The defense industry was mostly protected from the effects of sequestration thanks to behind-the-scenes preparations, experts say.

This was despite its public predictions of grim consequences, including millions of jobs lost and mass layoffs.

When the Budget Control Act passed five years ago, industry executives suggested the deleterious effects would prove unstoppable once the cuts went into effect in fiscal 2013.

The Aerospace Industries Association released a report in 2012 saying the sequester could cost 2 million jobs, including about 1 million in the defense sector. Lockheed Martin said it was preparing to issue layoff notices to all of its employees just days before the 2012 presidential election.

“There’s a lot of politics. There’s a lot of posturing involved in all of this, and that’s fine,” Todd Harrison, an expert at the Center for Strategic and International Studies, said this year. “I respect that that’s going to happen in a democracy.”

But amid the hand-wringing, companies readied themselves to absorb the cuts in the best way possible, which is something many wish the Pentagon had done better.

“On the back end, what these companies were doing was very smart,” Harrison said. “The[y] saw that there was a downturn coming in the budget and they started restructuring, and so Lockheed did a lot to consolidate. They closed some facilities. They let go a lot of workers gradually over time. You know, they did a lot of things to consolidate and get more efficient.”

Defense contractors released their fiscal 2016 third-quarter earnings statements last month. Most of the big ones are doing well.

Lockheed Martin’s net sales were $11.6 billion, up from $10.1 billion over the same time period the year before. Northrop Grumman reported a 3 percent increase in sales in the third quarter of fiscal 2016 compared to 2015. Boeing’s profits were 34 percent higher compared to the third quarter of 2015.


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“You look at their performance on Wall Street, and they’re really stars over the past few years. These companies are doing really well,” Harrison said. “The defense industry I think eventually did get it.”

One way they prepared for the Budget Control Act was by diversifying their business to avoid relying on the Defense Department, according to Justin Johnson, analyst at the Heritage Foundation. They tried to increase the proportion of business deals struck with the commercial sector, to sell to more foreign militaries and to broaden what they do for the U.S. government.

“Defense industry folks are rational actors. They saw all this happening and by and large tried to find ways to inflate themselves or diversify or just find ways to brace for the impact and by doing so, have helped mitigate the negative impact of sequestration,” Johnson said.

But Katherine Blakeley, a research fellow at the Center for Strategic and Budgetary Assessments, says not all companies can diversfy equally. Northrop Grumman and Lockheed Martin, for example, still mostly serve the Pentagon, but Boeing has a “pretty robust” commercial sector to offset a drop in defense sales.

Capped budgets have forced industry to become more efficient to protect its profit margins, searching for ways to assemble something faster or improve the manufacturing process, Blakeley added.

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“Any time there’s less money, there’s more pressure to demonstrate how you’re bringing value,” she said. “It’s a challenging time for industry, but what isn’t?”

But adaptation can only go so far. If Washington decides to buy only eight planes instead of 20, industry inevitably takes a hit. Its revenue is cut by the reduced sale, but its costs also rise because it has less price leverage with suppliers, Blakeley said.

One reason that the dire predictions from 2012 did not come true is that industry executives “missed a key fact in the law,” according to Harrison. The Budget Control Act cuts budget authority, which is money appropriated by Congress that has not yet been spent. But it does not cut outlays, which is when the money is actually given to a business.

This delay between when money is appropriated and when money is spent has made the impact on industry gradual rather than immediate, ameliorating the harshest consequences that were predicted.

“It takes time before budget authority becomes outlays,” Harrison said. “You only have economic impact when it becomes outlays. And there are several years of delay for procurement spending. You know, it can stretch out three, four, five years before budget authority becomes outlays. The same is true with research and development funding. It can be several years.”

One benefit of the caps is some level of predictability for industry, Blakeley said. “It might not be what they want, but at least you have a fairly consistent level you can feel pretty confident that Congress is going to budget to,” she said. “I don’t think Congress is ever going to budget to less than the caps.”

But industry has not emerged from the first five years of capped budgets unscathed. It’s difficult to quantify, for example, what impact tighter budgets will have on research and development for future technologies.

“You don’t pay for that lack of investment now, you potentially pay for that in 10 or 20 years. So I think that’s certainly an area of risk for industry,” Johnson said.

Blakeley said research and technology funding has largely been protected, but it’s uncertain that the government will have the money to buy and use platforms that incorporate the new technology. As things get more advanced and more expensive, limited budgets may mean the country cannot buy the weapons it needs, she said.

The last five years of budgets also may discourage new business partners from working with the Pentagon. While larger firms have been able to succeed, the sequester means smaller firms are more reluctant to begin doing business with the Defense Department.

“It’s not perceived as a growing market,” Blakeley said. “People talk about getting into defense, but I’m not sure anyone has done it.”

Read more in our sequester series:

• Sequester special report: Military men and women hardest hit

• Sequester special report: Warships, fighters, vehicles mostly saved

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