By Aaron Mehta BreakingDefense.com
August 12, 2022 - In the wake of Russia’s invasion of Ukraine, defense budgets in the US and Europe have increased dramatically, with companies on both sides of the Atlantic looking to cash in. As CEO of Leonardo DRS, the American arm of Italian giant Leonardo, William Lynn III has a unique view on the state of industrial cooperation between Washington and the European capitals.
A former No. 2 official at the Pentagon, Lynn talked with Breaking Defense during last month’s Farnborough Airshow. The following interview was condensed and lightly edited for clarity.
Obviously, inflation is hitting extremely hard right now. How is it impacting your business?
It’s tough with an organization as complex as DoD to measure the actual impact of inflation. You have to kind of segregate it — you know, fuel costs this much and the pay raise is gonna be higher as a consequence, that’s both civilian and military. And then you have the material costs that are in the weapon systems [which are also a concern.] Our salaries are going up faster as a consequence of inflation to stay competitive, they’re up a point or two. And then we’re dealing with the same supply chain inflation issues as everybody else.
You have fixed price contracts, it’s challenging. You put escalation factors in there, but not at 8%. On the other hand, you know, depending on the contract, some of the risk is borne by us, some of the risk is borne by suppliers. Cost-plus contract [risk] is borne by the department. So obviously it increases risk for us. We just have to manage it. We have a pretty significant operational efficiency program at DRS, and so we’ve been using the savings from that, so far been pretty good at offsetting the increased inflation cost.
Have you begun to look at any contracts that you need to go to DoD and try to renegotiate, or talk about renegotiating with suppliers?
We’re not there. No, not at this point. You know, we’re stretched in certain places. But as I said, I think we’re able to use efficiencies to balance it. So far, that’s worked. [No one knows] how long inflation is going to last. I’m sure it will come back down over time. It’s a matter of how much time. But no, we’re not in that kind of stressed situation where we’d have to cancel contracts or, you know, threaten to cancel or renegotiate.
Post-Ukraine, do you see more willingness for European countries to work with US firms, or do you think they will focus more on domestic industrial players?
I think it’ll be more complex. I think that the additional funds in Europe are going to strengthen the European defense companies, because it’s their home markets. I also think it’s going to increase the amount of competition between European and US defense companies, because US companies will be going after those same dollars and euros. So could that produce collaboration? Maybe. I mean, if you’re an American prime, maybe you want to team with a European, improve your chances. There’s going to be more funding, there is certainly going to be interest in promoting European defense industry, [but] also interest in American products. I think Leonardo is well positioned for this. They have obviously with DRS, a very large presence in the US and obviously a large presence in [Europe], so we can manage that transatlantic trade as well as anyone I think.
When you talk with other folks from industry about where the defense industry is in terms of its health, coming out of COVID, the supply chain issues, in terms of its political standing for lack of better term — what’s the general sense of where things are?
I think things are stronger. The budget situation has gotten better. The political consensus has gotten stronger, largely due to Ukraine. We talked about inflation and the economy, recession possibility. Generally defense is a good haven in a riskier [market], isn’t molded as much by the normal kind of political or economic crosscurrents. It’s more of international tensions and so on that drive the budget. So I think we’re in a stronger place than we were a couple of years ago.
To your point though, this is driven in large part by Ukraine. We’re already seeing some “Ukraine fatigue” setting in, especially with the economic impacts countries are seeing. So from your industry standpoint, and from the view you would have taken as deputy secretary, how concerned are you that the pro-defense push we’re seeing right now could peter out?
But it’s not Ukraine in and of itself that has, I think, changed the dynamic. I think it’s the fact that Putin is willing to violate all these international norms and use force to accomplish his goals. I think NATO is justifiably worried that if he succeeds in Ukraine, NATO countries, either the Baltics or Eastern Europe, would be the next target for his aggression. And I don’t think you’re gonna get bored of that. That’s really what’s driving, I think, the changed circumstances for defense more than — I mean, there is lots of support for Ukraine and people want to ship them the weapons they need and so on. But I think in terms of the uplift of the defense budget, it’s that broader threat. That’s what’s changed.
And you think even if populations start to lose the focus on the day to day, that the governments are going to maintain that focus strongly?
I think so. They should. This is pretty serious.