US Fiscal Cliff Trade-Off #20: Sharp Reduction in US Defense Costs Needed

All US citizens know the importance of national security.  But a very high US Debt level substantially weakens the country’s national security.  Thus, a country’s true national security is not just how strong it is militarily, but also how strong it is financially.

What the country spends on its defense just boggles my mind.     

But there is a clear trade off here.  The more you spend on the military, hopefully the more our US Defense gets stronger.  But there has to be diminishing returns.  After the US Defense spending reaches some point, the additional benefit is not worth the additional cost.

Whereas additional US Defense spending may increase our national security, it also will increase our National Debt, which is another element of national security.  And a will is much more certain than a may.  Thus, at the present levels of very substantial US Defense spending, coupled with very high National Debt, and with substantial annual US deficit increases on end, the compelling argument in maximizing our national security has to be on the side of spending less in US Defense.

In a recent The Economist article, a table of the US Office of Management and Budget: Congressional Budget Office showed that if we reduced the annual growth rate of US defense spending, which is now projected to be 2.4%, down to 1.4%, that would reduce the US Debt level in ten years by $286 bil.  Now, we are talking real, huge-dollar US Government cost savings.

In the current fiscal cliff negotiations, I think I would double down, and reduce the annual growth rate in US defense spending to in the range of 0.1% to 0.4% per year.  Thus, that would reduce the US Debt level in ten years by more than $500 bil. 
   

There are two major pieces that support a major cut in US Defense spending…..the number of Military personnel and the amount of US Defense Contract spending.   

Let me first address the number of Military personnel issue.

Many years ago, I was in the US Army as a non-officer in a support area Military Occupation Specialty.  So yeah, I clearly wasn’t on the front line.

It was very clear to me that we were way overstaffed in this support area.  All of the members of this military support group were exceptionally bright.  But we were nearly all substantially underutilized. 

And nearly all of us were very interested in doing a lot more to contribute to the support’s mission.  It’s just that there wasn’t anything else to do, because the support was so overstaffed.

I am pretty sure it was like that in a lot of support groups, not just in the US Army, but also in the other branches of the service.

On the other hand, I don’t think there was overstaffing in the front line US Army, like in the Infantry.  And the same probably also goes for the front line in the other branches of the service.

If the US Army were run like a business back then, I am sure you would have seen massive downsizing in our US Army support group…..somewhere in the range of 40% to 60%.

The US Army has changed since then, but my hunch is not by too much.  I am pretty sure that the many support areas are still overstaffed.

When I was in the US Army, if someone had asked me to fill out a survey on whether we were overstaffed, I would be worried about reprisals if I said we were substantially overstaffed.

The US Debt level is of utmost importance to our national security.  The US Government is trying to make a decision on how best to reduce dramatically the US Debt.

But you know what, I don’t think the US Government has good enough information to make a proper decision here. 

If they just listen to the top military brass, they won’t get the real story.  These military brass are clearly biased in having as many military under their command as possible.

And if they survey the military support group, they also won’t get to the real story, since those in these military positions don’t want to lose their jobs.  In addition, I think many of them would feel there could be reprisals if they didn’t take the top brass military position of having as many military personnel as possible.

My recommendation here is for some high-quality group, outside of the US Government, survey all former military who previously worked in military support groups.

And the most important question to ask is “If you had -----% fewer military personnel in your support group, would you still have been able to very successfully fulfill your support group’s mission?  And different percentages should be included in this above question…..10%, 20%, 30%, 40%, 50%.

I think the results would be eye opening, and also vary a lot by military support group. 
    

And when the results of this extensive survey of past military support personnel were analyzed, I think the clear cut conclusion is that the US military has way too many military support personnel…..it could fulfill its support group mission very successfully with substantially fewer military personnel.

But also, you clearly don’t want to cut front-line military personnel.  In fact, I think it would be best to increase their pay significantly…..and also the economic benefits of their families.

Now let me turn to the amount of US Government Defense Contract spending.

The most recent full fiscal year listing of US Defense Contractors was for fiscal year running from Oct 1, 2010 to Sept 30, 2011.  Below here are the Top Seven US Defense Contractors by US Government Contract Award Revenues:

		mils of $s
1	Lockheed Martin	33,274
2	Boeing	20,146
3	General Dynamics	18,592
4	Raytheon	13,884
5	Northrop Grumman	8,793
6	United Technologies	7,240
7	L-3 Communications	6,746
	Total all 7	108,675

Given that just these seven have total annual US Government Contract Award Revenues of more than $108 bil in just one year, you can easily see why this is an area where a lot more US Government time should be spent analyzing, to assess whether we are getting our national security money’s worth for this monstrous US Defense Contract spending.

So, just how well have these seven Defense contractors done in their reported annual earnings?

Well, below here is the annual Net Income of each of these seven in the most recent three years, as well as in 2000, 2001 and 2002:

	Net	Net	Net		Net	Net	Net
	Income	Income	Income		Income	Income	Income
	2011	2010	2009		2002	2001	2000
	mils of $s	mils of $s	mils of $s		mils of $s	mils of $s	mils of $s
Lockheed Martin	2,667	2,614	2,967		533	43	(477)
Boeing	4,011	3,311	1,335		2,319	2,826	2,128
General Dynamics	2,552	2,628	2,407		1,051	943	899
Raytheon	1,897	1,843	1,977		755	18	477
Northrop Grumman	2,086	1,904	1,434		697	459	625
United Technologies	5,374	4,711	4,179		887	755	853
L-3 Communications	968	966	911		212	115	83
Total all 7	19,555	17,977	15,210		6,454	5,159	4,588
Annual % Increase	9%	18%			25%	12%
% Increase from 2000 to 2011	326%

As you can see from the above chart, these US Defense Contractor’s total earnings have done exceptionally well, up a massive 326% since 2000.  The only sector doing as well since 2000 is Oil & Gas.  And after those two sectors, there is a huge drop off in profit increases.

And these US Defense Contractor stock prices have been consistent with these exceptionally strong earnings.

There are four very large US Defense Contractors which derive a very substantial portion of their Revenues from the US Government:  Lockheed Martin, General Dynamics, Raytheon and Northrop Grumman.  Below here is the Total Pretax Income, Net Sales and Profit Margin Percentage from 2001 to 2011 of these Big 4 US Defense Contractors Combined:

			Big 4
	Big 4	Big 4	Profit
	Pretax	Net	Margin
	Income	Sales	%
	bils of $s	bils of $s
2001	2.4	66.6	3.60%
2002	4.0	74.4	5.38%
2003	4.7	92.7	5.07%
2004	5.6	104.8	5.34%
2005	8.1	106.7	7.59%
2006	10.2	113.0	9.03%
2007	12.3	121.3	10.14%
2008	13.3	126.2	10.54%
2009	12.9	134.6	9.58%
2010	12.6	138.2	9.12%
2011	13.1	130.4	10.05%

Yeah, that's right, these Big 4 US Defense Contractors have had their combined Net Sales grow 96% in the past ten years from $66.6 bil in 2001 to $130.4 bil in 2011.

And these Big 4 US Defense Contractors have had their combined Profit Margin grow from $3.60 earned for every $100 of Net Sales in 2001 to $10.05 in 2011, an incredible 179% growth in the past ten years.

And when you compound this 96% Net Sales growth and the 179% Profit Margin growth, this yields a Pretax Income growth of an off-the-charts 446% in the past ten years, going from $2.4 bil in 2001 to $13.1 bil in 2011.

Clearly, the massive US Government Defense Contractor Revenues, and the resultant substantial US Defense Contractor profits, particularly since 9/11, has resulted in something accurately called "US Government Defense Contractor Spending Gone Wild".
   

So, what’s wrong with that?  Isn’t it great for everyone?  Well, yes for the stockholders of the Big US Defense Contractors and for their executives, but not so great for the US Debt level, since they are making a substantial portion of their revenues and profits from the US Government.

When trying to reduce the huge US Debt, US Defense Spending is the first place to look.  It clearly needs to be reined in.

The current US Government Budget which grows the prior fiscal year's US Defense Budget by an average of 2.4% per year over the next ten years is just flat out crazy, especially when you consider that the prior year base budget probably contains much more than $50 billion of unneeded, unwise spending.

When the US Congress authorizes Government spending, it is going to be spent.  There is no way the Pentagon, or any other part of the US Government, is going to give up a dime of what they are authorized to spend.  Their philosophy is "Use it or lose it".

So it's on the US Congress to fix the excessive spending it has granted to the US Defense Department in the past.  The US Congress has severely harmed the country's national security by authorizing this massively excess spending in the past, which has resulted in a monstrous increase to the US Debt.  Hopefully, they will get it right this time.

Now let me turn my focus to Executive Compensation of the largest US Defense Contractors.

From a review of their Proxy Statements filed with the SEC, below here are the Executive Compensation disclosures of each of these seven largest US Defense Contractors:

					2011	2011
					Non-equity	Increase	2011
			2011	2011	Incentive	in	All	2011
	2011	2011	Stock	Option	Plan	Pension	Other	Total
Executive	Salary	Bonus	Awards	Awards	Comp	Value	Comp	Comp
	000s	000s	000s	000s	000s	000s	000s	000s
Lockheed Martin
Stevens CEO	1,800	4,725	3,750	3,750	4,400	4,831	2,114	25,370
Kubasik	1,000	2,275	1,441	1,441	900	1,617	784	9,458
Tanner CFO	745	1,220	843	843	810	2,006	51	6,518
Heath	760	1,197	738	738	750	1,558	303	6,044
Maguire	650	1,046	648	648	590	783	171	4,536
Boeing
McNerney CEO	1,930		3,420	3,420	8,704	4,555	929	22,958
Albaugh	1,000		1,249	1,249	2,795	1,972	230	8,495
Bell CFO	891		1,109	1,109	2,649	1,059	249	7,066
Luttig	776		802	802	1,864	1,045	176	5,465
Muilenburg	780		735	735	1,343	1,102	110	4,805
General Dynamics
Johnson CEO	1,400	3,600	3,525	7,050			483	16,058
Redd CFO	755	1,000	824	1,648		515	100	4,842
DeMuro	683	1,000	874	1,749		369	102	4,777
Heebner	659	905	794	1,589		207	207	4,361
Novakovic	620	850	760	1,520		243	82	4,075
Raytheon
Swanson CEO	1,370		10,271		3,000	1,770	440	16,851
Wajsgras CFO	844		2,318		865	477	131	4,635
Yuse	506		2,068		600	1,226	178	4,578
Stephens	739		2,167		755	714	120	4,495
Crowley	667		2,068		500		117	3,352
Northrop Grumman
Bush CEO	1,471		9,401	3,577	4,028	5,276	2,490	26,243
Ervin	845		3,629	894	1,250	1,146	203	7,967
Pitts	845		2,350	894	1,200	2,355	165	7,809
Palmer CFO	845	250	2,350	894	1,250	1,190	918	7,697
Mills	770		2,115	805	1,150	2,435	231	7,506
United Technologies
Chenevert CEO	1,681	4,500	7,932	7,064	1,154	4,793	547	27,671
Darnis	873	1,500	2,007	1,791	733	1,422	154	8,480
Hayes CFO	716	1,220	2,340	2,085	317	1,060	171	7,909
Bellemare	606	800	1,727	1,538	142	775	119	5,707
Michaud-Daniel	598	710	1,814	1,619	111	187	157	5,196
L-3 Communications
Strianese CEO	1,300	2,500	6,080	3,700		2,976	106	16,662
Brunson	586	630	1,249	760		442	92	3,759
Ambrosio CFO	588	630	1,183	720		389	35	3,545
Dunn	584	925	855	520		486	83	3,453
Kanter	614	650	855	520		453	72	3,164
Total all 7 Corps	31,497	32,133	86,291	55,672	41,860	51,434	12,620	311,507

Here’s a couple of quick observations on the above executive compensation disclosures.

First, it just absolutely amazes me of the large extravagant items I continue to see in the All Other Compensation category of so many large US public corporations.

In Northrop Grumman’s case, the company spent $2,228,000 in just 2011 on the security protection of its CEO.  I’m not kidding.

But it gets much worse.  Northrop Grumman spent another $5,204,000 in just 2011 on the security protection of one of its Directors, who is also its Executive Chairman.  Again, I’m not kidding.

In Lockheed Martin’s case, the company spent $1,664,000 on the security protection of its CEO, and another $322,000 on the security protection of another of its executives.

Common folk just can’t see how they should be paying for 35% (the US Federal Income Tax Benefit the company receives) of this extravagant security cost spending. 

Nor can they see how they should be paying for 35% of Northrop Grumman $750,000 costs to relocate its CFO.

I think it would be wise for the US Government to analyze in very much detail all of the Other Compensation disclosures for all large US public corporations.  The end result should be changing the Tax Code to only allow reasonable amounts of these Other Compensation charges as company tax deductions, for US Federal Income Tax purposes.

Second, it also amazes me why there is such a huge gap between the Total Compensation of the CEO and of the next highest paid Executive.  Just check out the relative total compensation numbers above for each of these seven largest US Defense Contractors.

With this kind of a huge pay gap, just between #1 and #2, it’s easy to see why there is also such an incredibly huge wealth gap between the rich and every else, which keeps expanding every year. 

Just think about the above #1 CEO, who averaged $21,688,000 in Total Pay in 2011, as compared with a cost accountant, with heavy college loans, making $50,000.  The gap between the CEO Top Executive and the cost accountant is 434 times.

And then just think about the above #1 CEO, as compared with a recent college graduate, with heavy college loans, being underemployed and working three part-time jobs, with a total pay of $20,000 per year.  The gap between the above CEO Top Executive's Average Pay of $21,688,000 and the underemployed recent College Graduate, making $20,000 is a massive 1,084 times.  And the underemployed recent college graduate has substantial college loans, to boot.

The setters of compensation levels of CEOs are one of the causes of this economic disparity.  But another causer of this economic disparity is the US Government, which drives the Revenues and Profits of these companies.  I think the US Government should be involved in the setting of compensation levels of large US Defense Contractor CEOs.   

Third, there is a huge disparity in the relationship between the Net Income and the CEO Total Compensation of these seven largest US Defense Contractors.

On the positive side, Net Income per dollar of CEO Total Pay is $194 for United Technologies and $175 for Boeing.  On the negative side, it is a much lower $58 for L-3 Communications and $79 for Northrop Grumman.

And fourth, the $51,434,000 total increase in Pension Values in just one year is way too extravagant.  For these above 35 Executives, this is an average pension value increase of $1,469,543.  Somebody working at places like Walmart, and lucky enough to be working full time, only makes about $20,000 per year, thus these execs here are having just the pension increase portion of their pay go up by 73 times a Walmart worker’s total pay. 

There’s something clearly wrong with this.  And common people just don’t understand not just why these pensions have to be so large, but they also don’t understand why, in the long run, they end up funding 35% of these executive pension pay increases through the US Federal Income Tax Benefits these companies receive on them.

Further, many of these companies’ Total Pay of their Board of Directors, which includes their stock and stock option awards, is way too high, pretty much across the board.  Again, common people just don’t understand why this Board of Director Total Pay has to be so large.  And they end up funding 35% of it through the US Federal Income Tax Benefits these companies receive. 

I think the US Government should establish reasonable pay for Directors based on such metrics as company size and company profitability.  And any amounts paid above this reasonable pay should not be tax deductible by the company.

Also, the US Government should not allow any US Defense Cost Plus Contracts.  The motivation of the US Defense Contractor in Cost Plus Contracts is to simply spend more money, since that increases its Revenues, and thus its profits.

From a review of Proxy Statements filed with the SEC, below here is the Executive Compensation Disclosures of the Top 5 Executives of the 15 US Defense Contractors, with the highest Total Executive Compensation, which are in the Top 100 US Government Contractors in US Government Contract Award Revenues, other than the Top 7 shown earlier.

					2011	2011
					Non-equity	Increase	2011
			2011	2011	Incentive	in	All	2011
	2011	2011	Stock	Option	Plan	Pension	Other	Total
Executive	Salary	Bonus	Awards	Awards	Comp	Value	Comp	Comp
	000s	000s	000s	000s	000s	000s	000s	000s
Honeywell
Cote CEO	1,800	4,300		9,850	19,000	2,464	428	37,842
Anderson CFO	900	1,225		3,451	5,500	1,908	96	13,080
Fradin	1,050	1,300		3,451	5,473	484	66	11,824
Mahoney	763	800		2,636	3,192	955	35	8,381
Kramvis	624	875		2,196	3,500	206	58	7,459
General Electric
Immelt CEO	3,300	4,000	3,579			10,255	447	21,581
Rice	2,100	3,400		3,392		9,788	1,900	20,580
Neal	1,900	3,440		3,392		8,199	375	17,306
Sherin CFO	1,765	3,150		3,392		7,655	249	16,211
Krenicki	1,600	2,800		3,392		6,623	136	14,551
IBM
Palmisano CEO	1,800		14,308		6,500	7,577	1,614	31,799
Daniels	745		5,110		1,372	1,213	246	8,686
Rometty	715		5,110		1,470	797	250	8,342
Loughridge CFO	748		4,088		1,360	1,661	163	8,020
Mills	706		3,577		1,258	1,597	235	7,373
Verizon
Seidenberg CEO	2,100		19,549		3,544	342	921	26,456
McAdam CEO	1,400		18,750		2,363	127	481	23,121
Mead	725		3,806		734	175	220	5,660
Ruesterholz	700		3,675		709	175	143	5,402
Shammo CFO	675		3,544		683	4	144	5,050
Hewlett-Packard
Apotheker CEO	1,153	6,400	17,661				5,199	30,413
Whitman CEO				16,146			373	16,519
Lesjak CFO	825		9,310		679	90	102	11,006
Bradley	850		9,272		464		105	10,691
Joshi	850		7,965		638	264	76	9,793
Computer Sciences
Laphen CEO	1,086		3,894	2,589		2,101	11,190	20,860
Owen	583		807	537		1,552	8	3,487
Cook	580		892	593		1,161	6	3,232
Mancuso CFO	632		1,184	646			20	2,482
Hains	606		989	521			80	2,196
McKesson
Hammergren CEO	1,680		8,602	6,133	12,828	10,076	363	39,682
Julian	1,063		4,760	3,403	6,323	3,048	219	18,816
Campbell CFO	861		3,173	2,262	3,453	1,507	127	11,383
Seeger	683		2,004	1,406	2,193	1,300	81	7,667
Owen	680		1,587	1,161	2,222	1,538	87	7,275
AT&T
Stephenson CEO	1,550		12,750	45	3,788	3,330	555	22,018
Stankey	858		4,350	4	1,600	4,446	203	11,461
de la Vega	854		4,350	39	1,600	2,926	129	9,898
Watts	745		3,400	8	1,020	3,125	208	8,506
Lindner CFO	350		4,300	4	666	18	106	5,444
Chevron
Watson CEO	1,571		5,065	7,222	4,000	6,592	277	24,727
Yarrington CFO	843		3,572	2,803	1,425	2,577	68	11,288
Kirkland	1,271		2,867	4,036	2,600	5,571	168	16,513
Wirth	939		3,572	2,804	1,500	2,474	90	11,379
Pate	726		3,782	2,018	1,075	133	80	7,814
Caterpillar
Oberhelman CEO	1,430			8,309	4,935	2,081	148	16,903
Vittecoq	1,035	227	58	2,065	3,067	1,389	67	7,908
Wunning	806	170	86	2,159	2,265	696	108	6,290
Levenick	795	100	58	2,065	2,089	956	123	6,186
Lavin	724	142	57	1,971	1,988	731	364	5,977
Accenture
Green	1,250		12,125		2,725		5	16,105
Nanterme	1,155		5,225		3,404			9,784
Craig CFO	1,190		3,625		2,091			6,906
Campbell	1,176		3,550		1,889		2	6,617
Frerichs	1,266		2,050		1,565		19	4,900
Exxon Mobil
Tillerson CEO	2,387	4,368	17,891			9,755	519	34,920
Humphreys	1,170	2,994	9,860			4,327	135	18,486
Albers	943	2,070	6,679			3,838	107	13,637
Dolan	991	2,232	7,220			4,657	106	15,206
Pryor	972	1,905	6,123			1,834	111	10,945
Kraft Foods
Rosenfeld CEO	1,541		7,754	1,934	4,232	6,207	276	21,944
McLevish CFO	758		2,067	543	980	292	90	4,730
Anthony	758		2,017	507	1,167		133	4,582
West	657		1,298	308	1,050	820	71	4,204
Khosla	751		1,494	362	1,036	372	94	4,109
Dell
Dell CEO	987		9,435	2,388	3,315		14	16,139
Schuckenbrock	767		6,910	1,900	1,204		1,934	12,715
Felice	771		5,451	1,900	1,328		224	9,674
Bell	774		5,410	1,900	1,057		182	9,323
Gladden CFO	753		4,460	1,662	1,266		36	8,177
Harris Corp
Brown CEO	535	4,500	4,622	3,374	800		435	14,266
Lance CEO	461		3,717	5,918	220	3,253	355	13,924
McArthur CFO	563		1,535	567	214		47	2,926
Mehnert	463		1,338	434	347		47	2,629
Pearson	527		558	527	207		44	1,863
Total all 15 Corps	76,311	50,398	337,877	130,325	149,173	157,242	33,923	935,249

And lastly, below here are the Executive Compensation Disclosures of the CEOs of 30 other Top 100 US Defense Contractors in US Government Contract Award Revenues.

						2011	2011
						Non-equity	Increase	2011
				2011	2011	Incentive	in	All	2011
		2011	2011	Stock	Option	Plan	Pension	Other	Total
Corp	CEO	Salary	Bonus	Awards	Awards	Comp	Value	Comp	Comp
		000s	000s	000s	000s	000s	000s	000s	000s
Navistar	Ustian	1,238		4,671	4,996	1,450	2,718	94	15,167
Fedex	Smith	1,263			5,372	6,575		471	13,681
United Parcel Service	Davis	1,023		9,455	451	567	1,517	41	13,054
Huntington Ingalls Industries	Petters	857		7,000		2,250	2,462	340	12,909
Textron	Donnelly	1,000		5,323	2,241	1,403	1,468	85	11,520
Cardinal Health	Barrett	1,277		5,139	2,861	1,810		123	11,210
Valero Energy	Klesse	1,500		3,328	1,277	3,733	987	201	11,026
Humana	Broussard (President)	42		7,000	3,489			2	10,533
Health Net	Gellert	1,200		2,766	1,977	1,539	2,758	89	10,329
Fluor	Seaton	963		4,188	2,063	2,306	22	200	9,742
Alliant Techsystems	DeYoung	917		3,040	760	1,885	2,387	203	9,192
KBR	Utt	1,050		4,227	1,250	1,857	21	611	9,016
Exelis	Melcher	637	14	3,907	3,427	728	206	58	8,977
Tesoro	Goff	1,011	250	4,381		1,879	1,276	14	8,811
Express Scripts	Paz	1,116		4,320	2,880			200	8,516
Tyson Foods	Smith	900			2,476	2,969	1,038	321	7,704
Humana	McCallister	1,057		1,277	2,313	2,114		546	7,307
Rockwell Collins	Jones	1,084		1,819	1,876	1,335	668	218	7,000
National Fuel	Smith	835		598	575	2,577	2,203	171	6,959
URS	Koffel	1,000		2,264		1,349	988	799	6,400
Jacobs Engineering	Martin	1,223		3,131	848	646	5	7	5,860
AAR	Storch	867		2,665	578	850	50	826	5,836
CACI	Cofoni	780		2,419		1,982	353	202	5,736
SAIC	Havenstein	1,000		1,750	1,870	710		15	5,345
World Fuel Services	Stebbins	575		1,573		2,852		41	5,041
Amerisource Bergen	Collis	835		727	1,327	1,084		637	4,610
Mantech	Pedersen	1,851	610			1,240		152	3,853
Booz Allen Hamilton	Shrader	1,163		377		439	10	1,118	3,107
Oshkosh	Szews	983				960	1,013	6	2,962
Cubic Corp	Zable	788	681					97	1,566
Total all 30 Corps		30,035	1,555	87,345	44,907	49,089	22,150	7,888	242,969

 
The more Proxy Statements I review, the more I better understand why there is such a huge gap between the wealthy and everyone else.....and also another key reason why the level of US Debt is so incredibly high.