Magazine article National Defense

Forecast Calls for Stormy Business Climate

Magazine article National Defense

Forecast Calls for Stormy Business Climate

Article excerpt

* Bad news keeps piling up for Pentagon contractors. In the past six months alone, the defense-contracting sector has been buffeted by draconian budget cuts and by proposed new rules that would further limit government reimbursement of contractor salaries. The industry also has become the target of backlash over the former contractor and leaker of government secrets Edward Snowden.

The business climate might even get worse before it gets better. Any hope that sequester would be undone is rapidly fading as it becomes apparent that the bipartisan coalition that the defense industry could always count on to bolster military spending no longer exists.

U.S. defense budgets are projected to decline 20 percent between the post-9/11 peak reached in 2010. It will be downhill at least until 2017, according to forecasts. Weapons manufacturers had anticipated that budgets would come down after the wars ended, but were not prepared for the chilly environment on Capitol Hill. Deputy Defense Secretary Ashton Carter, who has been on the front lines of the Pentagon's battle against sequester, recently called out Congress for allowing political agendas to take precedence over national security. "We are not feeling the recognition of the need to keep a strong defense," he said.

Former undersecretary of defense for policy Michele Flournoy said the Pentagon and defense industry must come to grips with the new reality that they no longer command the influence on Capitol Hill that they once had. "The politics of these issues have changed," she said.

Defense industry leaders are just going to have to keep fighting the political and fiscal head winds, suggested Wesley G. Bush, CEO and president of Northrop Grumman Corp. Even if industry lobbying failed to stop the sequester--which would slash military spending by $500 billion over the next decade--companies in the defense sector still have a "real obligation to be vocal," Bush said. "Going silent on this issue would be a real mistake."

Industry CEOs, with the benefit of hindsight, recognized that their plan to roll back the Budget Control Act--which Congress passed in 2011--might have suffered from over confidence as it had been assumed that politicians would protect defense spending because it creates jobs. Bush said industry should begin to promote other contributions, such as its potential to unleash technological advances, and, indirectly, bolster national security.

Corporate profits, meanwhile, will be squeezed on multiple fronts. The automatic spending cuts, whose effects are slowly trickling across the Pentagon's supplier chain, will result in many delays and cancellations of weapon programs. The upshot could be more layoffs and industry consolidation. And companies might have to curtail their executives' salaries in light of a proposed new rule that sets limits to how much the government can reimburse contractors for their employees' compensation.

Under current policy, the top five executives at defense corporations are subject to a $763,029 cap. The revised rule would extend the cap to every contractor employee working for the Defense Department, the Coast Guard and NASA. The Senate's recent immigration reform bill would expand the scope of the rule to executive salaries of Department of Homeland Security and National Guard contractors.

Thomas A. Lemmer, a partner at McKenna Long & Aldridge LLP, a law firm that advises government contractors, said these compensation caps are part of fiscal restraint as the government cuts back, but also are politically motivated. …

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