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Fewer contractors, bigger pie

At a time when defense theorists say the military needs to reconfigure for the challenge of terrorism, the defense giants have a huge interest in resisting anything that shuts down a production line.
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A few years back, a senior Navy official wanted to add a line to his upcoming speech at the Newport News shipyard in Virginia explaining how free enterprise would spur competition and hold defense costs down. The speechwriter, a seasoned senior military officer, was aghast. “I said, ‘You can’t say that,” the speechwriter recalls. “I know it sounds nice and Republican, but it just ain’t true. There’s one place in the world building aircraft carriers — Newport News. And there’s only one customer — the U.S. Navy. Say the words ‘free enterprise,’ and they’ll think you’re out of your mind.’ ”

“The idea that there is a free market out there — or even a competitive market — is not in line with reality,” says Andrew Ross, a Naval War College professor and co-author of a Navy study of the future of the defense industry. “You just don’t see commercial firms coming in and taking market share away from an established defense player like Northrop-Grumman or General Dynamics. There are too many barriers to entering the market, and so what you end up with is a government industrial policy aimed at keeping certain capabilities around, like building aircraft carriers or nuclear submarines.”

In the years since President Eisenhower first ruminated about the dangers of a self-interested “defense industrial complex,” the landscape has shifted radically for America’s military contractors — the “industrial” side of Ike’s construct. The constellation of agile, innovative companies that once vied for the right to build aircraft carriers, fighters, tanks or missiles — Douglas Aircraft, Convair, Bath Iron Works — is now a cluster of giants, each of them winning an ever larger share of the federal defense budget with less competition.

Indeed, Newport News itself, sole American builder of nuclear aircraft carriers, was absorbed into Northrop-Grumman late last year.

Old is better?
In practical terms, the mergers made sense during the 1990s, when defense spending dipped. Yet at a time when the Pentagon’s own leadership is pushing the military to reconfigure for the challenge of terrorism and “asymmetrical warfare,” the defense giants have an enormous interest in resisting anything that shuts down a production line, regardless of that weapon system’s applicability to the world of the 21st century.

“Contractors make more money off production rather than research and development,” says Ivan Eland of the Washington-based Cato Institute, a policy group that favors free markets. “A mature production line is where they make money as the unit costs begin to drop. The longer a weapon is produced, the more they make, no matter what its utility.”

Official U.S. defense policy calls for “transforming” the military — a process known in the business world as “disruptive innovation.” But military analysts say defense contractors, seeking to extend profitable lines without retooling, prefer incremental improvements in their existing products — “sustaining innovations” in business school parlance.

“Left to their own devices, suppliers will want to sell what they’re selling now,” says Ross. “The constituency for disruptive innovation is almost entirely in the secretary of defense’s office and maybe a small number of military commanders. But it certainly is not out in industry.”

A contractors' market
The relatively few changes in what defense dollars are buying since Sept. 11 has raised questions about Secretary of Defense Donald Rumsfeld’s own very public advocacy for “transforming the military.” Some Pentagon insiders, both skeptics of transformation and its advocates, say Rumsfeld has lost this battle.

A case in point: The Air Force, in Bush’s budget at least, gets all three tactical fighters it wants; the Army’s fleet of heavy tanks is being maintained at enormous cost; the Navy’s plan for a new generation of attack submarines — the Virginia class — also is plowing ahead. All this, despite the disappearance of the threats — mainly Soviet — that each system was designed to counter. In many cases, experts concede, these decisions are made more as a means of sustaining the ability to build weapons like nuclear attack submarines than to fill an actual need.

Many officials and contractors say it is unfair to expect the military and its suppliers to do an about-face on decades of doctrine less than two years after Sept. 11.

“The idea that you can take an institution like the military, which has a $390 billion budget, and do ‘high G’ maneuvers on procurement policy simply isn’t reasonable,” says Bill Martel, an Air Force Space Advisory Board member who also works on new weapons with the Defense Advanced Research Projects Agency. “It takes time to develop ‘transformed’ systems. They take years to show up in the budget, and in the meantime it makes sense to maintain the industrial capacity to build traditional platforms as well.”

Breaking 400 billion
The Bush budget now heading for congressional debate would lay out $399 billion for defense, an increase of about $17 billion over the $382 billion to be spent in 2003. About two-thirds of the budget is upkeep: the cost of operations, salaries, training and facilities. But critics say too much investment still is going to maintain a force built to fight the Warsaw Pact.

In the 2003 budget, which saw an increase of $45 billion, “only about $20 billion of the $45 billion [increase] went to things that could even loosely be deemed “anti-terrorism,” says Eland. “Major weapons systems are grossly overfunded, and special forces grossly underfunded. They’re building new submarines, maintaining thousands of nearly immobile tanks, and worst of all, adding three new types of fighters and no new bomber. That’s astounding.”

‘Pet projects’
An example of Eland’s point can be found in funding for the most widely used items in the Afghanistan war: Raytheon’s Tomahawks, Boeing’s JDAMs smart bomb kit and Northrop Grumman’s Unmanned Aerial Vehicles, or UAVs. Eland notes that only about $3.2 billion in the president’s budget request last year went for more of these systems — all of them “disruptive innovations” that threaten more profitable systems.

“Much of the new Pentagon funding will be used to bankroll longstanding pet projects of the military-industrial lobby,” Eland wrote in widely read study of defense budget increases of recent years. “In fact, more than one-third of the Pentagon’s fiscal year 2003 $68 billion procurement budget will be allocated to big-ticket, Cold War-era systems that have little or nothing to do with the war on terrorism.”

For decades, contractors’ lobbyists and powerful state congressional delegations with significant defense industries back home — Georgia, Connecticut and Missouri among them — have kept these lines rolling by adding items to presidential budget requests. During the 1990s, Georgia’s delegation, which then included Senate Armed Services powerbroker Sen. Sam Nunn, a Democrat, and House Speaker Newt Gingrich, regularly worked to add two or three extra C-130 Hercules cargo aircraft for the big Lockheed-Martin plant back home in Marietta.

A similar tactic took place in Connecticut, where the Navy found itself with more SB-60 Seahawks, an anti-submarine helicopter, than it requested. The SH-60 is built by Sikorsky, based in Stratford, Conn., a frequent stop for the state’s powerful congressional delegation, led by Democratic Sens. Christopher Dodd and Joseph Leiberman.

The Navy’s study of future defense industrial needs noted this practice, saying that “defense firms can use congressional pressure to maintain low rates of production and/or to sell goods not necessarily requested by DoD, earning reliable profits like a politically savvy, regulated public utility.”

More money, fewer players
There are no apologies from the few giant firms that came out on top in the 1990s merger mania in the defense industry. They garner more of a growing pie than ever before and wield more clout in the annual tussle over spending priorities. But they contend that their lobbying plays no part in decisions to add extra aircraft to a budget or direct money toward existing systems rather than new weapons research.

“Members are elected by the citizens of this country to make decisions that are in the best interest of our nation, especially when it comes to the defense of our country,” a Lockheed-Martin spokesman said when questioned about the C-130 additions.

Lockheed-Martin, now the world’s largest defense firm, won a record $17 billion in Pentagon business last year and will likely exceed that in the upcoming budget.

The company’s power is the result of a 1990s acquisition strategy that saw Lockheed go from a struggling aerospace company to a defense behemoth. Beginning in the late 1980s, it bought its way into fighters and guidance systems (Martin-Marietta); systems integration (Owego); satellites (Comsat and others); and other sectors.

Indeed, had it not been for the pesky Clinton-era anti-trust regulators, Lockheed-Martin’s proposed buyout of rival Northrop-Grumman in 1997 might have gone through, concentrating even more business in one shop.

Northrop-Grumman’s tale is similar. It won some $8.7 billion from the public purse last year and will win more business in fiscal 2004. Since 1990, when Northrop was a third-ranking producer of fighter aircraft, it too has become a dominant contractor. After swallowing rival fighter manufacturer Grumman, it expanded into nuclear submarines and aircraft carriers (Newport News), space systems (TRW) and surface warships (shipbuilders Litton and Avondale).

And like all the major contractors, it has positioned itself for the vast spending expected on a national missile defense system by beefing up its satellite and laser weapons research.

“What were 33 separate businesses in 1990 are five defense firms today,” says Jeffrey Bialos, the head of industrial affairs in the Clinton administration’s Pentagon.

Defense contractors see nothing wrong with this, and they point out that government policy encouraged the mergers during the 1990s, when defense spending dipped.

“Whether there are two companies or 10 ..... competition is used to get the best product at the best price,” says the Lockheed-Martin spokesman, speaking on condition of anonymity. “Lockheed-Martin and Boeing were engaged in a heated competition to design and develop the Joint Strike Fighter (the last major fighter aircraft program awarded by the Defense Department). At the end of the competition, the government customer selected Lockheed Martin to design and develop the JSF based on its technical superiority and affordability. The competition achieved what it was set out to do.”

Amazingly, many of these firms still fail to turn a profit, a fact due more to the poor performance of their non-defense businesses, Wall Street analysts say. With defense spending projected to rise by $20 billion every year for the rest of the decade, the future is hardly gloomy.

Even if the sky isn’t all blue, though, the big defense contractors are pretty sure their interests will be looked after.

“Basically, the government makes sure the big defense contractors remain healthy because we need to be able to build certain kinds of things that might not be profitable if there was real competition,” says Ken Allard, a retired Army colonel who is now an NBC News defense expert. “This is hardly a classical demonstration for the ideas of Adam Smith or the application of free-market economics.”