New competitors will push traditional defense players

With renewed optimism among industry leaders because of expected defense and IT spending increases, there is also a heightened focus on innovation and efficiency that has companies wondering what the federal market’s landscape will look like going forward.

An innovation push by the Defense Department in particular could bring more opportunities to services companies and smaller platform makers below the large primes, according to a Nov. 15 report from credit ratings agency Moody’s Investor Service.

Moody’s believes consolidation among lower-tier companies “has expanded the pool of bidders capable of leading opportunities.” And over the next five years, Moody’s estimates $30 billion-$40 billion worth of opportunities could open up to tier-two contractors.

While there is still work to be done in Congress, there also is a sense of optimism that an upturn will occur amid expectations of large increases in national security spending.

The almost $700 billion National Defense Authorization Act for 2018 passed the House late Tuesday after its leaders reached a deal with Senate negotiators. The new NDAA also includes the Modernizing Government Technology Act to give agencies working capital funds for IT modernization.

Consider how consolidation over the past few years among smaller platform makers and government services contractors has re-shaped the market’s second tier below the five largest tier-one defense primes: Boeing, General Dynamics, Lockheed Martin, Northrop Grumman and Raytheon.

A more formidable second tier creates more bidders to take on research-and-development costs for “small and medium-sized contract opportunities without seeking reimbursement,” Moody’s says.

Those bidders are more likely to use a platform integration development approach that sees either new technology put into existing platforms or application of commercial technology to defense systems, the analyst firm says.

Science Applications International Corp. is one example with their military vehicle business, where the contractor seeks to apply its technology engineering work. SAIC is pursuing the Marine Corps’ Amphibious Combat Vehicle program against BAE Systems, plus the Army’s Mobile Protected Firepower program versus BAE and General Dynamics.

Kratos Defense and Security Solutions has been another notable winner from DOD’s effort to grow the pool of competitors. Moody’s notes that Kratos often battles in unmanned competitions against defense giants Northrop Grumman and Lockheed Martin, plus the drone maker General Atomics. Kratos has been “successful at winning such contracts and competitions,” Moody’s said.

San Diego-based Kratos and General Atomics are in the final round of the Defense Advanced Research Project Agency’s “Gremlins” program, for example. Due for award in early 2018, Gremlins envisions an aerial drone that can be launched and retrieved in-flight.

Some of the growing opportunities for tier-two companies traces back to the run of services business divestitures by tier-ones, which cut their internal R&D spending as budgets contracted. Moody’s expects the tier-one primes to make greater investments in response but also face competition against pure-play defense services companies focused on engineering and program management services.

That R&D growth forecast is an item worth watching. Defense spending would go up significantly after years of flat or declining budgets and figures to give industry renewed optimism for growth and opportunity.