Say 'NYET!' to Mergers
In an important Washington Post op-ed today, former senior Department of Defense officials Dov S. Zakheim and Lt. Gen. Ronald T. Kadish (Ret.) point out that the lack of competition in the Pentagon's buying has led it to become a Soviet-style system:
The Government Accountability Office reported last month on how things are going with nearly 100 major U.S. defense systems. Not well, it seems. They have exceeded their original budgets and are, on average, almost two years behind schedule.
The GAO report lays bare a festering problem in our nation's military procurement system: Competition barely exists in the defense industry and is growing weaker by the day.
It was a different story just two decades ago. In the 1980s, 20 or more prime contractors competed for most defense contracts. Today, the Pentagon relies primarily on six main contractors to build our nation's aircraft, missiles, ships and other weapons systems.
It is a system that largely forgoes competition on price, delivery and performance and replaces it with a kind of "design bureau" competition, similar to what the Soviet Union used--hardly a recipe for success.
With less competition, contractors have few incentives to keep costs down and performance high. In essence, we are left with a few super-sized contractors that are holding all of the cards. As witnessed by the Air Force tanker deal and the recent IBM suspension, the government has few places to turn--it has, in effect, handcuffed itself.
The Pentagon pushed a policy in the mid-90s to consolidate the defense industry, which has led to the situation we have today. Zakheim and Kadish describe a fateful Clinton Administration "Last Supper" meeting that precipitated the mergers.
Even worse, however, was that the federal government paid for the defense contractor mergers under a policy which its opponents, including POGO, called "payoffs for layoffs." At the behest of defense contractors, the Pentagon and its friends in Congress paid the contractors billions of dollars to merge. At the time, POGO noted:
These mergers contain an even more fundamental problem: even if there are short-term savings for the government, in the long run any lower prices are likely to be offset by the effects of reduced competition from excessive corporate merging. The Pentagon has not yet fully examined the long-term government costs of reduced competition from the tremendous concentration currently underway in the defense industry.
The health care, homeland security, and IT industries are also following a similar path toward merger-mania. In some instances, new companies are being gobbled up by the large DoD contractors. Too much power, influence, and control over the government marketplace is not good for taxpayers. POGO agrees with Zakheim and Kadish--more oversight isn’t going to fix the problem. The government has to do something to increase competition and bring in the many small and mid-sized firms that can help the government meet its needs.
-- Beth Daley and Scott Amey
The Defense industry mergers that were foreseen/encouraged during the "Last Supper" were made possible by the novel antitrust review and settlement procedures used by the US Federal Trade Commission during the Chairmanship of Robert Pitofsky under the administration of President Bill Clinton. The mergers that the FTC identified as anticompetitive were nevertheless permitted under FTC consent orders that regulated the post merger behavior of the consolidated firm in a manner that purported to maintain competition. Despite finding that the proposed mergers of the defense industry firms, Lockheed and Martin Marietta and the subsequent acquisition of Loral by Lockheed Martin would likely reduce competition substantially, the FTC allowed the mergers on the condition that erect internal information "firewalls" to prevent the consolidated firm from using proprietary information held by the acquired firm about remaining competitors. Neither the FTC nor the public knows whether these "firewalls" did in fact preserve competition by maintaining the confidentiality of proprietary information because the firewall mechanism depends on the honesty of self reporting system established by the consolidated firm. The Loral order permitted an incongruous arrangement in which part of Loral continued as a separate rival company even though it was to be partially owned by Lockheed. The CEO of the surviving Loral company was allowed to sit on the Lockheed board directors and barred only from discussions and votes on matters that involved matters that concerned the direct rivalry of the two firms. See FTC press release dated April 18, 1996. Traditionally American merger law had forbidden anticompetitive mergers trusting that competition would be preserved only by rival interests of competitors and rejected the notion that unverifiable promises or good intentions could substitute for market forces. Have those novel FTC remedies contributed to our present problems. It appears that the number of surviving defense firms is now so small that effective competition between American firms no longer exists with the expected result that quality, innovation, and service has diminished and prices have risen.
Kenneth Davidson
Senior Fellow
American Antitrust Institute
Posted on: Apr 29, 2008 at 11:28 AM