The Pentagon and the primes step up in the face of the pandemic.
As the COVID-19 pandemic shut down or slowed down businesses across the nation, the defense industrial base was among the first to get help from Congress and will likely be among the first to bounce back once the crisis is finally past.
It may not come back as it was, though, as Congress and the nation rethink priorities in the wake of trillion-dollar emergency spending bills, a coming recession, and the long road back to a robust national and international economy.
It’s a more severe, dire situation than even after 9/11.Eric Fanning, Aerospace Industries Association president and former undersecretary of the Air Force
Defense contractors were specifically directed to keep working, while protecting the health of their workers as much as possible. The Pentagon accelerated progress payments, and the massive $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act injected more than $17 billion in cash for defense, plus another $80 billion in loans for the broader aerospace industry.
“The largest stimulus package in the history of the country has impressed us, and it happened in pretty quick order,” said retired Gen. Herbert “Hawk” Carlisle, president of the National Defense Industrial Association. Progress payments rose from 80 to 90 percent to larger contractors and from 90 to 95 percent for small businesses, to ensure healthy cash flow, Carlisle said, and DOD accelerated pay for small businesses. Some companies, did, as well: Lockheed Martin accelerated payments to its supply chain, he said.
Undersecretary of Defense for Acquisition and Sustainment Ellen Lord’s office issued a series of memos deeming defense work “critical” to ensure employees could travel to work without running afoul of local pandemic-related travel bans. This sent a message to defense firms to hold the line, even as other industries ground to a halt.
She also moved to ensure smaller businesses don’t become vulnerable to “adversary capital,” where peer competitors such as China offer cash-strapped firms a lifeline in exchange for access to innovative technologies. The Pentagon wants its suppliers to stay in business “without losing their technology,” Lord said in a press conference. She offered no details on foreign attempts of this sort, but allowed that the crisis “presents a greater attack surface, if you will,” for such approaches, and said it’s important that DOD “mitigate that uncertainty.”
There’s been no letup in the Pentagon’s demand signal for defense goods and services, Lord noted, as she pledged to play “offense … using our trusted-capital mechanisms” in cooperation with the Committee on Foreign Investment in the U.S., or CFIUS, to support the industry.
Eric Fanning, president of the Aerospace Industries Association, said defense firms are somewhat insulated from the crisis because, unlike commercial clients, the Pentagon’s spending isn’t subject to the whims of markets. By contrast, commercial aviation “is dependent on the customers.” Airlines were among the hardest hit by the crisis as travel thinned to a skeleton schedule.
“It’s a more severe, dire situation than even after 9/11,” Fanning said. “We don’t know how fast the airlines will get back flying. … We haven’t faced anything like this before, so it’s hard to model it.”
Unlike 9/11, when defense priorities instantly changed to fighting terrorism, there is no obvious uptick in sight for defense, noted Byron Callan, a veteran defense and aerospace stock analyst with Capital Alpha Partners.
Defense stocks plunged with the rest of the stock market and, while not as far down as some firms, did not rebound with the likes of tech firms Amazon, Microsoft, and Apple. The defense recovery will be slow.
“It’s going to take a couple of years,” Callan said.
The $2 trillion CARES Act—and potentially other massive rescue packages—will have its own impact on Pentagon spending downstream, he explained.
The Office of Management and Budget now predicts “trillion-dollar budget deficits for the next couple of years,” he said. If interest rates remain low, that may be manageable. But if rates rise, pressure on defense and the wider federal budget will mount. The defense sector could find itself in “a world of hurt” come 2024 to 2026, he said.
The pandemic will also likely shift defense priorities, Callan predicted. Congress may be less willing to support the Air Force’s plan to divest dozens of aircraft to fund its ambitious joint all-domain command and control systems, for which there is no obvious voter constituency.
Cutting airplanes would “have direct job impacts in congressional districts,” Callan said, and lawmakers eager to restart the economy will see little value in doing away with ready-made jobs. “You want to keep people busy at work,” he said.
Strategically, however, COVID-19 could ramp up concern about global stability. Iran suffered disproportionately in the pandemic, relations between the U.S. and China grew tense, North Korea has resumed missile testing, and Russia is growing more impatient with economic sanctions. Tensions and accusations arose as the U.S. questioned China’s reporting of its COVID-19 data, and China sought to fill a void in global leadership and generosity by sending masks and other supplies to various parts of the world, including Europe and the U.S.
Rising tensions means the U.S. may be “looking at a whole new array of security threats,” Callan said, and “a messier, more insecure world in 2021 and 2022.” That could reduce the impulse of Congress and the administration to view defense as the “piggy bank” to fund other emerging needs.
The National Guard could be a winner in this scenario, especially if there is a sense that it was underequipped for the domestic crisis. That spending would translate directly to home districts—and could come at the expense of Pacific-focused investment.
Carlisle, however, does not envision a major shift in defense priorities.
“We still see our great power competition and China being the pacing threat, with Russia to a lesser degree and then North Korea and Iran,” he observed. “China hasn’t changed their plan. They want to be the No. 1 economy in the world, they want to replace us as the superpower with influence, and they want to replace the international rules set [to a system] that benefits just them.”
The U.S. emphasis should remain “building those alliances and friendships … the asymmetric advantage we have against our adversaries.”
Added to that will be questions about preparedness, Carlisle noted: “How do we respond to another situation like this? How do we get early indications that something like this is going to happen?”
NDIA published an analysis of the health of the defense industrial base in February, “Vital Signs 2020,” before the brunt of the COVID-19 pandemic hit. That report cited cyber theft, a shortage of skilled labor, and rising prices for critical materials as critical concerns. The pandemic largely validated the report, Carlisle said, including that there are too many opportunities for “single-point failures in the supply chain.”
American overreliance on China for certain products, including pharmaceuticals and critical defense materials, is unacceptable, he asserted.
In the aftermath of the pandemic, “with our friends, partners, and allies, we’ve got to build a robust supply chain, address the fragility of it, address the single-point failures,” Carlisle said. “And that’s going to take money and dedicated effort, both on the part of government and industry.”
Another key takeaway is that there is a shortage of people with skills in key trades: “electricians, physicists, engineers, mathematicians, across the entire spectrum.”
Small businesses may bear the worst of the COVID-19 damage, Callan predicted, referring to companies the Air Force has wooed in recent years through AFWERX and its various pitch-day events. Their access to cash may become more restricted and their business models may be weighted toward commercial markets that may be in trouble. Some “may have a real struggle for survival, here, depending on what happens the next couple of months,” Callan said.
Air Force acquisition chief Will Roper created a coronavirus task force on March 25 aimed at ensuring cash flow to contractors and aiding small businesses so they can survive the upheaval. Pitch days will continue, with new contracts awarded. Indeed, at a time when face-to-face business is stressed, Chief of Staff Gen. David Goldfein cited USAF’s efforts to accelerate acquisition with credit card purchases as a success that proved useful under quarantine conditions.
An AFWERX event intended to coincide with the South by Southwest conference in Austin, Texas, went forward virtually in March, even as the wider event was canceled. The Air Force signed 550 research contracts worth about $1 billion as a result of the event—before stay-at-home orders were issued. Roper said he instructed program managers to accelerate contract awards where possible.
Lockheed, the nation’s biggest defense firm, announced in early April it had hired almost 1,000 people in the latter half of March and plans to hire another 5,000 workers this year to meet mounting orders for F-35 fighters, hypersonic and subsonic cruise missiles, and the Air Force’s new Combat Rescue Helicopter (recently named the Joly Green II), among others.
“We recognize that providing jobs during this period of economic downturn is … critically important,” said Lockheed CEO Marillyn Hewson. She said the company would pay bonuses to employees whose jobs demand they be present—rather than telework—and that it was accelerating payments to suppliers.
Speaking for the industry, Fanning emphasized that most of the funding in the CARES Act are loans, which must be paid back.
“A company will decide whether it wants to access those loans,” Fanning said. “It comes with the provision that it be paid back. And the provisions are going to be worked out, but they’re likely to be business terms with a little premium.”
Even if some loans to smaller firms will ultimately be forgiven, the flow of funds through the industry, from prime contractors to subcontractors, suppliers, and employees, ultimately flows into the general aerospace and defense “ecosystem,” Fanning noted.
“Most of the money going into those big companies goes into the supply chain,” he explained. Boeing, for example, sends 70 cents of every dollar into the supply chain. “It’s the most efficient way to get money into the smaller companies without trying to target them individually.”
Fanning, who was Secretary of the Army and Undersecretary of the Air Force under President Barack Obama, said the federal response to COVID-19 had been appropriate and effective: “Government actually playing its role.”
Boeing’s Mounting Woes
With more than 160,000 employees and 17,000 suppliers, Boeing is at the apex of the aerospace ecosystem, but its heavy dependence on commercial work and missteps with some important defense contracts has left it vulnerable at a critical time.
With airline traffic ground to a near-halt and airliner deliveries all but suspended, Boeing shut down its facilities in Puget Sound, Wash., including those that make the Navy’s P-8 patrol plane and Air Force KC-46 tanker. It also shut down facilities in South Carolina, where it builds the 787 airliner. The plants reopened with reduced staff April 13.
The pandemic piles on to Boeing’s already-acute problems getting the 787 Max flying again. That aircraft has been grounded more than a year due to problems discovered from high-fatality crashes in late 2018 and March 2019.
Boeing must adjust to a “new reality,” CEO David Calhoun wrote to employees.
That reality will likely bring a smaller and different sort of commercial market in the wake of the COVID-19 pandemic. The company offered early retirement incentives as the first step in reducing its workforce and has sought aid from the government. But Calhoun balked at some of the conditions Congress imposed, such as limiting company executive pay, stock buybacks, and paying dividends. Calhoun and Larry Kellner, Boeing’s chairman, said they would forgo their salaries through the end of the year, and the company suspended paying dividends to shareholders.
To ease the strain, the Air Force released $882 million that had been withheld from Boeing because of deficiencies on the KC-46 tanker. In exchange, the company agreed on a plan to fix the plane’s faulty Remote Vision System at its own cost. Air Force acquisition chief Will Roper said the agreement will incorporate new technology in the KC-46 without making the aircraft more expensive for the Air Force. The program will continue, Roper said: “We wanted to send a clear signal in the deal that this is our tanker for the future.”