As federal contractors try to figure out how to brace for the impact of sequestration in January, one thing about the potential $1 trillion in cuts over 10 years is becoming clearer. The government will end up paying more for products and services currently under contract.
Robert Stevens, the retiring-Lockheed Martin CEO, said Tuesday one consequence of sequestration that few have talked much about is vendors will likely ask the government for an “equitable adjustment” to their contracts.
“Many people have stretched throughout our supply chain to lower their costs and provide the most affordable prices for this high technology equipment,” he said during a company media day in Arlington, Va. “They’ve done that with an expectation that within reasonable boundaries what the future business environment is likely to look like. If sequestration occurs in January, which again is the law, those expectations upon that cost and pricing structure that have been built will be completely off the table.” He said the Defense Department or civilian agencies haven’t given them any idea or hint to how they would modify contracts. But if sequestration occurs, every agency would ask their vendors to reduce costs.
“When we have a modification of our contracts, we will rephrase and reschedule, in our case, up to 40,000 suppliers,” Stevens said. “My sense is, those 40,000 suppliers will say that is a business disruption and we will provide a claim to you for the adverse cost impact for the disruption in that business. It has happened before even when individual contracts are modified.”
Stevens added he has not heard any discussion of how those requests would be managed by the government. It’s also unclear to Lockheed or their suppliers how this process could work, and that puts everyone under a lot of pressure.
Lockheed Martin is the government biggest vendor by total sales with more than $19.6 billion in 2012 and more than $39.9 billion in 2011, according to USASpending.gov.
Spread this uncertainty and request for contract modifications across every vendor and all of a sudden, agencies will be paying more because of how agencies and vendors develop acquisitions.
“When we early on are working with our government counterparts to conceptualize how a program is going to unfold, volume, quantity, timing and capabilities are all part of that,” he said. “Very clearly, as we move through programs when that volume is reduced in many cases we and our suppliers have provided an element of capital investment to produce a rate over a period of time. When we don’t produce at that rate, we’ve apparently over applied the assets which drives up the unit costs. So that is a phenomenon that I think is broadly observed across all platforms throughout our industry. It is a concern and it is an element that drives up the cost of the programs.”
He said any change to that plan has a snowball effect across all tiers of the supply chain and back up to the government.
Beat the sequestration drum
Stevens continued to beat the “sequestration is bad” drum, just like DoD and other administration officials. He said planning for what amounts to a 10 percent across-the-board cut for agencies can only be “done in the abstract and lacks clarity.” He said Lockheed has some big brush strokes knowing that sequestration is the law and they will comply with it.
“The single greatest challenge faced by our company and our industry for which we have no good response is sequestration,” Stevens said. “The near term horizon is completely obscured by a fog of uncertainty. With only 196 days remaining, we have no insight as to how sequestration, this law, will be implemented, which programs will be curtailed, which sites will be closed, which technologies will be discontinued, which contracts will be reformed, which suppliers, particularly our small business participants who are so vital to our supply chain, will be impacted and certainly most tragically, how many people are going to be affected, how many dedicated employees are going to lose their jobs and how many families are going to be disrupted?”
Stevens said what Lockheed and other vendors do know is they have responsibilities under the law.
“The Worker Adjustment and Renotification Act is in place and requires people like us to when we are going to engage in either in plant closing or significant lay- offs to notify workers,” he said. “It’s part of the standards that we are held to and therefore that establishes a framework where we are compelled to start talking to employees, 123,000 of them and 40,000 suppliers, which you might guess all of whom want to know, ‘Will I have a job in January?’ and ‘Will I have a contract in January?’ The answer from us today is ‘We’re not clear about that.'”
Reducing costs without sequestration
Lockheed has taken several steps over the last year in recognition of the changing federal spending environment. The aerospace giant is trying to reduce its costs whether sequestration happens or not.
“Things we have publicly announced like closing the Eagan, Minn., facility. We are doing a lot of consolidation in the Fort Worth, Texas, area. We have numerous facilities that are being consolidated in Montgomery County, Md.. We have numerous leases off I-270 we are consolidating,” said Chris Kubasik, who will take over as CEO when Stevens retires at the end of the year. “That’s the plan we have in place based on our business outlook and drive to continue to be more efficient. If sequestration would occur, there would be additive numbers to that at locations yet to be identified.”
The company already has reduced 1.5 million square feet of office space and would like to reduce another 2.9 million square feet by the end of 2014.
But Stevens said the company would not cut across the board in the face of sequestration, but some of the things it had been doing, would be accelerated or increased.
“Our workforce is 18 percent smaller than it was just three years ago and the pace of our hiring has slowed considerably,” Stevens said. “And in each of our programs we know program execution is critical to delivering affordable products and services to our customers.”