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 August 2015 

Gen Craig R. McKinley, USAF (Ret)

Realities of the Defense Industrial Base

August 2015

by Gen Craig R. McKinley, USAF (Ret)

 

In my first column in April, I made reference to President Eisenhower’s 1961 farewell address that coined the phrase “military-industrial-complex.” What the president was describing in 1961 was true. Because of the Cold War, the nation had developed a large military industrial base, and it had significantly shifted its ownership from the public to the private sector. 

I pointed out that while the notion of a large defense industrial base persists, the reality is much different, and policymakers in the government must focus on this reality rather than the outdated image.

A former senior Defense Department official recently noted that in his view, not only were most policymakers unaware of how compact the contemporary defense industrial base had become, but most thought it was “bigger than ever.” There are, of course, numerous ways that one can measure size, and comparisons over a lengthy time frame are always heavily dependent on economic data conversions, but it might be worth considering a rather direct comparison using a well-known and nationally noted database.

Fortune Magazine recently released its annual “Fortune 500,” the listing of the top companies and corporations in the United States. It tells an interesting story about the shape and size of the defense industry over time.

Just to establish some broad context, the companies on the Fortune 500 generate about $12 trillion in annual revenue. In other words, they account for about two-thirds of the U.S. GDP. The top 100 companies on the list — led by Wal-Mart — comprise more than 60 percent of this $12 trillion. The question is, how many defense companies are there and how have they fared over time?

In 1961, there were 16 aerospace and defense companies in the Fortune 100. Today there are four, and only 11 in the entire Fortune 500. Of those four, the highest ranked at 27 is Boeing, followed by United Technologies Corp. at number 45, Lockheed Martin at number 64, and General Dynamics at number 100. Combined, these companies have annual revenue that is less than 3 percent of the top 100, and less than half of Wal-Mart standing alone.

This may paint a rather somber picture, suggesting the diminished size of the defense industrial base. However, there is a more positive picture than actual circumstances suggest, for two reasons.

First, in 1961 General Dynamics was the largest of the defense firms and ranked number 15 on the Fortune 100. So although still one of the widely acknowledged “top tier” defense firms, its decline to last place on the Top 100 listing is notable.

Which leads to the second observation. For GD, about 20 percent of its annual revenue is generated by its Gulfstream aerospace division, which produces high-end business jets for the commercial market. In addition, Gulfstream is its most profitable business unit. For Boeing, two-thirds of its annual revenue comes from the Boeing Commercial Aircraft division, a segment of its business that has grown enormously over the past five years, while its defense segment has been relatively flat.

United Technologies’ business is only about 20 percent defense, primarily consisting of the Sikorsky division that makes military helicopters. The company has announced that it will divest this division because of low margins and low growth prospects.

When one removes the commercial components of these four firms, the annual revenue produced by their defense units alone makes their percentage of the top 100 go from less than 3 percent to less than 1.5 percent. This certainly does not merit categorization as a “complex.”

In the Fortune 100, does there exist some sort of complex? That would, of course, largely be in the eye of the beholder, but nearly two-thirds of the companies in the top 100 fall into four broad categories: healthcare and pharmaceuticals; financials and insurance; petroleum and chemicals; and information technology. Former Deputy Defense Secretary William J. Lynn recently noted that Apple — number five on the Fortune 100 — could buy the majority of the top defense firms with cash on hand.

What message should be taken from all this? Policymakers need to understand that the defense industrial base is no longer the major presence in the U.S. economy that it once was, and no longer contains the large number of firms it once did.

The Defense Department is always interested in two things from its defense industrial base: innovation and cost control. The member companies of NDIA share those goals. But, in economic terms, both of these desirable items are largely a function of competition, which is itself a function of the number of firms in the marketplace. However, if the number of firms continues to decline — as they clearly have over the past 50 years — and they continue with decisions such as United Technologies’ to largely exit the market, then innovation and cost control inevitably become more difficult.

This suggests that Pentagon policymakers need to give clear-eyed consideration to factors that encourage companies to enter rather than exit the defense marketplace. With the growing challenges in the strategic environment, it is imperative that they do so.

 Please e-mail your comments to cmcKinley@ndia.org.

 

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