Defense Electronics Headed For Major Consolidation Moves

Consider the challenge faced by ITT Defense as it prepares to become independent from the conglomerate that currently owns it. Anywhere else in the world, ITT would be a national gem — the most accomplished player in military electronics and related fields within several time zones. But in the United States, it is just a moderately-sized player, overshadowed by rivals such as BAE Systems, Northrop Grumman and Raytheon. Some observers think $5-6 billion in annual sales isn’t big enough for ITT to make a go of it in the coming defense downturn, so they expect it to either be bought or take on debt to buy rivals.

ITT Defense still has a way to go before it is independent, so it’s too soon to say what strategy management will embrace. But one thing is already apparent — the future domestic market probably can’t sustain as many large-scale defense electronics players as there are today. Every one of the big military-system integrators has a major electronics business, and all are focused on a single customer (the Pentagon) that currently generates about half of global demand for security-related technologies. If demand from that dominant customer begins to soften, increased overseas sales probably can’t make up the difference. After all, the Asians and Europeans have their own electronics houses, and there is a gradual convergence under way between the electronic technologies valued by military forces and the kinds of products the commercial sector produces (China passed the U.S. in overall electronics production in 2006).

Some companies are in better shape than others. For example, Lockheed Martin has positioned its defense electronics business so it does not compete head-on with most of the other heavy hitters in the electronics space. And BAE Systems has fostered a collaborative internal culture stressing cross fertilization that continuously generates innovations customers need. But the bottom line is that the United States simply has too many world-class integrators of military electronic systems for the market conditions that lie ahead, and so some of them will have to disappear in the sector consolidation that accompanies every defense downturn. That’s how names like Sanders and Singer and Tracor disappeared from the ranks of Pentagon suppliers after the Cold War.

Defense department acquisition chief Ashton Carter recently disclosed some tentative guidelines for how policymakers should approach mergers among key contractors, stressing that combinations of top-tier integrators were unlikely to be approved. However, those guidelines raised more questions than they answered in the case of defense electronics, because as often as not the big electronics houses are subcontractors rather than prime contractors, and there are many more of them than there are aircraft, warship or vehicle integrators. Look at the Navy’s Next Generation Jammer competition — four highly qualified teams are competing, each of which could do a better job on the project than any other company in the world outside the United States. There probably won’t be many more new starts like the jammer in this decade, so the losers will be hard-pressed to preserve their design teams and core competencies. Something has to give, and the usual release valve is sector consolidation — coming soon to a defense electronics supplier near you.