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Northrop Grumman’s success formula

22 July 2010 No Comment

By Helen Kaiao Chang

See original story on SDNN

Wednesday, May 27, 2009

Defense contractor Northrop Grumman’s success strategy may seem specific to the defense industry, but in fact can be emulated by other businesses in San Diego.

The strategy? Business focus, advanced technology and service contracts. These are tactics well-suited to the strengths and resources of San Diego county.

Northrop Grumman has succeeded by focusing on its core industry – defense , said Ken Herbert, aerospace and defense director, Frost and Sullivan, a market research firm.

Business focus

In the early 90s, many aerospace companies moved into the intelligent transportation business, “which never became anything,” said Herbert. In 2005, defense companies also started launching satellite networks for telecommunications, resulting in a market glut and revenue losses.

In contrast, Northrop Grumman concentrated on products for the defense industry. “They’ve traditionally been very focused and very selective in their markets,” said Herbert.

The key example of this is the unmanned vehicles market. Fifteen years ago, Northrop Grumman’s leaders foresaw that it would be a strong sector in the defense industry and they went after it, according to John Pettit, Northrop Grumman’s lead executive in San Diego.

In 1999, the company bought San Diego-based Ryan Aeronautical, inventor of the Global Hawk stealth plane. Northrop Grumman absorbed Ryan’s 3,000 staff and took the product to the next level.

The unmanned vehicle systems are the stuff of military dreams – planes, helicopters and tanks that are controlled entirely by remote control, requiring no human pilots – sort of like those remote toy airplanes you find people playing with at Mission Bay. Except that these vehicles are life-size, capable of shooting real missiles and controlled across different continents. Pettitt calls them “stealthy, flying Dorito chips.”

“Northrop Grumman recognized the importance of UAVs early on and they executed it really well,” said Phil Finnegan, director of corporate analysis, Teal Group, a market research firm. “They continued to put high priority on it, even when other manufacturers did not. ”

Today, the company is the industry leader. Northrop Grumman has nearly 45 percent of the $3 billion UAV market, said Herbert. “They’ve got a very strong lead in this market,” said Herbert.

Its closest U.S. competitor is General Atomics, which has 20 percent of the market, said Herbert. General Atomics is also based in San Diego, with its main facility in Rancho Bernardo and production facilities in Sabre Springs. Their unmanned vehicles are on the lower end of the market, said Herbert. But growing orders from the U.S. military has buoyed the company’s expansion.

Northrop Grumman’s Pettitt said: “We saw 15 years ago that unmanned systems definitely had a future. We invested a lot of money into that area and we’ll build on that.”

Advanced technology

Like many companies based in San Diego, Northrop Grumman has also done well by focusing on advanced technology. In the UAV market, its Global Hawk commands the high-end. “The global hawk is already established as a strong niche in the market, as really the premier high-altitude, long-endurance UAV,” said Teal Group’s Finnegan.

The general price range for Global Hawks is $30 million to $60 million each, depending on the model and sensor level, according to Jim Dunnigan, publisher of StrategyPage, an online military news site.

On average, the U.S. Air Force and Navy paid $58 million for each Global Hawk. Since 2003, the military has bought nearly 20 craft, with each new version flying longer and farther, according to StrategyPage.

The total U.S. Air Force contract commitment is about $107 million, with about $26 million fulfilled already, according to a Department of Defense statement.

Other U.S. and foreign manufacturers dominate the lower-end market, making smaller, more tactical UAVs. But Northrop Grumman has not competed in that area. “They’re really at the higher end, the higher-scale, generally more-capable UAV that a lot of countries will be looking for,” said Finnegan.

This has made Northrop Grumman competitive in the global marketplace. The company has sold Global Hawks to Germany, with potential orders from Japan, South Korea, and Australia, among others.

Selling UAVs overseas does not compromise U.S. security, said Finnegan. This is because buyer countries are friendly and the government must approve technology missile sales. “It’s in the U.S. interest to have Allies using U.S. equipment,” said Finnegan. “It promotes defense ties, operability between forces.”

This proprietary technology has enabled Northrop Grumman to broaden its product range. It is now developing stealth helicopters, called Fire Scouts, which would be sold to the U.S. Navy and Army, as well as other countries.

“This really has the potential for being a large area for growth for Northrop Grumman,” said Finnegan.

Service contracts

Northrop Grumman has also boosted revenues by moving into service contracts. In addition to selling its products, Northrop Grumman has generated more sales by repairing and maintaining them.

“That’s one of the broad shifts we’ve seen in the market, in revenue from hardware and software to the service side of the business,” said Frost and Sullivan’s Herbert. “But Northrop is a firm that has done a very good job in this.”

With federal budget cuts, defense companies are pursuing the service business, said analyst Finnegan.

“Especially now, more of these companies are going after the service business, because the defense budget may be declining,” he said. “Service revenues are going to be much more stable than the actual procurement of items. That makes it particularly desirable.”

The company’s sales revenue for manufacturing and services also shows this shift. In 2000, product sales income was $6.13 billion, or 81 percent of total revenue, while services generated $1.49 billion, or 19 percent, according to company spokesperson Thomas Henson.

By 2008, this had moved to product sales of nearly $20 billion, or 58 percent, and $14.3 billion in services, or 42 percent of total revenue, according to Henson.

Breaking that down further, a typical Global Hawk plane costs $30 million to $60 million, and the longevity is still too early to tell, said StrategyPage’s Dunnigan in an email. The “cost per flight hour, including maintenance, is cheaper than for manned air craft, but is still several thousand dollars an hour,” he said.

The same might be said of Northrop Grumman’s information technology and shipbuilding sectors. Northrop Grumman is the U.S. government’s second-largest information systems contractor. In San Diego, the company is a lynchpin for the City, with a $100 million contract to maintain 130,000 computers, servers and data centers, such as those in San Diego’s public libraries. This five-year contract lasts through 2012, providing stable revenue for the company in the interim.

Northrop Grumman’s IT division is “likely to be less cyclical than their hardware manufacturing businesses,” said analyst Finnegan. “It adds stability to the company.”

The same is true in the ship repair business. Northrop Grumman is the U.S. Navy’s largest ship contractor. In San Diego, Northrop Grumman is the leading ship repair contractor for the U.S. Navy, in charge of servicing the USS Ronald Reagan (CVN 76) aircraft carrier.

Going forward, the company expects the service side of the business to continue to grow. “We’re pursuing some major programs out of San Diego,” said Pettitt.

More stories in this series about Northrop Grumman:

Northtrop Grumman: A Stealth Path to Growth
Northrop Grumman’s Business Challenges
Northrop Grumman’s Economic Impact in San Diego

Follow Helen on Twitter @HelenChang.

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