General Dynamics and the Double-Edged Petard

Are American defense contractors hoisting themselves on their own petards?

Ever since Dwight Eisenhower uttered his famous leave-of-office presidential address warning of the dangers of a rising military-industrial complex, the defense industry has done its level best to prove him right. $500 toilet seats may have passed into the history books as asterisked anachronisms, but companies continue to win defense contracting bids by lowballing bids on cost-plus-profit contracts, only to later declare "Oops! The cost rose, and so must our price" -- and profit.

But in recent weeks, firms like Lockheed Martin (NYSE: LMT) and General Dynamics (NYSE: GD) have learned that such tactics can turn around and bite them in the, er, stern. Because of an escalating scandal over climbing costs at the Littoral Combat Ship program, Lockheed has already lost one of its two contracts to build prototypes of the coast-hugging warship. And we learned last week that unless General Dynamics agrees to switch from a cost-plus to a fixed-price construction deal, it may lose its second contract as well.

General Dynamics may have shot itself in the foot, asking for 50% to 75% more money than it had originally agreed to build the ship for -- a sum that seems GreeDy with a capital GD. But the collateral damage that began with General Dynamics may not stop there. Both Northrop Grumman (NYSE: NOC) and Britain's BAE Systems (AMEX: BAE) also enlisted in the General's contract-winning brigade, and would suffer loss of revenue right along with it if the General can't agree to call a truce with the Navy.

And who might benefit if (worst-case scenario) the Littoral Combat Ship contract is put up for rebid? Raytheon (NYSE: RTN) lost out on the initial bid (because it proposed a realistic price, perhaps?) and should be game to pick up the pieces if its rivals fall apart.

For more on the defense contractors' ups and downs, read:

• Lockheed's Laser Clicks
• General Dynamics Caught in a Firefight
• Defend Yourself, Fool!