Analysis of Competition in the Defense Industrial Base: An F-22 Case Study

By King, David R.; Driessnack, John D. | Contemporary Economic Policy, January 2007 | Go to article overview

Analysis of Competition in the Defense Industrial Base: An F-22 Case Study


King, David R., Driessnack, John D., Contemporary Economic Policy


I. INTRODUCTION

In the last decade, significant change has swept the defense industrial base. U.S. defense budgets related to the procurement of weapon systems fell by more than 65% in real terms following the end of the Cold War (Perry, 1993). Defense firms responded to decreased defense spending by either exiting the industry or concentrating their operations within the defense industry (Augustine, 1997; Deutch, 2001). The defense industry consolidation has resulted in primarily three firms, Boeing, Lockheed Martin (LM), and Northrop Grumman, serving as prime contractors to the U.S. government for major weapon systems. The move toward an oligopoly of defense firms has led to concerns about the level of competition (e.g., Birkler et al., 2003; Kovacic, 1999) and is recognized as an area requiring further research (Lorell, 2003).

Government policy is an integral part of the structure of the defense industrial base as the government plays both the role of regulator and the only customer (Sapolsky and Gholz, 1999). A policy implication related to the consolidation of defense firms is that it has diminished the viability of some traditional methods of government oversight. Specifically, the impact of barring prime contractors from government work may be untenable. Quite simply, the impact of excluding prime contractors from defense contracts for misconduct, even temporarily, could be counterproductive when it eliminates the only available firm to meet a given requirement. For example, a suspension of Boeing's space division for military contracts was waived multiple times, since it was the only firm that could provide space launch services in the required time frames (Merle, 2003). Still, as a result of identified transgressions, Boeing will lose approximately $1 billion in business and gain a stronger competitor in the space business as LM rebuilds its space launch capabilities (Wong, 2003).

An important policy question is whether defense industry consolidation has maintained levels of competition needed to encourage both cost reduction and innovation (Birkler et al., 2003; Cole and Squeo, 1999). Some research has questioned whether competition within the defense industry actually contributes to either innovation or cost reduction (Birkler et al., 2001; Kovacic and Smallwood, 1994). For example, innovation in combat aircraft historically occurs at times of increased demand, emergence of new component technologies (e.g., engines, guided weapons, radar, and stealth), and significant changes in government requirements (Lorell, 2003). The goal of the current article is to examine competition in the U.S. defense industrial base and make associated recommendations to address policy concerns.

We define "defense firms" as companies that have established capabilities and competencies in dealing with the Department of Defense. The defense industry is a niche market in that it involves small numbers where both buyers and suppliers have significant bargaining power. Defense firms have developed a scarce competence in dealing with a monopsony customer with regulatory oversight (Driessnack and King, 2004). The scarcity of this competence can be readily observed as foreign firms and firms not accustomed to defense procurement teaming with defense firms when competing for a new U.S. Navy shipbuilding contract (Squeo, 2003).

Although an important sector of a nation's economy, it is difficult to perform empirical analysis of the defense industry (Anton and Yao, 1990). The difficulty in performing research on the defense industry has resulted in existing defense industry research exhibiting multiple shortcomings. One shortcoming of existing research is that studies often do not go beyond prime contractors, or the largest firms within the defense industry (e.g., Birkler et al., 2003), when the role of small firms in industries, in general, (King et al., 2003) and the defense industry, in particular (Squeo, 2002), has been recognized as important. …

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