State of Competition Within the Defense Industrial Base

By Heberto Limas-Viller - NDIA Junior Fellow

As part of President Biden’s Executive Order on advancing competition, the Department of Defense (DoD) recently submitted its report on the state of competition within the defense industrial base (DIB). Competition remains vital for the DIB given that it allows the DoD to receive cost-effective and high-quality solutions necessary for a healthy defense industry. In the report, it notes that the industry has consolidated since the 1990s leaving the DoD dependent on a small number of contractors for satellites, tactical missile suppliers, and fixed-wing aircraft. While it does provide recommendations to encourage less consolidation among contractors, there are gaps within the report that limit its effectiveness.

DoD measures competition by contracts and orders with its competition rate shown by taking the dollars obligated for competitive contracts (i.e., two or more offerors) divided by the total dollars obligated. They also used a different method, where they divided the number of contract actions for competitive contracts divided by the total number of contract actions. When it was measured by dollars, the DoD found that the competition rate was consistently between 50-60% range since 2012, though the competition rate was around 90% when measured by the number of contracts. When it comes to major weapons systems, the competition rate declines to around 15-40%, depending on the weapons system. The report states that the number of aerospace and defense prime contractors shrank from 51 to five.

Such measurement of concentration is flawed given that there are numerous considerations for contractors to bid. The report doesn’t consider some major U.S. contractors, or even major foreign contractors that compete for contracts. Another issue is that it doesn’t consider the conditions as to how certain systems would lead to natural concentration (e.g. constructing aircraft carriers versus supplying ammunition). Lastly, its measurement of market concentration is flawed in contrast to the Herfindahl-Hirschman Index (HHI) used in NDIA’s annual Vital Signs report. Vital Signs does show some concentration, albeit not at the levels shown by DoD. Of note, the consolidation that has occurred is not correlated to an increase in the cost of acquisitions.

The main reason provided by the department for such consolidation in the DIB is significant merger and acquisition activity in the industry, fueled by cheap capital over the previous 20 years. Yet there are also other reasons for such consolidation that are mentioned. The first has been budget cuts to services, which caused contractors to leave the industry, notably shipyards. Another reason has been the prevalence of joint programs such as the F-35 with different versions for the Navy, Marines, and Air Force. Lastly, there is also the issue with lowest-price, technically acceptable contracts which is still prevalent among acquisitions and discourages competition.

What is most important in the report are the recommendations it provides to improve competition. It offers five recommendations: strengthening merger oversight, addressing intellectual property limitations, increasing new entrants, increasing opportunities for small businesses, and implementing sector-specific supply chain resiliency plans. The key recommendation is encouraging small businesses and new entrants. What is critical to increasing the number of competitors in defense and attracting capital is to lower barriers to entry, encourage risk-taking, award programs to enable new entrants to scale, and to re-establish budget stability to allow industry to properly plan and invest.

Topics: Defense Department, Industrial Base