U.S. budget pinch presses arms makers to cut costs

WASHINGTON (Reuters) - Mounting budget pressures worsened by the global financial crisis are giving new urgency to calls for the Pentagon and its top suppliers to rein in the runaway costs of nearly every major arms program.

Top corporate executives, military officials and analysts told the Reuters Aerospace and Defense Summit this week that seven years of sharp growth in U.S. defense spending were ending and future budgets would flatten out at a high level.

But they said the incoming administration of President-elect Barack Obama had already emphasized its intent to scrutinize major weapons programs closely and make reforms.

Defense Secretary Robert Gates told U.S. troops in Kyrgyzstan last week there would be no major cuts in the defense budget for the "next year or two," but "the significant increases that we've seen in recent years are likely to come to a screeching halt."

Gates, asked to stay on by Obama, said the Pentagon would clearly face "tougher expectations of us in terms of how we spend what we get."

Jim Albaugh, head of Boeing Co's (BA.N) $30 billion-plus a year defense business, said some of Boeing's biggest programs, including the U.S. Army's $160 billion Future Combat Systems modernization and missile defense, would face tough reviews.

Boeing's challenge was to ensure its programs remained healthy and on schedule, since troubled programs would be particularly vulnerable to cuts, he told the summit.

To hit its growth target, Boeing needs to extend current production programs, win contracts to replace Boeing weapons already in service and increase international sales, while reducing its own cost structures and offering the Pentagon cheaper alternatives to new programs, Albaugh said.

BRIDGING TO NEW

For instance, Boeing is offering the Navy more F-18 fighter jets for less than $50 million a piece to help bridge an expected "fighter gap" on its aircraft carriers, especially if work on the new F-35 Joint Strike Fighter runs into delays.

Similarly, the Air Force could buy more of the communications satellites already being built instead of launching the costly new Transformational Satellite (TSAT) program, Albaugh said.

"We're working very hard to drive down our cost of doing business," he said. "We're looking at: are there ways to provide our customer an 80-percent solution at a much lower cost?"

Robert Stevens, chief executive of Lockheed Martin Corp (LMT.N), the Pentagon's No. 1 supplier, said affordability would take on even more importance for contractors in coming years, but military officials also needed to stop adding requirements to weapons systems once they began.

Tom Captain, who heads aerospace and defense analysis for Deloitte LLP, said cost overruns on the Pentagon's biggest weapons programs totaled $295 billion or 26 percent since 1993. If current trends continued, major weapons programs would be 46 percent over budget by 2018, he said.

"The big squeeze means that we can't pay for everything that we want or need," Captain told the summit. He said the worldwide economic crisis would exacerbate pressures already facing the Pentagon, including the high cost of adding 92,000 troops and paying for their health care.

The Pentagon also faced tens of billions of dollars in bills to replace and repair equipment worn out in Iraq and Afghanistan, he said, adding, "Something has got to give."

Stevens acknowledged the new Littoral Combat Ship that Lockheed designed for the Navy had more than doubled to $500 million in cost during its six-year development, but ultimately the ship would save the Navy huge amounts over its life because it had a much smaller crew and was far cheaper to maintain.

The Navy plans to buy 55 of the new ships, but could eventually buy as many as 62 in coming years, the Pentagon's chief arms buyer John Young told reporters this week.

SOMETHING HAS TO GIVE

Thomas Christie, the Pentagon's chief weapons tester for four years until February 2005, said it was time to leave behind the "make-believe world of defense budgeting."

In a book of essays about Pentagon reforms published last month, Christie pegged the problem to what he called unrealistically high defense budget projections paired with equally unrealistic low cost estimates for new programs.

Defense analyst Loren Thompson of the Virginia-based Lexington Institute said it would remain difficult to cancel programs outright, given fierce lobbying by contractors and lawmakers' efforts to hold onto good jobs in their districts.

"You can't fix the acquisition system unless you can find some way of restraining Congress from micromanaging programs," he said, noting that lawmakers had few incentives to cut programs and make them more efficient. "They want to hear about how you're going to keep their constituents employed."

Marion Blakey, who heads of the Aerospace Industries Association, said her group was preparing recommendations for the new administration on how to fix defense procurement and said Obama officials already appeared very interested.

"There's no question that there's going to be significant interest on this front... and this may very well be the administration that can do it," she told the summit.

(For summit blog: summitnotebook.reuters.com/)

(Additional reporting by Jim Wolf; Editing by Tim Dobbyn)