DEFENSE DEPARTMENT
Defense Market Facing Major Transformation
12/1/2016
By Jon Harper
By Jon Harper

Photo: Jon Harper
Multiple factors are set to compel a major transformation in the makeup of the defense market in the coming years, according to an industry executive who previously held the number two position at the Pentagon.Since the outset of World War II, the U.S. defense industry has undergone two major pivots, said William Lynn, a former deputy secretary of defense, who is now CEO of Leonardo North America and DRS Technologies Inc.
The first occurred when the United States moved from a government-run arsenal system to one where the defense industry comprised large conglomerate manufacturing companies that had defense-focused divisions such as General Motors, IBM and GE, he said.
The second one followed the famous “Last Supper” at the end of the Cold War when then-Secretary of Defense William Perry gathered defense industry leaders and told them that the Pentagon no longer had the capacity to support the breadth of industry that existed at the time, Lynn noted.
“We ended up with the structure we have today which moved really from conglomerates to specialists,” Lynn said Dec. 1 during a panel discussion at the Center for Strategic and International Studies.
For most of the major defense industry players today, 60 to 80 percent of their revenue comes from defense, he added. “We’ve gone from 40 or 50 major players of size in the defense market to a half a dozen.”
Another major sea change is on the horizon, he argued. “We’re at the cusp of a third pivot in terms of the structure of that market,” he said. Several trends will drive the transformation, according to Lynn. One is consolidation.
“At the platform level, the numbers of major platforms that the department is buying is getting narrower and narrower,” he said. “As a consequence, the number of competitors in that space is narrowing down to two and in some cases one” company.
There is only one prime contractor that builds aircraft carriers, and only two that build the Navy’s submarines, he noted.
“Tactical aircraft is moving in that direction,” he said. “You still have Boeing and Lockheed but at some point we will stop making … [Boeings] F-18s and F-15s and we’ll center on the [Lockheed-built] F-35. How do you keep a competitive structure in that?”
A second driver of change is the internationalization of the industrial base.
“You see it very definitely now in terms of the supply base of all of the major defense companies,” Lynn said. “It’s a global supply base, whereas if you look even 20 years ago it was heavily an American supply base. And now it’s very global [and] they go for the best technology, the best prices. I would argue that that’s going to start to shift to the prime level as well, and it has already started.”
The third and perhaps the most important force leading toward another structural change is the source of technology, he said. In previous decades, research-and-development spending by the Defense Department was a key driver of innovation that later spilled over into the commercial sector, he noted, citing the development of GPS and the internet as examples.
But today, much of the cutting-edge innovation is happening outside of the Pentagon and the federal government including areas such as 3D printing, autonomy, material science and nanotechnology, Lynn said.
“The weight of the R&D is more on the commercial side. And so one of the big challenges for defense is how do you pull that technology now into the defense industrial base and operationalize it for military uses?” he said. “It’s a different model.”
“All of those forces are pushing us toward a different type of defense structure. I think the most important thing for the new [Donald Trump] administration is to think about how they want to shape it,” he added.
The new Pentagon leadership needs to focus on improving the agility of the acquisition system and incentivizing R&D spending, Lynn argued. The uncertainty surrounding the defense budget in recent years is making it difficult to do the latter, he said.
“It’s very hard to ask companies to make significant investment in R&D if they don’t know what the department is going to buy even 18 months from now,” he said.
Embracing the commercial sector will also be critical, he noted.
“Probably the most important [question is] … how do you have a structure that allows defense companies to import commercial technologies or allows commercial companies to compete directly?” Lynn said. “The department I think has a strong interest in making sure that the defense market is permeable to those commercial structures.”
Topics: Budget, Business Trends, Defense Department, Defense Contracting
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