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What do you do when your number one customer begins to pull back? Take some lessons from these defense contractors

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Many a small company learns a hard lesson when a large customer goes belly-up. Or changes suppliers. Or cuts back. Consider the case of the defense contractor, perhaps the most stark example of the company captive to the fate of its major customer. Since about 1988 the Department of Defense (DOD) has slashed its spending by something like $100 billion, and the bloodletting is hardly over.

And yet, and yet. At least 15 companies on this year's Inc. 500 list have been heavily dependent on military contracts. Almost all are profitable, and several are more profitable than they were five years ago. They are opening new offices, adding to the payroll. The Lockheeds and IBMs of the world are calling them. So what gives?

When the going got tough, these companies didn't wait around for government "retraining." While they haven't abandoned the DOD, they have figured out how to zero in on new government and commercial niches. If one overarching successful strategy has emerged, it is this: they have found ways to get everyone in their companies on the lookout for new applications and new markets.

In the early Reagan years, "you could practically write a contract on the back of a matchbook," quips Jerry Lopez, CEO of Technautics (#212), in Arlington, Va. True enough, lots of small companies have done well under the government's minority/small-business set-aside programs. But by the mid-1980s, when Lopez started Technautics, things were changing. Tighter restrictions on those programs and Pentagon cutbacks brought more competition from the big guys for every type of military-related work. "Small companies have to be more creative now," Lopez says. "It's harder to compete because everyone is so hungry."

Having all his eggs in one basket made Lopez nervous. The $4.7-million company won its first contract outside the DOD on good references and luck: the National Institutes of Health wanted a minority-owned company to survey the career opportunities for minorities in biomedical research. As Lopez puts it, it was "180 degrees out" from what Technautics had been doing, namely, providing engineering and technical support to weapons programs.

But a funny thing happened as the company took on projects (research on the deaf as well as on drug use and AIDS) further and further afield from its initial market. "It was refreshing," Lopez says, and it proved to potential customers that the company was flexible.

Now, three years later, defense-related work accounts for 35% to 40%, rather than 100%, of sales. One employee, who used to work on Technautics' weapons program, now heads a project analyzing technology transfer for the Federal Highway Administration.

All senior managers are on the lookout for opportunities. As for other employees, Lopez says, "they've adapted to the new environment. They understand that defense alone would be really limiting. It all gets down to people's being willing to learn. No one wants to stay doing the same thing forever."

How times change. "I was laughing when I came across an old capabilities brochure," Lopez recalls. "It reeked of the DOD. Looking at the experience we have now, it's fun to dream where we'll be four years from now."

When three-time Inc. 500 winner H.J. Ford Associates (#114), also in Arlington, Va., began to diversify, chief executive Don Alducin was flabbergasted to discover just how talented his staff was. "My employees are incredible," he says. "They really came through."

A former air-force officer and former director of production on the DOD's Joint Cruise Missile Project, Alducin knew what it took to build a good missile and provided the military with engineering specs ("what the government doesn't have the resources to do"). But in the past 18 months, he's maneuvered sales from 100% DOD to "80% and going down." A good mix of other government agencies -- the General Services Administration (GSA), the IRS, the Department of Energy, the Department of Transportation -- has filled the gap.

Alducin gives his staff full credit. The turning point was landing an $800,000 contract from the GSA to work with the IRS, a quest that began with a cold call. The IRS wanted to automate its wage-information division. "They asked, 'Do you have the experience?' We said, 'No, but we have people who can do this." A frantic call for help down H.J. Ford's halls -- "Does anyone have imaging experience?" -- turned up one programmer, Zack Iseminger, who did. He put together the bid.

Later, two other employees got the smart idea to put every H.J. Ford employee's résumé on line, using the technology developed for the IRS. Potential employees' résumés are also on the system. "If an opportunity comes up for a specific type of programming, we can see who has the experience," says Alducin. His banker loved the idea.

Five years ago Galaxy Scientific (#5) was a one-man shop with 100% of sales coming from military contracts. Typical work then: generating the performance requirements for "jam-proof" communications systems, from walkie-talkies to sophisticated computers for fighter planes. Today Galaxy employs 242 people, and the DOD work is down to 45% of business.

As the cold war wound down, CEO James Yoh, a nuclear physicist by training, figured his best chance for growth would come from within. His plan: to turn the company into one big research-and-development reconnaissance team. As he staffed up in 1988, he created five autonomous profit centers around the talents of nine of his early employees. He gave them full freedom to "change the battle plan when they see fit."

An early target was the Federal Aviation Administration. The company won a contract to train airplane safety inspectors on the fail-safe maintenance of the very kind of communications and navigation equipment Galaxy played a part in designing for the DOD. One of Yoh's hires, a Ph.D. in education, recognized that power operators at electric- and nuclear-power plants had the same need to get it right 100% of the time; he was right. The demand for Galaxy's "life-and-death" expert-systems-based training is "growing every day," says Yoh. Today commercial clients kick in 10% of sales, while government agencies outside the DOD contribute 45%.

As he promised five years back, this year Yoh distributed 25% of the equity to his key players. An employee stock ownership plan is in the works for 1994

to reward the next generation of leaders. From his Pleasantville, N.J., headquarters, Yoh has little trouble recruiting talent. An open house in late 1992 drew 150 people from miles around, many laid off from GE, RCA, and Martin Marietta. -- Susan Greco