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Monopoly in Military Expenditures

The defense industry in the US is largely oligopolistic. However, even though there are very few major contractors, they employ numerous subcontractors. This examines how economic and defense spending fluctuations affect the industry on the whole.

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Monopoly In Military Expenditures

The defense industry is largely oligopolistic, with the federal government the sole customer, or "monopsonist" (McConnell, 1991). The industry consists of relatively few very large contractors and many small satellite subcontractors which cluster around them. The business of a contractor in defense work comprises research and development and/or production. The work can vary from exploratory studies, costing thousands of dollars, to extensive production programs involving billions and requiring broad subcontracting arrangements. In practice, the firm that does the research and development often contracts the production work as well.
As much as 75% of the annual dollar value of all prime

Oncethe physical hardware stage is reached, controls become comparativelylight, and the more normal techniques of management are generallyapplicable. In commercially directed research anddevelopment, the goal of any project is anticipated profit, and such firmsspending money on research and development undertake some element of risk.This is not the case, however, for research and development that has beencontracted by the federal government. Consequently, the federal government tries tomaintain such organizations in place to the extent feasible by encouragingmergers and consolidations when prudent, by distributing contracts aswidely as possible, and by encouraging conversion to civilian production.Such policies promise to accelerate and intensify as the defense budgetgradually shrinks due to the end of the Cold War. In such a system, for instance, a contractorcould bid $1 million dollars for a given job, and expect to receive $7 , in profits. Monopoly In Military Expenditures The defense industry is largely oligopolistic, with the federalgovernment the sole customer, or "monopsonist" (McConnell, 1991). Large defense firms are less susceptible to failure than are smallerones (Kuttner, 1991). For large contractors, industry entry and exitare quite difficult. Almost any firmwith a desirable product, technical capability, and a reliable financialstanding can get government support. An exception to this is when thegovernment hedges, and extends a backup contract to a second source. Larger firmsfrequently absorb or merge with them, continuing them as operatingsubsidiaries. The level of complexity in program management diminishes throughsubsequent stages of research, development, and hardware. Even in times ofdeclining defense contract needs, the government must support defense firmsto some extent. Thisis rarely done, however, and is only an effective measure in the initialstages of a project. The development phase isslightly more tangible and predictable. Most of the problemsin the industry-government relationship occur in the initial, ordefinitive, stages of the program and in the necessity of working outmutually satisfactory relationships between supplier and customer. Inaddition, patent laws also restrict the free flow of information in thedefense industry. The product of the industry is technology, and dynamic technology makesfor a volatile market. The industry is comprised of numerous small tomedium firms which have split off from larger ones, or have been formed toexploit an area in response to a government requirement. So,especially in an era of declining defense needs, the industry mustdownsize, diversify, or merge. BibliographyByrns, R. Thesecompanies are extremely vulnerable because technological shifts can quicklyeliminate their market. Programs can also be cancelled due to unsatisfactoryperformance, shifts in mission, technological obsolescence, and costconsiderations, among other reasons. In a study done by the National Aeronautics andSpace Administration (NASA), it was concluded that the transfer oftechnology from missiles and space programs to the civilian sector of theeconomy, though the direct adoption of products has been relativelyinsignificant. This profit margin is determined by the government's policy of "costplus fixed fee" contracts. Finally, production involveslearning curves with respect to costing, so that phase tends to be the mostpredictable of the three. Often a screening process is undertaken to narrow the possiblesources to two or three. Such companies must have a vast investment of assetsin the form of plants, equipment, and skilled personnel which the USmilitary depends on. The End of Laissez Faire. The work can vary from exploratory studies, costing thousandsof dollars, to extensive production programs involving billions andrequiring broad subcontracting arrangements. Contractors have often purposelyunderbid and underestimated time and cost requirements because they realizethat once the bid is submitted, the direct competition is over. On theother hand, if the work is completed for less than the bid amount, thecontractor must return the unused portion of the bid amount, but retainsthe fixed fee, which increases the profit margin. However, if actual costs go beyond the original bid --something that happens all too frequently -- the government can review theprogram and allow overrun funds to cover the deficiency. Large defense firms seeking diversification are constantly looking forcompanies with technological skill, a proprietary idea, or a profitablecontract (Kuttner, 1991). On the other hand, if the practiceleads to increasing the minimum viable size for entering firms in theindustry, that can lead to technological stagnation and discourageinnovation by small companies. (It may be argued, however,that within the government market there is inter-agency and inter-servicecompetition for contracted services and products that creates anenvironment that is more like the free market than a single buyer market.)Prices are thus determined after cost estimates and inflation, and includethe profit margin that has been designated by the government. Even so, theprofit margin will remain at 7% of the original bid, and thus thecontractor will receive less than 7% of the actual total costs. Heath. In such cases, if there is no significantcommitment of government resources, it is often economically expedient todiscontinue operations or be absorbed by a larger company. Assuch, there is an absence of product precedent and competition, andtherefore, no basis by which to set prices. Theindustry consists of relatively few very large contractors and many smallsatellite subcontractors which cluster around them. In the preliminary stages, before a program isdefinitively submitted, a project may be approached in several ways.Competition may be based on design, program feasibility, time, technicalcapability, price, and management. Unfortunately, costunder runs are exceptionally rare, and cost overruns are exceptionallycommon. Initially, competition can be extremelykeen. As much as 75% of the annual dollar value of all prime militarycontracts -- those awarded directly by the government -- are awarded toless than one hundred companies. American Government. TheNASA study identified six types civilian benefits of missile-spaceprograms: 1) the stimulation of basic and applied research; 2) thedevelopment of new processes or techniques; 3) the improvement of existingproducts; 4) the increased availability of materials; 5) the development ofnew products; and, 6)cost reduction. In the long run, this approach is moreeconomical and manageable, and creates a more realistic balance betweengovernment commitment and business. The most difficult phase of any contract isresearch, because it is the least tangible. In fact, this has been apattern in much of US industry in general, as can be seen by the union ofRCA and GE in the electrical field. The business of acontractor in defense work comprises research and development and/orproduction. When military spending is onthe decline, as it is currently, the larger companies tend to reducesubcontracting in order to increase in-house work; this enables them tomaintain their staffing and facility levels at the same level, even thoughthe overall output required of the company has been reduced. This is because the issue of national security isinvolved, and also because new companies that can handle the government'sdefense needs are not easily formed (Kuttner, 1991). (1982). Many variations of such arrangements arebeing used; they generally relate to time and level of technicalaccomplishments. Work performed by defense firms often has little or no immediatecommercial application, and yet much of it ultimately results in commercialproducts (Kuttner, 1991). In practice, the firm thatdoes the research and development often contracts the production work aswell. There are many small essentially one-product firmswhere the work is limited to narrow technological boundaries. In contrast, inthe commercial market, the need for extensive research and developmentconstitutes a severe entry barrier. Lexington, MA: D.C. Economics. Such incentive provisions are tailored to the type ofwork being undertaken. Often, moreeffort is concentrated on research, with lessening government support inadvanced development and the production of hardware. NY: Knopf.McConnel, C. In addition, security restrictionsprevent widespread dissemination of many categories of information. (1991). The solution has been a seriesof mergers and consolidations of the larger firms, like McDonnell andDouglas, and Lockheed and Martin Marietta. (1987). Even though the government usuallystipulates subcontracting provisions in such prime contracts, the smallsupporting firms are more vulnerable to fluctuations in the defense marketthan the principle concerns (Byrns, 1987). The defense industry exemplifies an oligopolistic industry of a fewlarge prime contractors, supported by many small high-tech and/orspecialized subcontractors. But the defense industry has built up tremendous productioncapabilities, and unless it diversifies into commercial areas, thesefacilities will not be utilized to capacity (Kuttner, 1991). Afterresearch and development have started, it is extremely difficult to shiftthe project to another firm because of the time lost, the technologicaltransfer loss, and the termination costs. A negative aspect of this market, especially for larger defense firms,is the difficulty involved in exiting from the industry. Despite the oligopolistic nature of the defense industry, it isrelatively easy to enter it, especially as a subcontractor (Kuttner, 1991). NY: McGraw Hill.Wilson, J. The federal government guarantees a"fair and reasonable" profit for contracted research and development.Furthermore, the government is the sole buyer and user of the products thatare created -- the government alone decides what and how much to buy. To a large extent, the governmentunderwrites risk, and thus provides a reasonable probability of profits.In addition, with the government as the buyer, market and distributionchannels do not need to be developed to sell the product. Economics. The smaller firms willfollow much the same path; they will either be acquired by biggercompanies, convert to civilian products, or go out of business altogether.While certain patterns are evident, the most conclusive thing that can besaid about the defense industry as a whole, is that it is in a state offlux. (1983). In many prime defense contracts, research and development is theprimary element (Wilson, 1983). Most small defense firms are technically sound,but suffer from financial or managerial inadequacies. However, the indirect benefits are quite significant. Glenview, IL: Scott Foresman.Kuttner, R. Competition in the defense industry is limited to the bidding orproposal stage (Kuttner, 1991). The appropriateextent of federal backing for these companies is ultimately resolved bydetermining the level of desirable defense effort; due to the end of theCold War with the ex-Soviet Union, that level is gradually declining.However, elasticity must be built into the support and personnelcapabilities of the organizations so that they can respond to emergencysituations, such as the Gulf War with Iraq. In recent years, the government has been phasing out the "cost plusfixed fee" contract in favor of those that carry incentive payments basedon performance (Wilson, 1983). It further suggested thattechnological fallout could be accelerated if it were not for the lack ofinformation flow between defense organizations; most consider theirfindings proprietary, and do not publicize results until they are ready toreap commercial benefits from them.

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