Military contractors waiting on reforms to spur export growth

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Medium and small suppliers to primary military contractors in the US are positioning themselves for growth in foreign markets ahead of cuts in defense spending and reforms in export controls.

There are a vast number of manufacturers in the US making highly-engineered and high-tech components that are used for military purposes and most of these products are strictly controlled by export regulations because they are classified as potential components for weapons. But many of these regulations are out of date.

The Obama Administration ordered a review of the export controls list in August 2009 that found “the current export control system is overly complicated, contains too many redundancies, and, in trying to protect too much, diminishes our ability to focus our efforts on the most critical national security priorities.” The reforms aim to loosen controls on the vast majority of products on the list that are not sensitive to national security while implementing stricter controls on products that are.

Taller fence around a smaller field

Industry analysts have called the reform initiative “a taller fence around a smaller field.” For example, IEE Inc., a California-based manufacturer of display systems, expects its overseas sales to significantly increase once export controls on its products are relaxed, said Jim Foti, the firm’s international sales director. The company assembles monitors and mobile display systems that can be used anywhere from military hand-held devices to grocery store check-out counters, Foti said. But just because its display systems can be used in hand-held controllers in the military doesn’t mean their check-out stand displays have to be regulated by the US Munitions List, Foti said. That is precisely what the current regulations do. Most of IEE’s products fall under the US Munitions List, which limits the sale of goods that could be potentially used for military purposes in foreign countries. The list is governed by the International Traffic in Arms Regulations (ITAR) which falls under the jurisdiction of the Department of State. A classic example used by industry analysts are video game controllers, which are so sophisticated nowadays that they would be regulated by ITAR.

Commercial contracts account for only a quarter of IEE Inc.’s revenue compared to military contracts, which account for roughly half of the business, Foti said. But they see a lot of potential for growth in fast developing areas where grocery and retail stores are expanding, he said. The company has been somewhat active in doing business overseas already. It is close to securing a contract with a large Argentinean retailer this year and have a number of customers in Europe, Foti said. The company also won a large contract in 2008 where its products were used in Carrefour grocery stores in China, he added. These sales are lucrative but not as frequent as the company would like, Foti said. Many times potential contracts are lost to foreign competitors due to export controls, he said.

“If we find a sale we have to tell the customer that the product is considered an ITAR controlled item and we have to get a license before we ship it,” Foti said. “They just say, ‘Forget it.’ Yes, the government is trying to fix this and we hope it can be done in a relatively short time.”

Another company that is anticipating these changes is Pratt & Whitney Rocketdyne, the California-based rocket engine manufacturing subsidiary of industrial giant United Technologies. The firm has been an integral part of the NASA space shuttle program since the program’s inception and three Rocketdyne Space Shuttle Main Engines (SSME) were used in the final shuttle flight on July 8 this year, according to a company release. The SSMEs powered all 135 launches over the course of the three decade long shuttle program, with 100 percent mission success. To make up for the end of that program, the company has been ramping up development of commercial energy systems that will not fall under ITAR restrictions, said a source at the company. In addition to domestic commercial sales, the company is also focusing on increasing foreign commercial sales to make up for the loss of the NASA program as well as declines in domestic spending, the source said.

Lack of clarity holding companies back

The lack of clarity on what products fall into export regulations likely causes many US companies to miss out on export opportunities altogether. Mearthane Product Corp., a private equity-backed, Rhode Island-based manufacturer of thermoset polyurethane components, books a small portion of its revenue from producing waterproof seals that are used in military submarines. The company’s CEO, Kevin Redmond, said he expected that this product line was “probably” controlled under export regulations and that Mearthane would prefer to focus on other export opportunities than have to deal with navigating that terrain.

Another reason for these smaller companies setting their sights overseas is the decreasing defense spending, said Byron Callan, director at Washington DC research firm Capital Alpha Partners. Depending on what the final budget for the defense will be over the next decade, expected cuts ranged from USD 400bn to USD 1 trillion, according to various reports. Larger aerospace and defense companies have already been making moves to diversify their revenue, Callan said. Honeywell International CEO David Cote highlighted the aerospace and technology company’s growth in international sales of aftermarket parts during its second quarter earnings call. The growth in that line of business and other opportunities overseas has been somewhat of a surprise, the chief executive said. “It’s certainly coming at a good time now, though, when we’re looking at how do we offset the anticipated US defense declines,” Cote said during the call.

Smaller companies may not currently have the tools to make those large overseas sales, but many will be able to carve out a presence in the global markets, Callan said.

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