The sharp decline in spending by DOD since 1985 has resulted in a dramatic consolidation in the defense industry. The defense industry is more concentrated today than at any time in more than half a century. As the single customer for many products of the defense industry, DOD must have the ability to identify and address potential harmful effects of mergers and acquisitions. Questions have been raised about whether the consolidation has gone too far-adversely affecting competition in the industry. Many defense industry transactions are recent, and there is little evidence that the increased consolidation has adversely affected current DOD programs. Antitrust reviews have identified some problems, and remedies have been implemented. However, the consolidation could pose future problems unless DOD takes actions to improve its ability to identify problem areas and devise alternative ways to maintain competition in defense acquisition programs. There are several approaches DOD can take to maintain competition. For example, it can design acquisition strategies to compete missions rather than products and direct research and development funding to develop alternative suppliers or technologies. However DOD cannot know what action to take unless it has adequate visibility into the industrial base-especially at the lower tiers. Progress has been slow in gaining that visibility.

Defense Industry Consolidation: Competitive Effects of Mergers and Acquisitions

This article reviews recent changes within the defense industry and examines the effects such changes might have on the ability to conduct military operations. Specifically, it addresses the significant reduction in large defense firms capable of producing and delivering complex weapon systems and the concentration of market share in some key military product lines. Key issues are presented, to include the expected loss of competition from mergers and consolidation (horizontal integration). Other issues include increased vertical integration among prime contractors and the potential impact of consolidation on technology development. The article concludes with a brief review of key DoD initiatives intended to mitigate these concerns and a review of other options that offer some possible benefits.

In 1993, there were 21 companies doing major defense aerospace work -- today there are five: Boeing, Raytheon, Litton Industries, Lockheed Martin, and Northrop Grumman. The battle for the shrinking defense budget has resulted in not only mergers, but also an increased emphasis on the formation of partnerships among defense contractors. As the defense industry has consolidated, the remaining firms have been forced to cut back on internal research and development (R & D) expenditures and other efforts to innovate due to cost pressures. Should we expect a further reduction in internal R & D efforts by contractors? How does the number of competitors vying for a particular contract affect the overall level of R & D? Does it matter whether we have consolidation via acquisition, mergers, or bankruptcy? The theory described in the model provides clear predictions for partnership behavior as the publicness of the prize they pursue changes. The analysis suggests that when relationships among partners change, the fate of the partnership will tend to change along ways conjectured by Olson and Zeckhauser (1966). That is, the partnership will expend more resources if the spending by one member provides less benefit to the other member. Although the behavior on the part of partnership members didn't follow the predictions exactly as predicted, there is still strong evidence of a reduction in partnership spending as the publicness of the prize increases. Specifically, we observed a reduction of approximately 30 percent in partnership spending as the publicness increased. Additionally, there is an overall decrease of approximately 25 percent in total research expenditures by all firms competing. The experimental results provide fairly strong support for the Olson and Zeckhauser conjecture. The implication of the study is clear -- as defense contractors rely more and more on partnerships, alliances and/or teams, fewer resources can be expected to be devoted to research.

Defense Industry: Consolidation and Options for Preserving Competition