What’s Left of the Defense Industry

July 1, 2005

Fifteen tumultuous years of consolidations, mergers, and reforms have radically reshaped the nation’s military industrial base, leaving the US with a system that scarcely resembles the vast complex that churned out advanced weapons throughout the Cold War. The change prompts questions that go to the heart of national defense.

Once, the US military industry comprised dozens of major manufacturers and subcontractors, lineal descendants of the vast “Arsenal of Democracy” of World War II. However, paltry Pentagon budgets and a resulting “procurement holiday” in the 1990s changed the landscape in dramatic fashion—and for good.

Today, after a major market shakeout, only a handful of industrial giants remain. In the aerospace field, the amount of military business is sufficient to support only three major aircraft manufacturers.

These firms have managed to stay profitable and innovative, producing guarded optimism in some quarters.

Others, however, are far more pessimistic. The industrial trend has prompted public expressions of concern from USAF’s two highest officials—Michael L. Dominguez, the acting Secretary of the Air Force, and Gen. John P. Jumper, USAF’s Chief of Staff.

In an April 7 letter to Sen. John Warner (R-Va.), the chairman of the Senate Armed Services Committee, they pointed to Congress’ deep unease about the decline of the US shipbuilding industry and then added: “We believe the same situation exists with regard to our nation’s aerospace manufacturing industrial base.”

Earlier this year, Jumper observed, “We have more shipyards in this country than we do factories that produce airplanes. We need to think about that very carefully.”

Jumper evidently has concluded that reduced US production capacity has had negative side effects, not the least in the cost of new systems. As evidence, he cited the example of the C-130 aircraft. In 1964, Jumper said, the price of a single new C-130B was $11.5 million (as calculated in inflated 2005 dollars). The new C-130J being produced today costs five times that amount. “The capability is certainly better,” said Jumper, but the C-130J “doesn’t carry 500 percent more [troops or cargo].”

“Minimum” Aerospace Industry

In their letter to Warner, Dominguez and Jumper called on Congress “to define a minimum aircraft manufacturing industrial base” and develop “a strategy that ensures America remains the world leader in aerospace technology, innovation, and production.”

In the 1990s, there was widespread concern that the defense industrial base would be unable to meet DOD’s demands for the 21st century. As the number of programs dwindled, long-standing aerospace powers faced increasingly bleak prospects.

The most dramatic case emerged in 1996, when McDonnell Douglas, the proud producer of the Air Force’s F-15 and the Navy’s F/A-18, found itself locked out of the next generation fighter market. It had lost the Joint Strike Fighter competition and soon merged with Boeing.

The Pentagon encouraged such consolidation. DOD officials feared that there was not enough money to sustain a large number of contractors and that any attempt to do so could lead to an outright collapse.

Defense firms took this admonition to heart.

What in 1980 was a field of roughly 75 major aerospace-related companies had by 2001 been transformed by consolidations and mergers into a slimmed-down group of five prime contractors. In 1990, the Pentagon had eight major military aircraft suppliers. Today, it has three.

The truly major defense contractors that remain—Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, and Raytheon—now account for 46 percent of the top 100 defense contracts.

Industry’s consolidation drive slowed when DOD became concerned that declining numbers of prime contractors would limit competition and drive up costs. Northrop Grumman and Lockheed Martin announced plans to merge in 1997, but called it off after the government opposed the move.

In 2003, then-Air Force Secretary James G. Roche told an industry audience that he was still dealing with the consequences of the “pell-mell” industry consolidation of the 1990s. “The most direct way to drain innovation and cost savings out of programs is to deaden competitive pressures,” Roche said. “Excessive consolidation, unfortunately, contributes to that problem.”

Refuting Pessimists

Today, the Pentagon’s civilian leadership is reasonably satisfied with its industrial situation. DOD industrial policy officials feel the competitive pressure of the marketplace is “the best vehicle to shape an industrial environment that supports the defense strategy,” said the “2004 Annual Industrial Capabilities Report to Congress.”

A series of 2004 Pentagon studies “refute the concerns of those bemoaning the excesses of the consolidation of the 1980s and 1990s,” DOD industrial policy officials wrote last October. “Our research has changed our views about the size and composition of the industrial base.”

The industry “has not” become too consolidated, officials wrote.

In 2001, most industry analysts were convinced that the F-35 Joint Strike Fighter program would be split between competitors Boeing and Lockheed Martin. Lockheed in the early 1990s had won the competition for the only other big new fighter program—the Air Force F/A-22. The need to build manned fighters, went the thinking, was too important for the government to allow Lockheed to have a de facto monopoly.

Despite Pentagon assurances that JSF competition would be “winner take all” in character, there was much speculation about how the program might be split to keep two firms in the fighter business. The loser might build aircraft under contract, it was said, or get a chance to compete separately for the Marine Corps short takeoff and vertical landing design.

It was not to be. DOD awarded the JSF contract—all of it—to Lockheed Martin. When it came to next generation tactical aircraft, Boeing was left with only a subcontractor stake in the F/A-22 and a chance at the new unmanned combat air vehicle program.

This produced a great deal of hand-wringing, yet some top officials now believe it worked out for the best. The Rand Corp., for instance, thinks so. The venerable defense-oriented think tank has on several occasions taken careful looks at the F-35 business case and has found that splitting the program would have boosted its cost by $40 billion.

A 2003 Rand report maintained that competition might have brought down that figure “somewhat,” but there would be a “very small chance” that DOD would have recouped all $40 billion.

What’s more, Boeing (as well as Northrop Grumman and other contractors) has continued work on unmanned aerial systems “that may require skills similar to fighter development,” Rand wrote. “Northrop Grumman may also retain considerable fighter design, development, and production experience through its participation in the JSF program.”

Rand further noted the likelihood that these firms will eventually challenge Lockheed’s grip on tactical air systems. It pointed to a similar challenge that occurred at the dawn of the stealth era in the early 1980s.

Who’s Hungry

As Rand pointed out, Lockheed and Northrop at that time were “two extremely ‘hungry’ second-rank fighter prime contractors that had been largely cut out of the conventional fighter market” during 1970s fighter competitions. In response, Rand continued, they “pursued radical and innovative technologies in an attempt to dethrone the reigning leaders of the fighter market in the prestealth era: McDonnell Douglas and General Dynamics.”

Lockheed Martin subsequently won competitions to produce the F-117, F/A-22, and F-35—all stealth aircraft—while Northrop Grumman produced the winning design for the B-2 stealth bomber.

Periods of technological innovation in the aerospace industry, such as the stealth revolution, are almost always led by “second-rank” prime contractors, Rand found.

That, however, was in an era of multiple aerospace firms. Large numbers of aerospace companies tend to produce an abundance of new ideas. Innovative ideas may now be less numerous than before.

It is not possible to predict these long-term consequences. “With only one remaining dominant developer of advanced US fighter aircraft, and with almost insurmountable barriers to new entrants,” Rand asked, “what companies in the future will play the role [played by] the second-rank firms in the past?”

Some say Raytheon or General Atomics—producer of the highly successful Predator unmanned aerial vehicle—could turn out to be the prototypical “hungry” aerospace companies that rise to prominence in the future.

Lockheed Martin, Boeing, and Nor­­th­rop Grumman are the largest contr­act­ors not only for the Air Force but also for all of the Defense Department. The three are now the only companies deemed able to design and build advanced manned military aircraft, and each of the three has diversified far beyond fighters.

Lockheed Martin has a major space and missiles program. Boeing is the world’s premier commercial aircraft manufacturer. Northrop Grumman has a major stake in shipbuilding.

In 1990, the US aerospace industry employed more than 1.1 million workers. This number plunged to 673,000 by 1995 and then continued to drift downward. According to the Aerospace Industries Association (AIA), aerospace employment bottomed out at 569,000 in February 2004 and rebounded to 588,000 last September.

Having a much-smaller workforce is a mixed bag. Industry executives note that it is more productive than before. In 2004, profits were the best they had been in five years. Industry sales are expected to grow again in 2005 for the seventh year in a row.

Many worried that military research and development funding was not sufficient to maintain a core of trained scientists and engineers. This situation has improved somewhat. During the Bush Administration years, R&D investments have increased. Companies also have expanded their in-house research.

Industry officials warn that the defense base still has major structural problems—small military orders, stifling export policies, and unreliable government “plans.” To cite the most egregious example: Where once plans called for building 750 F/A-22s, that number has dwindled to about 180 today.

Institutional Memory

Foremost among the current concerns is the need to protect institutional knowledge over the long term. “I’m a little worried about keeping a workforce together,” said F. Whitten Peters, a former Secretary of the Air Force and member of a recent commission formed to study the ills of the aerospace industry.

For one thing, the few development and production programs now on the books tend to last for decades. This greatly limits the opportunities for engineers to hone their craft, compared to what was true a generation ago. The F-15 and F-16 each were quickly fielded, allowing engineers on those projects to move on to other aircraft programs. In contrast, the F/A-22 has been in development since 1991.

In 2002, the Aerospace Commission (Peters was a member) determined that all of the design work for the F/A-18E/F, F/A-22, and F-35 programs will be complete by 2008.

Peters observed, by way of example, that, if you wanted someone to design a new heavy bomber, “it’s not exactly clear where you would go to do that.”

Rand has observed that there will be work on a new tanker, unmanned combat air vehicle, and intelligence-surveillance-reconnaissance aircraft, but that work will sustain design teams for only about another five years.

The number of engineering students entering aerospace has declined, and some fear students see a dead-end field. “You want a steady stream of workers coming forward,” Peters said.

In the future, another manned fighter may be needed. The commission warned that, when the time comes, the US may come face to face with a serious problem. Where will it find “experienced design teams” to create such an aircraft if the manned fighter design process “is in fact gapped for 20 years or more?”

Boeing and Northrop Grumman have major unmanned programs under way, and these may protect their expertise. Peters compared UAVs to fighters in the 1950s—“a thousand flowers are blooming out there.”

A lack of institutional knowledge can have concrete consequences. A 1999 study of space-launch failures “found that inadequate engineering expertise was a major contributing cause,” the Aerospace Commission noted. “More recently, the Secretary of the Air Force has pointed to the decline in systems engineering skills as a major contributor to cost overruns in military space programs.”

Diversification into military, civil, and space applications helps the aerospace companies ride out slow military acquisition periods. AIA President John W. Douglass, however, said the military, space, and civil sectors have independent business cycles, and the industry can be damaged by dry spells in each of them.

Are Bailouts Good

While the contractors have made major strides toward self-sufficiency, government spending remains critical to the health of the industry. Peters acknowledged the concern that USAF’s proposed KC-767 tanker lease from Boeing was seen as a bailout, but added that the acquisition would help the company weather some of the market’s peaks and valleys. Sometimes the government must step in to ensure that its industrial base stays healthy.

Much of the aerospace sector’s research has both military and commercial potential. But relying on the commercial sector can also be a mistake. In the case of USAF’s Evolved Expandable Launch Vehicle, the “business case” for funding two suppliers—Boeing and Lockheed Martin­—was predicated on EELV boosters being used primarily for commercial space launch. DOD would buy “at the margin” launches that were expected to be low cost.

Unfortunately, “worldwide demand for commercial satellite launch has dropped essentially to nothing—and is not expected to rise for a decade or more,” the commission warned. “Reliance on the economics of a commercially driven market is unsustainable.”

It could be worse. The shipbuilding industry is probably on shakier ground than aerospace. Nuclear submarines and aircraft carriers have no commercial applications, and the government frequently resorts to expensive split-production programs and national teams to maintain a viable industry.

The most acute concerns center on maintaining specialized capabilities. Recent studies have found a wide range of these, some of which will require government protection. They include production of chemical oxygen-iodine lasers, the Global Positioning System, hypersonic propulsion, and radiation-resistant components.

The Aerospace Commission said that the government “must assume responsibility for sustaining, modernizing, and providing critical … defense-related technologies” such as these, “when it is in the nation’s interest.”