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For almost 40 years, U.S. Navy ships patrolling war zones have relied on the Aegis Combat System, computers and radars that work together to detect threats and guide missiles to their targets. In March 2003, Aegis-equipped cruisers in the Persian Gulf took part in the “shock and awe” campaign to remove Saddam Hussein.
As the sole supplier of Aegis, Lockheed Martin (LMT) has reaped huge rewards. Daniel Goure, former director of the Office of Strategic Competitiveness at the Pentagon, estimates it has been worth at least $30 billion to the company and its predecessors, including international sales. Lockheed gained control of the system—adopted by navies in Australia, Japan and South Korea—when it merged with Martin Marietta in 1995.
Until now, Lockheed has won Aegis work in a noncompetitive, “sole source” process that shut out potential rivals. The Navy’s next contract, designed to modernize and test the system and worth at least $500 million, will be open to competition.
The move is part of a Pentagon attempt to reverse a rising trend of noncompetitive awards. The value of sole-source contracts awarded government-wide rose from about $82 billion in fiscal year 2001 to about $174 billion last year, according to data compiled by Bloomberg Government.
Still, given the power of Lockheed’s incumbency, “it’s tough for the government to ensure there is robust competition in situations like this,” says Robert A. Burton, former administrator of the Office of Federal Procurement Policy who is now a partner at the Venable law firm in Washington.
Since the Navy has no plans to introduce an alternative system to Aegis, the winner of the 2012 contract will be guaranteed a generation’s worth of opportunities, according to Goure, now vice-president for defense programs with Lexington Institute, a U.S. policy research organization. The Navy deploys Aegis on 60 destroyers and 22 cruisers. Two more destroyers are under construction, and the Navy plans to build 11 more ships over the next five years. “The system’s going to be around for decades,” he says. “It’s got to be worth $10 billion or $15 billion over the next 10 years. You’ve not only got the new construction, but you have the upgrades.”
Howard A. Rubel, a defense analyst at Jefferies (JEF), says the Aegis competition could threaten the loss of a core piece of business for Lockheed. The company is the No. 1 U.S. defense contractor, with $261 billion in Pentagon awards in the 10 years to 2010, according to Bloomberg Government data. The scope of the contract and the complexity of the system will limit the field of challengers, however. “The only company that’s likely capable of competing for this is Raytheon,” Rubel says.
Raytheon (RTN), along with Lockheed, is a leading maker of Navy surface combat radars and combat system integrators. The company also is a subcontractor for Lockheed on the Aegis system. In 2008, Raytheon filed a protest over three Aegis contracts awarded to Lockheed on a noncompetitive basis, arguing that it had the capability to take on the work. The Government Accountability Office denied the protest, accepting the Navy’s view that turning to another company would cause delays. “We had always intended to break this system open for competition, even when Raytheon protested,” says Elliott B. Branch, executive director of acquisition and logistics management for the Navy. “The issue really was how quickly we could break it open.” A Raytheon spokesman declined to comment on the company’s bid plans.
Given the long history of Aegis—the first contract for an “Advanced Surface Missile System” was awarded to a Lockheed predecessor in 1969—it’s hard to calculate exactly how much the system has cost the American taxpayer. Navy Rear Admiral James D. Syring, program executive officer for integrated warfare systems at the Pentagon, could say only that it amounts to “multiple billions.” The system, named after the protective shield featured in Homer’s The Iliad, was first deployed on navy ships in 1973.
In the end, technological innovation may drive competition and savings in future upgrades, says the Navy’s Branch. “We had complex, specialized military-unique hardware with software development requirements that kept us in this silo of sole-source over the years,” he says. “Today, it’s just the opposite; the same hardware that your kid may use to execute a learning program or play video games is the same hardware we can use to compute firing solutions.”
Even so, Goure admits, “I’d be shocked beyond belief if the winner was not Lockheed.”
The bottom line: Lockheed’s long dominance over contracts to build and maintain the Aegis combat system may be coming to an end.