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Defense Contractors Weigh Options While Stuck in Budget Limbo

National Defense Magazine - November 28, 2011, By Sandra Erwin

With no sign that Congress is prepared to return to a “normal” budgeting process any time soon and anxiety about impending budget cuts gripping the Pentagon, many contractors are resigned to the idea that business will be anything but usual for the foreseeable future.

Companies that depend on Defense Department orders for their survival — especially those in the weapons and technology sectors — are walking a tightrope as they wait for the Pentagon to decide what programs will live or die in the coming budget crunch.

Although the Pentagon is far from being cash strapped — its budget has doubled over the past decade, reaching nearly $700 billion this year — the expectation of cuts and incertitude about where the reductions will fall have paralyzed decision makers and are keeping suppliers in a wait-and-see mode.

“It’s really hard to plan your business when your customer says, ‘We have no money, we expect to get the money, but we don’t know when,” says George Eanes, vice president of business development at Modus Operandi, a high-tech software supplier in Melbourne, Fla., whose entire business is in government contracts.

Anticipated budget cuts already are prompting firms to weigh whether they should lay off staff or try to weather the storm. Even more disruptive is the helter-skelter budget process of the past two years, with Congress incapable of passing year-long appropriations and instead funding the government by short-term stopgap measures. That makes for a “murky future, for which it is hard to plan,” Eanes says.

The congressional gridlock that has kept federal agencies on short-term budget leashes has been a “big problem” for contractors, especially small businesses, Eanes says. “They [members of Congress] talk about supporting small businesses. But I’m not sure they understand the impact of continuing resolutions. … They may care but they care more about their political livelihoods,” he says. “CRs have a big impact. They keep kicking the can down the road on budget decisions, and that really hurts us.”

Budget cuts that Congress already approved for fiscal years 2012 and 2013 are expected to hit weapon procurement programs, as the Pentagon is unlikely to make major reductions in personnel. More cuts could come beyond 2013. But until the dust settles — which could take a year to 18 months — contract awards will be delayed, and companies will face tough decisions such as whether they can afford to keep engineers and designers on the payroll.

Modus Operandi executives already are contemplating such options following the Army’s decision to suspend the procurement of the Enhanced Medium Altitude Reconnaissance and Surveillance program after the first four aircraft. The service is considering transferring the project to the Air Force, and there is growing speculation that it will be terminated. Modus Operandi supplies software for EMARS. “We have to find other homes for skilled employees that were on that program,” says Eanes. “There aren’t many new programs for us to chase.”

These are tough calls because Pentagon contract employees who work on sensitive intelligence programs such as EMARS have security clearances and cannot easily be fired and rehired. “If we lay off someone it’s difficult to get them back,” says Eanes. “We have to find other programs for them to work on or have them work on internal R&D.”

Analysts have predicted the current business environment will lead to a major consolidation of second- and third-tier suppliers, and many small firms will not be able to cope with the downturn of the funding instability. It is still too soon to tell whether small businesses will exit the Pentagon market in droves, says Elizabeth Ferrell, an attorney and partner for the government contracts practice at McKenna Long & Aldridge. Uncertainty about the future is a major concern for many of her small business clients, she says.

Larger companies generally are in a better position to adjust to leaner budgets. Some actually welcome the downturn as an opportunity to sell products that aim at helping the government cut costs.

“This is one of the best times to be in business,” says Alan Weakley, president of CSC’s North American Public Sector Defense Group, of Falls Church, Va. The company is one of the government’s largest suppliers of information technology systems and services.

“I say that because there are significant opportunities that are developing that we are very excited about,” he says. “These opportunities are being developed by the tightening of the budget. The government is very serious about finding ways to be innovative and efficient.” Software that automates operations, for instance, can help reduce labor costs.

Weakley also predicts a growing business in the military intelligence, reconnaissance and surveillance (ISR) market as the Pentagon buys fewer aircraft and drones, and instead outsources the data-collection and analysis work to industry. “ISR as a service is a major shift in the way the government does business,” he says. “The Naval Air Systems Command recently put out a proposal that we responded to, asking for the contractor to provide unmanned aircraft, data links, ground control stations,” he adds. Under this model, the “government is not carrying the logistics tail or operations expense.”

Eanes, of Modus Operandi, sees such forecasts as overly optimistic. “Quite honestly, I think the government is going to want to keep ISR in house just because of the sensitivity of the ISR programs and the data,” he says. “I don’t see ISR as a service being a big windfall for small businesses like us.”

 

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