United States General Accounting Office

GAO Testimony

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

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.

Overview 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

1

National Defense Authorization Act for Fiscal Year 1998, (P.L. 105-85), November 18, 1997.

Page 1 GAO/T-NSIAD-98-112
industrial base—especially at the lower tiers. Progress has been slow in

gaining that visibility.

Consolidation in the

Defense Industry

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

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 decrees2

 to address potential problems.

2

Consent decrees are agreements by the parties to a proposed transaction to take specific steps to

alleviate antitrust concerns.

Page 2 GAO/T-NSIAD-98-112
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 architectures4

 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.

Initiatives to Monitor

Competition

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.

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.

Page 3 GAO/T-NSIAD-98-112
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.

Mr. Chairman, this concludes our statement. We will be glad to answer any

questions you or other members of the Subcommittee may have.

Page 4 GAO/T-NSIAD-98-112
Page 5 GAO/T-NSIAD-98-112
Appendix I 

Defense Market Sectors

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)

Sector

Reduction in

contractors 1990 contractors 1998 contractors

Tactical missiles 13 to 3 Boeing

Ford Aerospace

General Dynamics

Hughes

Lockheed

Loral

LTV

Martin Marietta

McDonnell Douglas

Northrop

Raytheon

Rockwell

Texas Instruments

Boeing

Lockheed Martin

Raytheon

Fixed-wing aircraft 8 to 2 Boeing

General Dynamics

Grumman

Lockheed

LTV-Aircraft 

McDonnell Douglas

Northrop

Rockwell

Boeing

Lockheed Martin

Expendable launch

vehicles

6 to 2 Boeing

General Dynamics

Lockheed

Martin Marietta

McDonnell Douglas

Rockwell

Boeing

Lockheed Martin

Satellites 8 to 5 Boeing 

General Electric

Hughes

Lockheed

Loral

Martin Marietta

TRW

Rockwell

Boeing

Lockheed Martin

Hughes

Loral Space Systems

TRW

(continued)

Page 6 GAO/T-NSIAD-98-112
Appendix I 

Defense Market Sectors

Sector

Reduction in

contractors 1990 contractors 1998 contractors

Surface ships 8 to 5 Avondale

Bath Iron Works

Bethlehem Steel 

Ingalls

NASSCO

Newport News

Tacoma

Tampa

Avondale 

Bath Iron Works

Ingalls

NASSCO

Newport News

Tactical wheeled

vehicles

6 to 4 Am General

BMY

GM Canada

Oskosh

Stewart & Stevenson

Teledyne Cont.

Motors

Am General

GM Canada

Oskosh

Stewart & Stevenson

Tracked combat

vehicles

3 to 2 FMC

General Dynamics

Harsco (BMY)

General Dynamics

UDLP

Strategic missiles 3 to 2 Boeing

Lockheed

Martin Marietta

Boeing

Lockheed Martin

Torpedoes 3 to 2 Alliant Tech Systems

Hughes

Westinghouse

Lockheed Martin

Raytheon

Rotary wing aircraft 4 to 3 Boeing

Bell Helicopters

Sikorsky

McDonnell Douglas

Boeing

Bell Helicopters

Sikorsky

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.

(707288) Page 7 GAO/T-NSIAD-98-112
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