Today we bring you two absolutely incredible stories. The first is Lockheed’s legendary Skunk Works division — the elite team of aviation geniuses who produced some of the greatest airplanes in history: the U-2, the Stealth Fighter, and the incomparable SR-71 Blackbird. The second story is arguably even more important, but not widely known! It's the secret and true origins of Silicon Valley — and Lockheed’s primary role in it. We take you from WWII to the Cold War, all the way to today to unpack and analyze the industry dynamics of defense contractors in the modern era. Tune in and prepare to be blown away by what you’ll learn about the history of our industry!
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We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.
Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!
Purchase Price: $4.2 billion, 2009
Estimated Current Contribution to Market Cap: $20.5 billion
Absolute Dollar Return: $16.3 billion
Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…
Total Purchase Price: $70 million (estimated), 2004
Estimated Current Contribution to Market Cap: $16.9 billion
Absolute Dollar Return: $16.8 billion
Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!
Total Purchase Price: $188 million (by ABC), 1984
Estimated Current Contribution to Market Cap: $31.2 billion
Absolute Dollar Return: $31.0 billion
ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”
Total Purchase Price: $1.5 billion, 2002
Value Realized at Spinoff: $47.1 billion
Absolute Dollar Return: $45.6 billion
Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.
Total Purchase Price: $135 million, 2005
Estimated Current Contribution to Market Cap: $49.9 billion
Absolute Dollar Return: $49.8 billion
Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.
Total Purchase Price: $429 million, 1997
Estimated Current Contribution to Market Cap: $63.0 billion
Absolute Dollar Return: $62.6 billion
How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.
Total Purchase Price: $50 million, 2005
Estimated Current Contribution to Market Cap: $72 billion
Absolute Dollar Return: $72 billion
Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.
Total Purchase Price: $1.65 billion, 2006
Estimated Current Contribution to Market Cap: $86.2 billion
Absolute Dollar Return: $84.5 billion
We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”. With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.
That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.
Total Purchase Price: $3.1 billion, 2007
Estimated Current Contribution to Market Cap: $126.4 billion
Absolute Dollar Return: $123.3 billion
A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...
Purchase Price: $1 billion, 2012
Estimated Current Contribution to Market Cap: $153 billion
Absolute Dollar Return: $152 billion
When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.
Methodology and Notes:
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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)
David: Those two movies are so freaking good. It's so shocking how good Maverick is. So many years later in such a different environment, and then delayed due to Coronavirus.
Ben: The funniest thing is when it was delayed for whatever years during Coronavirus, the fighter that Maverick is in is an F/A-18 Hornet, the Boeing plane. By the time the movie gets released, it's basically discontinued within a couple of years. That's when they end the life of the F/A-18 Hornet for the Navy. Did you catch the Lockheed thing in Maverick?
David: The skunk on the tail of the plane?
Ben: Oh, yeah, on the Mach 10 Darkstar aircraft. All right, let's do it.
David: All right, let's do this.
Ben: Welcome to season 12, episode 5 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.
David: I'm David Rosenthal.
Ben: We are your hosts. Today's episode is on a critical piece of American infrastructure, Lockheed Martin. They are the nation's largest defense contractor. They're actually the federal government's largest contractor, period. The American taxpayers pay Lockheed Martin around $50 billion a year. Just to state this early and clearly, Lockheed Martin makes, among other things, killing machines.
The company is of course critical to defending the American way of life. Most of these things they make, fortunately, are used as deterrents to keep peace. But we should not mince words, they make weapons synonymous with phrases like overwhelming force and air superiority. You may feel and probably should feel conflicted as you learn about this company.
There are really no easy answers to the question, is what they make right or good? That's why we entrust the decision to use their products to the Office of the President of the United States. This company's history is absolutely fascinating. There are stories of hardcore engineering, daring innovators, and it's frankly just inspiring.
David: Going back, learning all this, and soaking in the history of the times when Lockheed was really forged, gave me at least a whole new perspective on this killing machines and deterrence question. To tell the full story of Lockheed, Lockheed Martin, and all the predecessor companies that came before it—I think it's 17 companies all merged together at this point—would probably require a full season of Acquired, so we're not going to do that. Instead, we're going to focus on two interwoven stories from Lockheed, not Martin, but Lockheed's golden eras.
The first of those stories is the famous Skunk Works. The second one, I'm not going to say what it is, so we don't spoil it just yet. But as a teaser, it's unbelievable and is directly tied into the birth of Silicon Valley. If you're in the tech world, and you think Lockheed Martin and defense fighter planes don't apply to me, think again, because pretty much everything you do came out of this, so I can't wait to tell it.
Ben: Quite the teaser, David. Listeners, this episode was selected by Acquired LPs. If you want to help pick an episode for next season, you can become an Acquired limited partner. Come closer to the show in other ways, including a private Zoom call with us every month or two for all the LPs. You can join anytime at acquired.fm/lp.
If you want more from David and I, you should check out our interview show, ACQ2. Our last episode was on the topic of how generative AI can be valuable specifically to B2B SaaS companies, and probably more importantly, where it cannot. Listeners, you can just search ACQ2 anywhere podcasts are found.
David: We've got some awesome interviews coming up too. ACQ2 is on fire.
Ben: Yup. Join the slack, acquired.fm/slack. We'll be discussing this episode there afterwards. Without further ado, David, take us in. Listeners, as always, the show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only.
David: For many of you listening, one thing you may not know that I didn't really know till we started the research is that the company that eventually became Lockheed Martin today was two companies. It was Lockheed and Martin Marietta, and there was a huge merger in 1995.
Lockheed was actually the second Lockheed company, or really maybe the third. The first Lockheed Company was founded in 1912 by one Allan Lockheed. But if you were to look at the spelling of his name, it would look like lug head.
David: Yes, but it was pronounced Lockheed because of the Scottish lock like Lochness, Lockheed not Loughead. He eventually changed his name to Lockheed and the name of the second company to Lockheed to avoid mispronunciations.
Ben: Which is great. He didn't just renamed Lockheed the company. He's like, yeah, I'm actually going to change my own name spelling to match it.
David: Yes, so great. He started the first company with his brother, Malcolm. They were more or less contemporaries of the Wright brothers. It was based in San Francisco, of all places, and it was mostly a tourist attraction. They had one plane, the model G, and they flew tourists around over the bay, and evangelized this new flying technology. It had a bunch of ups and downs.
Malcolm leaves the company and goes to Detroit to seek his fortune in the automobile industry, where he invented the modern hydraulic brake system for automobiles. Every time you press the brake in your cars, you're using Malcolm Lockheed's technology.
Ben: No way.
David: Yeah, super cool. They also ended up hiring into this first Lockheed company, one John Northrop. That name might ring some bells to help them design their future airplanes. John would go on to be a co-founder with Allan of the second Lockheed company, then leave the strike out on his own, where he founded the Avian Corporation. It gets acquired by Douglas and becomes a big part of Douglas. Douglas, of course, is now part of Boeing.
After that, John, as you might imagine, founded Northrop, which is now Northrop Grumman. This one dude was responsible for founding are playing a major role in three of the remaining five defense prime contractors today. But anyway, the first Lockheed company goes under. They start the second one a few years later. They have some success with the Vega airplane. People might be familiar with that. It becomes a favorite of Amelia Earhart and Wiley Post, famous early aviators.
It becomes successful, this second Lockheed company. They end up selling it to a consortium of Detroit auto moguls, maybe through the relationships from Malcolm or something, that have formed the "Detroit Aircraft Corporation" or the DAC. This includes Charles Kettering, the founder of Delco, and Head of Research at GM is part of this.
Ben: You may know Memorial Sloan Kettering.
David: Exactly, same dude. The idea was they were going to build the General Motors of the air. There was just one problem with that. Aviation did not become a consumer industry like the automobile industry. Allan Lockheed departs at this point in time and is tangentially involved, but this company that to this day bears his name, after this point in time, he doesn't really have a lot of impact on.
Shortly after this maybe harebrained GM of the air idea comes together, and Lockheed gets sold to the Detroit Aircraft Corporation, the stock market crash of 1929, the Great Depression happens, and DAC predictively goes bankrupt. They sell off the Lockheed division, which is actually still fairly profitable, out of bankruptcy to an entrepreneurial young businessman named Robert Gross. This is really the founding of the modern Lockheed.
Ben: The craziest thing, this price that he bought it for, $40,000, was so low that Allan Lockheed actually considered bidding to buy his company back when they had it on the auction block. His considered bid was $50,000, but he thought that is so low that it might be insulting. There's no way they'd ever sell it, so he didn't actually bid. The winning bid was $10,000 less.
David: It's so amazing when everything you've known of Lockheed today got bought out of bankruptcy for $40,000. It's crazy. Under Robert Gross and his brother Courtlandt who gets involved, they really are the ones who turned Lockheed into the great company it became.
Before World War II during the 30s, Lockheed builds the famous Electra airplane, which is absolutely iconic. This is the plane that Amelia Earhart disappears in. Perhaps, even more timelessly, this is the plane at the very, very famous scene at the end of the movie Casablanca went and Rick puts Ilsa on the plane with Victor to escape the Nazis and says, here's looking at you kid. That plane is an Electra, I believe an Electra junior.
Ben: Listeners, you know this plane. It's one of those romantic early aircrafts that were always perched up at an angle, where if you saw it standing still on a runway, it looked like it could just take off at any moment.
David: Absolutely beautiful. The Electra and Casablanca brings us to the first core part of our story, which is World War II, which transforms everything. A man named Clarence "Kelly" Johnson, who started the famous Lockheed Skunk Works division.
Ben: This is great because before I started the research, I was loosely aware that Lockheed had the first skunk works. Now, it's become almost like Kleenex when someone says skunk works. Oh, we're going to start a little skunk works division. It was not a thing, until Kelly Johnson started the skunk works.
David: There's a wonderful book. There are a bunch of wonderful books around Lockheed, but a book titled Skunk Works, that was written by Ben Rich, who was Kelly's second in command for a long time at Skunk Works, and then took it over when Kelly retired. This book is like the Top Gun of historical autobiographies. You read it, and you were just fired up. It is amazing what these people did.
Ben: It's top gun for engineers.
David: Yes, it's so great. I also highly recommend a book called Beyond the Horizons, which is hard to find that most people don't know about, by Walter Boyne. That is an amazing history of Lockheed during all these areas that we're going to talk about.
Ben: David, that's so mean, you're recommending an out-of-print book to people.
David: We keep doing this. This one, I think, I only paid $40 for on Amazon. It's not quite like the taste of luxury and LVMH, which I think that's now $3000, $4000, or $5000.
Ben: Yeah. We definitely spiked the price.
David: We did. All right, who is this Kelly Johnson? He's basically the Shigeru Miyamoto of airplane design. His nickname is Kelly because when he was in grade school growing up in Michigan, either his real name was Clarence, an older boy called him Clara on the school yard. Johnson attacked him so viciously that he broke this kid's leg. After that all of his schoolmates never called him Clarence or Clara again, and they nicknamed him Kelly.
Ben: Okay, not Clara, but why Kelly?
David: There was some character of Kelly, an Irish tough guy, that they named him after. That really was his personality. After every skunk works test flight for the rest of his tenure running Skunk Works, they throw a big party, and Kelly would challenge anyone all comers to an arm wrestling match. Even when he was 60 years old, he was still beating people.
Ben: You should Google a picture of this dude. He is just a 1930s man's man at his finest.
David: And maybe the best airplane designer ever to live. That is Kelly Johnson.
Ben: When you hear the stories about him, he could intuit the answer to difficult math problems in his head. Not just math problems, but physics problems, applying Bernoulli principle in his head, and coming up with an answer that was 5% off from the actual answer. Someone else would go spend hours and hours and hours with pencil, paper, and slide roll to come to basically the same number.
David: The quote from his first boss, Lockheed's chief engineer at the time, Kelly would become the chief engineer. His boss at the time, Hall Hibbard, would say, that guy can see the air.
Kelly ends up winning the Collier Trophy twice, one of only two people to do so in history. The Collier Trophy is the equivalent of the Oscar for Best Picture. It's the best airplane design of the year. He wins it twice. He ends up being bestowed the Presidential Medal of Freedom by Lyndon Johnson later in his career. He is a true American hero.
He ends up joining Lockheed right out of the University of Michigan Engineering School—I'm sorry, University of Michigan, Ohio State; sorry, Ben—in 1933 at 23 years old. Kelly is really one of the, if not the principal engineer that designs and builds the Electra. He becomes the star of Lockheed's then only six-person aviation design and engineering department. There were six people that were making these things.
He does basically everything himself, engineering, designing, testing, even flight testing. There's this amazing quote in Skunk Works. This in Ben Rich talking. "Kelly once said that unless he had the hell scared out of him at least once a year in a cockpit, he wouldn't have the proper perspective to design airplanes." It's so great.
Okay, so the start of World War II rolls around. The first thing that Kelly and Lockheed do is they adapt the Electra into a bombing vehicle called the Hudson. Even before the US enters the war, the British Royal Air Force ends up buying about 3000 of these Hudsons from Lockheed.
Ben: This is a thing that was eye-opening to me doing the research. Lockheed's big customer in World War II before the US enters was Britain's Royal Air Force. They were a way bigger customer than the US was for many, many years.
David: Once the US enters the war, and as they're gearing up to enter the war, Kelly designs the amazing P-38 Lightning Fighter, which was the US' elite, fastest, most maneuverable aircraft during World War II. They made over 10,000 of them during the war, and all of the top bases in the US Army Air Corps flew them. It was the plane that shot down the transport that was carrying Japanese Admiral Yamamoto, the guy who had masterminded and overseeing the Pearl Harbor attack. This is a legendary airplane.
Ben: Side note. I will say that last week, partly in preparation for recording this, but partly because it's something that I've always wanted to do, I went to Pearl Harbor. There is truly nothing like being there and experiencing that. Growing up in America, we basically haven't had attacks on our soil. It's 9/11 and Pearl Harbor, period.
It's a very unusual thing to see, in your own country, the remnants of an attack. Being over this sunken USS Arizona from the Japanese bombing, it's harrowing and heavy. I think that's an experience I'd recommend to anyone.
David: Okay, that was Lockheed and Kelly during the war. Fast forward now to the waning days of World War II and of 1944 into 1945. It's pretty clear that America and the allies are going to win the war at this point in time, but it's also becoming evidence that there are two big problems that are emerging. One very immediate and one longer term.
The immediate problem is that in the skies over Europe, in the air theater of the European front, a new technology is appearing on the German side. Jet powered fighter planes have begun to pop up.
We're not a Military History podcast. Save this for Hardcore History and Dan Carlin. But my understanding of this is that the German jet fighters entered the war too late to make a difference. But if they had entered service earlier, it would have been a big problem. The US and the allies are like, oh, crap, we need to step up our game and get a jet fleet in service for us ASAP.
Ben: For anyone who's not an AV geek out there or an aviation geek, it's worth knowing, going from a prop airplane to a jet airplane is not just incremental. It's an entirely different technology. You may have heard the phrase, if you've looked into this before, suck, squeeze bang, blow. It is a completely transformative process of how the engine uses the air in order to create thrust that is much more sophisticated than just a propeller.
David: My understanding is the engines that airplanes were flying before then, even the P-38, as sophisticated as it was, were basically automobile internal combustion engines.
Ben: Totally. We're observing overseas. Our enemy has a completely new technology that we have not tamed and mastered yet. We're at a disadvantage.
David: That's one problem, and we're going to focus on that first. The other problem to put a pin in for later, and we start to get worried that our ally, the Russians, the Soviets, our relationship with them might not be quite what we think it is. We might have to address that in the coming decades, so keep that in the back of your mind as we go along here. Let's start with the jet problem.
The German plane that had started appearing in the skies over Europe was the Messerschmitt Me 262 nicknamed the Swallow. It was the world's first operational jet-powered aircraft. It flew close to 550 miles an hour, which is over 100 miles an hour faster than any Allied plane, including the lightning P-38. The US government turns to, of course, the very best person for the job to start the US jet fighter program, Kelly Johnson and Lockheed.
They tell him, go make us a jet fighter as soon as possible and by any means necessary. When we say as soon as possible, we want to prototype in 180 days with the spec that it must go faster than the German Swallow, so at least 600 miles an hour. You need to pull out all the stops, bypass any red tape, do absolutely anything necessary to make this happen.
Ben: For those tracking along at home, 600 miles per hour, not quite the speed of sound, not quite Mach 1, but approaching that, something like 80%-ish to Mach.
David: Yup. Johnson handpicks 23 of Lockheed's very best engineers and designers and about 30 of the best shop people, the people that actually build the airplanes. He rents a literal circus tent to house them in the parking lot next to a plastics factory that is nearby to Lockheed's headquarters in Burbank, California. It is because of this that the name Skunk Works is born because of the outdoor nature in the tent and the smell coming from this plastics factory.
At the time, there was a very popular comic strip called Little Abner. A character in this comic strip had an outdoor moonshine still making bootlegs of prohibition era alcohol. This still in the comic strip was called the skunk works.
Ben: I think it was called the skonk works.
David: That's right, the skonk works. Eventually, the publisher of Little Abner sues Lockheed over using skonk works, so they changed it to skunk works.
In this circus tent in a parking lot, Kelly and this super elite team from Lockheed build the first prototype US fighter jet named the Lulu Belle in 143 days from start to finish. This is just wild.
For years, the US had been working on this technology. They hadn't gotten it operationalized, the Germans beat them to it. Then in 143 days, Kelly and Lockheed go from zero to flying prototype. Crazy. What a testament to him and to this organization in the circus tent that he has built, the skunk works.
Ben: Seriously. This 180-day thing is a very interesting constraint placed on them. It means that they immediately need to go to an Acquired axiom that we've talked about forever, don't do something that's not your core competency.
David: AKA, doesn't make the beer taste better or make the plane fly faster.
Ben: Exactly, and outsource everything else. If you only have 180 days to do it, you are not going to become an engine manufacturing company. You are going to look around and say, okay, which of my allies has the capability to just give me an engine? They find this British company Halford, and they take the Halford H. 1B Goblin engine, and that is what they put in this prototype.
David: Yes, this prototype, the Lulu Belle would go on to become the P-80 Shooting Star. Lockheed would ultimately make about 2000 of them. While they weren't really used in World War II because the war ended, they would be used in Korea, and it would be the first jet fighter plane in the US military.
You raised a really important point, though, that we didn't cover earlier about Lockheed and skunk works. They are not engine manufacturers. All of the engines that we're going into the planes before, during, since, they're getting from other companies.
Ben: That is true across the aerospace industry. It's interesting that the value chain evolved this way, where basically no aircraft manufacturers to this day make their own engines. In commercial, you've got Rolls Royce, GE, but every single one of these Lockheed planes, the engines are made by someone else.
David: Yeah, very different from how the automobile industry evolved, where obviously, Ford, GM, and whatnot, they're making their own engines. This amazing feat, building what becomes the P-80 Shooting Star and the US' first jet fighter plane in less than six months, is the beginning of skunk works.
Kelly realizes, hey, this is something pretty special here. I want to read a little quote from the Skunk Works book. "That primitive skunkworks operation set the standards for what followed. The project was highly secret, very high priority, and time was of the essence. The Air Corps had cooperated to meet all of Kelly's needs, and then got out of his way, and boy did they deliver."
Ben: The P-80 would eventually give way to the F-104 Starfighter, which was another invention from Kelly and the team. Kelly would win the Collier Trophy for this.
David: After the war, Kelly says, hey, this is special, we should keep this going. The Gross brothers and Lockheed's management agree. They say, yes, you can keep this "skunk works" division going as long as it doesn't take too much money, and it doesn't distract from your duties in the rest of the company as now the new chief engineer. Kelly is both the chief engineer of all of Lockheed and running skunk works at the same time.
Ben: It's insane. This not taking too much money thing does become a core tenet of the skunk works operation because you can get around management's ire, management's need to report to shareholders and things like that, if you're doing amazing things and pulling rabbits out of hats. When it's not going well, you're not a huge burden.
David: Yeah. I'm going to read a little more from Skunk Works here. “Kelly and his handful of bright young designers that he selected took over some empty space in building 82.” This is a building on the Lockheed campus, which is right next to the Burbank Municipal Airport. It's an unmarked building. Literally, this is a commercial airport that average people are taking off of every single day. Then it continues.
“Those guys brainstormed what if questions about the future needs of commercial and military aircraft. If one of their ideas resulted in a contract to build an experimental prototype, Kelly would borrow the best people he could find in the main plant to get the job done. That way, the overhead was kept low, and the financial risks to the company stayed small.
His small group were all young and high-spirited, who thought nothing of working out of a phone booth if necessary, as long as they were designing and building airplanes. All that mattered to Kelly was our proximity to the production floor. A stone's throw was too far away. He wanted us, the engineers and designers, only steps away from the shop workers to make quick structural or parts changes.”
Ben: Yes, I love this. I think this is a huge learning. Keeping your designers as close as possible to production, so the game of telephone is as short as possible and is incredibly valuable. Having the designers be able to glance up at their desk and see literally the way things are being manufactured. They can say, oh, that looks good in the diagram, but in practice, you have to bring this big thing around over here. Maybe we can make that better the next time we design it. It's just such a great key insight.
The other thing on the small number of people, this gets to the skunk works rules. Kelly created this incredible document, 14 rules that we'll link to in the show notes. They're all incredible, but the third of which really applies here. "The number of people having any connection with the project must be restricted in an almost vicious manner. Use a small number of good people, 10%–25% compared to the so-called normal systems.
David: These people should all be together, all of them building relationships, collaborating, working together to produce the very best product.”
Ben: You see this in products in the future too, the iPhone, the iPod. You read the stories about their early teams, there were 6, 8, 10 people. They're all full stack. There were these unicorns that cross disciplines, and they're 10X, 100X engineers. You really only need a handful of really good people.
David: I think it's worth going through a bunch of Kelly's rules. But first, we have one of our very favorite Acquired companies to tell you about.
Ben: Yes, Vanta. We have something all new to share this time. Of course, you know by now that Vanta enables companies to generate more revenue by getting their compliance certifications. Of course, you also know it's amazing for startups since it's the fastest and easiest way to get SOC 2, ISO 27001, and other certifications that as a small startup, you just would not otherwise have the resources for. But today, we want to talk about why Vanta is also the best security compliance platform as you hit hypergrowth and scale your company into a larger enterprise.
David: Yes. Vanta now has a tremendous amount of customization to meet your increasingly complex security needs. If you're already a larger company, and in the past, you maybe showed Vanta to your compliance department, and heard, oh, we already have a process in place, we can integrate this, now, even if you already have a SOC 2, Vanta makes maintaining your compliance way more efficient and robust.
For example, just last week, they launched vendor risk management. Take for example the aircraft industry, where you have tons of subcontractors that are working. You don't know what risks they have, you need to know this. This allows your company to quickly understand the security posture of the vendors that you are choosing in a standardized way that cuts down on security review times. This is awesome.
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All right, David. What makes skunk works work?
David: To start, all that mattered, literally the only thing that matters is rapid delivery of superior products. That was driven by the expedient requirements of World War II, literally saving America and the free world and then the Cold War, which is going to come in a big way in a second here.
Listeners might be thinking, isn't all that matters in any business, rapid delivery of superior products? Why isn't this new, unique, and different? The reality, though, is that that's almost never the case. There's politics, there are personalities.
Ben: You rarely have an existential threat that you must cut through all the red tape. It's like Operation Warp Speed, the way that we got the vaccines as fast as we did. If the world is on the line, what can you do away with in your processes, and which people can you hand-select to solve it?
David: Competition and existential competition has a way of bringing out the best in people. Ben, you already talked about rule three.
Ben: Did we pick the same ones? I'm so curious. We got 14 to pick from. Let's pick three that we're going to highlight here. We already talked about number three, what are your others?
David: The next one I want to talk about is, “the skunk works manager must be delegated practically complete control of his program in all aspects.”
Ben: Yeah. This is like the Auteur theory. You have to have a single person's vision and the buck stopping with a single person who has ultimate control and isn't a squeezed middle manager. He's the program manager for any given program that they're working on, any new aircraft.
Also, he's the guy flying to Washington to interface with the government. It's not like he's dealing with the engineers, then call them the sales force, and being like, hey, can you go to a steak dinner with our guy up in Washington? No, it's Kelly.
David: And at its most productive, skunk works I think was about maybe 50 designers and engineers, and maybe 100 machinists and shop people. This is not a large organization.
Ben: It's crazy.
David: My last one is the last one of the rules.
Ben: Yes, this was one of mine, too.
David: “Because only a few people will be used in engineering in most other areas, ways must be provided to reward good performance by pay, not based on the number of personnel supervised.”
Kelly has a quote about this in the book. "In the main plant, they give raises on the basis of the more people supervised. I give raises to the guy who supervises the least. That means he's doing more and taking more responsibility. But most executives don't think like that at all, they're empire builders." This is so important.
Ben: Yup, totally agree. In fact, it's thinking like a capitalist too. It's really like, how can we achieve the most with the least, not how can we achieve a fixed amount with a fixed margin.
David: There's one more thing that isn't in any of the rules because I think it's just an implicit unspoken assumption. All of this only works if the small group of people that you've brought together are highly motivated. I think the reason this was taken for granted for all of skunk works heyday was, hey, the mission here is preserving your life, the lives of your loved ones, and America from losing World War II, and then having nuclear bombs dropped on it by the Soviet Union. You don't really need a lot of extra cajoling or motivation here.
Ben: Totally. You got to think back, this was a time where American superiority was not guaranteed. I think we have a reasonable amount of complacency today. Americans feel very secure. Sure they're enemies, but are we going to be fine? Totally.
We don't need to think about this that much. We can decide to prioritize other things, have passions, and say, yeah, other people can take care of the national good because we'll be fine either way. That was not the belief at the time.
David: No. There's this great quote in Skunk Works, where Ben Rich tells the story of his first day in Skunk Works, where he's shown the U-2 prototype. We're going to talk all about the U-2 in a minute here. But literally, day one, he's shown the prototype of this top highly classified, highly secret airplane that nobody can know about.
He says, "The full weight of government secrecy fell on me like a sack of cement that day inside Kelly Johnson's guarded domain. Learning an absolutely momentous national security secret just took my breath away. I left work bursting with both pride and energy to be on the inside of a project so special and closely held, but also nervous about the burdens it would impose on my life." This is exactly to your point, with great power comes great responsibility here.
Ben: Yup. Okay, what are the machines that unfold from here?
Ben: All right. A minute ago, I was talking about the two problems that America and its allies had at the end of World War II. One was the jets. Skunk works addresses that with the P-80 Shooting Star. The other problem is, yeah, we're going to win this war, but there's a whole new war that's just about to start.
Ben: Yeah. The war we're coming out of is World War II. But of course, the cold war against the Russians is just starting.
David: This is so hard for us to process today. But doing the research, I really felt it. I think, for a lot of people, the stakes, the pressure, and the worry about the Cold War was greater than World War II.
Ben: Yeah, that's a great point. When the Americans entered World War II, we had reason to believe that we could come in and win. The Cold War, I think to the American psyche, felt very different.
David: I think we had good reason to believe we were not going to win. Right after the war, Churchill comes to America and gives his famous Iron Curtain speech in Fulton, Missouri that an iron curtain has descended over Europe in the form of the Soviet Union. Before the end of the decade—I didn't really realize the timeline on this—in August 1949, the Soviet Union detonates its first nuclear bomb. Nobody believed that they were going to have the bomb that quickly or that powerfully.
Not only did they have the bomb, but whether this was real or not, or positioning, people really believe that the Soviets and Khrushchev's intention is to use the bomb against America, If they ever believe that they could do so without fear of retaliation, that they could knock us out first, that they would do a first strike and use nuclear weapons on America.
This kicks off the Cold War arms race. People probably know and learn about mutually assured destruction and deterrence. This really was the policy of the military in the American government that we need to have capabilities to deter the Soviet Union from launching a first nuclear strike against us by being able to guarantee and have them know that we guarantee that if they do so, we will destroy them. They can't do this because if they do, they will be destroyed. That was the whole policy.
That's a really scary place to be in. This is like, if somebody over there in the Kremlin decides one day that they think they can win, we're all going to die. In 1955, there was a national poll that asked the question, what do you think you are most likely to die from? Over half of America responded that they thought they were most likely to die in thermonuclear war above any other cause. Let that sink in. Over half of the country thought they were going to die in nuclear war.
Ben: Horrifying. In a war perception, intelligence is paramount.
David: Bingo. It is the most important thing. Even more important than your ability to strike and wage war is your ability to know what the current state of the opponent's ability is to strike and wage war. That means that the battleground is no longer the use of weapons, but the intelligence about the existence and positioning of weapons. Nobody is better suited than Skunk Works to be the US government and military's primary—sounds cliche to say—sword and shield during this war.
Ben: Yes. This brings us to the U-2 spy plane. This plane serves such an important purpose that it ended up being brought into service in 1955 and was only decommissioned in 1989.
David: Yeah, incredible.
Ben: Now, there are many airplane programs that have 10-, 20-, 25-year timeframes.
David: For very different reasons.
Ben: Yes, that we will talk about in the military industrial complex. The U-2 was basically the first time that America found a plane that it could use for a long time and wasn't rapidly replaced by the next best thing.
David: Okay. It would be really great if you could fly a plane over Russia and take pictures and understand all this.
Ben: Because there are no satellites yet.
David: Are there satellites? We'll talk about that a little later. You can't just fly a plane into Russia and do that, it's a closed country. The Russians are going to shoot you down if you do it.
Ben: We're not technically at war, so it would violate international treaties to go into their airspace. We would start the war by doing that.
David: Exactly. It's funny that it's in the news now, that China is doing this now. The first thing we try is unmanned spy balloons. We send balloons over Russia.
Ben: Failed weather experiments.
David: Yeah, failed weather experiments. That fails on many fronts, including actually returning usable photos of Soviet nuclear installations. Really, it becomes clear that what's required is an entirely new type of airplane that can either do one of two things, and ideally, both. Fly over Russia stealthily and undetected by radar, or fly high enough or fast enough that they can't shoot it down, even if they do.
Ben: Skunk works, being the ambitious organization that they are, tries for option one. We frankly don't know very much about what Russia's capabilities are. We're pretty sure that we can build some airplane that flies high enough that their radar systems won't detect us and great, so let's do that.
David: Yeah, great. This is interesting. What government agency contracts them to do this? It's not the military. We're in the spy game now. It's not the Army, not the Navy, not the Air Force. It's the CIA. They are building their own air capabilities. All of the work that skunkworks does here and for many years to come is for the CIA.
What exactly is the challenge that Skunk Works has laid out in front of them for designing this new spy plane? At the time, the maximum altitude that airplanes flew was about 40,000 feet.
Ben: The US thought that the Soviets best interceptor fighter aircraft could get to about 45,000 feet.
David: We also thought that their radar wouldn't function above 55,000, right?
Ben: We were like, all right, as long as we clear 65,000, we should be higher than their radar could even detect and certainly higher than their fighters could come get us.
David: Right. The CIA's spec for Skunk Works for the U-2 is to fly at 70,000 feet. Now, there are a couple of problems with that. One is that normal jet fuel doesn't work at that altitude. At that altitude, the pressure, the temperature, everything about the environment, you're getting to be closer to space than you are to normal earth's atmosphere, and things start going wrong.
That one, they actually subcontract with Shell Oil to make a new formulation of jet fuel that does work up there, so that problem is solved. Problem number two is maybe a little bigger, and that is that humans cannot survive at that altitude.
Ben: Certainly, you need a pressurized cabin. But if something were to happen, and you needed to be out of the cabin, cold, no air, blah-blah-blah.
David: Yeah, and I don't know the technical details, but I think even the cabin pressurization technology that existed then was not going to cut it at 70,000 feet.
Ben: You basically need a spacesuit.
David: Exactly. Some of this technology came from diving suits, and some other things that came before this. I think this was the big coming together of the technology that created the spacesuit. That's what they put these pilots in. Lockheed and Skunk Works win the contract from the CIA. They start working on this plane some time in 1953.
Ben: Incredibly top secret. We wouldn't reveal the fact that this existed to the Russians, our own people for years and years and years.
David: This is the quote from earlier that we read from Ben Rich when he started working on this project day one, and saw the prototype as it hit him like a sack of cement, how important this was. Skunk Works completes and delivers the plane by July 1955. A year-and-a-half, and for a total project cost of $3½ million dollars, for one of the most important products and pieces of technology in American history. Astounding. This is what Skunk Works is capable of.
Ben: They're flying higher than any plane has ever flown before, they're using a different type of fuel, people are flying in spacesuits for the first time. It feels like to be a reconnaissance aircraft, you would also need one other key component in order to achieve the mission of spying on the enemy.
David: Yeah. To take photos, you need a camera.
Ben: Indeed. You would need an all new type of camera with an all new type of lens, capable of taking photographs of something 70,000 feet away from you through a whole bunch of atmosphere. Gosh, if only the US had someone who was just incredible at this pioneering optics technology.
David: Indeed, the US did, and that was Dr. Edwin Land and the Polaroid company, who subcontracted and created all of that. Actually, I believe it was Edwin Land himself that helped convince President Eisenhower to even pursue this project in the first place. He was like, we can build the camera that can do this. If we can get the airplane built, we can do this project.
Ben: This blew my mind. It's so cool to see the intersections of different innovators throughout history. Edwin Land is the man who inspired Steve Jobs, and he's building the U-2's camera.
David: Just wait. We're going to have a lot more tech in Silicon Valley and Apple stuff that's going to come up here in just a little bit. They built the plane, but you got to test this thing. They're not going to roll it out on the runway in Burbank, take off, and just head for the Soviet Union. You got to test it. It's got to be secret and whatnot. Remember, Kelly Johnson, one of his big principles is, we test our products. You, the government, don't test our products, we test our products.
Ben: We should be clear, this U-2 spy plane looks crazy.
David: It has a 100 foot wingspan.
Ben: Yeah, this thing, if you saw it taking off, you would be like, okay, I've seen airplanes, that thing is completely different. It's not like they could disguise it. You need to figure out somewhere in the United States, where there's basically no buddy so that you can test this thing.
David: This is so fun. The smile on our faces is like… you can't see us, but it is stretching out of the room here. You can't just paint this thing like a school bus and pretend it's something else. They need to find a suitable test site. They go scouting all across the western US and remote areas. Kelly Johnson is like Sam Walton in his prop plane, scout now for Walmart locations flying sideways.
Ben: And then they get an idea. That idea is, where is a place where even if there were people before, there sure aren't people now? Because nobody in their right mind would want to be anywhere close to where we just tested our nuclear bombs. They go, oh, as long as we figure out that it's safe, that would be a perfect place for us to test this airplane.
David: They find a dry lake bed in Nevada called Groom Lake. There's a quote from Kelly Johnson here about this in the book. "We flew over it. And within 30 seconds, you knew that this was the place. It was right by a dry lake. Man alive, we looked at that lake, and we all looked at each other. It was another Edwards like Edwards Air Force Base. We wheeled around, landed on that lake, taxied up to one end of it. It was a perfect natural landing field as smooth as a billiard table without anything being done to it."
Ben: How insane is it that this is where we were testing nukes? I actually do not understand how there was no radiation poisoning. I don't fully understand the half life and all that needs to be done, but how was that safe?
David: Yeah, it's insane. Not only were there recent nuclear tests happening right nearby, I believe that nuclear testing continued right nearby while they're using this site, Groom Lake, to test the U-2.
Ben: A hundred percent. It's the craziest thing. They had to, sometimes, take some time between the most recent nuclear test and when they wanted to go fly because these sites are12 miles away from each other or something pretty close. If you're curious, listeners, there's this great documentary on Amazon called Secrets in the Sky: The Untold Story of Skunk Works that has a bunch of footage of all of this.
David: Wow. Listeners, if you haven't caught on already, the location that we are talking about...
Ben: A Nevada Test Site in the middle of the desert.
David: Nuclear, some really strange looking flying aircraft. This is Area 51. Skunk Works creates Area 51.
Ben: Of course, there are rumors of UFOs there. They want to keep everyone away. For the people who they can't keep away, they're going to see some really weird flying stuff. Of course, the rumors are going to start. It's all goodness for Skunk Works. This cover is great.
David: It's even better than that. I can't remember which plane or when this was, but at one point in time, one of the test flights crashed. The pilot survived and somebody saw him. He was wearing a spacesuit. Nobody knew what a spacesuit was. Of course, he looked like a freaking alien.
Ben: Right. It would be another 10 years before we would have the moon missions.
David: Yeah, it's so funny. Amazing. It's all skunk works and the U-2. And then the Blackbird and everything else we're going to get into later in the story, all happening out of Area 51.
Ben: The prep work that the pilots had to go through before getting on these planes too were nuts. They needed to breathe pure oxygen for two hours to remove all the nitrogen from their blood in case they had to eject because remember, there are our test pilots on a super experimental aircraft. They were often ejecting. Things went wrong in these tests.
David: Yeah, a bunch of people died doing this, we should say.
Ben: Yeah, a great sacrifice to bring this program and subsequent skunk works programs into the world. But basically, what was happening is, if you didn't breathe pure oxygen for two hours, you could get the bends for anyone who's scuba dived, and you can't fly right afterwards from ejecting.
It's like, well, if you managed to get out of the aircraft before it crashed, then that could kill you. You needed to make sure that this oxygenating of your blood and getting rid of all the nitrogen made it so that if you did need to eject, then you would survive this as well.
David: Yeah, crazy. Okay, they test the U-2 at Area 51. It's so great. They get it up and running. In active service as an operational spy plane, pretty much the world's first, at least of this type, within a year, the first Soviet Union overflight happens on July 4th, 1956.
Ben: Of course, it was.
David: Of course, it was July 4th. This is so interesting. There are a whole bunch of things that happen when they take off. They don't know what's going to happen. Is this thing going to work? Are the Soviets going to see us? We're going to learn so much here.
You can't script this stuff. The Soviets tracked it on radar, even at 70,000 feet the whole way. Right from it taking off, the whole flight path to Russia, they knew everything that we were doing.
Ben: We were super wrong about their radar. They didn't just have low altitude radar. They were capable of radar that could see straight up into space. Wherever we were flying, they were going to see us.
David: Yup, which we had no idea, so we learned this as part of it. Here's what's funny. We know that they see it from takeoff. They track the U-2 the whole way. This whole top secret program like, oh, no, it's busted. They see it, but it turns out that they can't hit it.
A whole bunch of fighter jets scramble. The fighter jets, they can't get up that high, so they can't intercept it. They launched surface to air missiles. The missiles can't hit anything that high up. The U-2 just flies along. They're tracking it the whole way. There are planes flying along behind it, and they can't do anything.
Ben: At least we get the Intel now in the US that, okay, they can see up here. It's probably just a matter of time before they're capable of shooting something down up here, too.
David: Yes, but here's what's so interesting. Remember, this whole war, my God, it's fascinating. It's a war, but it's not a war. It's a war of perception. In that flight, we get incredible photographic observational evidence. We would fly so many missions over Russia for the next few years, getting this incredible intelligence.
The Soviets never say anything because if they were to say anything and say that they tracked us into it, then they would be admitting that they were powerless to stop it. This war of perception, it's so crazy the incentives and motivations here, but it makes sense. They're not going to say anything and reveal the program. It remains top secret. Because if they did, they're positioned and posturing of strength would be compromised.
Ben: Neither country really wants to be at war, so we're both maintaining this. We're not at war, and we're not going to tell you that we're preparing for if we need to be, but of course we're going to do whatever we can to understand the best about our enemy or not our enemy, other countries that we're not at war with.
David: I actually think, there may be military historians that understand this better than us. I think this was actually an optimal outcome for the US because remember, just like you were saying, Ben, nobody actually wants to go to war here. The goal is for both sides to keep each other in check. The U-2 and these reconnaissance missions become a major chess piece for us on our side of the board to keep the Soviets in check. We like the state. I think that they know about it, but nobody talks about it.
Ben: The other crazy thing is this camera is incredible. If you look up photos taken by the U-2 spy plane, it is remarkable what in the mid-50s this thing was capable of taking photographs from 70,000 feet.
David: The engineering all around that went into this is just incredible. You could do a whole podcast just about the technical aspects of the engineering advances.
Ben: It basically works. They find a whole bunch of nuclear test sites. They find where missiles are kept. We basically have a real time count of the Soviet Union's warheads, the Soviet Union's fighter jets, the capabilities that they have with their radar because it's painting our airplanes, so we now know that that exists. Mission accomplished in spades on this thing.
David: We talked earlier about the cost of $3½ million. I think you could make an analogy to the Louisiana Purchase in terms of the best deals that the United States government ever got relative to the benefit to America. This is huge.
Ben: Arguably the last great deal they got from Lockheed Martin.
David: There are some more that we're going to talk about in a minute. This all continues. We fly dozens, maybe hundreds of U-2 missions over the next few years. The Russians are constantly trying to shoot them down. They fail, and nobody says anything.
Then on May 1st, 1960, ironically on May Day, we launched the U-2 program on July 4th. It ends, at least over the Soviet Union, on May Day 1960. The Soviets finally have developed a missile that can reach 70,000 feet with accuracy, and they shoot down a U-2.
This was the first time in history that a ground to air missile had shot down an airplane. I didn't realize this. I read that and I was like, oh, I guess maybe the technologies didn't exist during World War II, the Korean War. This was a major historical moment in so many ways. America, the CIA, the government, the president, were like, okay,
Ben: Right. What do we do? America's posture is we were never there.
David: Right. We know now that the motivation for Russia not to talk about it now is gone. Now they can position this as like, hey, we're so strong that we can keep people out. We expect them to say something right away. A couple of weeks go by, they say nothing. Quite surprising.
Ben: All we know is we've lost contact with our pilot, and we didn't see them come back and land. We presume that they shot down our pilot, but they're not saying anything.
David: But we don't really know. We presume that if this plane was shot down, as we think, probably the pilot was killed, having you shoot down a plane from 70,000 feet. Probably the pilot was killed.
Ben: That's 14 miles in the air.
David: Yeah. No. The pilot was not killed. The pilot's name was Francis Gary Powers, pilot Powers. If you know anything about US history, you probably know his name. You probably know that he miraculously did survive, was captured, interrogated, and probably tortured by the Russians. This was the revealing of the U-2 program.
What happens? It turns out that there was a big summit in Paris scheduled for later in May between Eisenhower and Khrushchev. Khrushchev announces on the eve of the summit that they have captured an American pilot. They have captured this new plane that the US has been illegally and in a provocative manner, flying over Soviet airspace. They have defended their country and shot it down. This creates a huge mess.
Eisenhower first denies this, and then admits it when we realize that like, oh, shoot, this pilot is still alive. He confessed like, wow, this is a disaster. I guess there probably was a path where this could have led to escalation. Fortunately, it does not.
It does mean that the U-2 program, at least over Russia, is done. We don't fly anymore U-2s over Russia. We can't. If we were to do it at this point, we know they can see us. They now can talk about that they can see us and they can shoot us down. It would escalate to war if we kept doing this. We have to stop.
Ben: The U-2 becomes quite useful for other locations around the globe, but not over the USSR itself.
David: This, though, is a huge, huge problem. This was the most important thing in the war, and now it's gone. We now have no way to take photos of military sites in Russia because we can't fly planes over there anymore, right?
Ben: We're blind, what do we do?
David: What do we do? The world would not know until 1995, when this would all become declassified under the Clinton administration. That was only true for about three months, thanks to another super secretive Lockheed division that figured out another way for us to take pictures of the Soviet Union.
Ben: Yes. This, listeners, is where, if you've read Skunk Works, or watched documentaries about Skunk Works, what we're about to talk about is not in any of those. This is a completely separate story that takes place in a different place in California, that is a detour from our Skunk Works story. We'll be back because my God did Skunk Works do some incredible things after the U-2.
Before we do that, we want to take you to Northern California, the origins of Silicon Valley, and Lockheed participation in that. This is a great time to tell you about one of our other favorite companies that is back as a sponsor of season 12 is our good friends at Tiny, the Berkshire Hathaway of the Internet. Tiny, as you know, listeners, has built and acquired the world's premier collection of wonderful internet businesses.
David: This time and this year is so great for the Berkshire meeting and Tiny because just like Berkshire, Tiny is now a public company. They're a publicly traded holding company. We're so happy for them.
Ben: Yup. They really are becoming the buyer of choice for wonderful internet businesses. There are a lot of people who are talking about how great it is to buy small companies, especially when these profitable businesses with 30%–40% operating margins, maybe they're doing 5, maybe they're doing 10 million in revenue.
David: There's a whole subcategory of Twitter devoted to this.
Ben: I'm watching all these tweets, and I'm like, okay, geniuses, do you remember what Andrew and Chris were talking about a decade ago? Tiny has proved at this point that they can do this very well, that they can continue to compound capital, that they can let these businesses grow and run. You think about businesses like Dribbble, Pixel Union, Creative Market, 80/20.
The last 15 years, Tiny has just been buying businesses. They've let them run. They empower their own independent managers to run them, oftentimes the founders of the business, but oftentimes professional CEOs that they bring in to run them and take them to the next right stage of the company.
David: What's great, especially now that Tiny is a bigger scale and now being a public company, they've always historically done this with bootstrapped businesses, which they certainly still do. They now do it with venture-backed businesses, too, especially in this environment.
There are so many businesses over the last couple of years that took VC dollars and no longer makes sense in a VC portfolio. These companies used to be orphaned within venture firms. There's really a less than ideal situation, but Tiny can now come in and acquire those companies, and it has been doing that to great effect.
Ben: Yup. If you're valuing your next fundraising round, and you're looking at actually what your business' natural growth rate is or natural margin profile, and you're like, you know what? This is not going to be a $10 billion Uber style business. This is just a regular good business on the Internet. I think you should talk to Tiny.
It ends up being a total win for everyone. This is a product that absolutely needs to exist in the market, especially in this moment. Shoot them a note, email@example.com. Just tell them that Ben and David sent you.
Okay, David. I had forgotten about this story. I knew a little bit of it from watching Steve Blank's talk maybe 5–8 years ago, the secret history of Silicon Valley. But you found the last 20 minutes, then just dug in like a splinter on this particular moment in history, and how it is all tied into Lockheed Martin. Where are we going?
David: Yeah, and it's even lesser known than that. Only certain versions of that talk that Steve has given contain the Lockheed story because so much of it has only recently been declassified, a lot of it, even after he first started giving this talk.
What really turned me on to this was some of the chapters in Beyond the Horizons. Even though that book was written in the late 90s, I started digging in. I started watching some YouTube videos with some of the people involved in this, and I was like, oh, my God, there is this incredible story here that we don't realize.
Ben: Yes. In typical David Rosenthal fashion, you sent me a note the other day and said, you have to listen to this starting at eight minutes and 50 seconds. I was like, what is this? I click, and it's a guy at a podium with a terrible recording setup from the IEEE Silicon Valley history videos, so industry association. This thing has 124 views after being posted seven years ago. This stuff is buried.
David: I honestly can't believe it, and I'm so glad that we get to tell it here. All right, let's set the context. If we rewind back to World War II, one thing we mentioned here now as we were talking about the U-2 and the Russians tracking it on radar but we didn't talk about during World War II, was the importance of radar.
So much of World War II was an air war, both in Europe and then especially in the Pacific. The development of both radar and anti-radar technologies was paramount in the war efforts. Yes, there were lots of land based fighting, tanks, and all that stuff, but World War II was the first real air war. Obviously, that importance of radar continued into the Cold War, just like we were talking about with U-2 flights.
During World War II, where was all of the US and allied radar work and research being done? It was primarily being done out of two institutions in Boston, MIT with the Radiation Laboratory or the Rad Lab, and Harvard with the Harvard Radio Research Laboratory. Here's what's interesting. Neither of these two labs at MIT and Harvard existed before the war. The government directed MIT and Harvard to set them up as part of the war effort. They didn't exist before, and then MIT and Harvard, very fortunately for California and Silicon Valley, shut them down after the war.
It turns out that the head of the Harvard lab was a professor named Frederick Terman. It might ring some bells for people, especially people who went to Stanford. Terman was probably the world's leading expert on radio engineering and also vacuum tubes and early computing, except Terman wasn't actually a Harvard Professor. Terman was a Stanford professor. He was just on loan to Harvard during the war years because that's where the government set up the radio labs.
Ben: The government allocated millions and millions of dollars of funding to Harvard and MIT and something like $50,000 to Stanford. All of the funding for this was Harvard and MIT.
David: Yes, they assembled all of the world's experts. Terman was arguably one of, if not the leading world expert in radio engineering, assembled them there in Boston, I guess in Cambridge at Harvard and MIT. Cambridge residents would get mad at us if we say Boston.
After the war, Terman comes back to Stanford because Harvard shut down the lab. He comes back to Stanford, and he does three things. First, he recruits away all of the best people that he worked with at the Harvard RadioLab from universities all over the country. He recruits them to Stanford.
Ben: And he gives them tenure immediately. He's like, I want to make this deal as sweet as possible for you because I want to will Stanford into existence as an engineering institution.
David: Yes, of the highest order. That's one. Two, soon after he gets back to Stanford, he becomes the provost of the entire university. As provost, he completely changes the way tech transfer is done at Stanford. No other university has as good of a tech transfer policy as Stanford.
Ben: They're notoriously friendly.
David: Yes, notoriously friendly everywhere else, including Harvard, MIT, Princeton, blah-blah-blah are notoriously unfriendly and hard to work with.
Ben: The classic story is Stanford owned 1% of Google that spin out, which ended up making them an ungodly amount of money because of how big Google became. If that were at other universities, they would have said, 50% is what we need to keep, or 33% is what we need to keep. They would have smothered the innovation before it could become commercially viable.
David: In the back of my mind, I sort of knew this because I had watched Steve Blank's talk many years ago, but I forgotten. I just thought, I was like, oh, well, that's because Stanford in Silicon Valley, we get it. We're smart. Not that we're smarter, but there's this attitude of if you're in Silicon Valley, even to this day, you're like, yeah, we get how the culture works here, and the East Coast doesn't get it.
Ben: As if this somehow existed a priori because it was just in the water and came from nowhere.
David: Not at all. It's all thanks to Terman, World War II, and his experience at the radio lab. When he becomes provost. He's still a super devoted patriot. He knows how important this work is that it was during World War II. He knows it's just as, if not more important during the Cold War.
What he does is he encourages students and professors to leave Stanford, go set up companies, work for defense firms, and work for the military, not to make money, but to be in the nation's service.
Ben: Take the research and the people who are doing the research out, start a brand new company. He would try to help you find funding, which at that point, venture capital didn't exist, so he was introducing you to customers who could pre order from you to fund your research. He basically believed that a commercial ecosystem leads to more innovation than one that is purely happening in academia, and thus could better serve the needs of the nation.
David: Customer, hang on to that thought for one second.
Ben: If you were doing all of this 10 years before the university would have looked at you and said, what are you doing? You're encouraging the stuff to go away from us.
David: It would have been career suicide in academia to do this. Instead, at Stanford it becomes the best thing you can do for your career because in Terman’s mind, it's the best thing you can do for your country. Okay, that was number two.
Number three, he carves off a big part of the Stanford campus. If you've ever been to the Stanford campus—my God, I was so lucky to spend two years there—it's paved in gold. It's literally Shangri La. They have so much land. It's the most beautiful, idyllic place in the world.
Ben: And 80% of the land is still undeveloped.
David: Yeah, they own all the way out to the ocean, I think. It's crazy. He carves off a part of the Stanford campus and develops it to be leased out as commercial space to corporations and the government to people to start companies, companies to come to build to participate in this ecosystem right there on campus. It's initially called the Stanford Industrial Park.
Today, it's called the Stanford Research Park. It still exists if you've ever been there. It's basically all of the office buildings up and down Page Mill Road in Palo Alto.
It's HP (Hewlett-Packard). We'll talk about that in a minute. It's Tesla's landlord today. It's VMware. It's where Xerox PARC was. It's where NeXT was and Steve Jobs. It's where Facebook's office was for a while. This is where Theranos was. Oh, my God. You might be listening like, well, this is cool, maybe I knew this stuff, maybe I didn't. This is really fun Silicon Valley history. What does this have to do with Lockheed?
One of the very first tenants of Stanford Industrial Park, Ben, we're talking about customers, customer, who would go on to become the single largest employer in the area in proto Silicon Valley, by a huge margin was a new secret division of Lockheed. This blew my mind. His secret division is called the Lockheed Missile Systems Division, later to be renamed the Lockheed Missiles and Space Company.
What LMSC (Lockheed Missiles and Space Company) did, I honestly think it is bigger impact to the country, to the world, and certainly on business to Lockheed and to Silicon Valley than Skunk Works. This story is of a scale I don't know that we've ever really told on Acquired.
Ben: There are a lot of Skunk Works devotees, David. That is quite the assertion to say that this is a bigger deal.
David: Let's talk about it. Listeners, you can judge. They pattern themselves after Skunk Works and took so many of the skunkworks management principles up to Silicon Valley. I was reading Skunk Works, I'm like, oh, yeah, so many of these principles, they sound like Silicon Valley principles. There's a reason for that.
Okay. Lockheed makes the decision to start this new missile systems division in 1954, but it becomes so much more than that. Obviously, this is also top secret stuff just like Skunk Works. Just like Skunk Works, they set up the new missiles division in Burbank. Also in an unmarked building, they literally just copy paste Skunk Works right there in Burbank.
Ben: It starts in Southern California.
David: It does, but there are two problems with that. First, it's unwieldy for a big company like Lockheed to have not one, but two super secret unmarked divisions right there on the main campus that aren't supposed to know about each other or anything else going on. You start getting into weird territory quickly. But it's important that the missiles division did start there because they took, as I said, a lot of Skunk Works’ management practices.
The bigger problem is that it turns out that building missiles is a very different discipline than building airplanes. Because unlike airplanes, you don't have a pilot in the missiles. You need missile guidance systems. That means that you need radar and you need computing. Those two things are not what Southern California is good at.
But you know what's really good at those things? Fred Terman up at Stanford. Everybody that he's recruited, literally the best minds in the world at all of that who are now at Stanford, and who are now being encouraged to go spin out and start companies, who might just be subcontractors to a big missile system that you're trying to build.
Ben: Interesting. This is cool. This is a part of the research that you did that I don't know much about.
David: Yeah, this is great. The next year in 1955, Lockheed moves the missile systems division out of Burbank and up 101 to the Stanford Industrial Park, the very same Stanford Industrial Park that Fred Terman just carved out of the Stanford campus and developed on Page Mill Road. Lockheed becomes one of the very first and biggest tenants of the Stanford now Research Park, and is still there to this day.
They can't actually do everything they want to do on the Stanford campus. You're not going to build a missile and test it on the Stanford campus. Lockheed, pretty quickly after they established themselves in Palo Alto, also buys 275 acres just down the road in Sunnyvale. They build a huge campus there, 137 buildings. When Lockheed buys this, the population of Sunnyvale is less than 10,000 people.
David: Lockheed built Sunnyvale.
Ben: I didn't realize that. Wow. How many people would eventually work in Sunnyvale at Lockheed?
David: By the end of the decade, in 1959, just four years later, Lockheed Missile Systems employs almost 20,000 people in Palo Alto and Sunnyvale. A few years later, by the mid 60s, they would employ 30,000 people. This makes Lockheed by far the largest employer in this brand new proto Silicon Valley.
Remember, I just said Lockheed built Sunnyvale. You think of Sunnyvale, Silicon Valley today like Yahoo, Intel, and all that.
David: There was none of that. Lockheed built it. Hewlett-Packard was the largest tech computing company, Silicon Valley company at the time. Hewlett and Packard were students of Fred Terman. Fred encouraged them to spin out and start Hewlett-Packard. They were the largest new tech company. They only had 3000 people, one, two, three. Lockheed had 30,000 people.
Ben: Whoa. Oh, my God. It's a funny story. I knew, at least as of 2009, that the Lockheed campus in Sunnyvale was large because when I was interning at Cisco, I went on a run one morning. I was just exploring around, and I ran into Lockheed's campus, and I got chased down by a security guard who's like, you can't just run in here. I had my headphones in. I thought I was in big trouble.
David: Yeah, they had this huge structure called the Blue Cube that has since been disassembled. It's not there anymore. But you need a big hanger that you're going to build missiles in, and they end up building a lot more than missiles we're going to talk about.
Ben: You mentioned, they need radio and they need computing. Computing basically wasn't a thing yet. Shockley co-invented the transistor just a few years before started Shockley Semiconductor in 1955.
David: The same time as Lockheed is coming to Silicon Valley.
Ben: Right. Of course, Shockley is a predecessor to Fairchild Semiconductor, which is a predecessor to Intel. They've got Terman's radio background, but there really weren't any people with compute experience yet. That was all happening concurrently all around them in Sunnyvale and Palo Alto.
David: We talked about this a bunch actually on the first Sequoia Capital episode when we were telling Don Valentine's story. At the time, when we were telling the story, we're like, oh, Don, he was so legendary before he started Sequoia. He was the head of sales at Fairchild Semiconductor and the head of sales at National Semiconductor. We glossed over it. We were like, he was mostly selling to defense companies. Who do you think he was selling to?
Ben: He was selling to a defense company.
David: Yes. He was also selling around the country to other defense contractors too. Lockheed wasn't the only company that was working on missiles, but I think they were the only one that was working on missiles in Silicon Valley. By God, did they buy a lot of product out of all these startups and all of these silicon startups that are coming out of Stanford, coming out of Shockley, and just getting sprung up right there in Silicon Valley.
Ben: I can't believe that there were 10 times more employees at Lockheed in Silicon Valley than at HP in the late 50s.
David: Yes, it is totally insane. So many people came through Lockheed into Silicon Valley, including one Jerry Wozniak, who moved himself and his young family out to this new Silicon Valley to become an engineer at Lockheed Missiles and Space Company. That's right, Woz's dad. The reason that Steve Wozniak grew up in Silicon Valley is directly because of Lockheed Martin.
Ben: That is awesome. No Lockheed, no Woz in Silicon Valley, no Apple.
David: No Apple. Crazy.
Ben: Not to mention, there's a really interesting point here, which is you wouldn't have this open commercial spirit to Silicon Valley without Terman and without the belief that the right thing for America was for all these companies to become companies instead of academic research, or spread around in other parts of the country. It creates the Silicon Valley ethos and creates Silicon Valley as the place where that ethos would thrive.
It's worth pointing out for people who don't spend a lot of time in the Bay Area. This has absolutely nothing to do with San Francisco. Nowadays, it's this big blended soup of companies that have offices in both places, and you can drive or take the Caltrain between them.
David: Yeah, that's a recent phenomenon.
Ben: San Francisco is a completely different universe at this point that is in zero part responsible for the growth of Silicon Valley.
David: Yeah. Before this time, before the 50s, there was no Silicon. It was called the Valley of Heart's Delight. That was the name for it, it wasn't Silicon Valley.
David: Okay. What was Lockheed actually doing there? We talked about them working on intercontinental ballistic missiles (ICBMs) and missile defense systems. I think they probably did continue to work on that, but there were two projects that this new division of Lockheed took on that really changed history. Both of them together became, for Lockheed at least and the parent company, by far the biggest driver of profits for the coming decades.
Really, as we'll see, this division, not Skunk Works, this division kept Lockheed alive. Lockheed would have absolutely died without this division. What were these projects? One went up to space as perhaps is obvious, and we foreshadowed and literally is in the name of the company, the Lockheed Missiles and Space Corporation, and the other one went down under the oceans. Let's talk about that one first because I think it happened first, chronologically.
Submarines had obviously been a thing since World War II and even before that, back to World War I. There are lots of advantages to submarines during wartime. They're stealthy, they can basically travel anywhere in the world, you can stay hidden for long periods of time, especially once nuclear submarines are developed that can stay underwater for months at a time, self-powered. They're both a great offensive and a great defensive weapon during periods of active war.
During the Cold War, they're useless because if you wanted to have a chess piece in position to strike a land-based target, if you could even do that at all with a submarine, you got to get the submarine pretty dang close to the land, which means close to Russia, which means they know you're there, and that's a provocation. Unless somebody could maybe somehow figure out a way to fire an intercontinental ballistic missile out of a submarine and go up into the air, into space, and then hit a land face target far, far away.
This seems crazy. It's hard enough to make this happen from the ground. You're talking about doing this from the sea with all the waves and the lack of stability. No way this could happen.
Ben: This thing has to thrust through air after it thrust through water.
David: You're making the leap already that you would fire it underwater. At first, when the Navy contracts Lockheed to work on this in 1955 to build the Navy's fleet ballistic missile system (FBM), the idea is they're going to fire these things from the surface of the ocean. The submarines are going to rise up, and they're going to stabilize it in water, and they're going to fire off a missile from the deck of a ship or a surface submarine.
Ben: You could imagine another issue, which is these things have rockets on them. You have to not destroy the launchpad, which is the submarine full of American humans while launching it.
David: Yeah. This is a big challenge. The reason that it was worth trying was that if you could create a naval based intercontinental nuclear strike capability, it completely changes the strategic landscape of deterrence, first strike versus second strike, and retaliation.
What we were really afraid of, we thought the Soviets would pursue a first strike policy if they felt they were able to. The way that they would do that is if they felt that they could, in that first strike, knock out all of our nuclear capabilities. If they could target all of our land-based ICBMs, incapacitate them, then we will be incapable of responding with a second strike, and then they could blow up our cities and whatnot. If all of a sudden you have a mobile, naval-based missile system, that completely changes the chessboard.
Ben: It's quite the deterrent.
David: Quite the deterrent. You can now pretty much guarantee, as long as you can keep a fleet of nuclear submarines operating at all times that you can't take them out. They can move around and be anywhere. If you want to strike, they're going to launch right back. First strike is now off the table. This is a huge strategic win if you could put this actually operationally in practice.
The other medium, if you will, location, that could change the dimension too for doing this would of course be space. If you had nuclear missiles up in space, that also changes the dimension. This among many, many reasons, is why when the Soviet Union launches Sputnik into space in October 1957, even though Sputnik itself was far from having nuclear ICBM capabilities, the Soviets getting to space first was truly terrifying.
Ben: I can't imagine how disconcerting it is in an era that, now there are tens of thousands of satellites orbiting the earth all the time. When that was a brand new thing, when you could look up at night, if you could see Sputnik and you're like, oh, my God, that thing any day now could have a nuke aimed at us.
David: Right. Okay, back to the sea. It turned out, like we were talking about a minute ago, that firing ICBMs from the deck of a surfaced ship, be it a submarine or otherwise, bad idea, basically impossible. But firing missiles from under the ocean was doable. Lockheed did it with the help of Silicon Valley.
In December 1955, the Navy awards this contract to Lockheed. The name of the project was Polaris. People might have heard of Polaris missiles.
Just over four years later, after the contract is awarded in 1960, the very first US nuclear ballistic missile equipped submarine set sail on its patrol, and everything we just talked about is operationalized, equipped with Lockheed Polaris A-1 undersea-fired nuclear warheads, ballistic missiles, could reach land-based targets up to 1200 nautical miles away from wherever the submarine was when it launched it. It was all built out of Silicon Valley with many subcontractors all over the place.
Ben: Right. I'm assuming Lockheed doesn't actually make the nuclear warheads. That was still happening in national labs at Sandia and all the places that were pioneered during World War II.
David: Yeah, Lockheed did not make the submarines, nor did they make the nuclear warheads. I think a lot of this work was done out of Sandia, which we talked about on the Amazon episode.
Ben: Yeah. Bezos' dad worked there, right?
David: Grandfather. Bezos' grandfather was the head of Sandia, which was in New Mexico, the military nuclear program, the division of the US overall nuclear program. I think it was out of Los Alamos, but Sandia was the military arm of it.
Ben: Which weirdly, Lockheed, for many years actually had a contract to manage Sandia because there's some strange partnership that happens, where the federal government hires government contractors to manage national labs.
David: Yup. To enable this strategic chess piece, the key thing is the missiles. Nuclear submarines already existed, nuclear warheads already existed. The challenge here was to create a system by which you could launch a missile from under the ocean out of a submarine.
Ben: I just got to say, it is so fortunate and insane to me that neither side ever launched. All the deterrents for all the scary things that could have come out of it, all the itchy trigger fingers, and everybody getting close, it never happened. That is a big applause to humanity that we could have done this, and no one did.
David: This is one of the things that I mentioned at the top of the episode. Doing this research changed my mind on the war machine aspect of Lockheed in the military and the military industrial complex. I think people really believed, and I think there's a good chance this was reality. It was building all of these systems and advancing all of this capability that prevented it from being used. If we hadn't built this stuff, there's a good chance Russia would have done a first strike.
Ben: Yeah, it's crazy. Okay, Lockheed, after four years, successfully does the underwater ICBM launch.
David: Yes, and then that quickly, leads to more successor programs and developing the technology further. The Polaris becomes the Poseidon is the next program, and then the Trident. The Trident missiles had a 5000-mile range and carried a hugely destructive nuclear payload. Unbelievable.
David: All right. We just told this incredible story about LMSC taking Silicon Valley under the ocean. This program—Polaris, Poseidon, Trident—for most people listening, especially if you're American, these names aren't surprising to you. You've heard of these programs.
You're aware that the US, starting in the 1960s, had nuclear submarines carrying intercontinental ballistic missiles. If you think back to the chess game, it was in the government's best interest for the Soviets to know that we had these. The point was deterrence.
Ben: In fact, we probably should have bragged about this, even if it wasn't real.
David: Right. Maybe it wasn't. Who knows?
Ben: We should have had inflatable subs floating around that we thought were nuclear.
David: Maybe it's all the cover, maybe all the money that went into Silicon Valley… No, I don't think that was the case. Either way, you don't want to find out.
Ben: Speaking of cover, do you know about the things we did on top of the factories when we were building airplanes?
David: Yes, and Disney was involved.
Ben: Yeah, starting way back in World War II. But I think continuing after that, in the Burbank facilities at Lockheed, I know Boeing in the Seattle area and other places, too, built basically these burlap cities on top of factories that looked like suburbs, complete with 3D cars, trees, and stuff, so that anybody who was creating a spy plane flying overhead would mistake our manufacturing facilities for something innocuous.
David: Yeah, I think it was spy planes that also during World War II bombers, if bombers ever made it to the West Coast that they wouldn't know where to bomb. I'm pretty sure that Disney Imagineering was involved in creating these sets like they made for Disneyland.
Ben: It's crazy how sometimes it's in our best interest to make the adversary aware of our capabilities, and sometimes we want disguise capabilities. It's really interesting.
David: Super interesting. Okay, remember back when we pressed pause on the Skunk Works story and moved up the state of California off the coast to Silicon Valley? We'd said that when Gary Powers and the U-2 was shut down in May 1960, supposedly, this was the end of US observational capabilities in the Soviet Union and that it was for about three months, but nobody do it. LMSC is the reason that we got our eyes back in the sky.
Ben: You might know that eventually, after the U-2, Skunk Works would create the next great spy plane, the SR-71, which we will get to, but that wasn't for a little while. This intelligence gap was filled by this secret, not very well-known project.
David: I think a lot of people in the military who did know about this stuff, this is heretical to say because it's so beloved, but I think the Blackbird was a decoy. We were getting everything we needed from space, we just didn't want anybody to know about it. Everybody now's like, oh, the Blackbird, it's such a shame, the government shut it down. It was never used to its potential. Itf never needed to be because of LMSC and space.
Ben: Whoa. All right, I'm listening. I got a lot of hairs on my arms raised. I'm getting mad over here.
David: People are probably getting very mad. Here we go. When you think about America and space and the US space program, you think of course about NASA...
Ben: Gemini and Apollo.
David: Mercury, Kennedy, putting a man on the moon, all that amazing stuff, which for sure happened and was happening. All of that was basic science research. Nobody working on those programs, public observing it, it would be crazy to think there were going to be actual applications in space anytime soon. There's no infrastructure. These are science missions, this is research.
Even Sputnik on the Russian side, Sputnik was a research vessel. It was the size of a bowling ball or I think it was a little bigger, but it was very, very simple. It was a long, long, long, long time before you went from those initial science missions to applications in space, or so everybody thought. Because in parallel, there was a secret US space program being run by Lockheed Missiles and Space Corporation out of Silicon Valley.
In the same timeframe as the initial NASA missions, the initial Mercury (I think) were the first missions, basically concurrently with that, they got a fully operational observational spy satellite system up into space and functioning at the same time.
Ben: How did we launch them with nobody… Lay it out.
David: There was a cover story for what these things were. I think it was called the Discoverer program. I believe the cover story was that this was life form research and space. They were sending animals up to space like monkeys to prepare for manned spaceflight. That was the cover story. They may have sent some monkeys up there, but that was not the point. The point was to get these reconnaissance satellites up to space.
The first program was called Corona. You should google about it and read there's a great declassification document story that the government put out in 1995 when they declassified this stuff, and the Wikipedia page is pretty good.
Ben: Yeah, I downloaded it, and I have it over my computer. It's pretty crazy. It says secret. It has the classification, and then it struck through. It's literally the document that was prepared in secret and then declassified.
David: I think what the CIA and the National Reconnaissance Office does is they write these stories, maybe quasi in real time so that there's documentation of all this stuff, and then they stamp it secret, and then it never gets out until it gets declassified. It's just amazing.
Ben: But on the declassification website, which we'll link to in sources, you can see a bunch of the pictures that the Corona satellite took, including of the Pentagon. You can see something you know what it looks like, and you can see the level of fidelity that this 1959 satellite got of that.
David: Let's get into it. Okay, the name Corona, there are conflicting stories of whether it comes from the Corona typewriter or the Corona type of cigar that apparently the Pentagon official that championed this program really liked. We'll never know, it's all classified.
These satellites, like we've been alluding to, had cameras on them. The first one went up in August 1960. It's built in the years leading up to that by LMSC, and then went up in August 1960. While everything else happening in space was research vessels, this first Corona satellite had a camera system on it that was able to photograph any ground location that it passed over in its orbit around the earth, at a resolution as low as five feet from space. These were film systems.
The U-2 camera system did have a higher resolution than that higher ground resolution, but five feet was still plenty good. More importantly, the Corona system could take photos anywhere in the world on its orbit. If you had multiple of the satellites up there, you could pretty much blanket the earth, or at least everywhere you cared about pretty quickly at basically any point in time.
They're spinning around the earth. Yes, you can't do it in real time, but it doesn't take that long for the thing to fly around the earth and then fly around again. The very first Corona mission, that very first satellite that went up in August 1960, produced greater photo coverage of the Soviet Union than all of the previous U-2 flights combined.
Five years of operating the U-2 program, one satellite in one month-long mission, I think it was about a month before The Orbit decayed, got more than all of that. No need to fly a plane. No need to worry about getting caught. No need to worry about the Soviets knowing what was going on. No need to worry about being shot down. Unbelievable.
Ben: There's a crazy stat, over 800,000 images would be taken by these satellites over the course of the program. They got an enormous amount of coverage.
David: You might be thinking as you're listening, you're like, oh, I know how satellites and satellite imagery works today, you got Google Maps, you got Starlink Communication, but how did they beam these images down from the ground? These were not digital photography. This was a film freaking photograph. You got to get the film down from space is my point.
Ben: Which they literally did.
David: How did they do it? They dropped it.
Ben: Okay, this is the craziest thing. They dropped from space, a canister with film in it. Mind you, they can't mess up and expose the film and ruin it. This is a very delicate film. They drop it in a canister from orbit. It enters the atmosphere enduring all the heat and everything.
David: It's not like you just shove it out of the satellite. They had retro rockets built into the film canisters to re-accelerate out of the orbit and move it down to go into the atmosphere.
Ben: Right, because if you just drop it out behind you, then it stays in orbit. It needs to decelerate its rotational velocity so that it does move closer to the earth. It is in a custom designed canister called the film bucket that General Electric designed. It would separate and start falling to the earth.
After the incredible heat and violent action of moving through the atmosphere, the heat shield that surrounds the vehicle is jettisoned at around 60,000 feet, again, where the highest airplanes can start to fly, and parachutes would be deployed. You've got this film canister.
David: This is my favorite part. This is so good.
Ben: Coming down with a parachute, the capsule is designed to be caught in midair by a passing airplane towing a claw. The claw grabs the parachute, and they use a winch to bring the film capsule into the airplane.
David: It's like those claw games in the arcades. Literally, they had a freaking C-130 flying around with a big ass claw to snatch this thing out of the sky.
Ben: Unbelievable. You might say, what if the C-130, which, by the way, is a Lockheed airplane that still flies today, the C-130J, what if the airplane misses it? It seems like that's a pretty reasonable probability when this thing's falling from space and you're trying to catch it with a moving object.
It can land at sea. There's a self-destruct mechanism, where there's a salt plug in the base that dissolves after exactly two days. If that happens, then the film's sinks forever to the bottom of the sea. If the Navy can't retrieve it within 48 hours, the salt dissolves enough.
David: Because obviously, what would the biggest disaster be would be if somebody else or the Russians got their hands on this, and we're like, holy crap, somebody's taken photos from space of us?
Ben: Right? The whole thing is genius, crazy, and absolutely insane that it actually worked.
David: I believe it wasn't just one C-130. I think they had a whole fleet of C-130s all flying around where they thought this thing was going to reenter the atmosphere.
Ben: You would need to. When you have a satellite orbiting the earth that fast at Mach 20 something, it's pretty hard to predict exactly where your tiny film canister is going to come back and land.
David: All this happened in 1960. Oh, my God. All told the Corona satellite program, and LMSC also designed the Agena rocket, which was the upper stage rocket booster that the Corona satellite and other future satellites attached to.
Ben: I think they pioneered the concept of a second stage. We need a first stage to get us up, and then we need a second stage to get us to a very particular orbit that we care a lot about being in.
David: That system of the Corona and the Agena was the first spacecraft in history to do all of the following things: achieve a circular orbit, achieve a polar orbit, be stabilized on all three axes in orbit because you needed to be stabilized if you're going to take photos at five foot resolution of the ground, be controlled by a ground command, return a manmade object from space, and propel itself from one orbit to another.
Ben: By the way, they returned 39,000 manmade objects from space. They took 2.1 million feet of film, of photographs in 39,000 cans.
David: Any one of those things that I just mentioned, if this weren't a top secret black classified program for 3½ decades, we'll be all over the history books. As is, nobody knows about this stuff.
Ben: Yeah, it's the first obvious mapping of earth from Space. It's this first stereo optical data from space. It's the first reconnaissance program to fly a hundred missions at all, let alone one in space. This thing operated for 12 years.
David: Yeah, crazy. Corona would then lead to three follow-up programs that we know of, I'm sure many, many more. But there are three follow-on ones that LMSC did that have been declassified so far, some of these only very recently.
The strategy of the program evolution over time, followed the four stages that we know of. First, it was what they called See it. That was Corona just period. Can we see the Soviet Union from space? Corona proved that.
The next phase was, Can we see it well? Then the phase after that was, Can we see it all? And then the last phase, which is a lot of the last phase is still classified, is see it now. Let's talk about all of these.
Corona, like we said, was just see it, get photos. But the photos were at a worse resolution than what the U-2 was able to achieve. In 1963, only three years after the first Corona satellite goes up, LMSC and the government launch the Gambit program. This is the see it well.
Gambit's max resolution still has not been declassified. We don't know how sharp it was. This thing launched in 1963, and it is still classified how good it was. But it has been confirmed that the resolution was under two feet, which was better than the U-2 cameras, less than two feet from space in 1963.
Next was Hexagon. Hexagon was the "See it all program." This is starting to eclipse my technical knowledge a little bit, and I think there's also just less known about this because a lot of this is still classified, too. I believe the hexagon satellites had longer orbit lifespans and had more film capacity before they decayed. I think they were able to see more longer, I think, is what Hexagon was.
Ben: You basically would need a larger format film with a wider angle lens if you don't want to increase your number of satellites.
David: Yeah. I'm fuzziest on Hexagon. Then in 1977, they launch Kennen, which is still very classified. Some of it is out, so we can know a little bit about this.
There actually was an incident in 2019 when Trump was president. He tweeted an intelligence photo that was this incredible photo of incredible resolution of something that happened somewhere maybe in Iran. He tweeted like, oh, see, it isn't what you thought. People went nuts. People believe. It's never been confirmed that this photo was from a future version of the Kennen program.
What was Kennen? Kennen was see it now. It's the first real-time space-based surveillance system, I guess maybe the first real-time surveillance system, period. I don't know. By 1977, there were enough communication satellites up in the sky. Digital photography had come along far enough. The Kennen satellites are like what we think about, like Google Maps, it's real time, digital photography beamed down via ground link to stations in real time.
Lockheed has to build their own digital workstations to process these photos to display them, to manipulate them. I think these might have been the first or really early digital photo processing manipulation workstations that were sold to the CIA.
Ben: I didn't know about any of this.
David: Yeah, Lockheed built all this in Silicon Valley.
Ben: Wow. By the way, you keep saying Google Maps. There's a fun piece of trivia that I'm curious if you know. Do you know, I think it was the codename, the original name for the Corona program.
David: Keyhole, yes, which is one of the companies that Google acquired that became Google Maps.
David: Different Keyhole.
Ben: Different Keyhole, but I'm pretty sure Keyhole Inc, which became Google Maps, was named after this Keyhole program.
David: Very well could have been because it was 1995 when that was declassified, and I'm sure Keyhole was started after that. It's just super cool. Along the way, LMSC also does a lot of pioneering work in weather satellites, and they launched weather satellites because it turns out that most of Russia is under cloud cover most of the time, so they got to know when the weather is going to be clear enough to look pretty awesome.
Ben: That's when you get into all the synthetic aperture radar and all the other types of sensing that you have in satellites now that are not just the visible light spectrum in order to get visibility of stuff on the ground no matter the conditions.
David: Yup. They're part of the positioning satellites that the military puts up. That goes on to be opened up to commercial use, and that's the GPS system that we use today. Of course, I'm sure LMSC is part of many, many other things in space that we still have no idea about.
One thing that we have a lot of ideas about that they built, that I had no idea till researching all this, we're now in the 70s as this is going along, and we'll come back and talk a little bit about this as we come back to Skunk Works here in a sec, but we're getting towards the end of the Cold War. This stuff is less urgent. Lockheed and LMSC start moving into non-military applications or trying to, but LMSC gets a contract from NASA and builds the Hubble telescope. Did you know that?
Ben: I did know that. And Martin Marietta, future Martin and Lockheed Martin, built the large orange fuel tank for the space shuttle, which took the Hubble telescope to space.
David: That's so awesome. Different companies at the time, now the same company.
Ben: Yup. This is a great time to talk about our third favorite company of the episode, pilot.com. As you know, this season, we are joined by Waseem Daher, CEO of Pilot, for his tips he has for founders after starting three different companies.
David: Today, we're talking about a fun one, fake work. Don't get distracted by it. Tell us about that.
Waseem: Sure. I think there's a real temptation among early-stage startup founders to do something that's basically playing startup. There are the things you really need to do, but they're the things you think like, oh, this is what a CEO does, or this is what a business person should do, so I guess I should spend time on that stuff.
Going to networking events, giving talks, spending a bunch of time meeting VCs for coffee if you're not fundraising, being clever on Twitter, or just spending hours researching what corporate card is the best. You really have one job as an early stage startup founder, which is to find product/market fit, or to talk to your customers, build something that they really love and that they're willing to pay you for.
Anything that you do that is not that, in a way really is fake work. It feels like work. It takes up your time, but it doesn't actually advance the mission of the company, and it's consequently really, really dangerous. Sometimes it's working on priority 35.
This is a real task. It's a task that needs to be done, maybe, I guess by someone. You should be focusing on partner number one or two. Priority number 35 should be the thing that is below the line that you don't get to, but you do it because you're good at priority 35, or you happen to like that particular thing.
For me, the very concrete example recently is I wrote some elaborate Python script to sync data between our CRM and a spreadsheet I was using to track revenue. I was just like, no, why? That's an awful use of my time, but I like to program sometimes, so I did it. I justified it to myself. It's like, oh, I'm working, I'm helping compute the revenue or whatever. No, you have to be laser-focused on the real work, not the fake work.
Ben: Our thanks to Pilot, the largest startup-focused accounting firm in America. You can click the link in the show notes or go to pilot.com/acquired to get 20% off your finance, accounting, and tax prep needs for your first six months.
Frankly, everyone should do this. This is no one's core competency. Pilot has gotten extremely good at it. Human, software, keeping up with all the latest trends, and fintech platforms that you're probably using. Click the link in the show notes and give it a shot. I think they are fantastic humans, and we recommend it.
David: Thank you, Pilot. It's funny to be talking about Pilot as we're talking about aircraft.
Ben: I know.
David: Here now, we're talking about pilotless aircraft, which is what you should be because you should use Pilot. You should outsource all of your finance and accounting to Pilot.
Okay, two other things that I want to talk about with LMSC before we come back to the coda on Skunk Works, the Blackbird, and all of that. One, I think I alluded to this earlier. LMSC—listeners, you be the judge—the stories that we've just told are more impactful to America and the world than what Skunk Works was doing. Personally, I think yes, but maybe you can debate. What is undebatable is that LMSC from a business standpoint within Lockheed, became the crown jewel of the company.
Ben: Which isn't true anymore, or at least it's not their largest business today.
David: I think at times in the 60s, 70s, and 80s, LMSC was the largest business by revenue. But almost through the whole time, it was by far the most profitable division within Lockheed. At times of what we will get into, Lockheed fell on some really hard times in the 70s. There were years where LMSC generated more than 100% of the profits of Lockheed. All of the rest of Lockheed, Skunk Works included, was in the red, unprofitable, bleeding money, and LMSC was keeping the company afloat.
If you think about it, I guess (1) Just what they're developing, the scale of it, and these contracts are huge, both under the ocean and up in space. (2) What they're doing is different from building airplanes. I alluded to this when I was talking about it's a different talent set. This is much more technology problems and computing problems that LMSC is tackling here.
Yes, they're building missiles. Yes, they're building rockets and all that. But the core value components of those rockets is computing in silicon and ultimately, software. As we talk about all the time on this show, that's really good margins, definitely better margins than building airplanes.
The stats I have, this is from Beyond the Horizons, which also is where a lot of the story, especially where Corona came from. During the 12-year period from 1960, when Corona first launched, to 1972, Lockheed as a whole did $26 billion in revenue over that 12-year period, and just $255 million in total profit. Not a high margin company during that period.
LMSC accounted for over a third of that revenue and 128% of the profit. That's what I was talking about. Everything else in Lockheed lost money, or at least in aggregate lost money. During the early post-Cold War period from 1983 to 1992, LMSC accounted for 46% of revenue, so growing percentage of revenue and 72% of profits during that 10-year period.
Ben: Wow, it really is a completely different company today. I want to save why as we drift toward today in analysis and all that, but that's crazy how big the LMSC business was at the time.
David: It was a great business just from a business standpoint. The other thing I want to talk about before we come back to Skunk Works is LMSC's operating principles and philosophy. So much of that was built off the shoulders of Skunk Works. A lot of the guys in the YouTube videos that I found talk about this. Their philosophy, though, they codified into seven tenets. Kelly had his 14 rules, LMSC had seven tenets, and most of them are very similar to the Skunk Works rules. We'll link an image of them in the show notes.
One of them, though, that I want to highlight and discuss that to me stands out as different from Skunk Works, is tenet number one. That one is focus on a threat-based need. I think that's really interesting. To me, when I read that and thought about it, that element is missing from Skunk Works and Kelly's philosophy.
This is conjecture here. There's no skunk works book about LMSC, so we have very little information to go on. But if that really was tenet number one for the company, I think you could maybe extrapolate that a little bit to the market context is really important for what you're doing, and don't lose sight of the market context for what you're building.
Kelly's philosophy of all that matters is rapid delivery of superior products. Nowhere in that statement is there room for the market. Who decides what's superior? Maybe a small number of people want this, but do a large number of people want this? How important is this? Obviously, what Skunk Works was doing was really important.
Ben: Or so they thought. If they knew about this robust spy satellite system...
David: This is the argument. Maybe it wasn't that important. Maybe the Blackbird was a decoy.
Ben: Okay, we have not talked about the SR-71. Can you please take us back to Skunk Works? I'm dying from my Mach 3 airplanes and ripping engines here.
David: Okay, let's do it. Keep that in mind though, a threat-based need. Was there a threat-based need for the SR-71? Maybe.
Ben: My computer wallpaper needs to exist, so that's a need.
David: There was a market need. Was there a threat-based need? Okay. Skunk works, the greatest airplane ever built.
Ben: It sure would be nice if we had a plane that couldn't be shot down.
David: When Gary Powers shut down in May 1960, of course, as you would expect, the CIA and Skunk Works are already hard at work on the successor airplane to the U-2. Everybody believes it's a miracle that they were able to fly for five years like they did. They knew that this day was coming when the Russians would be able to shoot it down.
As we talked about, the U-2's primary defense, as it so happened, wasn't intentional, but as it happened in practice was how high it flew. It was obviously trackable on radar.
Ben: 70,000 feet.
David: Yup. It's not like you could evade enemy fighters or missiles in this thing. It had a 100 foot wingspan. It turned into a school bus. It was how high it flew. All of a sudden, that was no longer defensible.
Ben: It's not very fast, and it doesn't fly high enough to evade missiles, so kind of useless.
David: If you remember back to the original spec for the program, there were three vectors that were possible for how you could operate a program like this. One was fly high enough. That's what the U-2 ultimately did. There was also, though, fly so that it can't be seen by radar, stealthy. We'll come back to that in a few minutes here. And then three...
Ben: Make it go so fast that even if they do fire at you, it just falls behind and then explodes miles behind your incredibly fast airplane.
David: Yup. That's the path they took.
Ben: If you can evade them, outrun them.
David: Yup. It's like the Sonic the Hedgehog of airplanes. This program, if you know anything about the SR-71 Blackbird, you're like, well, that's an Air Force airplane. We're talking about the CIA here. The Blackbird was not a CIA airplane.
The program that the Blackbird ultimately came out of was the A-12 OXCART. This was essentially the same airplane. We'll talk about the differences in a minute. This was the CIA contract that they had Skunk Works working on. It was the goal of make this thing so fast that whether they see it or not, they're not going to shoot it out of the sky.
Ben: It has an even better camera, I think, also designed by Edwin Land, and it can get these incredible photos flying really, really fast.
David: Yup. To be able to avoid surface-to-air missiles, that basically meant that the specs for this thing were that it had to go Mach 3 or faster. To outrun any missiles, it had to do that with a pilot. There had to be humans in this thing. Faster than Mach 3 is faster than 2000 miles an hour.
Ben: If you fire a rifle, that bullet doesn't go Mach 3. If you're standing on the ground, you pick up a rifle, and you shoot it, and an SR-71 flies over your head, the SR-71 will beat the bullet.
David: Yeah, it goes about two thirds of a mile every second.
Ben: This thing also is not very good at turning, as you would imagine. There's a fun stat about the SR-71. It cannot turn around in the state of Ohio. Its turn radius, to change direction by 180 degrees, is a wider turn than the state of Ohio. Its decommissioning mission, just to show off how fast it ever went, was one hour and five minutes from LA to DC.
David: For being placed in the National Air and Space Museum.
Ben: Yup, coast to coast in an hour.
David: I remember being a kid and looking at this thing like, why don't we commercialize? You can't commercialize this thing. You got to be in a spacesuit to fly this.
Ben: Totally. It flies at 84,000 feet, up looks black to you, straight basically looks black to you. You can see the curvature of the earth. You can't really navigate by earth-based landmarks because the earth-based landmarks are moving by you too fast. The best you can do is be like, the Rockies are in front of me. Oh, the Rockies are behind me.
That's not terribly useful, so they had to invent a new navigational guidance system that sits on the top of the plane R2-D2 style looking like an astro mech from Star Wars to navigate by the stars. It is like 50 concurrent miracles that went into making this thing possible.
David: Hopefully this is obvious, but just to make the point again, some of you might be sitting there being like, well, you just told me about how the sister company LMSC did all this amazing stuff in space. You go a lot faster than that to get to space and whatnot. Yeah, but you don't have humans on there. A pilot's got to fly this thing.
Ben: These aren't rocket engines, either. Jet engines that they figured out how to make go Mach 3.
David: Yup. Okay. When Skunk Works, Kelly, Ben Rich, and everybody sit down to work on this, the current state of the art, fastest plane at the time—this is late 1950s when they start working on this—is the McDonnell Douglas F4 Phantom, which is able to hit just over Mach 2 with its afterburners on, so not sustained flight. When you punch the afterburners, it can barely touch Mach 2.
The F4 itself was only a bit faster than the Skunk Works built F-104 Starfighter that Ben, you mentioned earlier, which was the first Collier Trophy that Kelly Johnson won. The idea that you are going to achieve cruising speeds like sustained speeds above Mach 3, this is a big piece to bite off here, only a handful of planes have ever been able to do this since. I'm pretty sure no other plane has been able to do this at cruise speed without engaging afterburners.
Ben: It is still to this day, unless there are classified programs we don't know about, the highest and fastest humans have ever flown without rocket propulsion.
David: Yes. Okay, how are you going to do this? The only way you can do this in a jet-powered plane is to essentially design something that can run with afterburners on all the time. They're not afterburners, they're just burners. It's how the thing goes. To do that, you (a) require a tremendous amount of fuel, and (b) you also produce heat in doing so that's rocket-level proportions.
Ben: The skin of the airplane gets to 500 degrees Fahrenheit. The area near the engines on the airframe itself gets almost to 1000.
David: Yes. The engines, I think, inside the engines get too close to 3000 degrees, I believe. They had to build the whole plane out of titanium to make this work.
Ben: Which was a metal that no one had ever built a plane out of before.
David: Right, this is really funny. There wasn't enough titanium in the United States to build all these Blackbirds, or raw titanium that they could easily source.
Ben: There happened to be mines somewhere else with a bunch of titanium.
David: The government and Lockheed set up a bunch of dummy corporations.
Ben: In Europe, like European incorporated dummy corporations.
David: Yes. They source a large amount of the titanium that goes into the Blackbirds, the A-12s and then the Blackbirds out of the Soviet Union. Too funny.
Ben: By the way, you can't machine titanium with regular tools. Titanium is so hard that it will damage your tools. They had to machine new tools for the Blackbird itself out of titanium in order to manufacture the titanium plane.
David: I feel like it's like a diamond cutting facility or something.
Ben: Totally. I think traditional materials like aluminum would lose their strength around 300 degrees. You actually need a different material. Otherwise, the whole plane would just dissolve when it got that fast.
Ben: There's another funny thing here, which is metal expands when it gets hot. Normally, your airplane materials don't get that hot because you're not going that fast. It's fine if the metal expands a little bit, except when it's getting this hot, the panels, the skin of the airplane is going to expand quite a bit. That means if they expand a lot, you have to leave a lot of room. How do you leave room? What they want it to do is fit together really snugly while the plane is flying, which means the panels have to fit together loose when the plane's not flying.
David: Ben, are you telling me that the Blackbird had panel gaps?
Ben: The Blackbird had panel gaps. To add insult to injury, there are a variety of reasons they decided not to have custom fuel tanks. They literally just made the skin of the aircraft the fuel tank itself, so you didn't need multiple. You needed it to be light.
David: And you needed a lot of fuel in there.
Ben: Right. When it was on the ground after you fill it up, because there are gaps in the fuel tank, it would just leak fuel while it was sitting on the ground. To solve this problem, they went to Shell and had a custom fuel created for it that was not flammable on the ground. You could smoke a cigarette next to it, and it wouldn't burst into flames because after you feel this thing before it took off, it's just going to leak fuel all over the tarmac.
David: Oh, my God. This is one of the reasons why, and maybe spoiling it a little bit, but to flash forward, the Air Force hated operating these things. It costs I think $300 million a year just to maintain these things. These were beasts from hell in every sense of that phrase, the good and the bad.
Ben: Okay, that's some of the material challenges. Another problem was on the engines. The most advanced jet engines in the world at the time was the Pratt and Whitney J58. I believe, actually, they weren't even able to get the J5 in the first A-12s, and then only later in the Blackbirds did they put it in.
Ben: We should tell people, the Blackbird, the SR-71 was the two-seater Air Force version of the single seater A-12 CIA airplane.
David: Yup. Even the J58s couldn't produce nearly enough thrust on their own to get to and sustain the Mach 3-plus speeds that they needed to hit spec. In fact, at least according to Ben Rich in Skunk Works, they could only produce about 25% of the thrust required.
Ben leads a team that engineers the spike inlet system. If you're looking at a Blackbird, and you look at the engines, they've got these cones in front of these spikes, these big spikes. I'm sure everybody listening has seen a photo of a Blackbird.
Ben: If you live in Seattle, go to the Museum of Flight. There are a handful of these at various museums around the country.
David: You owe it to yourself if you have not seen one of these things in person. It's just one of the most amazing objects ever created, ever.
Ben: These cones, what do they do?
David: The engines get the thing up. Once it's up in the air, the cones expand and retract. First suck in, and then compress, and then superheat massive amounts of air that they then mix with fuel in the engines and ignite. Essentially, this is the world's most badass supercharger ever created.
These things are super chargers, that's what they are. The spec system is a supercharger for the engines. It provides three quarters of the thrust needed to get to Mach 3-plus and sustain it. Unbelievable.
Ben: Obviously, David and I are fanboying this thing. It's really easy to feel good about this airplane because it also never carried guns. It only carried cameras.
David: You couldn't shoot bullets out of it because it's faster than the bullets.
Ben: Right. I think Kelly and the Skunk Works team were really advocating to build a tactical aircraft that was based on this, or bomber, and that never happened. Every version of the SR-71, their early prototypes of the Archangel or the CIA spy plane, there are only ever badass airplanes that carry cameras.
David: And go really fast.
David: Fortunately, Skunk Works and the CIA had started working on the A12 OXCART before Gary Powers was shut down. It takes really quite a while to engineer this beast. They start test flying it in April 1962, of course, at Area 51. Where else are they going to do this?
Once they start test flying it, that's when the Air Force finally gets interested in the project and is like, oh, we want our version of this. That's how the Blackbird comes about. A fun little bit of trivia. Within the Air Force and the Pentagon, the project originally was called the RS-71, not the SR.
Ben: The SR-71 is strategic reconnaissance, but it ended up being backwards.
David: Yeah, so funny. It happened because President Lyndon Johnson actually announced the existence of this thing in a national speech. During the speech, he calls it the SR-71 instead of the RS. There's some speculation that it wasn't that he messed up and made a mistake, but that his speech writer wanted it to be called the SR-71 and intentionally modified the speech. Who knows?
What is relevant, though, post-Cold War politics becomes a huge thing here. Once Johnson says this, nobody is willing to contradict the president. Skunk Works has to go and redo all of their documentation for the whole damn thing. You can imagine Kelly Johnson's reaction to this.
The first official flight of the Blackbird happens on December 22nd, 1964. It reaches a top speed of Mach 3.4. The airplane wins Kelly his second Collier Trophy. Still, to this day, people lose their minds over this thing. It's stunning.
Ben: It, I believe, has never been shot down. There were some accidents in test piloting, but yeah, it's never been hit by an enemy. I think it took four years to ever even be detected by radar for the first time all the way until 1968. It has played roles in surveillance in Vietnam, Korea, Arab-Israel conflict in the 70s, obviously the USSR.
David: There's stuff you can find out there on the Internet. Obviously, nobody really knows. But supposedly, according to internet lore, over 4000 missiles have been shot at Blackbirds, and none of them have ever hit.
Ben: It is just such an awesome badass thing to say the way that we're going to get around getting shot down is just to be faster than the missiles, and be right about that.
David: It's especially awesome when you know, as the highest levels of the government, it's all a decoy anyway. You're getting what you need from other sources.
Ben: Man, this is a good time to talk about that. You keep saying that. I had no idea until you brought that up an hour ago. I think you're right.
David: Here's one area where I'm wrong. I do think that statement is mostly right, but you could argue with it, and people do and did, in that satellites are not real time. You know when they're coming, you know when they're about to fly over.
If you need to instantly get somewhere that maybe you don't have the right orbit coverage for, or where there's a dynamic situation, if an enemy knows that a satellite is flying over it and doing reconnaissance, they know when the satellite is going to fly over so they could hide stuff during those times.
If you need full flexibility, you need a Blackbird. It does have a use. It's not like it's useless. But unlike the U-2, which was everything, it's more of a niche use case here.
Ben: The Blackbird doesn't fly today, civilians are unaware of something that has flown faster. There's a crazy stat, little bits of trivia about the SR-71. This really puts into context how early this was and how strange it is that we've had nothing faster since. The SR-71's first flight was closer to the Wright Brothers than today.
David: Yeah. Wild, right?
Ben: It's totally wild. This whole thing was built with slide rules. I had a very controversial tweet geta community noted, where I said that it was before the invention of the desktop calculator. It's mostly true. There are technicalities to it, but Kelly and team basically did this thing independently of computers and calculators, and figured out all the unbelievable aero dynamism stuff about it.
Of course, there's also the first stealth airplane. That's the other thing that we didn't talk about. The reason this thing wasn't detected on radar for four years is because they figured out how to fly and start to evade radar.
David: Yup. I don't know the details of stealth with the Blackbird. I imagine a big part of that was the height, the altitude, and the speed of it.
Ben: It's not that, I don't think. It's more around the shape because radar will just go unimpeded out into space. There are famous stories about detecting where people's radar transmitters are by bouncing them off the moon, and figuring out the patterns of bouncing off the moon. It's more, I think, that the SR-71's bottom was one of the first airplanes with a flat bottom rather than a rounded fuselage.
Imagine I'm shooting a set of waves at a round sphere in front of me. Some of those waves are going to bounce back because some of that sphere is exactly perpendicular to me broadcasting it. There's one particular point that's exactly perpendicular, and I can tell the radius of the thing by how I'm detecting waves that are bouncing back at me.
If it's all flat, there's only one very specific angle for which I can shoot waves at it, where I'm perfectly perpendicular, and every other angle that I shoot radar at it, it's going to bounce off and not come back to me as a transmitter. You'd need transmitters coding all over the earth to figure out where all those waves are bouncing.
By making the bottom flat, they made it so that if it was truly flat, then there's only one exact moment in time that a given radar transmitter is useful. They also did a whole bunch of work around making the rivets exactly flush with the skin. It basically didn't have a whole bunch of rounded parts that could risk bouncing radar waves back at the transmitter or receiver.
David: Super cool. Keep in mind for a minute from now that idea of flat surfaces, planes and radar. Planes not airplanes.Planes like a flat plane, and surfaces. To close out on this amazing airplane, amazing and sad in a lot of ways, it's hugely expensive to build these things. $33 million per plane, which was a lot back then.
Planes now cost more, but a lot. As I said, $300 million a year just to keep them operational and run the program. You couldn't use it as a fighter or a bomber, it was only reconnaissance. It's not super popular with the military and the Air Force. They don't like it as an operational plane.
Ben: Right, it's a lusty airplane.
David: Yes. It's not a daily driver, let's put it that way. In 1970, the Pentagon cancels further orders, and they order Skunk Works to destroy all of the titanium tooling for it so that no more can ever be built. I assume that, so that it doesn't fall into enemy hands or something like that.
Ben: And it's like, we're serious about telling you we're done ordering these things, and we don't want political maneuvering to spin it back up, so we're going to be prohibitively expensive for you or for anyone to ever think about starting the program backup.
David: Yup. The existing ones do stay in service, but obviously this is a big blow to Skunk Works' revenue. They're not producing these things anymore. On the back of that, Skunk Works has to do layoffs, the Skunk Works division.
After the contract is cancelled in 1972, two years later, Lockheed and Skunk Works lose the bidding for the F-16 Fighter. General Dynamics wins that. Ironically, the later Lockheed right before the merger with Lockheed-Martin would acquire General Dynamics fighter plane business, so it does come back into Lockheed.
Ben: Still, they call it out in their earnings today. They're still selling F-16s today.
David: Here's what's interesting about this contract and Lockheed and Skunk Works losing it. This is an example (I think) to that first tenet from LMSC of threat-based need and real market need, maybe you want to adapt that to. Kelly Johnson, as amazing and a genius as he is, is a very stubborn man.
The stated purpose, the Air Force's goals with the F-16, was to have a cheap fighter. It didn't need the best, it needed to be cheap, that they can make a lot of these, and they could use them all over the world. That's not Kelly's MO. He and Skunk Works bidding on this project, they kept trying to give the Air Force what they didn't want, and they lost it. The idea of Skunk Works losing a contract, this is crazy.
Ben: In particular, he didn't really want to play ball the way the government was trying to bid out the contract. He looked at the requirements, he said, this is stupid. I'm going to design you an airplane that I think meets the needs of how this will be used in the field, rather than what these technical specifications say here.
Over the long run, he was right. As the program evolved, the specs actually changed to what Kelly decided to build their prototype airplane to do. But the prototype they produced was not in spec for the original F-16 requirements.
David: By this point in time, to bring some context back of where the country was, we're now basically post-Vietnam War. The Cold War for sure is still going on, but it's not the same level of urgency in Americans' minds as it was back in the 50s.
Ben: Not to mention, all military muscle is very unpopular in America. Any politicians who are seeking to expand the might, budget, and proactivity of the military are facing a lot of resistance at home. That is probably a good thing for our society that that was happening. At the same time, it made Kelly a relic.
David: Yeah, totally. This is not a challenge that LMSC, at least with the Corona project, had to face because nobody knew about it.
David: This is a really bad time for Lockheed. This is the period like we were talking about at the end of the LMSC chapter, where it's LMSC that keeps the company afloat.
Ben: Kelly retires.
David: Kelly retires, Ben Rich takes over as head of Skunk Works. Skunk works is doing layoffs. Lockheed really stupidly decides to try to get back into the commercial aviation business.
David: They make the L-1011, which by all accounts was a great airplane but turns into a disaster project. They're trying to compete with Boeing and with McDonnell Douglas here.
Ben: The DC-10, I think, was the McDonnell Douglas competitor.
David: Lockheed partners with Rolls Royce to make the engines right as Rolls Royce goes bankrupt and gets nationalized by the UK Government. All told, we won't go into the whole history here, but the L-1011 airliner project loses Lockheed $2½ billion. As we said a few minutes ago, this is not a super profitable company. They don't have $2½ billion in other earnings just sitting around to soak up the losses here.
At the same time, Lockheed also gets caught up in really nasty bribery scandals around the world, but these are nasty political scandals themselves. Basically, Lockheed comes out looking at least to the American public as a corrupt arms dealer. What happens is Lockheed and lots of people would argue that this is just the way you needed to do business in foreign countries, our allies that Lockheed sold these weapons to.
In the Netherlands, in Japan, and in Saudi Arabia, it comes to light that Lockheed employees and contractors are paying bribes to political officials to win contracts. This actually brings down the Japanese Prime Minister at the time. This is a huge scandal in Japan on the order of Watergate in the US. Huge scandal.
Sega actually makes an arcade game about it called I'm Sorry about the prime minister at the time. It's so funny. Lockheed also, on the military side, the main Lockheed divisions, engaged with a couple of helicopter projects with the military and then the C-5 Galaxy transport plane. Those projects go horribly. They have huge cost overruns.
The C-5 at least, I think, does ultimately become a good airplane, but costs way more than the initial bidding. All of this conspires that, especially postVietnam period, the American public starts to view Lockheed as this corrupt vampire, octopus, military, industrial complex, squid sucking on America. Things get really bad.
Lockheed's finances at the same time were so bad. They need a bailout from the government. The government has to guarantee a $250 million loan to Lockheed to keep them afloat, mostly because of the L-1011 disaster. It requires a vote of Congress to do this. It almost doesn't pass. This is really bad.
Ben: I didn't realize how dark it got there.
David: It got real, real dark. Again, it was only the profits from LMSC that kept the company from probably going under. Okay, we've mentioned stealth a few times here. Back to Skunk Works.
Ben: There is one more great Skunk Works airplane, and it is under the administration of Ben Rich, Kelly's successor.
David: One last hurrah, at least for the traditional Skunk Works organization.
Ben: There's a math paper published in a Russian journal.
David: Around the mid-1970s, right around this time.
Ben: Which I think gets published because the Russians don't really see anything of value there. They don't really know exactly what these particular equations that are getting published could be applied toward.
But somebody at the Skunk Works reads the paper and says, I think all the ways that we've been thinking about trying to make an airplane stealth like the SR 71, with flattening the bottom a little bit, trying to use particular materials, paint, and stuff like that, I think it's good. But if I apply these equations to make a stealth aircraft, then I think we can do something two orders of magnitude better than anything we've done before. I think we can make an airplane go from looking smaller than it is, like a bird on a radar, to something like a BB on a radar.
David: Or a ball bearing, famously.
Ben: Or a ball bearing.
David: That Skunk Works employee was then 36-year-old Dennis Overholser, who was a mathematician. He, like you said, reads this paper and brings it to Ben Rich, who just six months earlier had taken over from Kelly as head of Skunk Works.
Ben: He's told don't stick your neck out, no one's getting the crazy amount of rope that Kelly had, so prepare to just be Lockheed's yes man. We're going to use the Skunk Works for branding and marketing, but we're not doing anything too nutty in your little shop over there.
David: Even Kelly himself, he's retired, but he stays on as an advisor, so he still has his fingers and everything, he's so disillusioned at this point. He tells Ben Rich, he says, don't even pursue this, it's not worth it. Missiles are where the future is, nobody's making planes anymore. Don't invest the money on this.
Ben: In particular, because when you apply these equations to design an aircraft, the way you have to design it makes it incredibly not aerodynamic. If it works, it will be a thing that is invisible on radar, but Kelly looks at some of the early sketches of what you would have to do to make this thing into an airplane, and basically thinks that's not an airplane, that won't generate lift.
David: He's such an aesthetic snob. He's like, that's not an airplane, and we can't make it. It doesn't look beautiful.
Ben: It's not just that it doesn't look beautiful. Literally, there's only a hint of Bernoulli in there. The way that it's shaped is unclear that it will generate enough lift to lift itself.
David: Yes, also correct. I think the bigger problem was less about lift, although I'm sure that was a problem, but more about, could you control it? Could you fly this thing?
Ben: What's being proposed here is basically an enormous looking cockpit, this big globular fuselage, and you can Google the F-117A.
David: The name is the Nighthawk.
Ben: Stubby wings. These two little super thin tall tail fins look super unstable, and the whole thing has basically zero round surfaces on it. It's faceted. It looks like a diamond. In fact, its codename or I would say probably not its codename, but its nickname internally was the Hopeless Diamond.
David: Yes. You know what this thing looks like? If you aren't already intimately familiar with images of it, I actually think it looks really cool.
Ben: Totally. It doesn't look like it will fly or fly in a controllable way. It looks like you made a paper airplane, then you put a rock on top of it, and you were trying to get that thing to fly.
David: Totally. To me, it looks like the plains in the first Star Fox game for the Super Nintendo. When Nintendo and other 16-bit game developers during that generation were trying to make 3D games with 16-bit hardware, you didn't have enough processing power and polygonal power to make rounded shapes, so they have flat surfaces.
Ben: These big ass triangles.
David: Big ass triangles, that's what this thing looks like. It literally looks like not a Star Fox 64, a Starfox Super Nintendo plane.
Ben: Right. Ben Rich decides that he wants to put his career on the line.
David: Yeah, and take a risk and make this. He goes to the Air Force. The Air Force says, on the one hand, your timing is good. We actually also think stealth technology is worth pursuing. We have an active RFP out there. We didn't come to you guys because Skunk Works hasn't made a fighter plane in God knows how long. You guys just had layoffs. We don't like the Blackbird. Sorry, you guys are old news.
Ben Rich, like you said, risked his career six months into the job pursuing it at all. He risks it even further. He goes back to Lockheed corporate and says, I want to pursue this and make a prototype anyway without a research contract. We're going to fund this internally.
Ben: Which this is not something that defense contractors do. We'll talk about this as we get into playbook, but it's not like a tech company where you do a bunch of forward looking R&D, and then amortize it over a bunch of customers later. You go bid on a contract, you get that contract, and then you build the thing.
David: It's so funny reading less so in the early history, but when you read about Lockheed today and the industry today, there's all this talk of the customer. The customer, there's only one customer.
Ben: The DoD.
David: The DoD is the customer. It's like Amazon, like, oh, the empty seat for the customer in the room. It's not a metaphorical customer. It is a specific customer.
Ben: No, it's like, what does the Pentagon think? Which is a good and a bad. They're unbelievably customer-focused. Lockheed Martin doesn't build stuff, unless the US government says I'll order it, which means they don't have to take a lot of risk. But on the other hand, they also don't get the upside from taking risks, typically.
David: This is how crazy this situation is. It is literally the opposite of what you just said. This is Ben Rich's neck on the line. This is Skunk Works on the line. This is everything.
They go and they build a prototype. It's nicknamed the Hopeless Diamond. The codename is Have Blue. I mentioned ball bearings earlier. They make a model of this thing, a wooden model. They put it up on a pole. They tested in their radar range alongside the other prototypes from other contractors for a stealth fighter that the Pentagon has put out. This thing is invisible.
The way that the Air Force inspectors come up with testing it is they get a set of ball bearings of increasingly smaller diameters, and they attach them to the nose cone of the wooden model at the radar range. They see, if you can detect the ball bearing, or if it's blacked out by this massive plane model behind it, they can detect a ball bearing down to a diameter of an eighth of an inch. The radar signature of this plane is less than an eighth of an inch sphere.
Ben: It's unbelievable. The thing is all flat surfaces. It basically bounces the radar everywhere, except for the transmitter receiver that is actually shooting the radar waves at it. Will it fly and can you control it are still open questions, but we now know that it is like, oh, my God, radar invisible.
David: Out of that, the dark horse Skunk Works wins the contract to build the Air Force's stealth fighter. They do. They solve the challenges you just mentioned, and they solve them with computers for the first time, or at least that we know of, really the first time in Skunk Works' history.
The way you control this thing is with fly by wire, which I'd heard that term before. But fly by wire means that the planes' systems are controlled by a computer. When you move the controls as a pilot, you are not directly moving the mechanics. The computer decides how to translate your intentions into stabilized movements for the plane.
Ben: Power steering.
David: Exactly. It's even more than that. It's like doing all sorts of stuff that you have no idea how to make it do what you want it to do.
Ben: Right. It's a Tesla basically. It's abstracting away your inputs and doing the thing that is optimal based on what it's pretty sure your inputs want it to do.
David: Yup. They win the contract. They start testing this thing at, of course, Area 51. The stealth fighter really looks like an alien spaceship.
Ben: I don't blame all these people with the binoculars who are pretty sure there are aliens.
David: I don't blame them either. The Air Force starts taking delivery in 1983 of the stealth fighter from Skunk Works. They ultimately buy 59 of them of the F-117A Nighthawks at $43 million each. That is $2½ billion dollars in revenue for Lockheed at a time when they desperately needed it, and Skunk Works desperately needed it.
Ben: Huge win for Ben Rich.
David: Huge win. The real combat debut for the Nighthawk is during the Gulf War during Operation Desert Storm.
Ben: That's six years that they keep it undeployed, where they have it, but the US government has decided that we want to save it.
David: Where are they going to use it? We're not really fighting any wars. This is a fighter. This isn't a reconnaissance plane. This is a fighter/tactical strike plane, which again, Skunk Works hasn't built one of those since I guess the 104 Star Fighter?
Ben: I think that's right. The F in F-117 is fighter, the SR-71 was not an F plane.
David: The plane is never really tested in combat of what it can do until Operation Desert Storm. I remember watching this live when this happened. I don't know if you remember this, Ben, but I vividly remember when this happened. The first night of the war, Operation Desert Storm, which is broadcast live to the world, the US Air Force completely knocks out all of Baghdad's defenses and infrastructure. The way they do it is with the Nighthawks.
Ben: They came in under the dark of night, no one knew they were coming. They hit a bunch of the high value targets. These wars now tend to be these overwhelming force at the start, and then long, long drawn out battles after that. This set the stage for what modern military engagement looks like.
David: Yeah. A few quotes here that are in Skunk Works. First from the Secretary of the Air Force at the time. "We learned the first night of the Gulf War and for many nights after that, that stealth combined with precision weapons constituted a quantum advance in air warfare. Ever since World War II, when radar systems first came into play, air warfare planners thought that surprise attacks were rendered null and void, thought in terms of larger models to overwhelm the enemy, and get a few attack aircraft through to do damage. Now, we again think in small numbers, and in staging surprise, surgically precise raids."
Another quote here from one of the pilots that flew that night. "To put it in domestic terms, if Baghdad had been Washington, that first night we knocked out their White House, their capitol building, their Pentagon, their CIA, their FBI, and took out their telephone and telegraph facilities. We damaged Andrews Air Force Base, Langley, and Bowling, and we punched big holes in all the key Potomac River bridges. That was just the first night."
Ben: This thing is deadly. The Nighthawk very much worked.
David: The night hawk flew 1% of the air missions in Desert Storm, but accounted for 40% of all damaged targets.
Ben: While this plane was a massive success for what it was intended to do, this is where I want to stop glorifying some of the military might the way that we did in the Cold War, which was obviously for deterrent. This is when the foreign policy changes a little bit in a way where your...
David: Yeah, people are dying here. This is the incredible paradox of this. The most overwhelming and terrifying weaponry ever created and weapons capabilities ever created, was never used and was created so that it would never be used.
Ben: Right, it's fascinating.
David: Totally. But here, this stuff is used, and a lot of people died.
Ben: For the F-117A, 10,000 people worked on this airplane, the Nighthawk, and kept the secret for 21 years until it was declassified.
David: Wow, crazy. Let's just divorce any value judgments here for the moment. In terms of the airplane itself, Lockheed, Skunk Works, and the company, while Desert Storm was, on the one hand, this great success story for the airplane, there's also the end. That's the end of the Cold War.
There is no doubt after Desert Storm and all the other things that happened, the falling of the Berlin Wall by the early- to mid-90s, it's done. This success of the Nighthawk and success of the US military, from the military standpoint during the Gulf War, set the conditions to bring us to the modern era. Lockheed today, which is not Lockheed, but Lockheed Martin.
Ben: And Boeing today, which is not Boeing, but Boeing and McDonnell Douglas, and this incredible era of consolidation.
David: Right, and Northrop, which is not Northrop, but Northrop Grumman, and which very closely almost was part of Lockheed Martin, but got blocked by the DOJ.
Ben: Yeah, and then you have Raytheon and General Dynamics, which have eaten their fair share of all the other competitors, too.
David: The Gulf conflict, I think, ends in 1991, I believe. It becomes really obvious that the Cold War–era of arms buildup in the US is over. Defense budgets are going to shrink massively.
Ben: And we need to start nuclear disarmament. We need to start destroying a lot of the nuclear warheads that we build.
David: Right. Everybody in the industry knows it, and then it becomes super explicit. This is an amazing event that happens.
In July of 1993, the then Deputy Defense Secretary William Perry calls the CEOs of all the major prime defense contractors to a dinner in Washington, at which he explicitly tells them defense spending is going to shrink massively, and he instructs the CEOs present that you all need to consolidate and start merging with one another. We, the Defense Department, are no longer going to be able to feed all of the metaphorical mouths at this table.
The CEO of then Martin Marietta, soon to be Lockheed Martin, refers to this dinner, tongue in cheek, as the Last Supper. Indeed, it was. This is an amazing event. Literally, a government agency just told an industry what to do. This doesn't happen in America.
Ben: Very explicitly, and this was rumored for a long time. People were like, wait, did this really happen? The US government instructed these big companies to become anticompetitive to all merge together? This 1993 thing really kicks off an era of intentional government policy around combining companies.
David: Yeah, which is a very odd American industry. I think as we saw during the Cold War era, America functions on competition and thrives in competition. Here, the government is saying less competition.
Ben? In part, they're basically saying, look, it's an acknowledgment that a lot of the times, companies thrive because they're in growing markets, and this is now a shrinking market. What do you do if you want to maintain America's military industrial base, but you know for a fact the market is shrinking this year and likely every year for the next decade or two? What do you actually do?
I think the intent here is to say, we don't want to lose capability. We want the US to remain a country that has a whole bunch of people that know how to build this stuff, so if we need it, it's there. But you're going to put each other out of business because we just won't have enough for you. You need to merge and get more efficient so we don't lose the muscle, but you all have real businesses, real going concerns.
This whole so you don't lose the muscle thing, that is unique on this episode versus any other episode because the government is an indifferent player in almost every episode of every company that we talk about. But in this one, they're an extremely interested party where it is in the national interest.
David: They are the customer.
Ben: Right. It is in the national interest for us to maintain this capability, or so that's the policy.
David: Yup. This sets off an amazing series of events, similar to harkening back to the LVMH episode when Louis Vuitton and Hennessy merged not because they liked each other or because there was a business reason. They merged for practicalities, to avoid dying, and getting taken over by hostile raiders.
In 1993, Lockheed buys General Dynamics fighter jet business that we already talked about, the F-16 business. In 1994, the big shoe drops. They announced a "merger of equals" with Martin Marietta. That goes through in 1995.
Ben: Except they didn't merge everything about. There are two spinouts of the Lockheed Martin combination. One is there's another set of things that Martin Marietta does around minerals and mining. There's literally a Martin Marietta company that's publicly traded today that still exists that's around mining raw materials.
David: Do you know this because he looked up the Mine Safety disclosures?
Ben: I was disappointed to see if there were no Mind Safety disclosures in Lockheed Martin financials. There's another thing that spins out called L3 Communications, which is the set of things that won't be combining into Lockheed Martin.
This has actually become a fairly formidable competitor today. There are the five big primes, Lockheed Martin, Boeing, Raytheon, Northrop Grumman, and General Dynamics. L3 is growing, which is fairly unprecedented in this era of primes. You might be saying, what is the L3? There were three Ls involved in creating this company. One of them was the investment bank that helped combine them, Lehman Brothers.
David: Lehman Brothers, yes.
Ben: Frank Lanza, Robert LaPenta, and Lehman Brothers are the Ls.
David: The assets that do merge of Lockheed and Martin, in January 1996, shortly after the big merger goes through, they then acquire the defense business from Loral for almost $10 billion. As we said a minute ago, in July 1997, they attempt to merge with Northrop Grumman.
Ben: This is Lockheed Martin looks at the DoD, and they're like, are we supposed to keep going?
David: Yeah, like, you told us to do this, right? They misread the tea leaves on that one. That merger gets announced and signed off. The DOJ blocks it, I assume, with tacit approval from the DoD on that.
Ben: The thing with the five big primes is they're all very good at a certain bucket of things. If you start combining Lockheed and Northrop, which are the two that really bid against each other at this point in history, the B-2 bomber and the B-21, there's often this face-off between Northrop and Lockheed. If you combine them, then you actually do away with all competition.
David: Yup. Would have been so fitting, given that Northrop was a co-founder of Lockheed. All the way back to the beginning of the episode. The DoJ blocks that. But also in 1997, Boeing merges with McDonnell Douglas and becomes the giant that it is now.
Ben: Do you know why that happened?
David: I do not.
Ben: We're going to talk here in a second about the F-22 program and the F-35 program. We'll just skip over the F-22 for the moment just to hit this point. For the JSF, the Joint Strike Fighter F-35 program, this is going to be the biggest ever military contract. It's really worth going for.
There are three companies that are worth gunning for it in the mid-90s. There's Lockheed Martin right after their combination, there's Boeing, and there's still independent McDonnell Douglas. McDonnell Douglas is eliminated from competition, so it just comes down to Boeing and Lockheed as the two finalists. Within a month, Boeing announces that it's buying McDonnell Douglas.
David: Yeah, that was probably the end of McDonnell Douglas once they got eliminated.
Ben: Exactly. This contract is so big, and they were betting so heavily on it, that basically Boeing and McDonnell Douglas after McDonnell Douglas loses, need to just combine and size up in order to be a formidable competitor to Lockheed Martin going forward.
David: Do you know the size of the F-35 Joint Strike Fighter program in terms of dollars?
Ben: I do. It is a $30 billion DoD contract for 398 airplanes just for the US. We'll talk about that in a minute, but it was a prize worth going for.
David: If you lose this contract, this is literally life or death whether you get this or not.
Ben: Right. Losing this creates an extreme combination.
David: Obviously, this sets the stage. I'm going to hand it over to you in a minute to lead the discussion of all the dynamics around this, the military industrial complex and defense contractors today. To set the stage, I have a few quotes from Norm Augustine, who was CEO of Martin Marietta when the merger happened, and Dan Tellep, the CEO of Lockheed as the first CEO of the combined company.
Dan came up through LMSC, started there and worked in LMSC for decades, and then became the CEO of Lockheed. He's the first CEO of the combined company, and then Norm takes over for a few years after that.
In 1987, Norm is a character. He's a serious character. He writes a Harvard Business Review article. I want to read a few quotes from this. "Following the Last Supper,” which he termed the Last Supper, “it became evident that there were only two potential survival strategies. One was to move into new markets,” he’s meaning commercial markets, “a difficult and time-consuming option that has rarely succeeded." As we talked about, definitely, Lockheed tried that in the 70s and failed miserably with the L-1011.
“The other strategy entailed something almost as difficult. Increasing market share in existing markets during a period of severely declining businesses.” Duh, this is what we're talking about. He says, “Here's what happened.” He just lays it all out here. “Lockheed soon purchased General Dynamics aircraft business, and Martin Marietta purchased General Electric's aerospace business. All told, our company comprises 17 previously independent entities,” independent until recent times as he's writing this.
“General Dynamics, Sanders, Gold Ocean Systems, GE Aerospace, RCA Aerospace, Xerox, Electro Optical Systems, GoodYear Aerospace, Fairchild, Weston, Honeywell Electro Optics, Ford Aerospace, Librascope, IBM Federal Systems, Unisys defense, Lockheed, Martin Marietta, and Loral.” What a freaking company.
As we've been alluding to, these were not very profitable entities. Lockheed, at the time of the merger, did $13 billion in revenue, and only $422 million in net income. Martin Marietta was slightly more profitable, did $9.4 billion in revenue and $450 million in net income. Both of these are 10% or less net income margins.
Ben: Yeah, and you basically have a situation, where all these contracts go to all of the contractors. They just rotate around who's the prime on it. The prime makes the most money, then it has the most sway, and you don't want to be with a subcontractor, you'd rather be the prime contractor. But still, this current military industrial complex is very, all five players are basically in on all the big contracts. The government's very aware of that. The companies are all very aware of that, and it reached this stasis.
Ben Rich basically called it in 1992, when he was talking about—this is at the end of the Skunk Works book—the end of the B-2 bomber program, which by the way, the B-2 was a make-good when they gave that to Northrop Grumman.
David: This is the stealth bomber.
Ben: Yeah. By all means, that should have gone to Lockheed Martin. They have the expertise from the F-117A, Nighthawk. This is the Lockheed side of the story, but they beat the B-2 in a lot of early competitions, but the government still gave the award to Northrop Grumman because there was some particular plane that the government said Northrop could manufacture a bunch of it, then sell internationally, and then change their mind, so then Northrop was left holding the bag, with the Department of Defense being like, all right, you can win this competition. Who knows if any of these things are true. That's Lockheed side of the story.
Anyway, Ben writes, “Under the current manufacturing arrangements for the B-2, Boeing makes the wings, Northrop makes the cockpit, LTV makes the bomb bays, and the back end of the B-2 airplane in addition to 4000 subcontractors working on bits and pieces of everything else because of the tremendous costs involved. This is probably a blueprint for how big expensive airplanes will be built in the future.
For better or for worse, this piecemeal manufacturing approach, rather than the Skunk Works way, will characterize large aerospace projects from now on. With many fewer projects, the government will have to spread the work around across an even broader horizon. What will happen to the efficiency, the quality, and the decision making? At a time of maximum belt tightening in aerospace, those are not just words, but may well represent the keys to a company's ability to survive.”
I think that 1992 Ben Rich publishing the Skunk Works book, then the Last Supper, it basically marks the end of Skunk Works. Skunk works is still a term that is used to describe a part of Lockheed Martin, but is it the skunk works of the 50s, 60s, 70s? No, not at all. It's a completely different thing. Airplanes are just not built by small teams in this auteur way, the way that they were in Kelly's era.
Let's talk about some of these huge programs that these large fleets of planes that the US government has bought in recent years. We'll start with the F-22. This gives you a sense of how freaking long these timeframes take.
In 1981, the Air Force identified a requirement for an Advanced Tactical Fighter to replace the F-15 Eagle and the F-16 Fighting Falcon. That kicks off this, we're-going-to-need-some-future thing.
In 1985, the initial order, and I don't know if it's technically an order or how it changes over time, but the initial pseudo commitment is for the US government to buy 750 planes of what becomes the F-22 Raptor for $44 billion in the total program cost. That gets revised down.
Again, an airplane has not flown yet. Just before 1997 to 339 planes—that's going from 750 to 339—for $62 billion in total program cost, that cost went up, even though the number of planes dramatically went down to half.
David: I was wondering, I was like, did Ben misspeak there?
Ben: Nope. Then the F-22 program is over. That was a big thing in the Obama administration where he basically said, I'm going to veto anything that comes to my desk for any more Raptors. We're done with this, but it's not as good as it sounds. It's not as noble.
The final down from 750 to 339 is 187 planes delivered. They kept the $62 billion total program cost fixed. They managed to do that. Each plane ends up costing $360 million if you amortize all the R&D against the very few airplanes that they ended up making.
The F-22, much like the SR-71, there's not much we can complain about the plane. It is a badass plane. In fact, for seafair, here in Seattle, in the last few years they've had an F-22, it is an unbelievable thing to see live. It performs maneuvers that just look alien. You just don't understand how the physics makes it work. It was all about air superiority, it was all about speed. They took all of the stealth lessons from the F-117 and put it into a very fast air dominating airplane.
David: The stealth fighter, the Nighthawk, was angular and looked like a Super Nintendo Starfox plane because of the computational ability to model it at the time, it wasn't that you needed to have just flat surfaces. It's that you could have three dimensional rounded looking surfaces, you just needed to be able to model it for the radar signature. Computers weren't advanced enough at the time to be able to build a 3D modeled version of a radar stealth structure.
As they advanced, you are now able to do that in much the same way that in video games, you can now build lifelike-looking 3D models out of the same polygons before. The Sega, I think it was the model three arcade board that we talked about that was part of the real 3D revolution in video games.
Ben: They used it in the arcade cabinets, these cutting edge better-than-home-consoles computers.
David: Yup, Virtua Racer, Virtua Cop, Virtua Fighter being the big one were on that. Sega co-developed those boards with Lockheed Martin.
Ben: In order to model the stealth airplanes.
Ben: Unbelievable. That is insane.
David: It's so fun.
Ben: What we can see here is the classic modern boondoggle is probably the wrong word, but program gone awry, where there's a sensible total program cost for making a lot of airplanes. As there's more pressure on the budget over time, and there are cutbacks that happen, you end up making less and less airplanes. It's really hard to amortize all the R&D costs.
Because of the way that these contracts work, it's not the tech company that's left holding the bag. It's not the contractor holding the bag. Its total cost plus model, the company, the contractor, Lockheed doesn't take any risk.
Who's holding the bag? The government's just paying more for each airplane, rather than you can imagine if I was Apple, and I sunk a billion dollars into developing the next great device, and then no one bought them, I'm out a billion. But in this scenario, the government's like, look, I told you, I'd pay that much. I'm paying that much. Unfortunately, I just can't spread the R&D across as many units.
David: Wow. It's the R&D, but also the tooling, like we were talking about with the Blackbird.
David: The infrastructure that you need to spin up to make a new airplane is a lot.
Ben: Right. Following Ben Rich's hey, I think this is how airplanes are going to be made in the future, this happens in 46 states.
David: The F-22 is built in 46 states.
Ben: Yes, and it requires 95,000 jobs, which in some ways is good. It's good to employ people. In other ways, the reason that some of these projects get funded is because it creates these jobs. The reason that it's in 46 states is because that way, basically, every member of Congress is incented to vote for it.
David: You're talking about pork barrel politics.
Ben: Exactly. I think Lockheed has become world class in understanding where their bread is buttered. Yes, their customer is the US government, but the people approving their funding are individual people, these members of Congress who all want to get reelected.
Lockheed spreads all these operations around. They employ all these people, and members of Congress love nothing more than creating jobs for their constituents. They hate nothing more than participating in a vote that eliminates jobs. Congress can be simplified to 538 principal agent problems.
David: Contrast that with the team of 50 engineers and 100 machinists that built the U-2. Yeah, of course, the F-22 is a much more advanced airplane than the U-2, but the size of the engineering challenge relative to state of the art technology was way less than the size of the U-2 engineering challenge relative to state of the art technology.
Ben: Yup. Then there's the next program that comes along, the F-35 Lightning 2, the Joint Strike Fighter. The mindset here is, well, we finally get it, we need to make a lot of these things if we're going to make a big investment. The government pulls its resources, and the DoD works across the armed services. They reach out to all of our allies, Britain and others, and they say, what's a common platform that we can develop so that we can get the best economies of scale out of this thing? That's the right thing for the American taxpayer.
They come up with this idea for the F-35 Lightning 2. They're going to make three models, and each of the models are for a different purpose. It's this incredible piece of technology. One of the three models can actually angle its engine down and take off vertically using its engine to reposition. I don't think they can use this in combat, but they can use it to move itself around on an aircraft carrier and stuff like that. It's pretty incredible to watch videos of it if you just search on YouTube.
It interestingly has a different aim and mentality than the F-22. It's less about being the fastest plane in the skies, and much more about having the technology and the visibility to have the best information at all times. It's looking to the future of information-based warfare more than pure air superiority and speed. It's not all the way to a drone future or cybersecurity future, but you can see it drifting there. Really intense communications between a whole squadron of fighters, intense heads up displays with digital stuff for the pilots in the cockpit and in their helmets. It's the most technology-forward plane program ever.
When I say big, I mean really big in terms of the number of orders that are going to be placed. The initial order book is approximately 3000 airplanes worth a potential $200 billion for the total program cost.
In practice, it's as pork barrelly as the F-22. Lockheed won the contract, but it's subcontracted. It's peanut buttered out to all the other big programs too. The fuselage is Northrop Grumman. BAA Systems from the UK makes the rear fuselage. These pieces are shipped all over the globe before final assembly. We've expanded it even from pork barrel in the US to, which of our allies can participate in making this thing, and thus benefiting in their area, too?
Here are some of the stats from Lockheed 2022 annual report. The USA's F-35 order is a $30 billion order just from the US. That's 398 airplanes. That is $750 million per airplane. The Swiss have placed an order for $6 billion for 36 airplanes, Finland bought 64, Germany 35, Greece 20, the Czech 24, Canada 88, Poland 32. Lockheed Martin, this is an enormous win to win this program. It is, among us and our allies, the largest ever purchase anyone has ever made for any piece of defense equipment.
David: It's just so clear listening to you talk about that, and contrasting it with everything we talked about in the story portion of the episode. This is a different world than the Lockheed of World War II and the Cold War, and the military of World War II and the Cold War. It's very unclear to me what the threat-based need is here for this.
Ben: Yeah, hopefully deterrence.
David: I'm not a military strategist, but you mentioned drones. Drones are a thing now, and they're a lot cheaper.
Ben: Yeah, put a pin in that for the moment. I'll finish rounding out the national defense budget, just to put all this in context of what Lockheed represents here. Our national defense budget in the United States is $800 billion. As you would expect, that's more than any other country in the world. It's 3%–4% of our GDP we spend on defense.
Interestingly, it is down on a percentage basis of when you think about the percent of federal revenue spent on defense, it's actually down. Back in the 60s, we spent half of our federal revenue on the military. In recent years, it's fluctuated between 12% and 20%. I think that's a little bit of a counter narrative to people that like to complain about how much money we spend on the military.
David: I guess it is, to the point of consolidation in the Last Supper, the government was clear, we're going to spend a lot less. We're just going to spend it in a much more concentrated fashion.
Ben: Exactly. The military industrial congressional complex, it's almost like what's happened in the banking system. We pseudo nationalize a few companies. There are these too-big-to-fail entities that are in cooperation with the Government, neither can really exist without each other. We are okay with that. We say, okay, that's how the system works. For better or for worse, private industry and the government are tied at the hip there.
A few more stats on this. I said in recent years, the government's DoD or defense spending is between 12% and 20%. The total US government budget is $6 trillion. Defense in there at 800 billion clocks in. It's actually lower than social security, health care, and income security.
David: Wait a minute, you said it was 3%–4%.
Ben: It's 3%–4% of GDP, but it's 12%–20% of the federal budget. Okay, we know that of the $6 trillion budget, defense is less than social security, health care, and income security. It is more than Medicare, education, or transportation, just so people know where it sits there. Of that $800 billion, about half of the defense budget is spent on contractors like Lockheed Martin. Of that 400 that's spent on contractors, $50 billion goes to Lockheed. They are the single largest recipient of federal spending as a contractor, full stop.
David: Wow, not even just defense across all companies.
Ben: Across all companies.
David: Wow. I knew they were the largest defense contractor, but I didn't realize they were the largest government contractor, period.
Ben: Yup. Lockheed, then Boeing, then General Dynamics, then Raytheon, then Northrop, then McKesson. Wow, you get to five before you even get to a health care. You got that $50 billion that goes to Lockheed Martin from the federal government. How much of their total revenue do you think that is?
David: It's got to be 90%.
Ben: It's close, it tends to hover around 75%. $66 billion was Lockheed's total revenue last year, of which $50 billion came from the US federal government.
David: Makes sense. The rest, I would assume, would come from foreign governments.
Ben: Correct, our allies, because the US government basically has a role on anything and can put the kibosh on Lockheed exporting to anyone. It's not terribly profitable. Their net income margin is 8%, as we've been talking about the whole time. You can see the cost-plus pricing right there at the bottom line of the company.
Lockheed Martin makes a bunch of money. At the end, they only have 8%. That's basically contractually figured out, I think. Whenever one of these contracts gets bid out, the big defense contractor says, I'm going to slap 8%, 9%, 10%, 11% on top of it, and that's going to be the cost. That is exactly why their financial statements look the way they do is because that's exactly how the government decides to fund it.
David: Which we should probably talk a little bit about the rationale for that. I'm no expert in this, and we should probably have an economist on ACQ2 at some point in time to talk about it, but my understanding is that while Warren Buffett and Charlie Munger hate cost-plus contracts, and in general, they set up terrible incentives. They are useful in cases where you don't know what the cost is going to be, but it's an incredibly important investment to make.
Traditionally, that has been defense expenditures. We need the U-2. We don't know what the cost is going to be, but we need it to happen. We need the Corona program. We don't know what the cost is going to be, but we need it to happen. I think that is the rationale of how we got here.
Ben: But it doesn't make sense when the government's buying more modern things. We're buying Software as a Service. Let's say I'm making Slack, and I'm selling that to the government. If the contract to procure something that looks like Slack requires me to bid on it in a certain way, and I'm using Slack.
There are lots of defense software you can think about here. Palantir, for example. How do you let the government put out a contract to bid on that's structured a certain way, when the way that you've decided to structure your company where you do R&D upfront, you're willing to take on some of the risk, and then you want to sell something and amortize your R&D across all of your customers the way that every tech company does, and the way that you get operating leverage on your company, that doesn't fit in these gigantic cost plus contracts.
In fact, what it insures is you cannot get operating leverage on your company. No matter how large you scale, you will never have big fat gross margins that outrun your fixed costs. It's like the opposite of what every tech company is trying to do.
David: This is the great irony in the government together with Lockheed really seated Silicon Valley. The modern Silicon Valley and the modern defense industry are, in many ways, incompatible from a business model perspective.
Ben: Right. Someone told us as we were preparing and researching this episode that Palantir figured out that what they had to do was sell laptops to the government that came preloaded with their software. They could sell a physical thing that had a cost of goods sold associated with it, such that it could be bought in a cost-plus way.
David: Now, I think this is probably changing and certainly, there are smart people in the government that recognize this in their pilot programs to be able to buy software and technology. But if you look at some of the most successful Silicon Valley–style startups that are selling defense to the government, whether it's SpaceX, Anduril, or others, yeah, they're selling hardware. They're not selling software solutions.
Ben: Yeah, I'd say we're in the first out of the first inning and trying to figure out how to sell software to the Department of Defense.
David: Which is scary when you think about it because I suspect most Acquired fans will not find this a controversial statement, but I think it's quite likely that modern warfare is going to occur more in software than in hardware, just like the Cold War occurred more in capabilities than actual fighting.
Ben: Yeah, and it's probably fair to say, I didn't talk to anyone at Lockheed, I'm not judging anyone who works at Lockheed, but I think the reputation in the industry is, if you're a fantastic software engineer, you're probably going to go to a more interesting modern company. That's why you see the Andurils of the world and the Palantirs of the world sucking up top talent that has this as a thing that they're really passionate about working on.
David: Yeah. There's also a huge difference now versus certainly World War II, but also the Cold War. The motivation of people who are going to work at Skunk Works, they were doing it out of patriotism for their country. The clear and present threat of the Cold War was an extremely motivating factor. That's not there in the same way today,
Ben: Very different time we live in.
David: Very, very different time.
Ben: Or at least, there's a perception that it's a very different time that we live in. I don't really know for sure if it is or not.
David: Which is so funny about this whole thing. The Cold War and now, perception is reality. Nobody really knew then, and nobody really knows now what the reality of the threat is, but the perception is what drives people's behavior, and that's what drives the economy.
Ben: It is in the government's interest for everyone to feel safe and secure. You can rise above Maslow's hierarchy and do other stuff with your life. Create, innovate, and live happy, prosperous, enjoyable lives, and go to work and do things that aren't for defense and drive the economy forward. It is also in the interest of the country to make everyone a little bit aware of how we have this incredible quality of life in the US.
I don't think we're indexed in that direction, even 1%. I think as you talk to people, there's a lot of reasonably oblivious but well-intentioned people who are not willing to give credence to America's incredible military of why we get to enjoy such charmed lives in this country.
A lot of people that want to go live in this amazing, globalized, wonderful world, where no one needs to think about the military at all, do you live on this planet? I love peace as much as anyone, and that should be the goal. Also, the default state of humans.
David: Technology changes, human nature doesn't.
Ben: Right. Unfortunately, there are some sets of people who want to come and take your stuff. In the same way that price is set in a market by the person who is willing to pay the most, the need for security in the world is set by the person who's most willing to come and take your stuff. That's how much defense you need to have in order to stop them from coming and taking your stuff.
Hopefully, you don't need to get into armed conflict over it. I do generally feel that there is a disconnect between people who enjoy the way of life that we have, but are unwilling to acknowledge why we have it. I think that is extremely different today than it was 60 years ago.
David: Yes, I totally agree with everything you're saying. I also think there's another layer to this, which is really a huge theme of this journey with the research and doing this episode for me with Lockheed. That is the phenomenon of competition and its impact on human behavior, probably for both the Soviet Union and the US, although I'm less equipped to talk about the Soviet Union.
The fact of that competition led to tremendous advances for society. All the things we just talked about. Silicon Valley itself, for God's sakes, wouldn't have existed without this. There's a rational argument for having an adversary. Technology and society was pushed forward in America by the Cold War, by Lockheed as part of that.
Ben: Yeah. We've already done a bunch of playbook stuff. Before we get into that formally codified analysis section, let's just talk about, real quick, the segments of Lockheed Martin today so people understand, what do they actually do today? Because we've talked about a lot of this stuff.
There's aeronautics, which in theory contains skunk works. That's F-35s, F-22s, the old F-16s, the C-130 J Hercules Airlifter. The F-35, I believe, is the largest program generating 20% of all net sales across all segments.
David: Like you said, it is enormous.
Ben: Right, it's 66% of 2022's revenue in that aeronautics division. Aeronautics equals F-35. There's also missiles and fire control, then there are three rotary and mission systems, which contain helicopters. They bought Sikorsky, so it contains Sikorsky, the other helicopter company.
Four is space, which includes the Orion capsule that's evolved over the decades and is now part of NASA's Artemis Moon Program. It also includes ULA, which is the joint venture that we didn't talk about with Boeing. That was forced upon both Boeing and Lockheed Martin, where they both independently were developing launch capabilities for the US government. This is especially pre-SpaceX or before SpaceX was as powerful as it is today.
The US needed to contract launch services from someone. Lockheed and Boeing were both developing them. That didn't go terribly well. They ended up asking for bailouts from the government, and the government said, can you two combine? Lockheed Martin and Boeing came back and said, are you kidding me with that guy? No, these companies hate each other. They agreed to do it because they had to, so ULA is this shotgun wedding between the two companies.
David: Which as we talked about on the SpaceX episode, really opened the door for SpaceX to come in and compete.
Ben: Totally. The reason they didn't go well was because in the pre-SpaceX era, there were all these companies that wanted to put stuff in space that all ended up going out of business. You think like Teledesic, Iridium, a lot of bankruptcies. Boeing had tooled up this huge factory. Lockheed had done this, too. They were left holding the bag.
It got really ugly. Boeing was caught trying to steal proprietary data from Lockheed Martin. Ultimately, this JV has gone well. ULA is going to 2X their capacity to 25 launches a year, which is way more than they used to do, but still way less than SpaceX over the next five years or so with this Vulcan rocket. Still more expensive than SpaceX, but they started from big incumbents rather than starting from a startup. It's just a different disposition.
Joint ventures are not permanent things, and these companies can't continue to be in business together, so ULA is up for sale. It'll be very interesting to see if one company or the other ends up buying it, but it is an important part of NASA's Artemis program and others moving forward. It's also important to Amazon. A whole bunch of the Kuiper launches are happening on ULA.
David: Interesting. Is that because Bezos doesn't want to launch on SpaceX?
Ben: Neither company won't really say anything about that. There's got to be something in there.
David: Billionaire competition.
Ben: Yes. Those are the four segments. Much like our Sony episode—I'm pulling forward a playbook thing here—this is a pretty well diversified conglomerate. Fighter jets are their bread and butter at 40% of overall revenue, but missiles and space are each 17%, and rotary mission systems are 26%. All of them are 9%–14% margins, so they all are double digit percentage of revenue and double digit percentage of profit. Congratulations, we've got a conglomerate.
All right, let's head into our analysis section. This will be to pull together a lot of the strings that we've mentioned on this episode, but codify what are the real takeaways. Let's understand this business, this institution, and what it is in our world today to tie together some of the things we've teased out over the course of history here.
Again, a few caveats. (1) We know we did not tell the entire Lockheed Martin story, nor could we. (2) This is not a political or defense podcast. You can tell that I'm a conflicted person on this.
Let's start our analysis section with power. What we do in this section is we analyze what it is about a business that enables it to achieve persistent differential returns. To put it in another way, to be way more profitable than their closest competitor and do so sustainably.
This is adapted from a framework that Hamilton Helmer created in his book, Seven Powers. The seven are counter positioning as a startup versus an incumbent, scale economies across a broad customer base, switching costs versus other near competitors, network economies, process power, branding, and cornered resource.
David: I was really smiling as you're defining that as persistent differential returns versus their competitors, because I'm not sure that Lockheed has differential returns versus their competitors.
Ben: I don't know that there's really a market here, and power comes only in markets.
David: Correct. For this, maybe it's more useful to talk about the prime contractor industry as a whole versus any specific player.
Ben: All the players have the same profit margins too.
David: I guess where I'm going with this is, I think there's a coordinate resource and process power that the prime contractor industry as a whole has. The cornered resource is they are the ones that get the prime contracts from the government. The process power, which I think probably is really legitimate—and we talked to some folks in preparation for this—they are incredible systems integrators at what they do. What did you say there? 4000 or 3000 subcontractors for the F-35?
Ben: Something like that. It's nuts.
David: To orchestrate that and coordinate that into an airplane that does the things that that airplane does in practice, that's hard.
Ben: I can't believe it's not all made by the same company. The fuselage is made by a different company than the wings. Are you freaking kidding me? And that thing works?
David: Didn't you say that different parts of the fuselage are made by different companies?
Ben: Yes. on different continents.
David: Yeah. There's definitely processed power in that. You can't just pick that up out of Lockheed, put it somewhere else, and expect it to function.
Ben: Right. There are 100 years of know-how and 50 years of very well-honed ways of engaging with the customer here, the customer again being the Pentagon.
David: Right, the customer. It's like big brother, the customer.
Ben: I think you're right that we should think about it as the primes versus everyone else. It's really hard to become a new prime. Maybe impossible.
David: Palantir has done it. I guess Anduril is doing it. But these I think are still pretty small scale compared to the big primes.
Ben: The $50 billion of spend that the one customer has with the one company.
David: Yeah, it's really hard to break in and be a prime.
Ben: It's funny. Lockheed versus Northrop, there's no counter positioning, really. There's no scale economies because there's one customer to amortize costs across, but you're actually not doing any fixed costs stuff. Your customer’s absorbing all the fixed costs stuff, too.
Switching costs, I guess, but every time there's a new program, they rebid it out. The government's typically excited to give it to not the incumbent because they want to rotate these programs around.
Fighter jets are typically not made by the same company two generations in a row, although Lockheed Martin has shown with the F-22 and the F-35 that they have won that. I think you're right on process power broadly, but is Lockheed Martin's process versus Northrop Grumman's process? No. Branding, I don't think, matters here really. In cost plus contracting, you're just actually not willing to pay more to one company than the other. Cornered resource, no.
David: Not versus each other.
Ben: Right. There really isn't power within the industry. But to the extent that you have already become one of these five, then together, the five have power versus new entrants.
David: Which is so funny. You really, I think, nailed it at the beginning when you said this isn't a market. It's not a market. I guess, duh, obviously, it's not a market because there's only one customer. You can't really have a market when there's only one player on one side of it.
Ben: Yeah, that's all I got for power.
David: Yup, me too.
Ben: As we drift into playbook, I think the lens I want to take on this since we did so much analysis over the course of the episode is, what are the big takeaways? If I'm really sitting here stewing on all this thinking about, what matters in this episode, one of the big ones is that Lockheed Martin has a dual purpose for existing.
There are all the normal stakeholders involved—customers, employees, and shareholders—that they want to produce value for. But there's this second thing where they exist for the good of America and its interests, which causes some interesting second order effects. One being, what is the optimal number of competitors in the space? The government tries to optimize this as a heavily interested party. But before 1993, there were way too many competitors.
After 1998, they determined, we don't want to have any fewer competitors. But it's odd that there is a force that is not the market that is dictating how this plays out because that force, in this case the US government, is in charge of all of our well-being in a way where they don't trust that the market will look out for that.
When I say that, I mean if you left the free market to play out, what would happen is: (a) you'd sell arms to our enemies, which the government doesn't want, (b) a bunch of companies would put each other out of business, and we might lose our industrial base. People would start outsourcing to other countries. We would potentially lose capability if the government stopped buying it for 10 years, but we wanted it 10 years later, when we got in a war.
David: This almost happened. The government didn't let Lockheed go out of business in the 1970s. This was right as the Kennen satellite project was getting going. We could not let Lockheed go out of business because we needed that.
Ben: Right. A market cures a lot of problems like price, serving the best product to customers. There are exceptions to all these things, but it doesn't solve for making sure that America stays globally competitive. The government has to put their hand on the scale in all these different ways in this market for that reason.
David: Yup. Globally competitive is an interesting way for it to be safe and globally dominant. Let's put it that way.
Ben: That's probably the right way to put it. There's a second thing here, which is we literally fund these companies to keep them alive so that they keep employees trained, should we need the employees trained, which is something that doesn't really exist in other markets.
David: Which also is a huge part of the military side of this complex.
Ben: Right. Of the 2 million people employed by the military in the United States, do we need all 2 million of them today? No, it's to keep people in reserve, literally.
David: That's not a market-driven organization, nor I think would anybody argue it should be.
Ben: Right. This gets into the arguments for and against the military industrial complex, generally. There's this, keep the industrial base strong. It's good that we have this big spend on industry because we need to have lots of people employed there and all this stuff.
There's the second one, which it's literally a jobs program, where you have congress people, as we mentioned earlier, voting affirmatively for things because it puts jobs in their state. This is the most pernicious argument of any of them for a pro big military industrial complex. In particular, in this book that you and I both read, Profits of War, the book basically just argues that this is all a massive misappropriation of funds, and a whole bunch of people acting in their own self interest and not for the country's self interest.
David: It is as far to the side of the scale of the military industrial complex is bad and evil is the Profits of War book.
Ben: Right. This is an excerpt from that book. “The irony is that almost any other form of spending from education, to health care, to mass transit, to weatherizing buildings, even a tax cut creates more jobs than military spending. That just falls on deaf ears over and over again with these programs,” F- 22 in particular, as that book points out. “It creates lots of jobs.” That argument continues to win the day. This 95,000 people are required to build the F-35, it's like, oh, good. Jobs for Americans. That is a terrible reason to fund something.
David: Right. I'm thinking about the recent period in tech companies in Silicon Valley that we are mercifully exiting out of now, where it was all about employee headcount, capturing engineers, and Facebook had God knows how many people working on Oculus and why. That was the equivalent of the F-35.
Ben: Yeah. I google cornering resources on really smart people, despite the fact that they weren't getting any economic output out of them. The biggest argument against dates all the way back to 1961 and Eisenhower's farewell address. He gave this legendary military industrial complex speech where he says, "In the council's of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist."
David: It's interesting, I have two things. One, I think that was maybe in part from observing what was happening in the Soviet Union, where the military and military spending overran the whole rest of the economy. Clearly, as we're talking about here, I think this is a nuanced issue, and certainly a lot of degree of non market-based dynamics are warranted here. But you can't let the military industrial complex get so big, it overruns the rest of the economy. That would not be good.
The other thing I was going to say is, I think the end of that quote or speech, or at least part of it is, Eisenhower's I think very naively puts forth the solution. What does he say? An engaged and vigilant citizenry, a populace. Especially in this day and age that things are so complex, that's not possible. Is the average person really going to dive into the details of how the F-35 program works? No.
Ben: Right. That's not a good outcome either if everyone is preoccupied and keeping an eye to make sure the big complex doesn't get too complexy.
Ben: There's another one I've been thinking about, which is a parallel to our SpaceX episode, where if you remember on the SpaceX episode, we talked about—gosh, that was a lifetime ago, three years—how NASA prioritized safety over everything else. They took that to such an extreme, where things could happen on a 20-year time span instead of a 5-year time span. SpaceX came in and said, what if we do it on a 2-year time span? We figure out how to be much more iterative in our development, and we're happy to explode some rockets, not with people on them.
You take this, again, much more Silicon Valley approach to rapid iteration, testing your own prototypes internally, being okay showing off your failures, and gathering data from them. Whereas NASA couldn't do enough calculations before it finally was willing to do something to let something go to a launchpad. That would cause extreme delays, massive budget overruns, and at the end of the day, it actually wasn't safer. That's the important thing here.
In 130 or whatever it was space shuttle missions, there were two that were tragic loss of life calamities. You look at that, you're like, that's actually not a great safety record, so maybe this isn't the right way to do it. Maybe calculating something to 15 significant digits of unlikely to fail is not actually the best outcome.
It seems like the same thing in the military industrial complex, where we're willing to sign a contract for airplanes that we get in 25 years because they're these big, huge productions. It's just the opposite of the skunk works way of operating, where test your own prototypes, do it rapidly, start moving up and up and up, crash some planes in the desert. But overall, we're going to get to the same outcome, much faster on a much lower budget and maybe with equivalent or better safety.
David: A hundred percent. I can't think of a better place to talk about what I think are really the takeaways. For me, at least, and I hope for many people listening of this episode, and it's really the heyday, glory days, whatever you want to call it, of Lockheed, both with Skunk Works and LMSC, of how these small skunk works–type organizations achieved unbelievable, unfathomable things, with a small number of people, in an unrealistically tight timeframe, with very constrained resources.
That mindset is certainly not the only way that you can achieve great things, but it's a really damn good way to do it. That mindset got injected into Silicon Valley by these people, by the military and by Lockheed. It's just so funny that the military industrial complex has now become the opposite of that. It has become like what you're talking about with NASA.
Again, there are many ways to succeed in different situations that call for different things. But if you really need to or want to achieve something great, bordering on impossible, in a tight bordering on unreasonable time frame, Kelly's 14 laws and LMSC's 7 tenets are pretty damn good ways to do it.
Ben: That's so true. Otherwise, you get to this thing that Norm Augustine said, “How unbelievably expensive these things get if you do it the non skunk works way? We just move into this larger and larger morass. That's the direction we're basically going in these 25-year programs.” He says, “In the year 2054, the entire defense budget will purchase just one aircraft. This aircraft will have to be shared between the Air Force and the Navy 3½ days per week, except for leap year when it will be made available to the Marines for the extra day.
David: He really is such a character.
Ben: Truly, but the craziest thing is much like Moore's law. He accurately predicted the rate at which aircraft prices would continue to grow starting way back in 1983. He actually wasn't far off on the F-35 on his prediction on how expensive it would be on the cost curve.
To exactly your point, if you continue at current course and speed, we basically we'll have only billion dollar airplanes going forward. They will be made by everybody. There will be no new entrants.
David: Innovation will happen very slowly.
Ben: Very slowly. When you look at Lockheed Martin as a business, they're going to do just fine for a long time, no doubt about it. They're an incredibly protected insulated business with an unbelievably wedded to them customer.
The creative destruction cycle will happen on other frontiers. There will be some existential need to create something that these companies are bad at creating and that the US government doesn't know how to buy from them. The United States will have to figure out another way on whether that's cybersecurity, whether that's information warfare, or whatever it is, whatever threatens the American way of life.
I have pretty high confidence that the American government will figure out some way to make sure that we prepare for that issue, whatever that issue is. It may or may not be from one of these companies. It's very likely that the skunk works mentality ends up solving more problems for our country, but probably not from the Skunk Works division of Lockheed Martin.
David: I guess what is heartening, at least as an American, is the capability to do this definitely still exists. It just happened with vaccines for the Coronavirus.
Ben: Totally. Operation Warp Speed is a great example of rip down all the barriers and figure out how to do something, even if there's some risk.
David: Yup. You know what, that's a good way to put a threat. Back to the LMSC tenet number one that we talked about so long ago in the story of focus on a threat-based need. I maybe want to evolve some of my comments earlier about competition into that.
Competition creates threats. It's not always competition that leads to a threat. Human beings and organizations tend to perform at their best in response to threats. Otherwise, how are you going to be motivated to go to unreasonable extremes if you're not facing a threat?
Ben: Yeah. I like that nuance.
David: In this playbook of like, I certainly don't want to say artificially manufactured threats. But if you're building a company, you have an implicit existential threat all the time as a startup before you reach cash flow profitability, which is you have to make payroll, and you have to either get profitable, raise another round of funding, or you're done.
Ben: I think you're right. I think we're quickly teasing out. There are two different things here. Lockheed Martin exists to ensure the Americaness continues. As we know it today, current course and speed, as protected as it needs to be with the types of protections we need, great, we know where to get that. I have no doubt that will continue happening.
Also, there will be other motivations for people to form tight knit teams and accomplish great things. Those are going to be for other threats and happen by other groups of people. I want to hear your thoughts on that. Maybe this is the place to leave it. Rather than grading this time, let's come up with the main takeaway, but I'm curious what you think.
David: I like that a lot. It's probably a good thing that the nature of that motivation and the introduction of those threats to spur human ingenuity and creativity has moved, for now, at least mostly out of the war arena. It's probably good that it's not the threat of nuclear war that is motivating people to achieve great things.
Ben: Most people, yeah.
David: Most people at least, right now, mercifully, thankfully. That mindset was directly transferred from Lockheed in the military into Silicon Valley. That's how Silicon Valley operates today. That's what makes it special. It doesn't have to be because of threats of war, and it's a good thing that it's not.
Ben: All right. I think that's the right place to leave it. Do you want to do carve outs?
David: Yeah, let's do it. My carve out is a fun one I was reminded of because my favorite video game history podcast series Resonant Arc is covering it as their game right now. I think I might have had this as a carve out a couple of years ago.
The game NieR:Automata is a super fun game. The series that Resonant Arc is in the middle of is their video game story book club going through it. It's a really fun game to play. It was ahead of its time.
The theme of the game is all about, can machines think and feel, and what does that look like? It's really thought-provoking at the time. It's particularly thought-provoking right now in our era of OpenAI, GPT, generative AI, and all that. It's really fun to revisit that along with the great Resonant Arc guys right now talking about the themes of that story.
Ben: Nice. You'll have a whole niche of people that are listening to your carve outs for video game recs.
Ben: I have two. One is something that didn't quite fit anywhere in this episode, but if you love airplanes, and you are excited about the SR-71, you should google the SR-71 Blackbird Speed Check story. It's an awesome story that I'm not going to spoil for you, but is about pilot jocks at their finest and a triumphant Blackbird. It's a joy to read, it takes two minutes. I think you'll like it. We'll also link to it in the show notes.
The second one I have is a very, very boring carve out, but it's something I found surprising. Ego Lawn Tools, EGO is the brand. They make effectively the Tesla of lawn mowers. Growing up, I had a big gas lawn mower. You'd pull the cord to start it, it was loud, it was smelly, it was dirty, and it's with gas. These are battery-powered lawn mowers that are insanely powerful. I have a leaf blower also that lasts 30 minutes off of just a battery.
David: Look at you, you're just becoming a dad.
Ben: I'm finding some very good catharsis. I just throw an audiobook. As I'm researching an Acquired episode and go do lawn work for six hours, I find that to be greatly gratifying to get away from a screen.
David: I've chosen to go the hire gardeners route on this.
Ben: You also have a two-year-old, so that takes more of your time.
David: The nature of a yard in San Francisco is a little different. I'm not sure I'm capable of maintaining my yard, given everything that's back there. It requires more technical expertise, more systems integration.
Ben: More systems integration. All right, listeners, thank you so much for joining us. Our thanks to Pilot, Tiny, and Vanta. You can click the link in the show notes to get the great deals from each of them and learn more about each of their fine, fine products and companies.
If you want to become an LP, we would love to have you. Help us pick more episodes like this one in the future, acquired.fm/lp. When I get back from Berkshire, I think we'll do an LP call here in the next month or so.
You should totally check out ACQ2 if you like hearing us interview other people. I can assure you, the next few interviews are going to be...
David: They're going to be great.
Ben: Even the ones that are live now, the one we just did with Jake, the one with Avlock from AngelList, the one with David from Retool, fantastic Kamakshi with her company, Samooha, all really fascinating discussions. Look up ACQ2 in any podcast player. Now that you're done with this episode, come discuss it with us, acquire.fm/slack. We'd love to have you
David: Particularly, too, I think there's a good chance with this episode that we'll have a lot of new to Acquired folks who are listening. We unexpectedly had that in huge numbers with our LVMH episode. All sorts of new people coming in and experiencing Acquired and listening to us for the first time. If you're doing that now here with this Lockheed episode, definitely go check out some of our other episodes on other industries.
I just want a second whip and say, join the slack and come talk about it with us. We love hearing from people. We're obviously not in the defense industry. We love hearing from people who are, telling us about your experiences, what it's like, what we got right, where we got wrong, and educate all the rest of us in the community too.
Ben: Yup, seriously. All right. With that, listeners, we'll see you next time.
David: We'll see you next time.
Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.
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