VIEWPOINT: Mergers, Acquisitions Not the Solely Technique to Foster Competitors in Protection Trade
The antitrust companies answerable for reviewing proposed mergers and acquisitions to evaluate their affect on competitors launched their up to date “Merger Pointers” simply earlier than Christmas.
Not surprisingly, the rules mirror the present administration’s desire for more and more stringent opinions throughout industries. Throughout the protection and broader authorities contracting market, this elevated scrutiny has resulted in a number of contentious opinions and authorities fits to dam proposed transactions involving quite a few main protection companies.
Competitors is the lifeblood of the protection industrial base. Some observers have regarded merger and acquisition exercise as a consolidation of the protection industrial base that undermines competitors and limits the federal government’s decisions in acquisition. There’s little empirical proof to buttress this rivalry, nevertheless. In lots of instances, the actions assist authorities contractors scale to enter new or bigger markets, thereby growing competitors and reducing prices to the federal government.
A greater solution to foster competitors throughout the federal government contracting industrial base is to harness its inherent nature as a monopsony market — the place there is just one purchaser — and undertake practices that spur recurring competitors throughout the economic base.
Some extent of consolidation is a pure enterprise end result in any market section, industrial or in any other case. Drawing on the heritage of the Sherman antitrust regime and right this moment’s Hart-Scott-Rodino Act, the Federal Commerce Fee and the Division of Justice rightly work to guard shoppers and stop consolidation that leads to monopolistic behaviors.
The protection and broader authorities contracting markets, nevertheless, are considerably completely different than industrial markets as a result of there may be one “shopper” or purchaser, particularly the U.S. authorities. As a monopsonist, the federal government considerably drives the federal government contracting market by means of its spending and shopping for practices.
That’s key to understanding the present and potential future state of competitors within the protection industrial base.
Consolidation within the protection industrial base is a situation that has been current for the reason that preliminary post-Chilly Conflict flurry of mergers within the wake of former Deputy Secretary of Protection Invoice Perry’s so-called “Final Supper” in 1993, the place he urged consolidation.
As Beneath Secretary of Protection for Acquisition and Sustainment Invoice LaPlante has steadily famous, dropping protection spending from roughly 6 p.c to three p.c of GDP throughout that interval naturally led to a major consolidation of the protection industrial base.
A well-known chart displaying 51 firms merging over time to grow to be the 5 main primes in right this moment’s market: Lockheed Martin, Northrop Grumman, Basic Dynamics, Boeing and Raytheon — now known as RTX — tells the heritage of these companies, however that’s solely a part of the story. Since 2000, the general form of the economic base has stayed remarkably according to 5 main primes, round 100 tier 1 and tier 2 mid- to large-sized companies that function primes or subcontractors on varied applications, and 1000’s of small companies.
Inside that broad construction, mergers and acquisitions proceed to be a serious thrust of exercise within the authorities contracting trade, better than in most different trade verticals.
A few of this focus is pushed by the closely regulated nature of the federal area, which makes natural progress difficult. For instance, as a result of previous efficiency is a essential analysis consider most authorities procurement competitions, firms usually use acquisition as a serious element of any progress technique. By merging with a agency that has important previous efficiency in a special market, an organization can broaden into new market areas that might not in any other case be addressable.
Surprisingly, there may be extraordinarily little fact-based evaluation about whether or not consolidation has meaningfully impacted competitors over time. A 2018 Nationwide Bureau of Financial Analysis report, “The Influence of Trade Consolidation on Authorities Procurement,” is without doubt one of the few examinations of the affect of protection consolidation, and its findings didn’t assist a definitive conclusion. Particularly, the report discovered that “focus results in a rise within the award of noncompetitive contracts.”
On the identical time, the report additionally notes that they didn’t discover “any proof that [consolidation] elevated whole acquisition prices.” Even the 2022 Pentagon report, “State of Competitors Throughout the Protection Industrial Base,” which known as for heightened merger and acquisition opinions, acknowledged the dearth of “a robust correlation between consolidation and elevated program pricing.”
The Baroni Heart at George Mason College just lately examined the extent of market focus within the protection and broader authorities contracting industrial base utilizing the Herfindahl-Hirschman index, or HHI, the usual utilized by the antitrust companies when inspecting market segments. The report, “Efficient Competitors and Market Focus Developments within the Division of Protection Contractor Base,” tracked with that of the Nationwide Bureau of Financial Analysis evaluation. Particularly, the Protection Division’s efficient competitors fee and stage of market focus have been constant over time and observe intently with different federal companies.
Taking a look at all contracts from fiscal years 2010 by means of 2019, the division’s HHI rating was beneath 1,500, or reasonably concentrated, for all however one 12 months. Within the prime 5 product classes over the identical interval, 4 — info-tech and engineering, program administration and different skilled companies — had scores round 500, or unconcentrated, and one — medicine and organic — was extremely concentrated, with scores about 2,500.
Further analysis is due to this fact essential to make definitive conclusions about whether or not consolidation has had a constructive, detrimental or negligible affect on competitors within the industrial base. Fortuitously, nevertheless, the monopsonist nature of the federal government contracting market signifies that the federal government companies can immediately form the market by their shopping for practices.
The federal authorities buys services and products from roughly 200,000 companies. Within the companies space, there are numerous firms competing for prime and subcontract positions for main procurements of IT enterprise, skilled and technical companies. With low obstacles to entry, firms recurrently broaden and contract their positions in companies relying on their efficiency on varied applications.
In product markets, nevertheless, the variety of firms varies considerably due to greater obstacles to entry and specialised merchandise with few industrial makes use of. The Protection Division, which has probably the most product-focused applications, publishes its annual “Industrial Capabilities Report back to Congress” that illustrates the aggressive atmosphere in markets resembling plane, radars, floor automobiles and ships. Pentagon workplaces work to actively handle market segments by means of initiatives resembling cut up buys, mitigative actions and even suggestions to disclaim sure transactions that may result in monopoly positions such because the 2018 denial of the tried merger of Extremely and Sparton within the sonobuoy market.
Strong rocket motors are a main instance of the dynamics at play within the protection market. They’re predominantly defense-unique gadgets utilized in missiles and rocket propellants. There have been two home suppliers of the expertise for many years. With the retirement of the area shuttle and unpredictable episodic demand for missiles, these suppliers — Aerojet Rocketdyne and Orbital ATK — struggled at occasions, notably Aerojet.
Northrop Grumman acquired Orbital ATK in 2018 and in the end acquired approval from the FTC with a consent decree requiring Northrop Grumman to be a service provider provider to all opponents for missile contracts. Lockheed Martin’s bid to accumulate Aerojet Rocketdyne, nevertheless, was blocked by the FTC in early 2022. The corporate’s continued want for a purchaser didn’t go away, although, and L3Harris’ bid to buy it was authorised by the fee in 2023. The underside line for the rocket market was that there have been two home suppliers earlier than and after the mergers.
Curiously, the strong rocket motors market scenario has shortly modified as demand has elevated considerably due to U.S. navy assist to Ukraine. The just lately established U.S. subsidiary of Nammo, a Norway-based strong rocket motor and munitions supplier, received a $97 million award in late 2021. Anduril, a software-focused, nontraditional protection contractor, additionally entered the rocket motor area by buying Adranos in mid-2023 because it seeks to develop and compete with bigger protection primes by increasing its capabilities into new areas.
The inducement driving these companies’ entrance into the home rocket motor area is clearly the truth that market alternatives have elevated.
Because the strong rocket motor market illustrates, alternatives are what in the end drive competitors. Whereas the Protection Division can’t management market forces, it might management the way it buys. For the reason that Nineties, it has targeted on maximizing effectivity and value effectiveness in main applications. This has resulted in a bent for decades-long franchise applications that keep a single manufacturing line, however don’t foster competitors. Corporations are within the enterprise of creating a revenue, so they don’t seem to be going to remain engaged in markets the place they don’t have a market place or there may be not a foreseeable alternative.
Fortuitously although, latest division efforts are shifting to create extra market alternatives all through this system lifecycle. This can be a promising pattern that must be strengthened wherever doable. There was a dramatic improve, for instance, within the quantity of experimentation and prototyping alternatives by means of innovation-focused organizations such because the Protection Innovation Unit, AFWERX, NavalX and Military Futures Command. This has been facilitated by the enlargement and expanded use of acquisition approaches resembling Different Transactions Authority and Center Tier of Acquisition. These methods allow the division to work with modern firms to quickly prototype novel options, then advance profitable ones to provide at scale.
In main applications, there has additionally been a better concentrate on agile acquisition practices to assist drive competitors all through the lifecycle of a program. Modular open programs approaches have gotten more and more central to lots of right this moment’s main applications. These open architectures will allow better alternatives for expertise upgrades and the alternative of programs and elements over time versus closed-loop proprietary programs.
Merger and acquisition opinions are necessary regulatory instruments to forestall monopolistic enterprise mixtures, however making them extra stringent won’t result in extra competitors in authorities contracting markets.
To foster competitors, federal companies ought to harness the power of their positions as monopsonists and vigorously pursue initiatives like these outlined above to assist unlock new ranges of competitors throughout the protection and wider authorities contracting markets.
It will end in a extra strong, resilient and efficient industrial base to fulfill right this moment and tomorrow’s nationwide safety challenges. ND
Jerry McGinn, Ph.D. is the chief director of the Greg and Camille Baroni Heart for Authorities Contracting in George Mason College’s Costello Faculty of Enterprise and former appearing deputy assistant secretary of protection for manufacturing and industrial base coverage, the place his duties included opinions of mergers and acquisitions.
Matters: Acquisition, Protection Division