''Those companies are essentially creating larger, broader-based defense producers,'' Bitzinger says. Lockheed-Martin, for example, will make aircraft, space-launch systems, satellites, defense electronics, and certain types of tactical missiles.

Why are firms hanging tough rather than hanging it up? There are still big bucks to be made in defense, experts say.

Between a peak in 1985 and 1994, the US defense budget fell in real terms by about one-third, the DBP reports. But at the end of this decade, the US will still be spending roughly $80 billion a year on procurement and research and development, Bitzinger says.

''Eighty billion dollars, as I love to tell people, ain't chump change,'' he says.

Bucking the trend, some big firms are diversifying into nonmilitary production, though. North-rop Grumman is investigating the use of its composite technology in high-tech bus manufacturing, and Hughes is expanding its direct-TV satellite broadcasting business. Yet analysts say forays into civilian products aren't likely to supplant military revenues, soon, if ever for these firms.''Defense conversion, quite simply put, is a dead duck,'' Bitzinger says.

Analysts cite several reasons, such as the risk and expense to convert to nonmilitary production, past industry failures, and a corporate culture poorly organized for nondefense work.

''The bulk of capabilities that companies have really aren't transferable into a commercial arena,'' Mr. Harbison adds.

Smaller companies have been more successful at converting to nonmilitary production, he says. There are many more commercial opportunities available in the $20 million to $50 million range. Companies like Lockheed Martin, he explains, would have to find $12 billion of commercial business to transfer at least 50 percent of their sales into commercial ventures.

But Marcus Corbin, senior defense analyst at the Center for Defense Information in Arlington, Va., says: ''[Defense] firms can convert, and firms with billions of dollars of R&D and investment capital lying around ... sure can do it better than any one else if they go about it correctly.''

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