Abstract
The question of whether mergers in various industries lead to greater market power or improved efficiencies has been the subject of numerous public policy debates. This analysis focuses on the impact of consolidation in the U.S. defense industry over the past 20 years and examines the reasons behind the wave of defense consolidation, the results in terms of the reduction in contractors, the antitrust response to mergers, and evidence on the impact of the mergers on weapons systems’ total and per-unit costs. The analysis finds that merger activity was driven less by declines in spending following the Cold War than by a stronger economy and a vibrant financial market. The cost data show that 39 to 44 percent of systems experienced statistically significant change in either total costs or per-unit costs following a merger. Somewhat more systems were likely to exhibit lower postmerger per-unit costs than higher per-unit costs, suggesting improved efficiency. The analysis also examines the impact on weapon systems cost by type of weapons system, manufacturer, and service (Army, Navy, Air Force). The evidence suggested greater efficiencies following consolidation for many sectors. Army and Navy systems overall showed lower per-unit costs, but the Air Force weapons systems showed mixed results.
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Notes
These growth rates were calculated by the author from the raw data in the Historical Tables (Table 3.2) of theUnited States Budget for Fiscal Year [2008, pp. 56–60]. The growth rates are not annualized nor adjusted for inflation.
MDAP (Major Defense Acquisition Program) –Defined in 10 USC § 2430 as a “Department of Defense (DoD) acquisition program that is not a highly sensitive classified program (as determined by the Secretary of Defense) and that is designated by the Secretary of Defense as a major defense acquisition program, or that is estimated by the Secretary of Defense to require an eventual total expenditure for research, development, test, and evaluation of more than $365,000,000 (updated to FY 2000 constant dollars) or an eventual total expenditure for procurement of more than $2,190,000,000 (updated to FY 2000 constant dollars)” [Under Secretary of Defense Acquisition … 2006].
Paul G. Hough [1992] describes many of the difficulties in using SAR data, many of which do not apply to the type of data used in this study nor the analyses undertaken. The RAND note focuses on the problems in using SAR data to calculate cost growth and which estimate should be used as the baseline, while this analysis does not calculate cost growth at all. It also discusses the problems stemming from SARS not reporting base-year dollars prior to March 1974. This analysis uses data after that period. The RAND note notes that “when OSD escalation indexes are lower than actual inflation (the norm), cost ratios calculated from SAR base year dollars are higher,”(27) but that “OSD inflation rates do capture the bulk of price level changes in the economy”(29). This is not a significant concern for this analysis because it does not calculate cost ratios and it does not compare current estimates in base year dollars with current estimates in current year dollars. The RAND note points out that program managers reporting the costs of their programs could make errors or have inconsistent preparation techniques. This is a minimal problem here because this analysis does not compare different categories of costs.
Note that the aircraft carriers CVN76 and the CVN77 were eliminated from the analysis because, during the chronological period, their primary manufacturer, Newport News, did not merge with anyone. Rather, Newport News was spun-off in 1996 from its owner, Tenneco.
DoD Instruction 7000.3g, as well as the DoD Cost Variance Handbook and the training slides for the CARS software program used by program managers in their SAR preparations were very helpful to the author in explaining the various types of data found in SAR reports, how they are calculated, and how they are reported by program managers.
This specification was helpful in examining the impact of mergers on total costs and per-unit costs on a weapons-system-by-weapons-system basis. The author also pooled all the data and ran regression specifications that provided results consistent with the results reported in this analysis but which lacked the degree of detail on a per-weapons-system basis that the specifications reported in this study had.
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Acknowledgements
The author appreciated the financial support of the U.S. Naval Postgraduate School Acquisitions Research Program and has appreciated comments from John Warner, Russ Beland, RADM (ret.) Jim Greene, Stan Horowitz, participants at the USAF Air and Space Technology Exposition, the Defense Finance Conference, and the U.S. Naval Postgraduate School Acquisition Research Symposium.
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The views in this article represent only those of the author and not any institution with which the author is affiliated.
*Nayantara Hensel is the Chief Economist for the Department of the Navy. She provides economic guidance on growth projections, the federal budget, interest rates, unemployment, exchange rates, inflation, and the financial health of defense contractors, as well as trends in the broader economy and in the defense sector. She has taught at Harvard University, the Stern School of Business at New York University (NYU), and the US Naval Postgraduate School's Graduate School of Business and Public Policy. In the private sector, Dr. Hensel previously served as Senior Manager and Chief Economist for Ernst & Young's litigation advisory group, managing economist for the New York City office of the Law and Economics Consulting Group (LECG), and an economist in the economic consulting arm of Marsh & McLennan. Dr. Hensel has written over 30 articles and research reports. She is the Chair of NABE's Financial Roundtable and is one of 34 elected members to NBEIC, which is a group composed of the top corporate economists in the United States. Dr. Hensel received her BA, MA, and Ph.D. from Harvard University, where she graduated magna cum laude and Phi Beta Kappa.
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Hensel, N. Can Industry Consolidation Lead to Greater Efficiencies? Evidence from the U.S. Defense Industry. Bus Econ 45, 187–203 (2010). https://doi.org/10.1057/be.2010.15
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DOI: https://doi.org/10.1057/be.2010.15