Defense industry consolidation geared up well before the “Last Supper”

The end of the Cold War and the “Last Supper,” where defense officials actively encouraged mergers between contracts, are often credited with the major consolidation seen today in the defense industry. But in reality, it was merely an accelerant to a longer-term trend. Even during the upswing in defense budgets in the 1980s, the markets were rewarding companies for exiting or siloing their government businesses. Here’s some discussion from Barry Watt’s excellent 2008 paper, The US Defense Industrial Base.

Companies increasingly recognized that non-defense markets — which were growing, exploited technologies to develop new products, produced better financial rewards and served customers with less monopsonistic power — provided more at-tractive alternatives to their defense businesses. One result of these perceptions was industry consolidation. During 1985–1988 ten of DoD’s top sixty prime defense con-tractors either acquired, or were acquired by, others in the industry.

 

It is notable that these major changes in the defense industry predated the collapse of the Soviet Union. In spite of the continued importance of the USSR as the major military competitor, by the mid-1980s many corporations appear to have concluded that selling to the government was so much in conflict with their responsibilities to their shareholders that their defense businesses should be divested or isolated with-in their portfolio.

 

…. Declining sales, difficulties in managing profitability and the transfer of more and more risk to defense firms combined to undermine the value of defense firms on Wall Street. In 1988, for example, a Defense Science Board study included the following observations: “Investors believe that defense industries operate in a highly unstable and excessively complex business environment characterized by high risk, restricted cash flow, and low returns. Investors’ skepticism has caused a virtual closure of the equity and debt markets to all but a few major contractors.”

I think that term “monopsonistic power,” where a single-customer controls the entire demand of an industry, really is at the root of macro trends. Companies react to the incentives presented to it, as do their investors.