Neither company [Raytheon nor UTC] works as a platform producer, eschewing the production of aircraft or ground vehicles and instead focusing on the technology that makes them work. It’s a business model that has produced well for both firms…
“One of the first and foremost things we absolutely agree on is, we want to be platform agnostic,” [UTC CEO] Hayes said, noting that UTC sold off its Sikorsky helicopter unit almost five years ago because “we didn’t like the programmatic risk associated with platforms”…
Said Kennedy [CEO of Raytheon], “Neither of us essentially develop platforms or sell platforms. Why that’s important is, really, the amount of capital that you have to go and spend in maintaining and creating these platforms kind of takes your eye off the ball relative to investing in technology moving forward. So that was a big feature, that both companies are platform agnostic.”
That was from an interesting article, “Why the new Raytheon Technologies will eschew platforms for new technology development.”
You’d think that these companies want to be the major prime contractors, who are privileged to have responsibility for large platforms like ship hulls and airframes. It gives them basically a monopoly on developing and producing the platform, which can be maintained over follow-on programs as other competitors lose capabilities in that area.
Primes are also privileged to have most of the program funding flow through it. While the government separately buys and furnishes the prime with some subsystems, such as the engines for some Air Force programs and the armaments for Navy ships, usually the platform primes are assured huge revenue streams. The FY 2020 buy for Lockheed Martin’s F-35 amounts to $34 billion. A lot of that flows through one plant (Ft. Worth) in one business unit (Aeronautics). Compare that to the total sales for Raytheon in 2018, which came in at only $27 billion. And Raytheon is the third largest defense supplier.
At the same time, large weapons platforms present major risks to primes, and makes them risk averse to new requirements or technologies which may put the program in jeopardy. That $34 billion buy for the F-35 represents more than 60 percent of Lockheed’s 2018 revenues. Similarly, Boeing is counting on the KC-46, and Northrop Grumman on the B-21 bomber, General Dynamics on the Columbia-class submarine, and Huntington Ingalls on the Ford-class carriers.
With that risk, owning the platform provides the primes important access to DOD decision-makers, including the ability to help shape future programs. But those privileges are a two-way street. The government reserves the right to receive detailed reports for all areas of technical and business practices. Government ultimately has substantial decision-making power within the primes.
Numerous data requirements are added required on major systems contracts with the primes. However, most of the CDRL items only give the government insight into the prime’s data. One of the exceptions is the CSDR requirements, which are supposed to flow down to major subcontractors over a certain dollar threshold. “Should cost” studies and supplier “tiger teams” also allow government access to review subcontractor processes if it is first negotiated through the prime. Many times, the prime contractor permits the government to attend meetings with the subcontractors.
Yet for the most part, it is very difficult for the government to gain insight into subcontractors, especially below the major subsystem level. It is especially hard to get a government auditor there to check the books because the government hasn’t contracted directly with that supplier.
These subcontractors are often accused of earning handsome profits. The primes do not necessarily have the incentive to control costs because most often, the higher the cost of production the higher their profits. The prime earns a profit on the value of subcontracted work and other outsourcing. If the subcontractor’s profit is $1 million higher, then that comes in as a cost to the prime, who might then earn a cool $50,000 or $100,000, depending on the weighted profit guidelines.
So a defense firm that focuses not on platforms, but on subsystems and components, gains some benefits. They will not be subjected to the same level of scrutiny as the platform primes, particularly when programs go off the rails. They are far less likely to be found out if earning “excessive” profits, which may be routed back to General & Administrative expenses to reduce the overall profitability level if the company is primarily a government supplier, or it could get mixed in with commercial profits for commercial companies.
One of the issues for the Raytheon/UTC merger is that UTC more often plays the subcontractor role than does Raytheon, which still has the lead on several MDAPs. UTC certainly still abides by DOD regulations, but as they have sold off Sikorsky and focus on components, they will be able to skirt by the worst of the productivity effects of the regulations. That allows them to stay more competitive in the commercial markets.
If a commercializing UTC merged with weapons platform-oriented Raytheon, then the processes ingrained in the Raytheon unit may impede the success of UTC’s commercial efforts. Boeing, for example, was able to keep a pretty strict division between commercial and defense products, but the effects of that gradual dissolution are now becoming apparent.
Raytheon, to some degree, needs to “get on board” with UTC and leave the platform game behind. Together, the companies would be about 50/50 commercial and defense work. The more that defense work can take advantage of the protection of working at the lower-tiers, the better off the whole company.
The move also looks smart relative to the economy at-large, which is moving towards “combinatorial innovation” where companies are being made out of APIs, such as Stripe for payments, Twilio for text updates, AWS for cloud, and so forth. These APIs enable developers to rapidly build new products by recombining different modules. Standards for interfacing emerge informally and formally, but often without government’s say so.
Many entrepreneurs are looking “horizontal,” to develop these products that can serve across many “vertical” industries. In defense acquisition, horizontal products include sensors, robotics, cyber security, AI, precision strike, communications, and so forth. Having the best in class products for these components puts one in a good position to win a lot of work across the platform verticals like ships, aircraft, satellites, ground vehicles, and so on.
Not only will prime contractors protect these lower-tier suppliers from government intrusion, it doesn’t prevent them from going after government S&T work — like autonomy — or “middle-tier” programs — like hypersonics. These kinds of government contracts can, at least for now, use streamlined authorities which protects them from oversight and any potential corrosive cultural effects.
So while the Raytheon/UTC “platform agnostic” strategy may now show big gains in terms of revenues, it will help protect the commercial side from regulatory intrusion and it could lead to higher profitability overall. With that gamble comes the prospect that the DOD doesn’t adopt modular architecture, standard interfaces, and rapid builds. If the DOD continues to demand highly integrated systems that demand unique components designed in advance, then the lower-tier suppliers may not necessarily be able to stay platform agnostic.
Leave a Reply