The Defense Department, following Lockheed Martin's government-pushed termination of a $4.4 billion bid to acquire Aerojet Rocketdyne, is now pledging to combat "extreme consolidation" in the defense industrial base and bring new scrutiny to potential contractor mergers and acquisitions.
A new DOD report released today says the department recognizes it has an “historically consolidated” defense industrial base and plans to enforce greater competition in several ways, including by increasing reviews of company M&A activity and seeking new DIB entrants, preferably small businesses.
“Promoting competition to the maximum extent possible needs to be a top priority for DOD,” said a senior administration official who briefed reporters.
“Addressing consolidation in this space is critical,” the official said.
The Biden administration’s “ramped-up” focus in this area is already having “real results,” the official said, citing as evidence the Federal Trade Commission’s work to stop Lockheed’s proposed purchase of Aerojet.
“Obviously, the president made it a priority to nominate people to run the Federal Trade Commission and the [Justice Department] anti-trust commission who have a track record in robust anti-trust enforcement,” the official said.
The FTC sued to stop Lockheed’s acquisition of Aerojet last month, saying if the deal were allowed, Lockheed would be able to “jack up the price the U.S. government has to pay” for missile-centric weapon systems, “while delivering lower quality and less innovation.”
The Biden administration’s posture on defense business consolidation is a departure from the Trump administration’s more permissible approach, which allowed Raytheon to acquire United Technologies Corp. in 2020 and Northrop Grumman to acquire Orbital ATK in 2018.
The officials who briefed reporters said the new DOD industrial base report is being released in response to a July 2021 executive order to promote competition in the American economy, with much of the analysis pre-dating the FTC’s work on Lockheed’s proposed acquisition of Aerojet.
But DOD’s report states it intends to continue to assess defense industrial base consolidation.
“Given the extent of consolidation of key industries over the last decade, DOD will assess its approach to evaluating vertical and horizontal mergers, with adequate attention to risks to national security,” the report states. “DOD will work with interagency colleagues at the Department of Justice and Federal Trade Commission to further examine the impact of consolidation on the functioning of the defense market.”
Hypersonics squeeze coming?
The fact sheet on report states that “extreme consolidation” has reduced the number of prime aerospace and defense prime contractors from 51 in the 1990s to just five today.
“Such consolidation leaves DOD increasingly reliant on a handful of companies for critical defense capabilities,” the fact sheet states. “It also hurts taxpayers, as companies no longer feel the competitive pressure to innovate or perform at the highest level to win contracts.”
For example, the report states, 90% of DOD’s missiles come from just three sources.
Fixed-wing aircraft has gone from eight suppliers to three, satellites have gone from eight suppliers to four, and surface ships have gone from eight suppliers to two.
The report warns that the burgeoning hypersonics sector, a key concern for regulators assessing the Lockheed-Aerojet deal, could soon be next.
“One area within the [missiles and munitions] (and aircraft) sector where attention should be paid in the coming decade is hypersonic technologies,” the report states. “Within this sector, many primes, first-tier subcontractors, and first-tier material suppliers are positioning themselves to acquire lower-tiered hypersonic contractors and material suppliers. This vertical integration will likely lead to reduced competition and may eliminate it altogether.”
For instance, the FTC argued in its suit against Lockheed that the acquisition of Aerojet could result in control over critical missile propulsion technology “its rivals require to compete.”
The report states the increased demand for hypersonic weapons will require specialized manufacturers and suppliers.
“However, these small and nascent companies are at risk of acquisition from the major primes and subcontractors,” the report states. “Acquisition of these specialized hypersonic niche contractors (especially at this early stage of hypersonic technology and hypersonic missile development) will effectively prevent any other company from entering the market, thereby leading to reduced or limited competition, and capacity issues in the future.”
If the Pentagon cannot ensure competition, the report states, the only other viable acquisition approach is sole-source contracting.
“This was most recently demonstrated when Boeing dropped out of the Ground Based Strategic Deterrent (GBSD) engineering and manufacturing development phase competition saying ‘the current acquisition approach does not provide a level playing field for fair competition’, resulting in Northrop Grumman receiving a sole-source contract,” the report states.
IP rights pushed
The Pentagon, according to the report, is focused on ensuring supply chain resilience in five priority areas of the defense industrial base: castings and forgings, missiles and munitions, energy storage and batteries, strategic and critical materials, and microelectronics.
A renewed focus on intellectual property and encouraging small business participation will be key to DOD’s approach to securing its five priorities.
“The exclusive rights and legal remedies granted to IP owners are not undesirable or problematic merely because they may restrict full and open competition for technologies protected by those exclusive IP rights,” the report states. “In fact, IP rights can serve as an incentive to greater innovation. The government must recognize and plan for the impact of such rights, and use competitive pressure, its market power, and all the other tools available to mitigate against undesirable restrictions on competition when utilizing cutting-edge technology protected by IP rights.”
The department is planning to release a new intellectual property guidebook for contracting officers in the coming months.
Meanwhile, the Pentagon also intends to “leverage and promote” the flexibility granted by new acquisition authorities, such as other transactions, to “attract non-traditional and new entrants” to the defense industrial base.
The Pentagon also intends to release a small business strategy this spring to “promote a strong, dynamic, and robust small business industrial base by reducing barriers to entry, increasing small business set-aside competitions, and leveraging small business programs to grow the small business industrial base.”