XII

FINANCE AND MANAGEMENT

THE GOVERNMENT AS CAPITALIST

In the two wars privately furnished plant and equipment were only 22 percent of the total. Investment on work in progress also had to be large, and this, too, was financed by the government in the form of "progress payments," at the rate of 90 percent.

TABLE XII-1 WORLD WAR II AND KOREAN WAR INVESTMENT IN AIRCRAFT INDUSTRY PLANT AND EQUIPMENT

With the coming of peace in 1945 and 1953, it was proved that the practice had helped reduce over-expansion and postwar crisis in the aerospace industry. In the peacetime years before 1957 facilities were not stable: some government plants were sold, and much equipment was stored, but progress payments continued. In 1956, at the end of this period with the government as willing capitalist, ownership of aerospace plant and equipment stood as follows: government ownership amounted to $800 million undepreciated; private, to $200 million depreciated. The source of private capital was nearly all retained earnings. It is difficult to compare undepreciated with depreciated quantities, and another basis is Boor space: Boeing, Martin, North American, Northrop, and Republic occupied 16.6 million square feet of government-owned plant and also 18.9 million feet which they owned. The government's total share of the capitalization is probably larger after consideration of progress payments.

In 1957 a watershed in federal government financial policy was reached, and since then the government has tried to disengage from furnishing plant and tooling but to avoid a radical or abrupt termination of existing arrangements; it has continued, for example, to finance the extensive and expensive one-time tooling of special jigs and fixtures for a particular contract. Also in 1957, progress payments were cut back and were made less promptly.¹

For years the policy change was not too painful, for the fifties were a prosperous period for the aerospace industry, and the existence of a large and apparently permanent military establishment made private sources more willing to grant credit to the defense businesses. The aerospace firms increased their private long-term indebtedness by roughly $2 billion from the late fifties to early seventies. The significance of this sum and the change may be seen in the fact that, at the end of 1956, the industry's long-term debt was on the order of $200 million. Thus the increase has been tenfold.

Some figures on investment in aerospace plant and equipment in the sixties appear in Table XII-2. It should be noted that the last of the seven years listed were war years, and that space sales were on the rise for three of the years. These were years in which government investment would have been high under its pre-1957 policy of preventing overcapacity. Countervailing factors in the figures were the sharp rise in jetliner sales and a four-year dip in missile sales, factors that would tend to reduce the government's share. In 1972 Barry J. Shillito, assistant secretary of the Department of Defense for Installations and Logistics, reported that government-owned plants had been reduced from 288 in 1954 to 189. He also said that reducing the amount of government-owned equipment had been held up by the Vietnam War because potential contractors had balked at accepting government business which would displace stable and profitable commercial business, unless the contracts were made more acceptable by government provision of equipment. The government had nevertheless been able to reduce its inventory of equipment by 25 percent in 1970 and 1971.² Since 1960 the government has not replaced machines as they wear out. In 1967 85 percent of the profile milling machines, a major airframe tool, were bought privately.³ And although government facilities are still being used, such as the Boeing plant at Wichita, the value of the aging government facilities is low and still shrinking.

TABLE XII-2 INVESTMENT IN AEROSPACE INDUSTRY PLANT AND EQUIPMENT, 1964-1970

It should be noted that the government withdrew from financing the industry in the middle of the technological revolutions of the advent of missiles, space, and the R&D business. As these events resulted in a demand for new and different facilities, the government withdrawal took place just when major capital investment was needed. Furthermore, because company profits on defense business were set at a percentage of contract value, profits were appropriately corrected downward when government investment was high. But after the change in investment policy in 1957 they were not readjusted upward, probably from inertia and from bureaucrats' fear of criticism should they increase company profits. The result was a squeeze on profits, making them less and less a source of funds for capital expenditures.

The policy of reducing and delaying progress payments has been modified at different times since 1957. By early 1971 the private investment in working capital exceeded the share provided by the government's progress payments, although at this time the payments by the Defense Department were running at the rate of $10 billion annually, which was up from $4 billion in 1964. Deputy Defense Secretary David Packard was dissatisfied with the level, and in November a new procurement regulation was issued which was intended to reduce the payments. The rule required a prime contractor to pay his subcontractors before he could collect his payments from the government for work done, and the frequency of payment was reduced from weekly to biweekly. The percentage to be paid was unchanged: 80 percent on fixed price and 100 percent on cost contracts. The Defense Department estimated that this would reduce government financing of working capital by $700 million.⁴ The growing level of airliner business has also increased the proportion of private and airline-company financing. The airlines, too, make "progress payments" on their orders: normally 25 percent of the price has been paid upon order and the rest on delivery.

THE SHIN STUDY

William L. Baldwin came to similar conclusions:

. . . The thin equity structures of the aircraft firms. . . as well as the rise in fixed charges which these firms have assumed in recent years, suggest that the financing of the group is becoming less rather than more appropriate to the industry whose very survival is subject to risk. The significance of this deterioration in protection for creditors and owners is heightened by the low rate of return on total assets employed in defense production and by the growing necessity for private financing of these assets.⁷

THE NEW FINANCING: COALITIONS

The first significant coalition was General Dynamics and Grumman for the F-111. Others have been McDonnell and General Dynamics for the DC-10; Lockheed and General Dynamics for the C-5A; and Boeing, Northrop, and Fairchild for the 747. For the 747, 70 percent of the weight and 50 percent of the effort was spread among 1,500 major and 15,000 secondary suppliers, whose share of the program was $600 million out of over $1.6 billion.⁹

The coalition system saved Lockheed from bankruptcy in 1971 indirectly, in the following manner: Lockheed's coalition partners had $350 million at stake on the L-1011. The airlines could also be called coalition members, having paid $240 million to Lockheed in advance. TWA, in financial difficulties in 1971, had over $101 million invested in the L-1011, and it was believed that if Lockheed went under, TWA would soon follow. In fact there could well be an epidemic of failures. This the government found unacceptable; fear of a domino effect led to the granting of government guaranteed loans to save Lockheed.

The coalition system, along with diversification, should prove to be an aid to survival, by adding financial reserves to the aerospace industry.

PROFITS AND RISK

A principal critic of aerospace industry profits was Professor Murray L. Weidenbaum of Washington University, St. Louis, whose findings were given to Congress in 1968.¹⁰ Weidenbaum selected certain years to demonstrate that profits were too high: he used 1952 to 1955, and then he skipped to 1962 to 1965. This is a curious choice. He included three war years out of the eight used, a hardly representative selection, and he completely avoided the difficult years of contract cancellations and the introduction of the jetliners. In 1971 the GAG reported to Congress on defense industry profits, having measured profits for 1966 to 1969 on several bases: sales, total capital invested, and equity capital invested.¹¹ The results showed higher profits than in commercial business, but Karl G. Harr, Jr., president of the Aerospace Industries Association, criticized the report, claiming an overemphasis on investment.¹² J. M. Lyle, president of the National Security Industry Association, also criticized the report for failing to recognize the industry's high business risk, and stated that the profits were considered before the government's retroactive pricing procedures had been used.¹³ This author would criticize the years used in the report. A period of four years was too short, and they were mostly years of wartime equilibrium and a short, untypical period of peak sales. The view that profits have been low has been advanced by the Logistics Management Institute (LMI), a nonprofit "think tank" whose contractual relationship with the Defense Department has led to suspicions of partiality. The LMI study concluded that profits were not only low from 1958 to 1967 but were declining.¹⁴ They gave as the reason that favorable profits in the fifties attracted entrants to the industry, causing overcapacity in the sixties. In 1972 Professor Frederic M. Scherer presented the same conclusions to the Senate.¹⁵

Business risk concerns the potential of a setback in profits, and in 1968 Gordon R. Conrad and Irving H. Plotkin tried to find a quantitative . basis for evaluating this potential.¹⁶ They used the idea that variation in profits was a measure of business risk, and that a high dispersion of earnings was equated to high risk. They examined fifty-nine industries and found that some, such as aerospace, publishing, pharmaceuticals, and automobiles, were at the top of their list for rate of return and risk. Aerospace ranked seventh. This suggests that aerospace and autos, although they might be a desirable combination in other ways, could well be unfavorable partners because of the business cycle. By contrast, the cement industry was thirty-ninth on the list, confirming General Dynamics' and Martin's good judgment in diversifying into it.

There is, then, no agreement on profit levels,but there is agreement on the existence of high risks in the aerospace business. Successful mastery of aerospace company finances and business risk requires skilled management.

CAPTAINS OF INDUSTRY

There is no doubt that the most successful enterprise in the industry since the war, McDonnell, was firmly led by its engineer-entrepreneur, James S. McDonnell; who was young in 1945. But another Scottish engineer-entrepreneur, Donald Douglas, who played a role in running his firm until the end despite "retiring" in 1957, saw his company go from leadership of the industry to collapse. Sherman Fairchild, more of an industrial generalist than an aerospace specialist, chose to leave the immediate direction of his aerospace company to others. Fairchild's role was to step in when the company's situation was deteriorating. The firm's survival may well be due to his ability to detect trouble early, although his company did not fulfill his hopes in terms of growth. Grumman is a special case. Although the founder, engineer LeRoy Grumman, became relatively inactive early in the period of this study, the company has since been led by similar men. A closely knit association of fliers from the twenties, the management of Grumman has aptly been called inbred. Long a favorite with the Navy, Grumman's designs were called stodgy when conversion to the jet age began, and McDonnell took over Grumman's leadership in naval fighters. An attempt by Grumman to recoup with the F-14 led to a major crisis. Under founder Robert E. Gross, a business generalist, the modern Lockheed company flourished, living up to its motto, "Look to Lockheed for Leadership." When Gross died in 1961 the company was taken over by his brother, Courtland, also a business generalist but less aggressive. After Courtland came a team leadership by Daniel J. Haughton and A. Carl Kotchian. It is too early to know top management's role in Lockheed's recent years but, superficially at least, it appears that Lockheed has not been the same company since Robert Gross died. The Martin firm was still led at the end of World War II by its mechanic-entrepreneur Glenn E. Martin. He did not remain in active leadership after the company's Korean War crisis, when he was accused of contributing to the firm's problems. James H. Kindelberger, the partly trained engineer who was the entrepreneur of North American, guided the company until the end of the fifties and steered it in its conversion from aircraft to R&D. The firm was a notable success. Kindelberger was followed by a long-time associate, engineer J. L. Atwood. It was under Atwood that North American had its greatest difficulties since the forties. Yet Atwood may have accomplished more than Kindelberger, for he believed diversification was necessary and it was he who achieved the merger with Rockwell. For a few years after World War II John Northrop, a mechanic, led his company. The leadership was not spectacular, and Professor John B. Rae says Northrop was a genius of design but not of management.¹⁷

Thus, eight of the twelve aerospace companies studied were led by their founders for many years after 1945 and with varying results. The same variation characterized those eight when they were in the hands of successors and the four whose founders were already out of the picture in 1945. Boeing, the second most successful company since World War II, was led by a man who was well removed from the founder: lawyer William Allen. Republic was led from the late forties by another man far removed from the company founder; this was generalist Mundy Peale. Under Peale, Republic steadily lost ground relative to others in the industry and finally reached a dead end. Curtiss-Wright was in the hands of successors and faded early. General Dynamics, or Convair, had only one strong leader in the aerospace business until the present David Lewis, who is production oriented, and about whom it is too early to speculate. That one outstanding man was financier Floyd OdIum, whose intention . was only to rehabilitate the company and then step out, an intention which he carried out. A hypothesis has been advanced that General Dynamics has lacked adequate leadership through the top ranks because of the haste with which the company was assembled, that it never achieved the smooth efficiency of an established management. Martin was managed most of the time after 1945 by George Bunker, an engineer, who built a giant of a firm from the shambles he took over in 1951. In 1959 Northrop picked a winner in young engineer Thomas V. Jones, who altered the firm's direction and made it strong and successful for the first time.

Are there any patterns in the above? Some cautious hypotheses do present themselves. The entrepreneur-founders did exceptionally well until they became old. Then some stumbled. Perhaps they lost the ability to keep pace with the galloping technological, social, political, and economic changes. There is no pattern in founder versus successor as a guide to successful management; strong founders did not necessarily leave behind leadership vacuums when they retired. Generally, long tenure has been associated with successful management. Has dangerous complacency tended to set in after long production runs? The experiences of Grumman and Republic would indicate it does. Or perhaps they indicate that fliers do not make good businessmen when the competition gets stiff. During a period in American history when company leadership was mostly in the hands of financiers and market men, the most successful management in the aerospace industry-the supreme technological business-has been by engineers. Noticeably lacking have been production men, perhaps a dangerous flaw for an industry whose future is threatened by its nearly out-of-control costs.