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Finding opportunity in dollar decline

Like most businesses, aerospace and defense (A&D) companies are battling some broad economic headwinds. They also are being buffeted by powerful industry-specific downdrafts as governments tighten budgets, defer or cancel new programs, and revamp acquisition practices. The steady military budget spending increases of recent years are giving way to managers' concerns about how best to deploy assets and position their companies against further turbulence.

The good news is that A&D balance sheets are well-provisioned to weather turmoil. Even after paying down debt, buying back shares, raising dividends, making acquisitions and partially funding pension liabilities, the 21 largest global A&D contractors will have amassed an estimated $60-billion cash cushion by the end of 2009. In such uncertain times, management might be inclined to hunker down and conserve resources until the fog lifts. However, we know downturns shuffle the decks in terms of competitive positioning. The experiences of recent cyclical shifts show the more prudent course is to act decisively to strengthen core businesses and to position your company to accelerate when the business cycle turns.

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The economic turmoil of 2001-02 provides a stark illustration. A Bain & Co. analysis of more than 2,000 companies in 50 industries revealed that from the onset of the downturn to a year following it, more than one-third of companies in the bottom quartile-as measured by sales growth and profit margins-climbed into the top half in their respective industries. Meanwhile, a similar proportion of top-quartile performers sunk into the bottom half by the time the economic dust had settled.

This trend was even more pronounced in the A&D industry in the defense slump of the 1990s. Nearly half of the companies in the bottom quartile moved up to the top quartile, and better than one-third of the top performers dropped into the lower half. While some of these dramatic shifts were the result of industry consolidation, the companies that emerged in the strongest positions acted early to strengthen their core businesses.

Rather than sit on idle cash, now is the time to invest and seize leadership in critical markets. While the degree of consolidation in many A&D market segments is much higher today, management has many options for deploying its cash. For those who act early, the opportunities may be better than any time in the past 15 years. Among the options they should explore:

  • Double down on independent research and development. At a time when government is reining in spending for new programs, companies can prosper by spending proactively to address customers' most important unmet needs. Undertaking these investments requires a thorough understanding of customer requirements, but can open up new revenue streams for a company as a sole source supplier and developer of proprietary technology.
  • Retain and develop top talent. At a time when talent is at a premium in the A&D industry and a huge shortage of critical technical skills is looming, companies can take advantage of the current job market to recruit, train and retain premium technical and managerial talent.
  • Explore new business models. A&D companies need to invest in new processes and tools or forge new alliances that allow them to deliver products and services in new ways or to new customers. The opportunities are many-offering managed services, creating international partnerships or building commercial technology alliances. The investment required can be substantial, but companies that get an early jump stand to gain share in a down market and set the performance standard.
  • Target mergers and acquisitions. Even after the wrenching consolidation of the 1990s, some segments of A&D remain highly fragmented, creating opportunities for smart acquirers to take advantage of relatively low valuations to strengthen a core business or expand into an adjacent one.

These cash deployment choices require proprietary insights and a different mindset for many A&D executives, transitioning from a world of investing in response to government requests for proposals to a world of investing to create new opportunities and novel business models where a traditional program budget line item may not exist. Standing pat during uncertain times may mean making fewer mistakes, but companies that heed the lessons of past business cycles know competitive positions will change. There are 60 billion reasons to believe the change will occur again in this A&D cycle. The question is whether your company will drive the change or have it determined by what others do.

Michael Goldberg is a partner with Bain & Co. in Los Angeles and leader of the firm's global aerospace and defense practice.