Defense Industry Consolidation: Competitive Effects of Mergers and Acquisitions (Testimony, 03/04/98, GAO/T-NSIAD-98-112)
GAO discussed the issues surrounding consolidation in the defense
industry, focusing on: (1) approaches to preserving competition in a
more concentrated industry; and (2) the status of Department of Defense
(DOD) initiatives to improve its monitoring of competition.
GAO noted that: (1) the sharp decline in spending by DOD since 1985 has
resulted in a dramatic consolidation in the defense industry; (2) the
defense industry is more concentrated today than at any time in more
than half a century; (3) 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; (4) questions
have been raised about whether the consolidation has gone too
far--adversely affecting competition in the industry; (5) many defense
industry transactions are recent, and there is little evidence that the
increased consolidation has adversely affected current DOD programs; (6)
antitrust reviews have identified some problems, and remedies have been
implemented; (7) 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; (8) there are several approaches DOD can take to
maintain competition; (9) for example, it can design acquisition
strategies to compete missions rather than products and direct research
and development funding to develop alternative supplier or technologies;
(10) however, DOD cannot know what action to take unless it has adequate
visibility in to the industrial base--especially at the lower tiers; and
(11) progress has been slow in gaining that visability.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-NSIAD-98-112
TITLE: Defense Industry Consolidation: Competitive Effects of
Mergers and Acquisitions
DATE: 03/04/98
SUBJECT: Department of Defense contractors
Defense procurement
Competitive procurement
Procurement practices
Defense industry
Federal agency reorganization
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Cover
================================================================ COVER
Before the Subcommittee on Acquisition and Technology, Committee on
Armed Services, U.S. Senate
For Release on Delivery
Expected at
2:00 p.m., EST
Wednesday,
March 4, 1998
DEFENSE INDUSTRY CONSOLIDATION -
COMPETITIVE EFFECTS OF MERGERS AND
ACQUISITIONS
Statement of David E. Cooper, Associate Director, Defense
Acquisitions Issues, National Security and International Affairs
Division
GAO/T-NSIAD-98-112
GAO/NSIAD-98-112T
(707288)
Abbreviations
=============================================================== ABBREV
DOD -
============================================================ Chapter 0
Mr. Chairman and Members of the Subcommittee:
We are pleased to be here this afternoon to discuss issues
surrounding consolidation in the defense industry. As mandated by
the 1998 Defense Authorization Act we have been reviewing mergers and
acquisitions in the defense industry.\1 Fifty mergers and
acquisitions have occurred in just the last few years. These
transactions have raised questions about which defense market areas
have been affected and how to preserve competition in these areas.
Today, we will provide a brief overview of
-- consolidation in the defense industry,
-- approaches to preserving competition in a more concentrated
industry, and
-- the status of Department of Defense (DOD) initiatives to improve
its monitoring of competition.
After this overview, we will provide details about each of these
issues.
--------------------
\1 National Defense Authorization Act for Fiscal Year 1998, (P.L.
105-85), November 18, 1997.
OVERVIEW
---------------------------------------------------------- Chapter 0:1
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.
CONSOLIDATION IN THE DEFENSE
INDUSTRY
---------------------------------------------------------- Chapter 0:2
Since 1990, there has been a dramatic reduction in the number of
prime contractors in some defense markets. The number of contractors
declined in 10 of the 12 markets DOD identified as important to
national security. The largest reductions have been in the tactical
missile, fixed-wing aircraft, and expendable launch vehicle markets.
For example, the number of contractors producing tactical missiles
has dropped from 13 to 3. Only two contractors now compete in such
key defense markets as fixed-wing aircraft, expendable launch
vehicles, tracked combat vehicles, strategic missiles, and torpedoes.
Appendix I shows changes in the number of contractors in defense
markets identified by DOD as important.
These changes were not unexpected. DOD has encouraged the defense
industry to consolidate facilities and eliminate excess capacity to
remain competitive and financially viable. DOD expects that
significant cost savings will result from the consolidation.
Three huge firms--Boeing, Lockheed Martin, and Raytheon--have emerged
from recent mergers and acquisitions. Together, the three firms
receive a substantial portion of what DOD spends annually to acquire
its weapons and other products.
APPROACHES TO PRESERVING
COMPETITION DURING DEFENSE
INDUSTRY CONSOLIDATION
---------------------------------------------------------- Chapter 0:3
DOD can take several approaches to ensure competition in today's more
concentrated defense industry. Thus far, the government's antitrust
review process has been used to identify and remedy potentially
adverse effects of proposed mergers or acquisitions. Responsibility
for conducting antitrust reviews and approving mergers and
acquisitions lies with the Department of Justice and the Federal
Trade Commission. In recent years, DOD has become more involved in
antitrust reviews by sharing information and working more closely
with the antitrust enforcement agencies.
Through collective efforts, the Department of Justice, Federal Trade
Commission, and DOD have identified a number of situations where
proposed mergers or acquisitions could adversely affect DOD programs.
In such cases, they used consent decrees\2 to address potential
problems. Consent decrees were proposed and accepted in 10 of the
mergers and acquisitions.
The predominant concern addressed by the consent decrees was the
potential compromise of a company's financial, business, or technical
information. The usual remedy in these situations has been to
require "firewalls"\3 to prevent the disclosure of such information.
Consent decrees also have addressed concerns about teaming
arrangements and other exclusionary behavior. In these cases, the
merging or acquiring companies were required to divest certain
assets.
In the long term, DOD's ability to address the potential adverse
effects of consolidation will depend upon its ability to identify
problem areas and devise alternative ways to maintain competitive
pressures in its acquisition programs. DOD can do so in several
ways. For example, DOD can direct its science and technology
investments to encourage new companies to enter the defense market.
DOD can also fund alternative technologies to meet the warfighters'
needs and devise strategies to compete various approaches and
missions, for example, missiles versus aircraft. And it can (1)
require major defense contractors to use open-system architectures\4
in designing weapons programs, (2) make subtier competition a
specific source-selection criterion and contract requirement, and (3)
explore opportunities to meet military needs through greater
cooperative efforts with international partners.
--------------------
\2 Consent decrees are agreements by the parties to a proposed
transaction to take specific steps to alleviate antitrust concerns.
\3 The term "firewalls" refers to arrangements created by a company
to limit or prevent the exchange of competition sensitive information
among parts of the company.
\4 Open system architecture refers to a design approach where the
contractor defines system interfaces to a set of standards that a
number of suppliers agree to meet. This makes supplier products more
interchangeable in the design, and allows a wider range of suppliers
to participate in producing defense systems.
INITIATIVES TO MONITOR
COMPETITION
---------------------------------------------------------- Chapter 0:4
In May 1996, DOD tasked the Defense Science Board to determine
whether problems were being created as a result of vertical
integration, that is, mergers or acquisitions that add supplier
product lines to a firm that also makes products at a higher tier.
The Board reported that it could not measure the extent of vertical
integration because industry analysts and antitrust agencies neither
measured it nor had a mechanism for measuring it. The Board
concluded, however, that DOD was not in a position to recognize
emerging problems because it lacked visibility at the lower levels of
the industry. Consequently, the Board made a number of
recommendations designed to improve DOD's visibility into the
industrial base.
DOD agreed with the recommendations and initiated plans to (1)
increase acquisition program managers' scrutiny of prime contractor
teaming and supplier choices; (2) devise acquisition strategies to
promote alternative concepts and new supplier entry; (3) increase the
emphasis on industry knowledge and experience when filling DOD
acquisition positions and (4) monitor a select group of technology
areas to determine the impact of vertical integration. However, DOD
has not yet fully implemented the recommendations because of the need
to review several recent and complex mergers and acquisitions.
We believe it is important that DOD continue to implement the Board's
recommendations because without a more active, ongoing monitoring of
the defense industrial base, DOD may not be able to recognize
emerging competition issues.
-------------------------------------------------------- Chapter 0:4.1
Mr. Chairman, this concludes our statement. We will be glad to
answer any questions you or other members of the Subcommittee may
have.
DEFENSE MARKET SECTORS
=========================================================== Appendix I
As part of its effort to ensure that certain capabilities to produce
defense unique products continues to exist, DOD has identified
industrial market sectors comprised of types of products or weapon
systems important to U.S. national security interests. These range
from tactical missiles to tracked combat vehicles. The following
table lists the defense sectors that have experienced reductions in
the number of companies competing or under contract between 1990 and
1998. Submarines and ammunition are not included since these sectors
did not experience any changes.
Table I.1
Prime Contractors in Defense Market
Sectors (1990-98)
Reduction in 1990 1998
Sector contractors contractors contractors
------------------------- ------------- ------------- -------------
Tactical missiles 13 to 3 Boeing Boeing
Ford Lockheed
Aerospace Martin
General Raytheon
Dynamics
Hughes
Lockheed
Loral
LTV
Martin
Marietta
McDonnell
Douglas
Northrop
Raytheon
Rockwell
Texas
Instruments
Fixed-wing aircraft 8 to 2 Boeing Boeing
General Lockheed
Dynamics Martin
Grumman
Lockheed
LTV-Aircraft
McDonnell
Douglas
Northrop
Rockwell
Expendable launch 6 to 2 Boeing Boeing
vehicles General Lockheed
Dynamics Martin
Lockheed
Martin
Marietta
McDonnell
Douglas
Rockwell
Satellites 8 to 5 Boeing Boeing
General Lockheed
Electric Martin
Hughes Hughes
Lockheed Loral Space
Loral Systems
Martin TRW
Marietta
TRW
Rockwell
Surface ships 8 to 5 Avondale Avondale
Bath Iron Bath Iron
Works Works
Bethlehem Ingalls
Steel NASSCO
Ingalls Newport News
NASSCO
Newport News
Tacoma
Tampa
Tactical wheeled vehicles 6 to 4 Am General Am General
BMY GM Canada
GM Canada Oskosh
Oskosh Stewart &
Stewart & Stevenson
Stevenson
Teledyne
Cont. Motors
Tracked combat vehicles 3 to 2 FMC General
General Dynamics
Dynamics UDLP
Harsco (BMY)
Strategic missiles 3 to 2 Boeing Boeing
Lockheed Lockheed
Martin Martin
Marietta
Torpedoes 3 to 2 Alliant Tech Lockheed
Systems Martin
Hughes Raytheon
Westinghouse
Rotary wing aircraft 4 to 3 Boeing Boeing
Bell Bell
Helicopters Helicopters
Sikorsky Sikorsky
McDonnell
Douglas
----------------------------------------------------------------------
Note: The table reflects the ongoing Lockheed Martin/Northrop
Grumman merger as completed. The electronics sector is not included.
Source: GAO analysis of DOD data.
*** End of document. ***
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