The Department of Defense published a fascinating report yesterday analyzing the defense industrial base and the notable consolidation of prime contractors — the contractors who directly interact with the government as project managers and who then outsource much of their work to other subcontractors.
The details are grim: “the number of aerospace and defense prime contractors shrank from 51 to 5: Lockheed Martin (LM), Raytheon, General Dynamics (GD), Northrop Grumman (NG), and Boeing.” A table compiling different markets for acquisition and the trends around prime contractors vividly shows this pattern:
Horizontal and vertical consolidation has concentrated market power down to a handful of prime defense contractors, and in many cases, to sole-source suppliers. That drastically weakens the resilience of the defense industrial base, and also limits the competitive pursuit of the most advanced research and development.
The report was initiated by a Biden executive order in July 2021, and the current administration seems poised to intensify antitrust enforcement. Just this week, Lockheed Martin called off its $4.4 billion acquisition of Aerojet, a maker of rocket jets, due to regulatory roadblocks.
Antitrust enforcement is clearly in vogue in DC, in Beijing and across much of Europe, but there are challenging intersections of interests between competition, scale, and national security that remain entirely open questions as governments actively rein in the size of technology businesses.
When it comes to national security concerns, scale — in general — is good. As I wrote last week in “The West’s self-defeating technological sovereignty” on “Securities,” Berlin blocked the acquisition of chip wafer producer Siltronic by Taiwan-based Global Wafers out of a desure to protect its domestic industrial base. Yet, that autarky means that Siltronic will remain the distant number four competitor in the wafer market — a market that requires its participants to constantly invest vast quantities of new capital to effectively compete. By blocking scale, Berlin managed to limit the long-term health of its own industrial leader.
We see a similar tension in antitrust debates over Big Tech companies. America wants its tech giants to be globally dominant in a world where alternatives (particularly Chinese giants) are rapidly expanding in emerging markets. Yet, while splitting up Google or Apple or Facebook may add competition to the U.S. consumer market, it will also stifle the ability of these companies to effectively and financially compete in overseas markets. Ironically, such antitrust actions also opens the U.S. market to more overseas competition as well.
It’s a problem of scale. Social networks, search engines, defense programs — all of them lend themselves to monopolistic incumbents. It’s hard to have 10 simultaneous social networks, any more than there are going to be a dozen search engines or 20 companies building jet fighters.
In fact, the scale problem is particularly acute in defense tech, where huge scale is often required just to design and build major programs in the first place. The Gerald R. Ford-class aircraft carrier — one single ship, to put in bluntly — has taken roughly 15 years and $13 billion to construct as I wrote about in “Defense Fordism.” It's an insane amount of money, but it's also a market design that's fundamentally monopolistic — there aren’t going to be multiple aircraft carrier companies. Lockheed Martin owns this market, and it is going to own it for the duration of the Ford's lifecycle.
The primes are a disaster, but it’s disastrous by design. Massive, complex programs need one originating and responsible contractor — and that’s true for the vast majority of the work that the Pentagon acquires. If we migrate to a world of cheap, flexible, and autonomous — it’s possible to imagine a robust and competitive market to fulfill these contracts. But when the Air Force has a next-generation plane and the Navy one next-generation aircraft carrier — there’s a limit to how much competition can feasibly be supported.
Indeed, that’s the balancing act of resilience across supply chains in general. Customers — whether the Pentagon or everyday consumers — are already struggling with price inflation, and that doesn’t even include the overhead cost of supporting multiple suppliers to maintain resilience. It sounds great to have more competition — but the key question is whether competition would automatically lower costs enough to compensate for the overhead of having multiple competitors. The Pentagon is a fairly zero-sum budget — everyone can’t win more without more defense appropriations from Congress.
To the Pentagon’s credit (and probably to the chagrin of some antitrust acolytes), the DoD’s report is quite frank about its limited ability to effect competition in a range of industries, from microelectronics to materials. For instance, in regards to critical materials:
Critical materials manufacturing is capital- and time-intensive. Mining and processing concerns are risk-averse while capital recovery times are long. Furthermore, pricing of mined material is inelastic while downstream manufacturers more rapidly change suppliers and product formulations to obtain the lowest cost source. Companies are disincentivized from spending money on a project without surety of a profit in the long run. Changing the structure of the supply chain for these materials is difficult without government incentives and partnerships with the private sector.
While defense industry consolidation has been triggered by private equity firms and a general desire for efficient return on capital, the reality is also that such consolidation has been a survival mechanism in a competitive world where as the Pentagon notes, “Competition in the critical materials sector is distorted by political intervention and unfair trade practices in adversary nations.”
As I noted earlier in the post on technology sovereignty:
It’s the unfortunate complexity of modern industrial policy. Saving a company may mean selling it for parts, or selling it overseas to the one global company that might be able to make it a thoroughbred. Sometimes it is about losing the least, rather than gaining the most. Such are the tough choices in a competitive market where other companies have taken the lead.
Antitrust is not the panacea it’s often depicted. Just lopping off the heads of the giants doesn’t suddenly make for a fair market. If the structure of a market forces consolidation, no intensity of antitrust can or will change that. Big isn’t definitionally bad. But it can be. The challenge is knowing the difference, and targeting the worst offenders with a surgical strike rather than blasting an entire industry. The challenge of antitrust and national security is how opposed the two demands can be.