Looming defense cuts: Minn. businesses watch and wait

Minnesota businesses that supply goods or services to the U.S. Department of Defense are preparing for the fallout of massive federal budget cuts set to occur early next year if Congress does not agree on a plan to cut the federal deficit.

On Jan. 2, 2012, massive cuts to the Defense Department budget -- $492 billion, spread out over nine years -- are scheduled to start taking effect. The immediate effect will be across-the-board cuts of roughly 10 percent to all Defense programs and projects.

Minnesota has its share of major military contractors -- among them Lockheed Martin, BAE Systems and Alliant Techsystems -- but many contractors in the state are small businesses. All are waiting to see which of them will fall off the fiscal cliff of sequestration in January -- or if Congress will turn away from the cliff by eliminating or at least mitigating the scheduled cuts.

In 2011, Minnesota businesses signed more than 8,000 contracts with the Defense Department worth a total of nearly $1.7 billion. According to a 2006 report by the state Department of Employment of Economic Development, defense contract work was being done in all but 10 Minnesota counties.

Defense Department spending constitutes just 1 percent of Minnesota's gross domestic product, according to calculations by Bloomberg Government, which provides analyses of government spending, so the overall economic effect of defense cuts would not be serious. But the looming cuts could leave deep scars on communities and small businesses that depend on those dollars.

THE FAR CORNERS OF DEFENSE SPENDING

Among them is ReconRobotics, a company in the Twin Cities suburb of Edina that produces a small, dumbbell-shaped, tough-as-nails robot equipped with two wheels, a microphone and a camera.

The U.S. Army has awarded ReconRobotics a nearly $14 million contract for 1,000 of the throwable spybots, made to be tossed or driven into places where police officers or soldiers can't or don't want to go. Operators maneuver the robot with a big black remote control that includes precise movement controls and a high-resolution video screen.

Although the looming cuts have sparked gloomy predictions in Washington, Alan Bignall, the president and CEO of ReconRobotics, sees opportunity in them.

"Whenever you challenge an organization to significantly reduce spending, it gets more innovative," said Bignall. "I'm sure if it was Apple looking at this, or if it was Amazon or if it was Google looking at this, they'd say, 'OK, I know how I can make money out of that or I know how I could do that.' The hard side of it is, part of that turns into lost or changed jobs and those sorts of things. Those things are painful. They're never easy."

But Bignall is in a more comfortable place than many contractors. He's quite deliberately put his chips down on one of the defense industry's indisputable areas of growth: robots. Still, like everybody else, he's watching and waiting.

To the southwest, in the rural Minnesota community of Round Lake, Farley's & Sathers Candy Co. -- makers of Now and Later, Fruit Stripe gum, and Brach's --- is doing business with the military, too. For a five-year period, between 2007 and 2011, the Defense Commissary Agency paid the company more than $18 million for candy.

Not far from Round Lake, in Gibbon, Minn., the Army's Institute of Surgical Research paid Midwest Research Swine nearly $200,000 in the same period for medical research animals.

NOT YOUR GRANDFATHER'S MILITARY-INDUSTRIAL COMPLEX

Many Americans have an obsolete sense of the defense industry, said Peter Singer, director of the 21st Century Defense Initiative at the Brookings Institution in Washington, D.C. Today's industry, he said, is much more of a services provider.

"It's a different kind of approach than our vision of the 1950s [with] big assembly lines spitting out fighter jets," Singer said. "Now you have very complex organizations that might do everything from making components for fighter jets to providing cybersecurity services."

President Obama has requested $614 billion for the Pentagon in fiscal year 2013. But the money isn't concentrated among large industrial concerns.

Huge contractors increasingly share the responsibilities and risks of defense work with small and medium-sized businesses. The people who run these businesses are waiting and wondering.

For 15 years, Tom Heid, president of Aerospace Manufacturing in Eagan, has been a subcontractor manufacturing a part for the F-16 fighter jet. But for the first time, something is holding up the order, and Heid wonders if the threat of sequestration is to blame.

"Does that mean [the order] is going to happen and we just haven't been told?" he asked.

Todd Harrison, a senior fellow at the Center for Strategic and Budgetary Assessments, which occasionally does research work for the Pentagon, sees Heid's uncertainty reflected at small businesses across the country.

"The extreme fiscal uncertainty is across the entire federal government," he said, "but in the Department of Defense in particular, it is trickling down to those subcontractors ... some of them could be very small companies with a few dozen employees, and they may specialize in making a very particular piece of equipment that's used in military applications. They have very little visibility up the chain into what's going on and what might happen."

BAE Systems is way up the chain. It makes fighter jets, attack submarines, missile systems and ammunition, and it has a facility in Fridley, Minn. The company is moving manufacturing work from Minnesota to Kentucky, but company officials say they will retain 650 employees in Fridley.

In a statement, BAE spokeswoman Debra Parsons said sequestration cuts could result in the elimination of 10 percent of the company's U.S. workforce -- or approximately 4,000 jobs.

OPPORTUNITY IN UNCERTAINTY

The round of budget cuts may not mean a loss for all contractors. Some will gain, but it's not yet clear which ones.

"If the Pentagon was to say, 'OK, our budget is being slashed so we're going to buy less F-35s,' which is a new fighter jet, Texas would probably be hit pretty hard, because there's a major factory for it in Texas and the workers there would suffer," said Singer of the Brookings Institution. "In turn, workers in Missouri might go, 'This is a good deal for us,' because they're making the F-18 and the F-15, which are the fighter jets to be replaced by the F-35. So that means their wares are more likely to stay viable and active for longer periods of time."

This month, President Obama signed the Sequestration Transparency Act, which gives him 30 days from the day it was enacted to provide a report on how the cuts will be distributed.

The president's list is unlikely to resolve the uncertainties. There is still the possibility that Congress will act to reverse sequestration before it is scheduled to take effect Jan. 2.

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Here's a map which shows how much the Defense Department spends in each state:

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