A recent story in Defense News by respected naval analyst Christopher Cavas has investors speculating about the future of Northrop Grumman’s Avondale shipyard near New Orleans. The yard faces a bleak business outlook due to weak demand from its U.S. Navy customer and chronic production problems. That has led some to wonder whether the yard might be put up for sale. Perhaps investors should be thinking bigger. Why is Northrop Grumman in the shipbuilding business at all? A brief look at how it got into the business and how it has fared suggests that maybe the company would be better off focusing in its core areas of aerospace, electronics and information technology, where operating margins are stronger.
That’s actually what the company intended to do when the current decade began. Under the enlightened leadership of former Chairman Kent Kresa, Northrop Grumman had transformed itself in the early post-Cold War years from a second-tier military aircraft company into a world-class producer of satellites, unmanned aircraft, sensors and information networks. Many of the ideas about net-centric warfare later appropriated by the joint force originated in Northrop Grumman as it led the defense industry in exploring the implications of the information revolution for future warfighting. But towards the end of his tenure, almost as an afterthought, Kresa made his only strategic error — he got into naval shipbuilding.
Shipbuilding was never part of Kresa’s strategic plan, but when he sought to acquire the military electronics business of Litton Industries in 2001, he was forced to take the company’s Gulf Coast shipyards in the bargain. One of those yards, Ingalls Shipbuilding in Mississippi, was the biggest, most modern conventional shipbuilding facility in the United States, skillfully run by an industry legend named Jerry St. Pe. The Avondale yard in Louisiana was a less impressive operation, but having been bought by Litton in 1999 it was part of the package. Shortly after Northrop Grumman acquired Ingalls and Avondale, General Dynamics made a bid to buy the Newport News shipyard in Virginia. Faced with the possibility of his recently acquired yards being put at a competitive disadvantage by the General Dynamics-Newport News combination, Kresa fought back and wrested control of the Virginia yard away from GD.
Thus, a company that began the decade with no plans to enter the shipbuilding business backed into being the biggest shipbuilder in the Western Hemisphere. It isn’t hard to see why Kresa accepted this change of course, because on paper Northrop’s yards appear to be more capable than the smaller yards that General Dynamics operates in New England and California. In practice, though, GD has outperformed Northrop in most of the areas where the yards compete, and relations between Northrop Grumman’s yards and their Navy customer have deteriorated steadily.
In 2009, shipbuilding generated less than a fifth of Northrop’s sales while yielding profit margins well below those of the bigger aerospace, electronics and information segments. Repeated, unpleasant surprises from the company’s shipbuilding operations have become a drag on investor perceptions of what should be one of the world’s most respected technology companies. But maybe that shouldn’t come as a surprise. Why would you expect a company that is at the cutting edge of modern technology in most of its businesses to be good at old-fashioned, industrial metal-bending? And how many companies would even be willing to deal with a customer as surly and capricious as the U.S. Navy? Now that Northrop Grumman has recast its financial performance metrics to emphasize capital efficiency over mere revenue growth, company executives have to be asking themselves why they are in the shipbuilding business at all.
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