Defense contractors will need to become more efficient and push their costs down going forward into the new budgetary environment, Vice Chairman of the Joint Chiefs of Staff Adm. James Winnefeld said Wednesday.
“It may mean smaller profit margins, that’s up to industry,” he said at Bloomberg Government’s Defense Symposium in Washington.
As compensation for the decline of high dollar contracts, Winnefeld said the Department of Defense was actively guarding funding for research and design with an eye toward future contracting opportunities. R&D “will come down a little bit but disproportionately less than other parts” of the budget, he said.
“Keep the innovations coming,” he said to the audience, which included many members of industry. “We’re going to protect the R&D money as much as we can.”
Despite the somber cost outlook for contractors, Winnefeld noted that there was one area for business opportunities: cyber.
“We say flat is the new growth in DoD. Cyber is the only area where we’re actually growing,” he said.
Winnefeld did not quantify the rise in cyber spending at the department. Cyber was only briefly mentioned in Secretary Hagel’s Monday budget preview as a “critical capability” that was preserved along with the Special Operations Forces.
A panel discussion about the future of the defense industry following Winnefeld’s speech also recognized cyber as a growth area.
Jeremy Bash, founder of Beacon Global Strategies and a former chief of staff at DoD, explained that with more than three million civilian and military employees each holding multiple networked devices, there could be as many as 10 million devices connected to the DoD network.
“If you think of every endpoint as a vulnerability, you can start to grasp the complexity,” he said. “Every company is going to have to have a solid offering [in cyber].”
John Dowdy of McKinsey & Company’s Aerospace and Defense sector said he valued the cyber marketplace at about $50 billion. However, he believes the total defense market stands to lose much more than that.
“If your growth is $50 billion, it’s not enough to make up for the decline in the defense market,” he said.
In addition to cyber, Dowdy said contractors will be chasing opportunities in international growth, autonomous systems and services. While others have pointed toward the commercial sector as a place for growth, Dowdy was less sanguine about the prospects for commercial endeavors from the major contractors.
“I think it’s very, very difficult for a pure defense company to diversify,” he said, unable to name an example of a defense contractor that had done so successfully.
Bash suggested that a good business strategy for major contractors is mergers and acquisitions of smaller firms for their expertise, particularly in cyber and emerging technologies.
“In some ways, an acquisition can replace your R&D,” he said.
Bash does not expect mergers right away, but he said it will soon become a competitive landscape where contractors will have to go up against venture capital and private equity firms. In the meantime, he said contractors should focus on shorter timelines and simplicity instead of big-ticket awards.
“The era of massive 20-year acquisitions is over,” he said