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U.S. Department of Defense Concerned About Industry Consilidation

At a speech yesterday the Undersecretary of Defense for Acquisition Ashton Carter discussed the potential for shrinkage in the U.S. industrial base due to declines or flat spending by the Government on defense. He made it rather clear that while mergers and acquisitions would not be discouraged the Obama Administration is concerned about consolidation among the biggest defense contractors.

After the decline in spending in the Nineties caused by the collapse of the Soviet Union and the “Peace Dividend” the U.S. defense contracting world ended up with five big companies. These were Boeing (BA), which absorbed McDonnell Douglas; Lockheed Martin (LMT), which merged Lockheed and Martin Marietta; Northrop Grumman (NOC); which combined Northrop and Grumman; Raytheon (RTN) and General Dynamics (GD).

These companies became the major developers of systems and suppliers of large aircraft, ship, space and missile programs. The U.S. defense budget is very diverse and allows many other companies to participate including those that primarily provide services and consumable items such as fuel, ammunition and food to the military. The fighting in Iraq and Afghanistan has also allowed innovative systems like Unmanned Aerial Vehicles (UAV) to become important and a company like General Atomics can do very well through there product line.

The Nineties also led to penetration of the U.S. market by the large European defense contractors like BAE Systems (BAE:LSE) and EADS (EADS:P) necessitated by the need for competition and their acquisition of U.S. companies that provided or maintained systems like the M2 Bradley Infantry Fighting Vehicle (IFV).

Carter made it clear that the desire to maintain competition for future contracts and projects will outweigh thoughts on future efficiencies caused by the lack of work for many different contractors. He was asked point blank about Northrop’s plans to either sell or spin off their ship building division due to concerns about the amount of work available for it in the future. Carter expressed concerns that if Northrop did separate this part it had to be a viable stand alone company able to support the U.S. military.

As the fighting in Iraq and Afghanistan winds down and the continued pressure to reduce overall government spending rises the defense budget will see reductions. This will most likely affect new, future programs as the budget for their development and production will take the biggest hit. The Defense Department is committed to the Joint Strike Fighter as the biggest item in future spending. That program alone may eat up most of the available investment funds in the near term.

The government may be faced with problems as it tries to maintain a competitive industrial base while reducing the amount of spending to a point where they might not be enough work to go around.

Photo from Kevin Burkett’s flickr photostream.

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