Pentagon Views On Industry Consolidation Raise Two Questions

On February 9, Pentagon acquisition chief Ashton Carter delivered some friendly remarks to an audience of investors about how the Pentagon would view proposed mergers in the defense sector. Carter acknowledged that the defense marketplace is changing, and many participants will want to adjust by making strategic moves such as acquisitions and divestitures. In general, he said, the department is comfortable with allowing market forces to drive this activity. The one type of situation where the Pentagon will assert its interests, though, is when large-scale system integrators such as Raytheon and General Dynamics contemplate combining. Carter said, “the department is not likely to support further consolidation of our weapons systems prime contractors.” He also stressed that globalization of the defense market “is not an option — it is a reality,” so U.S. weapons makers can look forward to more competition in their home market from foreign companies.

Most of what Secretary Carter said was eminently reasonable, but the remarks were brief and much was left unsaid. In the case of strategic transactions between first-tier contractors, for instance, there needs to be some latitude for combinations that strengthen competition over the long run even if they reduce the number of players. For example, four very capable electronics houses are currently competing for the Next Generation Jammer program. They can’t all win the jammer competition, nor can they all win in tactical communications or airborne radars. The department needs to consider the possibility that there are simply too many defense electronics operations for all of them to remain healthy in a down market, and blocking combinations just because those operations are embedded in first-tier system integrators probably wouldn’t be in the department’s long-term interests.

To take another example, I have written in the past that Boeing might want to acquire the military aircraft business of Northrop Grumman as a way of getting in on the F-35 joint strike fighter, the only fighter the Pentagon is likely to be buying for most of the next three decades. No doubt about it, that would lead to greater concentration in the military aircraft sector. But is the government customer’s interest really better served by keeping Northrop as an independent subcontractor on F-35 while Boeing is gradually squeezed out of the fighter business entirely as production of non-stealthy airframes ceases? Wouldn’t it make more sense to approve a strategic transaction that permits Lockheed Martin’s only real peer in the tactical aircraft business to remain viable for the next generation of competitions?

On the subject of globalization, Pentagon policymakers seem to have fallen for the kind of fashionable thinking that is leading to the de-industrialization of America. Perhaps Secretary Carter was trying to prepare his audience for an Airbus victory in the Air Force tanker competition, but saying we need to open our military markets to outsiders when we know companies like EADS and Huawei do not compete fairly just weakens our security. In the case of Airbus parent EADS, the World Trade Organization has provided thousands of pages of documentation demonstrating the only reason there is a European alternative to the Boeing tanker is because the European company systematically violated trade treaties. Its ability to under-price the smaller Boeing offering is directly traceable to $20 billion in illegal subsidies — the same subsidies Airbus has used to reduce America’s share of the commercial transport market from over 80 percent two decades ago to less than 50 percent today. If this is the way globalization is going to work — with government officials helping foreigners to dismantle the U.S. industrial base — then it’s not so clear why Secretary Carter would want to embrace such a concept.