Congress Considers Fixed-Price Defense Contracts
- Summary: Weapons R&D work is usually billed on a cost-plus basis, but Sen. John McCain wants to shift risk to the contractors by requiring fixed-price contracts. Cost-plus contracts generated over 60% of sales for Lockheed Martin and Northrop Grumman in 2005, and abotu 50% for Raytheon and the defense businessses of Boeing and General Dynamics. Fixed-price contracts would prevent government budget exposure to cost overruns, such as the recent $20 billion increase in cost for the $277 billion Joint Strike Fighter program. A move to fixed-price contracts is the defense sector's "top legislative fear". The president of the Aerospace Industries Association trade group argues that cost-plus contracts are cheaper for the nation because they involve lower profit margins and claims that "the defense industry has had the lowest average operating profit margins of any industrial sector since 1980".
- Comment on related stocks/ETFs: Maybe the defense industry has low operating margins, but you wouldn't know that from the stocks. If Congress does insist on fixed-price contracts, expect a hit to the major defense contractors: Boeing (BA), Lockheed Martin (LMT), Northrop Grumman (NOC), Raytheon (RTN) and General Dynamics (GD).
