Industry Shrinks, Lockheed Grows

This week is a nostalgic one for Lockheed Martin's chairman, Norman Augustine.

The man who over the last five years put together the world's largest defense firm retires Friday after almost 40 years in the defense industry.

And he leaves it radically changed.

In 1992, Mr. Augustine launched the industry on an aggressive merger spree when Martin Marietta, which he headed, acquired General Electric's aerospace business. He has followed up with four other megamergers and this month announced that Lockheed-Martin will buy Northrop Grumman for $8.26 billion.

Augustine made his move one step ahead of the Pentagon. In 1993, then Deputy Defense Secretary William Perry told defense contractors that the cold war's end brought a need to consolidate.

Since 1985, the military procurement budget has plunged 67 percent, prompting more than 24 defense mergers and acquisitions in the past four years.

Both the Pentagon and industry executives say larger companies can better stretch that limited budget and deliver the big-ticket projects that characterize defense spending in the late 1990s.

Consolidating companies boast improved profit margins and cash flow, robust backlogs and healthier stock prices. But these shareholder gains carry a price for employees - 1.1 million jobs cut, about 25 percent of the 1987 level.

But industry executives like to point out that consolidating brings savings.

"The General Accounting Office has estimated that we save the taxpayer $2 for every dollar invested," says Augustine. "There's still time for additional savings, but so far that's pretty good."

One victim of the mergers "may be innovation," says Jay Behuncik, an analyst at Capitoline MS&L, a Washington consulting firm. "Important breakthroughs in military technologies have come when there's healthy competition among a number of firms."

Even Augustine acknowledges that defense mergers are not a panacea. "There's no question that we have much less capability in our industry than we had before. There's less manufacturing capability; there's less R&D capability; there's less competition."

Most industry observers expect defense consolidation to continue.

"At the top-tier level, consolidation is over," says Mr. Behuncik. "But at the subcontractor level, we haven't seen everything play itself out."

Among the likely companies that seem prime for joining hands are those with annual revenue under $5 billion - such as Litton Industries, General Dynamics, United Technologies, Allied-Signal, TRW, and ITT Industries.

A recent Defense Science Board study warns that vertical integration - prime contractors gobbling up their suppliers - threatens competition in the industry.