Former SecDef Perry: Defense Industry Consolidation Has Turned Out Badly

The architect of the post-Cold War consolidation of the defense industry believes that, in hindsight, the Pentagon paid a huge price for allowing top weapons manufacturers to merge into a handful of huge companies.

William J. Perry, secretary of defense during the Clinton administration, gained legendary status in the defense industry for having hosted the so-called “last supper” in the fall of 1993 — when he was deputy defense secretary. That evening, Perry assembled top industry CEOs and alerted them that military spending was about to plummet and the Pentagon would no longer be able to support such a large industry.

Perry’s warning set off an unprecedented wave of mergers and acquisitions in the defense industry. Dozens of prime contractors merged or were absorbed into mega-corporations. And many commercial companies that owned defense-focused businesses sold them off.

The end result was an “unnecessary, undesirable consolidation of the defense industry,” Perry said Dec. 3 during a breakfast meeting with reporters in Washington, D.C.

Perry is in town promoting his book, “My Journey at the Nuclear Brink,” which tells the story of his coming of age in the nuclear era and how his thinking has changed about the threats.

In his retrospection about the last supper, Perry recalled that the intent clearly was to help the Pentagon reduce the cost of weapons by compelling the industry to become leaner. But the opposite effect ensued, he said, as the industry became less competitive and continued to charge high overhead rates.

“The response we were seeking was a reduction in overhead,” Perry said. “What we got was the consolidation of the defense industry — few large companies, and less effective competition. … We got some of the things we asked for but also some things we didn’t ask for,” he added. “We would have been better off with more, smaller firms than with a few large ones.”

Perry pointed out that the phrase “last supper” to describe his meeting with with executives was coined by then CEO of Martin Marietta Norm Augustine, who stood next to him at the gathering.

“Augustine turned to the man on his right, and the one on his left and said, ‘One of us is not going to be here next year.’” Sure enough, within a year, Martin Marietta had merged with Lockheed to create the world’s largest defense contractor Lockheed Martin.

The Pentagon should be careful about allowing further consolidation, Perry said. “We are still going to face declining defense budgets for acquisition, but the way to respond, I think, is not by allowing defense companies to charge more overhead.” Perry suggests the Pentagon should put more pressure on companies to operate more efficiently. “We would hope we are not going to encourage more industry consolidation, because that would be moving in the wrong direction. We should learn that lesson from the 1990s.”

The Pentagon should be “more explicit in the kind of guidance we give to companies,” he said. Contractors should shrink overhead but that should not come at the expense of competition, Perry said.
Perry’s observations come at a time of growing angst at the Defense Department about industry mergers. Most recently, Undersecretary of Defense for Acquisition, Technology and Logistics Frank Kendall criticized Lockheed Martin's acquisition of helicopter manufacturer Sikorsky Aircraft. Kendall lamented the lack of legal means available to the Pentagon to prevent such deals. “The Department of Defense is concerned about the continuing march toward greater consolidation in the defense industry," he said. "The trend toward fewer and larger prime contractors has the potential to affect innovation, limit the supply base, pose entry barriers to small, medium and large businesses, and ultimately reduce competition — resulting in higher prices to be paid by the American taxpayer.”

Topics: Business Trends, Mergers and Acquisitions, Procurement