The Support Solutions business of BAE Systems, Inc. seems to be on much the same trajectory as this Minuteman ballistic missile. In July, it won an eight-year, $535 million contract to lead engineering support and sustainment of the 450 Minuteman III missiles in the nation's nuclear force, displacing 60-year incumbent Northrop Grumman. (U.S. Air Force photo/Joe Davila)
When BAE Systems BAE Systems, Inc. won an eight-year, $535 million contract to support the Minuteman ballistic-missile force on the last day of July, it wasn’t just a major white-space win for the U.S. unit of the world’s second-biggest military contractor. It was at least the fourth time in the last two years that British-based BAE has expanded its technical services offerings to the Pentagon at the expense of well-established incumbents — which means it is becoming a pattern.
I should mention up front that BAE Systems is a consulting client and modest contributor to my think tank. In fact, I have had relationships of one sort or another with almost all of the companies mentioned in this piece — not that any of them will enjoy hearing about how BAE Systems is eating their lunch.
But that is what’s happening, at least in the services part of the defense business, which claims nearly half of the billion dollars the Pentagon spends every day on outside contractors. In May of 2011 BAE’s Support Solutions unit defeated longtime incumbent ATK to win a ten-year, $850 million contract for management of the Army’s sprawling Radford ammunition plant. In August of 2012 the same unit beat Lockheed Martin Lockheed Martin in a competition to upgrade the electronics on South Korean F-16 fighters — even though Lockheed built the planes. In December, it bested the incumbent Sikorsky division of United Technologies United Technologies to win a five-year, $400 million contract for support of Navy training aircraft.
So when BAE Systems displaced Northrop Grumman Northrop Grumman as lead systems engineer and support integrator for the Minuteman intercontinental ballistic-missile (ICBM) force last July, it was just the latest installment in what is becoming an impressive chronicle of competitive successes. This isn’t the way that most technical-service providers have been faring in the defense sector lately, as spending on overseas contingencies declines and companies pare margins to try to stay competitive. It appears that BAE Systems has found a formula for growing in a defense downturn — a formula that enables it to steal market share from incumbents in areas where it was not previously a player.
Other players in defense services such as Engility have managed to grow market share by slashing costs and accepting thin margins, but what makes BAE’s wins especially noteworthy is that it has been able to sustain margins strong enough to support the defense sector’s heftiest dividend while still repeatedly displacing incumbents from valued franchises. In the case of the Minuteman win, it beat a company that has led ICBM sustainment for nearly 60 years — since before the launch of Sputnik. Northrop Grumman can still bid on ICBM support work for which BAE will now be disqualified because of its new role as lead integrator, but to say this is an outcome few observers were expecting is an understatement. It’s a big upset.
The win is probably especially satisfying for Erin Moseley, the executive who took over the Support Solutions unit earlier this year when David Herr moved up to oversee all of BAE’s domestic services businesses. The Minuteman award suggests that Support Solutions has lost none of its competitive edge in the transition to a new leader. Moseley grew up in the secret nuclear city of Los Alamos, New Mexico where America’s first atomic weapons were built and later worked on nuclear arms control at the State Department, so she has an intimate understanding of the role that Minuteman plays in U.S. strategy. Her business has been the lead provider of engineering support for the other part of the ballistic-missile force, the Navy’s Fleet Ballistic Missile Program, since the 1960s.
BAE Systems is probably the only foreign-based company that would be allowed to play such a central role in U.S. national security. The company was created when British Aerospace merged with Marconi Electronic Systems in 1999, subsuming such legendary military brands as DeHavilland, Hawker, Plessey, and Vickers. That had the effect of making BAE the national champion in military hardware for America’s closest ally, giving it access to parts of the U.S. defense market that no other overseas company could hope to penetrate. The company added to its U.S. defense operations at the height of the Iraq war, and as a result now generates about 40% of corporate revenues in America — one of several countries it considers a home market.
BAE Systems is best known in the U.S. for its signature combat systems such as the electronic-warfare suite carried on the F-35 fighter and troop carriers used by U.S. ground forces. Its services business is less well known, but is so big that if it were a stand-alone it would still rank as one of the Pentagon’s top suppliers. Moseley’s operation, which does not include BAE’s extensive cybersecurity practice, consists of six business units engaged in the support and sustainment of major combat systems for every military service. For instance, it is a leading supplier of systems engineering, ship maintenance and ordnance management for the Navy, and assists the Air Force in operating its deep-space surveillance network.
Linda Hudson, the head of all BAE Systems operations in the U.S., recognized before the current defense downturn began that services could potentially be a growth area going forward because when acquisition of new weapons slows, more effort has to be made to upgrade and sustain old ones. More generally, Hudson saw that defense was becoming as services-intensive as the commercial economy as military demand grew for everything from healthcare to data storage to vehicle maintenance. So Moseley’s Support Solutions unit has become a buffer against the possibility of declining sales in the company’s military-hardware business, increasing revenues at a time when demand for combat systems is expected to soften.
What few observers expected was that BAE Systems would prove as adept as it has at taking business from longtime incumbents thought to be leaders in their fields. Northrop Grumman’s legacy TRW business was first selected to provide engineering support for the Minuteman missile in 1954, and after six decades of delivering such services, it was assumed to have unique understanding of the missile’s features. BAE’s ability to wrest the Minuteman franchise away from a respected incumbent suggests that the contracting environment in which defense services are procured has changed — presumably in ways BAE grasped better than some of its competitors did.
Not surprisingly, the company’s push into new parts of the services business — “white space” in the vernacular of business development — has created challenges it has not had to deal with in the past. For instance, its success in winning upgrade work on F-16 fighters in South Korea opens up the prospect of further opportunities in the multibillion-dollar business of modernizing thousands of Cold War fighters. However, that work traditionally has been viewed as the exclusive preserve of Lockheed Martin, the original equipment manufacturer of the F-16. Obviously, Lockheed will fight back to protect its F-16 franchise, and beyond that BAE has to worry about how any bad feelings might spill over into its work on the F-35 successor to the F-16. Lockheed Martin is prime contractor on the F-35, and BAE Systems is one of its subcontractors.
But this is the kind of problem you want to have, because who thought anybody could beat Lockheed Martin on upgrading its own plane? Time will tell whether it was a fluke — maybe a reversible one — or the beginning of a sea change in the way military sustainment work is awarded. Having won billions of dollars in high-tech services work that once would have been deemed beyond its grasp, BAE Systems seems poised to do well in the U.S. defense market at a time when some of its competitors are likely to disappear due to declining demand. That would not only enable the company to sustain its high dividend, but also to claim that it has risen to the top ranks of suppliers in the world’s most competitive defense market.