UPDATE 3-Pentagon launches affordability push for weapons

* Pentagon seeks more bang for buck

* Eyes $400 billion spent annually on goods and services

* Goal is about 3 percent growth in warfighting funds (Recasts, adds Carter, trade association, analyst comments)

By Jim Wolf

WASHINGTON, June 28 (Reuters) - The U.S. Defense Department launched an efficiency drive aimed at squeezing more bang for the buck from the roughly $400 billion it spends each year on goods and services.

The plan is to reshape the way the Pentagon does business to shift $100 billion over five years from overhead to troops and arms upgrades, Defense Secretary Robert Gates said Monday.

"This process will take time, but I'm confident we'll succeed," he told reporters at a briefing.

If successful it will generate roughly three percent annual growth in "warfighting capabilities" even if the overall defense budget rises only one percent a year in real terms as projected, said Ashton Carter, the Pentagon's chief weapons buyer.

In a memo to his staff titled "Better Buying Power," Carter said the trick was to root out unproductive or low-valued overhead and transfer the savings to the sharp end.

The memo was subtitled "Mandate for Restoring Affordability and Productivity in Defense Spending."

Carter met about 300 industry executives earlier on Monday to outline the changes he wants, including what his memo called rewarding "higher productivity with higher profits."

The United States government does not build the fighter jets, nuclear submarines and other arms it uses as the world's sole remaining superpower. Instead, it contracts with private companies.

The Pentagon's biggest contractors are Lockheed Martin Corp (LMT.N), Boeing Co (BA.N) and Northrop Grumman Corp (NOC.N), followed by General Dynamics Corp (GD.N), BAE Systems (BAES.L), Raytheon Co (RTN.N), United Technologies Corp (UTX.N) and L-3 Communications Holdings Inc (LLL.N).

Carter told Pentagon reporters that "a healthy, vibrant and financially viable defense industry" is in the U.S. national interest.

"It's backwards to say it's about reducing profit," he said in reply to a question about the impact on defense contractors' margins. "It's not at all about that. It's about reducing cost."

He singled out a Northrop Grumman-built high-altitude unmanned reconnaissance drone called Global Hawk as a "perfect example" of the problem at hand.

"It's on a path to be non-affordable," Carter said. Northrop Grumman defended the program last week after the Air Force's top arms buyer stated dissatisfaction with its price trends among other things.

Robert Stevens, Lockheed Martin's chief executive, said the Pentagon's No. 1 supplier would be "relentless in focusing on program execution, on continuously improving our quality, and on driving affordability into every process and every program."

The Aerospace Industries Association, the chief trade and lobbying group for U.S. arms makers, used the opportunity to press for more efficient licensing management for programs dependent on allied collaboration among other concerns.

Gates, opening the Pentagon briefing, said some savings may come from scrapping unneeded programs and activities. He did not specify any but said more must be eliminated. In the past, he has raised questions about the need for a projected $13.2 billion landing craft being developed by General Dynamics.

Defense Secretary William Lynn said on June 4 that the department's goal was to free $101.9 billion in the five years starting in fiscal 2012, two thirds from support programs and overhead.

Shares of defense companies, as measured by the S&P aerospace and defense index .GSPAERO, ended down 1 percent on Monday.

Boeing shares fell 2.1 percent, the most of the major defense contractors, its stock also pressured by a reported threat to civil aircraft orders from Dubai's financial woes.

The Obama administration's core national defense budget request for fiscal 2011, that begins Oct. 1, was $548.9 billion, not including war costs in Iraq and Afghanistan, up 1.8 percent from the current year.

FBR Capital Markets, in an early morning note to clients, said Carter's briefing to the industry likely would "increase uncertainty, and the risk profile, of the defense industry and we expect it to cause the group to weaken as a result."

Tom Captain, an expert on the aerospace industry at Deloitte LLP, predicted profit margins would be squeezed as "there will not be enough work to go around for the current players."

Profit margins for the entire global industry in 2009 was 7.6%, a drop of 16.4% from 2008, he said in an email.

"We expect profit margins to hold steady for 2010, as whatever decisions about program cancellations or efforts to reduce costs otherwise, will likely affect 2011 and beyond, not as much in 2010."

(Editing by Tim Dobbyn, Bernard Orr)