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Defense mergers have gone too far

After encouraging more than $100-billion in defense mergers between 1992 and 1997, the Defense Department has finally said enough is enough by suing to block the $35-billion merger of Lockheed Martin and Northrop Grumman. But one wonders why the federal government allowed the number of major defense companies to shrink to four from 50 before taking action.

The ostensible reason for encouraging the consolidation is the decline in military spending, especially on new weapons, since the end of the Cold War. While it is true that spending on new weapons has dropped since the highs of the Ronald Reagan buildup, the fact is that the Pentagon is spending the same amount on new weapons as it did in the late 1970s and early 1980s.

Moreover, spending on new weapons is projected to rise by 50 percent over the next three years. (This excludes the $62-billion in weaponry the United States sold around the world in the past five years.)

Consolidation has allowed the defense industry to have the best of all possible worlds. The Pentagon has permitted the industry to offset merger costs by having the government absorb most of the expense _ through customary cost-plus defense contracts _ on the theory that the new, bigger company will give the government a better price in the future. But whatever efficiency gains might accrue to the government will be more than offset by the declining level of competition among these quasi-monopoly suppliers. Profits for defense companies in 1996 were actually higher than they were in 1990, and their stock prices have risen faster than the market.

Washington is correct in stalling on the Lockheed-Martin-Northrop-Grumman combination because of what it will do to real competition in the aircraft and electronics areas. However, it should have used the same criteria to halt the Boeing-McDonnell Douglas and Hughes-Raytheon unions. By approving the Boeing merger, the government allowed one of the three major builders of tactical aircraft to fall by the wayside. By permitting Raytheon to buy Hughes, it all but eliminated real competition in the air-to-air missile business.

This point can be illustrated by looking at two recent weapon systems competitions. When the Pentagon asked for bids on the $300-billion Joint Strike Fighter program, the only innovative design came from Boeing, which had not been a prime contractor on a fighter for 40 years. Now that Boeing has been allowed to merge with McDonnell, it is guaranteed some part of the JSF business. In addition, it is now the prime contractor for the F/A-18. There will not be an outside innovator on the next fighter competition.

Similarly when Hughes, which beat Raytheon to build the $12-billion advanced medium-range air-to-air missile, began to experience severe cost and quality problems, the Pentagon turned to Raytheon to hold Hughes' feet to the fire. This resulted in a 20 percent drop in the missile's unit cost and an improvement in the technology. The next time there is a similar problem, there will be no Raytheon to turn to.

Lockheed Martin, which has already bought up 20 competitors and is the nation's largest defense contractor, has the audacity to claim its merger with Northrop Grumman will increase competition. How can the removal from the arena of $9-billion Northrop Grumman increase Pentagon choices? What Lockheed means is that with Northrop Grumman, it will be more competitive with Boeing and Raytheon and get more business.

For example, Lockheed Martin builds F-16 and F-22 fighters. Guess who builds the radar for those planes? Guess who would get most of the electronics business on the JSF if Lockheed wins the race against Boeing? It will not be Raytheon, even if its cost is below Northrop Grumman's. There are at least three inconsistencies in Lockheed's position. First, Lockheed lobbied stridently against Raytheon's purchases of Hughes and Texas Instruments on the ground that it put too many competitors on one team. Second, the Pentagon justified the Boeing-McDonnell merger on the ground that only a mega-company could compete with Lockheed Martin. Third, Lockheed is already competitive with Boeing and Raytheon. For example, in early April, Lockheed bested Boeing and Raytheon to get the contract on the Joint Air-to-Surface Standoff Missile, even though the company had never built a cruise missile before!

The Republican Bush administration discouraged the Grumman-LTV and Aliant-Olin mergers on antitrust grounds. Moreover, the supposed "Party of Big Business" refused to subsidize any consolidations. The defense team in the first Clinton administration allowed the industry to run wild. The new team, headed by a Republican secretary of defense, has applied the brakes. It's too bad William Cohen did not come to his job sooner.

+ Lawrence J. Korb is a senior fellow at the Brookings Institution in Washington. +

Special to Newsday

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