Unintended Consequences of the Information Economy II

In "Unintended Consequences of the Information Economy" (2014) I cited an article in Foreign Affairs (2014), the journal of the Council on Foreign Relations, by former Deputy Secretary of Defense William Lynn. He talked in part about how companies in the technology sector typically invest far more of their revenue in research and development than do the handful of prime defense contractors in the United States.

What I didn't mention is how we arrived at the situation we currently find ourselves in: with just handful of big prime defense contractors.

In 1993, during the Clinton administration, then-Deputy Secretary of Defense William Perry convened defense industry executives into a meeting that came to be called "The Last Supper". He informed them that due to a huge reduction in the defense budget, there would have to be a consolidation of the defense industry.

John Mintz wrote about this and its consequences in "How a Dinner Led To A Feeding Frenzy" in the Washington Post (1997).

Perry's warnings helped set off one of the fastest transformations of any modern U.S. industry, as about a dozen leading American military contractors folded into only four. And soon it's likely only three will remain, with Lockheed Martin Corp.'s announcement yesterday that it plans to buy Northrop Grumman Corp. for $11.6 billion.

The unintended side-effect of the consolidation of the defense industry into just a handful of prime contractors was that there is now far less competition in the defense sector. If the Pentagon wants to buy a new major weapons system, there may only be a single contractor capable of delivering it.

Since this happened, the U.S. Departments of Defense and Justice and the Federal Trade Commission have tried to reverse this process by opposing further mergers in the defense industry.

John Deutch, also a former Deputy Secretary of Defense as well as Director of Central Intelligence, argued, in "Consolidation of the U.S. Defense Industrial Base", published by the Defense Acquisition University's Acquisition Review Quarterly (2001), that the consolidation also led to far less stability in the companies that did survive this process

In the 1993–1998 period of euphoria, defense companies experienced significant increases in equity prices based on the expectation of revenue growth and margin improvement from cost savings. In 1998, the outlook for the industry began to darken for several reasons. First, DoD reversed the consolidation policy. Second, expected cost savings were not shared with the companies, and hence margins were squeezed, especially from increasing interest payments on debt required to fund acquisitions. Third, defense companies making acquisitions were overly optimistic about the expected growth in top-line revenues from DoD, foreign military sales, and commercial spin-offs of defense technology. The anticipated increase in defense outlays had not materialized.

Finally, some key companies found it difficult to manage their expanded enterprises effectively in all respects and to meet their optimistic financial targets. The capital markets quickly shifted to more glamorous (at that time) dot.com and high-tech stocks not associated with defense.

My tiny one-man corporation has done its share of government contracting over the years, but always as a subcontractor to a far larger organization that had all the infrastructure, people, and processes in place to deal with the federal bureaucracy. The overhead involved is a significant barrier to entry for smaller organizations. And, remarkably, to larger organizations.

In my original article cited above, I related the story of Boston Dynamics, the spin-off of MIT that designs the human- and dog-shaped robots we all watch on YouTube. After the Defense Advanced Research Projects Agency (DARPA) poured a bunch of funding into the company, it was bought by Google in 2013, who basically said “thanks, but no thanks” to any further DoD involvement. Google went on to sell Boston Dynamics to a Japanese company, which in turn sold it to a South Korean company. All that government funding resulted in intellectual property that didn’t even stay in the United States, much less in the DoD. Many large tech firms have big revenue streams that for the most part don’t rely on the U.S. government; there are easier ways to make (lots more) money in the commercial sector.

This leaves much of the technology needs of the U.S. government in the hands of just a few big prime defense contractors.

In a recent edition of his newsletter "The Embedded Muse", embedded software and hardware technology pundit Jack Ganssle mentions that the Biden White House has issued an "Executive Order on Improving the Nation's Cybersecurity". Jack writes:

Uh oh. Do you sell to the US government? Since they buy pretty much everything, pretty much everyone does. A new executive order re security will make our lives much, much harder. Though the details are still being fleshed out, a pretty good overview here will raise your blood pressure. 

Jack references an article by a vendor who is, of course, trying to sell you something, but is none the less a pretty good overview of the EO. From that sales pitch:

This EO directs these agencies to develop new security requirements for software vendors selling into the U.S. government. These requirements will be incorporated into federal contracts for commercial software and hardware with the intent of imposing “more rigorous and predictable mechanisms for ensuring that products function securely, and as intended.”  This is a monumental shift that will have an immediate impact on global software development processes and lifecycles.

In addition to  a host of new information and operational security measures that government agencies need to implement, the new order establishes a robust approach to supply chain security. The new requirements will include security testing throughout the development process as well as a Software Bill of Materials (SBOM) to address security issues in open source components.

I expect this EO to be a huge boon for the few existing big prime defense contractors, while preventing the small-to-medium, and even large, tech companies from participating in providing innovative technology solutions to the federal government.

As both a software engineer and a taxpayer with many decades of experience doing both, I have very mixed feelings about this. I can appreciate the need to make sure that our tax dollars aren’t wasted, that expenditures are all accounted for, and that the products our government purchases are reliable and secure. But I feel pretty confident in predicting that it will mostly mean that giants like Raytheon and Lockheed-Martin will do well.