David and Goliath

Over the past few weeks there has been a lot in the press about the larger defense contractors worries about “shrinking” (see DoD Budget Cuts: Less of More) defense budgets and the effects on their profitability.  Bloomberg News had a piece today about deals dropping for Pentagon contractors.  While it doesn’t appear any of the big guys will be going out of business any time soon, they are indeed under pressure to deliver the goods to their shareholders.  I would guess that most everyone who has a 401(k) has some amount of money invested in the large  defense-related corporations, although they may not realize it.  We all want them to grow and prosper, but sometimes fail to realize that their “growing and prospering” all too often means ever increasing defense spending.  But what about the small and medium-sized businesses that are in the defense industrial complex?  How have they been affected by a slowdown in defense spending?  To answer that question, consider how companies  control their profits.  In this non-MBA’s mind, there are two ways to ensure that profitability stays rosy: 1. Make more revenue and if that’s not possible then, 2.Cut overhead and costs.  Alternative One doesn’t seem so probable if spending is down, so Number Two seems to be in vogue right now.  The large companies generally have fairly large cash reserves and can weather the downturns in spending without having to do much of Number Two (Maybe slash an executive or two’s compensation by few million).  They have the ability to spin off unprofitable business units, refocus defense units onto other areas and lay people off.  The options are more limited for the small and medium-sized businesses.  They tend to have much less in cash reserves and less flexibility to spin off unprofitable units (in fact, they probably don’t have but one business unit).  So the smaller guys have to rely on reducing overhead by letting people go, cutting operating costs (generally seen in people-related programs).  I liken it to flying an airplane.  You can maintain altitude (profit) as you slow down by increasing your angle of attack (reducing costs).  But you can only pull the nose back so far, and then you stall-often with very bad consequences.  I think many small businesses are getting to that point.  Over the last several years they have been cutting corners, letting their more expensive employees go and cutting back on people-related programs to the point that they have now where to go but down.  They have no margin for error and when there are spending freezes (like during the government shutdown) they can’t recover.   And when spending finally increases, they don’t have enough people to generate needed revenue.  It’s a vicious circle for sure.  The big guys muddle through, eat into reserves a little and go right on producing profits.

So what, you say?  Just that I think that too often the press focuses on large defense contractors and their troubles to the detriment of those who are impacted the most: small and medium-sized businesses.  They tend to be either veteran-owned or have large numbers of veterans employed in the aggregate.  It seems to me that the Administration and Congress should be spending more time taking care of those problems than worrying so much about “the industrial base” (meaning big corporations).  I just don’t see it coming out of DoD, the VA or the SBA.  What’s up with that?