oversight

Defense Industry: Trends in DOD Spending, Industrial Productivity, and Competition

Published by the Government Accountability Office on 1997-01-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States General Accounting Office

GAO             Report to Congressional Requesters




January 1997
                DEFENSE INDUSTRY
                Trends in DOD
                Spending, Industrial
                Productivity, and
                Competition




GAO/PEMD-97-3
             United States
GAO          General Accounting Office
             Washington, D.C. 20548

             Program Evaluation and
             Methodology Division

             B-265618

             January 31, 1997

             The Honorable William V. Roth
             Chairman, Committee on Finance
             United States Senate

             The Honorable Charles E. Grassley
             United States Senate

             The end of the Cold War marked the continuation of a decline in most DOD
             appropriations accounts from the peaks of the 1980s. Declines in
             Department of Defense (DOD) spending for procurement and research,
             development, test, and evaluation (RDT&E) have some effect on the broad
             industries that manufacture and produce weapons for DOD. The impact of
             declines in defense spending has been the focus of congressional and
             executive branch initiatives and programs designed to help communities,
             businesses, and workers adjust to the post-Cold War funding drawdown.

             You asked us to examine several issues about defense spending and
             defense industry since the end of the Cold War. In this regard, you asked
             us to conduct a broad review of productivity and competition in the
             defense industrial base. In this report, we describe (1) overall trends in
             productivity, competition, and other financial indicators in the defense
             industry over time, where possible, and (2) the relationship between these
             trends and indicators of defense spending over time, where possible.


             Victory in the Cold War brought changes in the size and resources
Background   available to today’s armed forces. A decline in DOD budgets has been a
             trend since the mid-1980’s peak in defense budgets. Since the collapse of
             the Soviet Union, the range of public and private businesses, departments,
             or facilities that work in the interests of U.S. national security operate in a
             defense environment different from the past, where defense policy has
             changed accordingly.

             DOD  is buying and developing fewer types of military systems and
             purchasing smaller quantities of the systems it does buy. Weapons
             purchased today have gained from considerable military and technological
             advances made over time. In constant dollars, DOD procurement outlays in
             fiscal year 1995 were 52 percent smaller than 1987 levels—the highest
             level since 1946. This has an effect on the defense industrial base
             (DIB)—industries that supply, manufacture, or assemble aircraft, ships,




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missiles, tanks, ammunition, weapons, and electronics and
communications equipment for national defense purposes. In fiscal year
1995, DOD procurement outlays were $55.1 billion and defense-related
industry employment was approximately 2.3 million.

As companies develop and implement strategies for survival in the new
spending environment, the Congress and the executive branch have
considered the balance between market forces that influence the structure
of the defense industrial base and the federal government’s role in
securing and meeting the nation’s defense needs. For example, DOD’s
Bottom Up Review (BUR) was designed to define the nation’s defense
strategy, force structure, modernization and infrastructure requirements
as a result of the end of the Cold War. Promoting a more efficient
post-Cold War defense industrial base is a goal of initiatives to reform
DOD’s weapons acquisition process.


While many of DOD’s recent acquisition reform efforts were embodied in
the Federal Acquisition Streamlining Act (FASA) of 1994, DOD has made
other efforts to adapt to the post-Cold War period of smaller procurement
budgets, shrinking defense industry, and increased international
competitiveness.1 In 1994, DOD set up groups to identify, coordinate, or
implement process improvements to reduce “cost drivers” believed to
cause increases in the price DOD pays for goods and services.2 DOD’s
initiatives to aggressively pursue acquisition reform include the
elimination of some military standards and requirements, adopting
commercial practices, and the use of Integrated Product Teams (IPTs) to
continuously include government and industry stakeholders in making
program and business decisions.

A large-scale post-Cold War transition assistance program, authorized
under the National Defense Authorization Act for fiscal year 1994, and
announced in March 1993 by the executive branch, is the Defense
Reinvestment and Conversion Initiative. The initiative included funding for
(1) worker training and adjustment, (2) investments in hard-hit
communities, (3) dual-use technology and commercial integration, and
(4) conversion opportunities in new civilian technology investment. In


1
 DOD’s Defense Acquisition Pilot Programs—which include the Fire Support Combined Arms Tactical
Trainer, the Joint Direct Attack Munition (JDAM), the Joint Primary Aircraft Training System (JPATS),
the Commercial Derivative Aircraft (also known as the Non-Developmental Airlift Aircraft), and the
Commercial Derivative Engine (F-117 Engine)—are examples of programs authorized under FASA.
2
See U.S. General Accounting Office, Acquisition Reform: Efforts to Reduce the Cost to Manage and
Oversee DOD Contracts, GAO/NSIAD-96-106 (Washington, D.C.: April 1996).



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                   fiscal year 1994, the Congress appropriated $2.5 billion for DOD’s defense
                   reinvestment and conversion program.

                   As described above, a number of issues have been addressed through
                   programs or legislation directed to assist the transition of the defense
                   industrial base in the post-Cold War era. In your request, you asked for
                   information on productivity and competition in the defense industrial
                   base. In this report, we describe the trends in available data on
                   productivity and competition and the related issues of trends in defense
                   industry employment, the status of major defense contractors in the
                   post-Cold War, and trends in defense budgets and outlays. We make use of
                   existing statistical information and supplement these data with
                   information collected from industry experts and defense contractors. This
                   work makes use of findings from studies, now just beginning to emerge,
                   that examine the industrial, economic, and national security implications
                   associated with the post-Cold War drawdown and conducted or sponsored
                   by DOD, as well as private research organizations or groups. We present a
                   broad historical overview of data about the defense industry to provide a
                   context for the significant changes that the defense industry has faced in
                   the post-Cold War period.


                   The size and nature of the defense industrial base is critically shaped by
Results in Brief   the amount and emphasis of U.S. defense outlays. Recent debate has
                   centered on the effect of the post-Cold War reduction in defense spending
                   and its effect on the viability of the industrial base. Although this
                   downward trend in budget outlays and particularly in procurement
                   spending is sizable, it is one of four times in post-World War II history that
                   the industrial base has had to adjust to changes in national security
                   requirements. In historical perspective, defense funding drawdowns are
                   not unique.

                   With regard to trends in the actual expenditures in segments of the
                   defense industrial base, after adjustments for inflation, recent spending on
                   procurement and RDT&E prime contract awards is similar to spending just
                   prior to the peacetime defense buildup of the early 1980s. Over the last 20
                   years, DOD has consistently allocated more money for procurement and
                   research of aerospace products—aircraft, missiles, and electronics and
                   communications equipment—than for tanks, ships, ammunition, and other
                   weapons. Aggregate procurement and RDT&E contracts for aerospace
                   products out-paced spending for all other equipment by over 3 to 1. Since
                   the end of the Cold War, prime contract dollars for aircraft research and



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development have increased and dollars for aircraft procurement have
declined the least. The available data did not allow us to determine the
distribution of spending across industrial segments based on subcontract
award activity; rather, they allowed us to determine such information only
for prime contracts. The available data on subcontract awards indicate
that dollars allocated to businesses through DOD’s mandatory
subcontractor program began to decline after the Cold War and are
currently below the average of the last 18 years.

Aside from outlays there are other differences in today’s industrial base
compared to past periods. Today’s weapons cost more than in the past, so
fewer can be procured as defense budgets decline. Changes in complexity
and sophistication of today’s weapons, and costs associated with related
weapons manufacturing processes, have contributed to this trend. DOD and
Department of Labor (DOL) data on productivity in defense-concentrated
industries, and other studies on productivity, indicate that the value of
output has increased over time while the quantity of output has decreased.
In particular, comparative data for military aircraft show that the 1993
inflation-adjusted budgets for aircraft procurement were more than double
those in 1973, while 65-percent fewer aircraft were produced than in 1973.
Similarly, DOD expects to move from purchasing large quantities of
low-cost helicopters to fewer high-cost, more capable, helicopters. DOD’s
ship and tank procurements also show a trend toward the purchase of
fewer higher-cost units.

The business environment for defense industry has also changed over the
years. Since the end of World War II the number of aircraft contractors
dropped from 26 to 7 in 1994.3 Missile contractors dropped from 22 to 9
and tank contractors from 16 to 2 over the same time period. Recent
defense contractor mergers and acquisitions are seen as a trend that will
perpetuate constraints on the number and nature of businesses that may
be willing and able to compete for business with DOD. These fewer
contractors are operating in an environment where DOD tends to award
more money on weapon procurement contracts using other than full and
open competition. Because of the nature of what DOD buys, substantial
amounts of procurement dollars are associated with single-source
providers. Little is known about how the ongoing reconfiguration of the
defense industrial base will affect or be affected by these trends in DOD
weapon procurement processes. This condition is aggravated by the lack
of data available for comprehensive analyses. There is no single,


3
 Includes helicopter contractors.



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comprehensive source of information about competition in defense
industry. Therefore, we are limited in our ability to address this issue.

Defense industry employment is another key factor affected by changes in
the industrial base. The loss of jobs related to the reduction in defense
budgets is widely documented, although estimates and projections vary.
DOD estimates a 39-percent decrease in defense-related employment
between 1989 and 1997, or 5 percent per year. Jobs have been lost in the
funding drawdown, but job loss does not necessarily equate to
unemployment. Losses can be absorbed as individuals acquire future work
in the same or in different sectors of the economy. The Defense
Conversion Commission reported to DOD that the concept of job loss can
overstate the effect of the post-Cold War drawdown on employment
because it does not account for the ability of the economy to absorb
dislocated workers. The commission estimated that the drawdown will
account for less than 2 percent of all unemployment between 1992 and
1999. The Congressional Budget Office (CBO) reports that overall growth in
the U.S. economy is a greater factor in reemployment for displaced
defense workers than what happens in the defense sector. We found a
correlation, or statistical relationship, between an indicator of
employment in defense-concentrated industrial sectors and an indicator of
procurement outlays in those sectors for the period 1975-91 that is not
large and is less than values considered moderate in size.4 However, the
lack of precise data on defense industry employment, differing procedures
for generating estimates, and the lack of precise figures on DOD spending
linked to defense sectors make it difficult for policymakers to make
definite determinations.

Market forces and expectations about future trends in DOD budgets have
facilitated the restructuring of the defense industrial base. Some
companies have taken action either to remain viable in the defense
business or leave it, while some top defense contractors have remained
profitable and financially stable in a time of reduced spending. Companies
have, among other things, been (1) attempting to gain market share and to
be more competitive for future defense business through mergers and
acquisitions; (2) reorganizing and restructuring internally, in ways that
involve job losses and layoffs, and reconfiguring job duties; (3) reducing
their supplier-subcontractor base; (4) engaging in team concepts or
entering joint ventures in which several firms subcontract with one
another; (5) expanding defense markets to broaden the international

4
 G.V. Glass, and K.D. Hopkins, Statistical Methods in Education and Psychology (New Jersey:
Prentice-Hall, 1984).



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                     customer base and increase sales; and (6) selling the defense business
                     segments that are not core business units or that do not represent niche
                     markets, as well as exiting segments of the defense industry.

                     DOD’s  industrial assessments indicate that companies have been profitable
                     since the funding drawdown and that its needs can be met in the segments
                     it has assessed.5 These assessments do not suggest that the trend toward
                     more mergers and acquisitions and fewer contractors is a liability against
                     maintaining current industrial capabilities. They do suggest that
                     consolidation and other efforts to reduce overcapacity in defense industry
                     may generate cost-savings for DOD. Our review of research from DOD and
                     the private sector and our discussions with industry consultants and
                     defense contractors all suggest that this assumption should continue to be
                     studied, tested, and validated.6

                     For part of its current “Defense Acquisition Reform vision” and under the
                     FASA, DOD has recently engaged and piloted several new acquisition reform
                     programs intended to achieve greater efficiency and value in weapons
                     procurement and to reduce unnecessary costs. These reforms and
                     initiatives focus on the use of commercial practices, changes in the
                     requirements for military standards and specifications, and increased
                     emphasis on the tradeoff between cost and performance increases, among
                     other efforts. Although these efforts are aimed at addressing critical and
                     relevant issues for the defense industrial base, it is too early to tell what
                     their full effects will be.


                     As stated previously, in this report we describe (1) overall trends in
Objectives, Scope,   productivity, competition, and other financial indicators in the defense
and Methodology      industry over time and (2) the relationship between these trends and
                     indicators of defense spending over time. To focus our review of these
                     issues, we developed the following six key questions, which we answer in
                     this report where data allowed us to.

                     1. What are the trends in DOD’s total, procurement, and RDT&E budgets?

                     5
                      DOD’s Office of Industrial Affairs and Installations has assessed and made available to us its
                     conclusions on the following industrial segments: conventional ammunition (September 1994), space
                     launch vehicles (January 1995), helicopters (July 1995), torpedoes (August 1995), tracked combat
                     vehicles (October 1995), and heavy bombers (December 1995). The September 1994 report entitled
                     “Building U.S. Capabilities in Flat Panel Displays” reported on a newly identified industrial segment of
                     important interest. We did not obtain DOD’s assessment of the Meal-Ready-to-Eat segment for this
                     work.
                     6
                      We describe known efforts to study savings associated with industry consolidation toward the end of
                     this report.



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2. What are the trends in the dollar amount of DOD procurement and RDT&E
awards to defense contractors and subcontractors over time?

3. What are the trends in indicators of employment, productivity, and
competition over time?

4. How are employment, productivity, and competition related to
indicators of defense spending?

5. What are the trends in the financial indicators of major defense
contractors over time?

6. What is the relationship between indicators of defense spending and
indicators of the financial status of major defense contractors over time?

The industries in our analysis include U.S. manufacturers of items for
major DOD procurement programs. DOD and other executive agencies have
identified them as “defense-dominated” industries, or industries in which
the output is largely purchased for defense purposes: aircraft, guided
missiles, ammunition and ordnance, tanks, ships, and electronics and
communications equipment. Where the industrial output of these
manufacturing industries is not purchased by DOD, it may be purchased by
commercial companies, other U.S. government agencies, or international
companies.

We designed a macro-level evaluation to describe overall trends and
patterns and to provide a basis for the additional phases of the work that
you requested.7 The highly aggregated nature of much of the existing data
and information about defense industries also in part required that we
adopt a macro-level approach. Since our focus was global, we did not
examine specific disparities, differences, or nuances in the data.8 The
aggregate nature of the data did not permit us to offer definitive
explanations for the trends these data reveal.




7
 In response to your request, we have a second study in progress to compare costs and productivity in
defense and commercial manufacturing sectors.
8
 For example, we calculated statistical correlations to compare trends in employment and productivity
in defense-concentrated industrial sectors to trends in the DOD budgets that are linked to those
sectors. The correlations characterize overall trends. A number of factors may explain any observed
correlation (time lags, idiosyncrasies in specific industries, idiosyncrasies in the data we received from
federal agencies, and others). Examining the range of factors that might explain observed trends or
relationships was beyond the scope of the work we were asked to do.



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                     We collected, integrated, and analyzed published and unpublished data
                     across the period 1975-95 from the executive agencies that maintain
                     information on defense industries—DOD, the Department of Commerce,
                     and DOL.9 This resulted in multiple data sources and multiple measures. We
                     used those that were the most comprehensive with respect to that time
                     period and the aspects of defense industry that we focused on.

                     We interviewed individuals and reviewed studies at Commerce, DOD, and
                     DOL as well as at private research and consulting organizations, Wall Street
                     firms, and major defense contractors. (A list of the offices we contacted is
                     in appendix I.)

                     The measures and data that were available provide a method to describe
                     and illustrate trends and patterns. The information that was available has
                     varying degrees of uncertainty and completeness. Appendix II details our
                     methodology and study limitations and defines our terms and concepts.



Principal Findings

Budget Trends        In order to understand the context for the post-Cold War trend in declining
                     defense budgets, we examined trends in DOD budgets over the past 50
                     years. The recent downturn in defense budgets is the fourth in 50 years.
                     The three prior funding drawdowns came at the ends of World War II, the
                     Korean War, and the Vietnam War. This fourth one follows the peacetime
                     defense buildup of the early 1980s. Figure 1 shows DOD’s 1945-95 total,
                     procurement, and RDT&E budgets.




                     9
                      In answering question 1, we used DOD budget data going back to 1945.



                     Page 8                                                GAO/PEMD-97-3 Defense Industry Trends
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Figure 1: DOD’s Total, Procurement, and RDT&E Budgets, 1945-95a


FY 1995 $ (billions)
$1,000




                       World War II
 $800




 $600
                                                                                                Reagan
                                 Korean War                       Viet Nam                      Administration

 $400




 $200




    $0
         1945            1950         1955    1960   1965          1970       1975       1980        1985        1990        1995

                                                       Total   Procurement RDT&E




                                                     a
                                                       Dollars are for total obligational authority. Total budget also includes military pay, operations and
                                                     maintenance, military construction, family housing, and revolving and management funds.


                                                     Average post-Cold War (1990-95) procurement outlays are 10 percent
                                                     higher than average Cold War outlays (1947-89). DOD’s yearly average
                                                     procurement outlays were $69.3 billion during the Cold War; since the
                                                     collapse of the Soviet Union, they have been $76.3 billion. Since 1990,
                                                     average yearly RDT&E outlays have been $38.5 billion, compared to the
                                                     average $24.3 billion from 1947 to 1989.

                                                     Because defense industry is most concerned with DOD’s procurement
                                                     budget, as it includes the purchase of weapon systems, we focus on broad
                                                     trends in procurement budgets specifically. The greatest 1-year percentage
                                                     decline in the procurement budget’s growth was the 80-percent decline in
                                                     1945, following World War II. The greatest increase was the 372-percent
                                                     increase in 1951, preceding the Korean War. These periods represent the




                                                     Page 9                                                    GAO/PEMD-97-3 Defense Industry Trends
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                                        most extreme past cases of growth increase and decrease. In post-World
                                        War II history, the period 1985-95 represents the longest consistent decline
                                        in the procurement budget. However, this period of decline includes fiscal
                                        year 1987, a year marked by the highest procurement outlays since the
                                        Korean War.10 Figure 2 shows the yearly percentage growth or decrease in
                                        DOD’s procurement budget throughout the past 50 years.




Figure 2: Yearly Percentage Growth and Decrease in DOD’s Defense Procurement Budget, 1945-95a

% real growth
400




300




200




100




   0




-100
       1945     1950   1955    1960     1965           1970        1975         1980    1985      1990        1995

                                        a
                                            Dollars are total obligational authority.




Trends in Contract Awards               Examining trends in procurement and RDT&E contract awards indicates
                                        DOD’s spending within industry segments. These data show where DOD’s
                                        procurement and RDT&E dollars have gone in the past. They also provide an
                                        indication of the industry segments that have experienced the most


                                        10
                                         After 1995, further decline in procurement is not projected for the out years. DOD’s future-years
                                        defense plan (FYDP) projects procurement increases to at least 1999.



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                                                                  funding decline in DOD post-Cold War contract dollars. In the past 20 years,
                                                                  DOD has spent more in procuring aircraft, guided missiles, and electronics
                                                                  and communications equipment than in procuring other major hard goods
                                                                  for national defense.11 (See figure 3.) In particular, expenditures for
                                                                  aircraft exceeded all others during the period.



Figure 3: DOD’s Procurement Contract Awards by Major Program, 1975-94

FY 1995 $ (billions)
$50




$40




$30




$20




$10




 $0
      1975     1976    1977   1978   1979   1980   1981    1982        1983   1984   1985   1986   1987   1988    1989   1990   1991   1992   1993   1994

                                               Aircraft Elec.-Comm. Missiles     Tanks   Weapons Ammunition   Ships




                                                                  DOD’s 1975-94 prime contract awards for aircraft, missiles, and electronics
                                                                  and communications equipment show a trend in which spending exceeded
                                                                  that on other weapon systems. Figure 3 shows that aggregate procurement
                                                                  spending on aerospace products has been 65 percent greater since 1975




                                                                  11
                                                                    Major hard goods are aircraft, missiles and space systems, ships, tanks and automotive, weapons,
                                                                  ammunition, and electronics and communications equipment (these are detailed in appendix II, table
                                                                  II.1, by DOD claimant program).



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    than the cumulative spending on ships, tanks, weapons, and ammunition.12
    Contract awards for missiles, electronics and communications equipment,
    and especially aircraft peaked in the 1980s. While their levels have since
    fallen, DOD’s constant dollar spending for aircraft, missiles, and electronics
    and communications equipment, and for most other major hard goods, is
    the same or nearly the same as just prior to the peacetime defense buildup
    of the early 1980s.

    The change in post-Cold War procurement contract spending has not been
    constant or equal across procurement programs. While the average
    post-Cold War reductions in spending for aircraft in 1990-94 were the
    smallest, at 3.6 percent, reductions in spending for ammunition were the
    largest, at 18.7 percent. The post-Cold War average percentage change in
    the dollar amounts of DOD’s prime contract awards for procurement were

•   aircraft: –3.6
•   ships: –8.7
•   weapons: –9.0
•   tanks: –10.0
•   electronics and communications equipment: –10.2
•   missiles: –11.7
•   ammunition: –18.7.13

    Like DOD’s procurement spending, its expenditures in the aerospace
    industry have dominated its RDT&E contracts. In every year of the past 20,
    RDT&E investments for aircraft, missiles, and electronics and
    communications equipment differed, but their trend was always to surpass
    RDT&E investments in weapons, ships, and ammunition (figure 4). The
    post-Cold War average percentage change in the dollar amounts of DOD’s
    RDT&E contract awards from 1990 to 1994 were




    12
      The aircraft (fixed and nonfixed wing) and guided missiles and much of the electronics and
    communications equipment that DOD purchases are considered products of the broader aerospace
    industry. We note that the DOD definition of “electronics and communications equipment” includes
    equipment that may be installed in ships, tanks, and other “nonaerospace” products.
    13
     This list includes funding through DOD prime contract awards and is a subset of all procurement
    spending mentioned previously. Average post-Cold War spending fell in all programs, but not all
    programs were reduced in every year. In some years, contract awards for aircraft, tanks, weapons, and
    ships were stable or increased.



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                                                           •     aircraft: +1.6
                                                           •     electronics and communications equipment: –3.7
                                                           •     missiles: –6.3
                                                           •     weapons: –9.0
                                                           •     ships: –18.3
                                                           •     tanks: –18.3
                                                           •     ammunition: –23.7.14


Figure 4: DOD’s RDT&E Contract Awards by Major Program, 1975-94

FY 1995 $ (billions)
$12

$11

$10

 $9

 $8

 $7

 $6

 $5

 $4

 $3

 $2

 $1

 $0
      1975    1976     1977   1978   1979   1980   1981   1982        1983   1984   1985   1986     1987   1988   1989   1990   1991   1992   1993   1994

                                             Missiles Elec.-Comm. Aircraft     Ships   Tanks      Weapons Ammunition




                                                                 Post-Cold War RDT&E reductions in aerospace have been the smallest
                                                                 relative to other major weapon systems; spending for aircraft has even
                                                                 increased approximately 1.6 percent. Post-Cold War RDT&E reductions for
                                                                 ammunition have been the largest, at 23.7 percent.


                                                                 14
                                                                  This list includes funding on DOD RDT&E prime contracts for major weapon systems and is a subset
                                                                 of all RDT&E spending mentioned previously. Funding in all programs increased in one or more years
                                                                 or remained the same from one year to the next.



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                        The only source of information available to describe trends in subcontract
                        awards to defense contractors, over time, is DOD’s records of participants
                        in its subcontracting program (see appendix II). The participants can be
                        small or small disadvantaged businesses or large businesses. For example,
                        companies like Lockheed Martin and Boeing have received subcontractor
                        awards under this program. DOD’s published sources did not permit us to
                        determine awards by weapon system or industrial segment but we were
                        able to observe that the trends in the dollar amounts awarded to
                        subcontractors are similar to those for prime contractors. Subcontractor
                        awards peaked in the 1980s and began a gradual decline in 1989. The
                        average change in post-Cold War funding available through DOD’s
                        subcontractor program is –6.7 percent.

                        A recent RAND report sponsored by the Office of the Secretary of Defense
                        (OSD) indicates that in the aerospace industry, small suppliers to “large
                        military aircraft programs” receive about 10 percent of defense dollars that
                        go to contractors. Therefore, in some cases, reductions in defense
                        spending should be expected to affect small suppliers differently relative
                        to large defense firms. Views that small defense subcontractors are
                        disproportionately affected by defense spending reductions merit further
                        evaluation given constraints in the macro-level information about defense
                        subcontractors we were able to obtain.


Trends in Employment,
Productivity, and
Competition
Employment              Our ability to examine relationships between defense spending and
                        employment, and to generate conclusions, is complicated by the fact that
                        employment data are often derived from models or estimation procedures
                        that have degrees of uncertainty. Post-Cold War cutbacks in defense
                        spending have been associated with declining employment in military
                        force levels, federal defense-related civilian employment, and
                        defense-related employment in private industry. On the one hand, DOD
                        estimates show a 39-percent decrease in defense-related employment
                        between 1989 and 1997—approximately 5 percent per year. DOL reports
                        that private employment generated by defense spending fell by 600,000
                        jobs between 1987 and 1992 and projects at least an additional 1.2 million
                        job losses by 1997. Between 1989 and 1994, McDonnell-Douglas




                        Page 14                                   GAO/PEMD-97-3 Defense Industry Trends
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               Corporation reduced its total corporate staff by approximately 70,000
               people.

               On the other hand, the Defense Conversion Commission reported to DOD
               that the concept of job loss can overstate the effect of the post-Cold War
               drawdown on employment because it does not account for the ability of
               the economy to absorb dislocated workers. The commission estimated
               that the drawdown will account for less than 2 percent of all
               unemployment between 1992 and 1999. In a report to the U.S. Senate
               Budget Committee, CBO found that cuts in defense spending, or in any type
               of federal spending, will temporarily reduce employment. However, it
               notes that defense cuts that are matched by increases in public-sector
               investment, or nondefense spending, can offset the short-term effects of
               spending reductions. CBO reports that overall growth in the U.S. economy
               is a greater factor in reemployment for displaced defense workers than
               what happens in the defense sector. CBO reports, as well as other reports
               we reviewed, also indicate that the effect of reduced defense spending on
               employment varies by regions of the country, whereas those that are less
               dependent on defense spending are generally affected to a lesser extent.

               We analyzed available indicators of defense sector employment and an
               indicator of DOD procurement outlays linked to those sectors over the
               period of our study to determine the strength of the relationship between
               the two (see appendix II for methods discussion). We found a statistical
               relationship between the available indicators of employment levels and
               procurement outlays for the period 1975-91 that was not large in size and
               is less than values considered moderate in size (r =.27 to .36, depending
               upon the indicator used). (See appendix III.) Because the available
               indicators of defense sector employment and DOD spending are estimates,
               they are subject to possible error that may come from the estimating
               procedures and “operational” errors, or errors in the primary data
               collection reporting or coding procedures of the offices that collected the
               data. Moreover, the limitations of correlational analysis also introduce
               uncertainty that does not permit definitive conclusions regarding the exact
               nature of the relationship between defense sector employment and
               defense spending.

Productivity   DOD,Commerce, and DOL maintain or collect some information related to
               productivity in defense industries, some of which overlaps and some of
               which is unique. All the information on defense industry productivity that
               we obtained from these agencies was based on economic models or
               methodologies that have some degree of uncertainty. From this



               Page 15                                  GAO/PEMD-97-3 Defense Industry Trends
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              information and data from others such as the Aerospace Industries
              Association (AIA), we observed the following trends.

              The value of production output in most defense-concentrated industries
              has risen while defense budgets, as well as subsequent contract spending
              for major hard goods, have fallen (see appendix III, figure III.2).15 When AIA
              data on unit production are plotted with trends in DOD’s aircraft
              procurement budget, there is a trend between 1969 and 1986 in which
              more aircraft procurement money is associated with the production of
              fewer aircraft. From about 1986 to 1993, the trend shows a relatively
              constant number of aircraft being produced while aircraft procurement
              budgets have declined.16

              In other segments of the aerospace industry, in its 1995 assessment of the
              helicopter industry DOD projects that the unit cost for military helicopters
              will increase while the number of units produced will remain relatively flat
              through 2004. DOD expects to procure fewer, “more capable,” higher-cost
              helicopters rather than larger quantities of lower-cost helicopters. Other
              DOD data on trends in ship and tank procurement indicate that DOD is
              purchasing fewer units at higher costs. One explanation for this trend is
              that the complexity and sophistication of weapons, and related weapons
              manufacturing processes, have increased over time. We were unable to
              locate research that could address this issue systematically and
              comprehensively for the range of weapon systems within the scope of our
              work.


Competition   Long-Term Trends in DOD Contracting. Within the scope of this report, and
              where data were available, we studied longitudinal trends in competition.
              There is little consensus on how to measure competition. Consequently,
              we chose to base our analysis on the concept of competition embodied in
              the Competition in Contracting Act of 1984 and the Federal Acquisition
              Regulation.




              15
               “Value of production” is a standard DOL measure of productivity. Whenever possible, DOL uses
              actual physical quantities as the unit of measurement; when this information is not available, as in this
              case, it uses a constant-dollar value of shipments, sales, or revenues. (See also appendix II.)
              16
               During this period, AIA data show that in 1989 and 1993 the numbers of military aircraft that U.S.
              defense manufacturers have produced for export surpassed the numbers produced for domestic use.
              Consultants at Booz-Allen and Hamilton indicate that if it were not for international business, many
              U.S. production lines would be closed, and, in fact, DOD views international business as one means of
              ensuring DOD’s future helicopter requirements.



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DOD collects a variety of information on contracting actions. The dollar
value of the contracts and the solicitation procedures used are recorded in
DOD’s DD350 database. It provided us with trend data on where the defense
dollar was being spent and in what solicitation category it was being spent,
such as “full and open competition” and “other than full and open
competition.” Hence, using the DD350 data, we measured one aspect of
competition: the total dollars awarded in each solicitation category.

The shortcoming of this database is that it does not fully capture the
number of offers received in response to solicitations in each solicitation
category, which could be another indicator of competition.

The DD350 serves as a basis for internal reports and reports to other
agencies and the Congress and contains the only available data on the
dollar amounts of contract actions for full and open and other than full
and open competition. The “other than full and open competition”
category captures instances where DOD uses various authorities to limit
competition such as soliciting only one source when awarding follow-on
contracts or when a “unique source” exists (see table III.1 for a complete
list of authorities).

Among all the legal authorities for using other than full and open
competition, dollars awarded under the broad category “only one source”
accounted for 80 percent of the total contract dollars between 1986 and
1994. Included in this broad category are “follow-on contracts” (17 percent
of the total), awards to a “unique source” (37 percent of the total), and
awards categorized as “only one source-other” (25 percent of the total).

DOD’s data on competition in contracting reveal that in the categories of
major hard goods we looked at, over the past 18 years, the money
associated with major systems procurement has been greater for contracts
awarded using other than competitive methods than for those awarded
using competitive ones. We found this trend as an 18-year average (see
figure 5 and figure 6) and in each individual year for most programs in the
period. (See also appendix III.3, figure III.16.)

DOD’s definition of its competitive and other than competitive contracting
procedures on the DD350, used as guides in our work, are shown in
appendix III, table III.1. Figure 5 shows the DD350 competition data we
were able to obtain for the period 1977-85, or “pre-CICA” (Competition in
Contracting Act) data. Figure 6 shows “post-CICA” data, for 1986-94. We
note that pre- and post-CICA data are based on different categories of



Page 17                                   GAO/PEMD-97-3 Defense Industry Trends
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required information that DOD collected concerning the use of competitive
or other than competitive procedures used to award procurement
contracts. Differences between pre- and post-CICA data stem from the 1984
enactment of CICA. In our work for this request, we did not audit the pre-
and post-CICA data derived from the DD350. Therefore, the full extent of
differences between pre- and post-CICA data and the accuracy of DOD’s
reported data for both time periods would require more evaluation.17

In general figures 5 and 6 show similar findings, although the data
presented are different measures of competition used in pre- and post-CICA
periods. The portion of average contract dollars awarded using
noncompetitive methods ranged from 66 percent for ships to 80 percent
for aircraft (figure 5). For the post-CICA period, the range for other than full
and open competition was 58 percent for ships and 81 percent for
ammunition (figure 6).




17
 See appendix III for additional discussion and definition of the data elements extracted from the
DD350 database for the pre- and post-CICA time periods.



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Figure 5: Average Dollars DOD Awarded Using Competitive and Noncompetitive Procurement Methods, 1977-85

                                                Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)
                       $26.1

$25




$20



                                                            $16.02
                                       $15.62
$15




$10
                                                                                   $8.81

            $6.64
                               $5.75                $5.76
 $5                                                                        $4.53
                                                                                                      $3.27           $3.25
                                                                                                                                        $1.93
                                                                                              $1.23           $0.93             $0.69
 $0
               Aircraft          Missiles           Elec.-Comm.                Ships           Ammunition        Tanks           Weapons

                                                                     Competitive   Noncompetitive




                                                               Page 19                                                        GAO/PEMD-97-3 Defense Industry Trends
                                                          B-265618




Figure 6: Average Dollars DOD Awarded Using Full and Open Competition and Other Than Full and Open Competition,
1986-94

                                                 Post-CICA Data: Solicitation Procedures
FY 1995 $ (billions)
$20




$15                    $14.32




$10                                    $9.73

                                                       $8.35



                                               $5.64
            $5.24
                                                                              $4.92
 $5
                                $3.8                                 $3.6
                                                                                                    $2.87
                                                                                                                         $1.98
                                                                                                                 $1.15                     $1.11
                                                                                           $0.66                                   $0.41
 $0
               Aircraft           Missiles     Elec.-Comm.                 Ships            Ammunition              Tanks           Weapons

                                               Full and open competition      Other than full-open competition




                                                          Post-Cold War Restructuring and Reform. The major defense contractors
                                                          we spoke with indicated that in the post-Cold War drawdown, defense
                                                          companies have been acting to improve production efficiency, reduce
                                                          costs and overhead, streamline operations, and reorient themselves
                                                          toward a more cost-conscious customer. One outcome of changes in the
                                                          way defense firms have been doing business since the Cold War, with
                                                          relevance for competition, is a reduction in the number of independent
                                                          defense firms by company mergers and acquisitions or by companies
                                                          leaving the defense business. Notable examples include the March 1995
                                                          merger of Lockheed and Martin Marietta, Lockheed Martin’s acquisition of
                                                          Loral’s defense electronics and systems integration business, the intended
                                                          Boeing-McDonnell-Douglas merger, Raytheon’s purchase of Texas
                                                          Instruments defense unit, and Northrop-Grumman’s acquisition of




                                                          Page 20                                                                GAO/PEMD-97-3 Defense Industry Trends
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Westinghouse defense electronics.18 In other areas of defense industry, the
January 1994 agreement between FMC Corporation’s Defense Systems
Group and Harsco’s BMY-Combat Systems Division to form United
Defense Limited Partnership (UDLP) changed three major competitors in
the light and medium armored vehicle market to two: UDLP and General
Dynamics Land Systems.

A goal of business restructuring in the post-Cold War environment is to
enhance or at least maintain a competitive position in the marketplace. We
did not evaluate the effect of the recent trend in mergers and acquisitions
on competition. However, in its 1996 annual report, while supportive of
consolidations, DOD has concluded that “Consolidation carries the risk that
DOD will no longer benefit from the competition that encourages defense
suppliers to reduce costs, improve quality, and stimulate innovation.”
Moreover, in its assessment of the conventional ammunition segment, DOD
concluded that a reduction in the number of suppliers has reduced
competition.

The number of contractors will continue to decrease, according to DOD’s
published findings, officials we interviewed at Booz-Allen and Hamilton
and TASC, and projections from officials at McDonnell-Douglas. They
expect more mergers in some segments of the defense industry, such as
helicopters and missiles, and expect some companies to keep the
possibility of acquisition within their long-term strategies. Moreover, at
least one noted defense industry expert has reported that barriers to
entering the defense business—created by the need for large amounts of
capital for preparing contract proposals and by the need to gain access to
scientific and engineering talent and to specialized, expensive, production
equipment—will continue to lessen the likelihood that new defense
companies will enter the market in the near future.

This post-Cold War process of defense industry consolidation and
restructuring may reduce some segments of the defense industry to one
major provider. For example, one possible avenue DOD sees to achieve its
stated goal of reducing costs for medium and heavy space launches is to
consolidate the medium and heavy launcher booster families and “evolve”




18
 This does not include the additional reductions in the number of defense contractors resulting from
acquisitions that Loral made before its agreement with Lockheed Martin. For example, in May 1995
Loral acquired the Defense Systems Operations of Unisys Corporation.



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a new family of launch vehicles. DOD’s procurement plan for this Evolved
Expendable Launch Vehicle (EELV) is to have a single provider by 1998.19

While not taking a position on consolidation and mergers, the Defense
Science Board’s 1994 report to DOD on the antitrust aspects of defense
industry consolidation states that reducing the number of firms capable of
developing a suitable design for a new weapon system may lead to higher
prices, poorer products, smaller advances in technology, and a reduction
in the number, variety, or quality of the proposals that companies submit
to DOD. The report further states that congressional findings, industry
opinion, and a large body of literature lead to the conclusion that DOD’s
regulatory and auditing procedures cannot substitute for competition as a
way of ensuring the best mix of price and quality.

Within its current Defense Acquisition Reform vision, DOD has recently
implemented several new acquisition reform programs intended to
increase efficiency and value in weapons procurement and to reduce
unnecessary costs. DOD’s cost as an independent variable (CAIV) reform
represents a move toward making cost the significant driver in system
design, compared to the Cold War era in which the emphasis was on
systems that could outperform or overwhelm Soviet threats. The fiscal
year 1996 Defense Authorization Act simplifies the processes for
commercial item acquisition by exempting procurements for commercial
items from cost or pricing data requirements. DOD created the Defense
Standards Improvement Council to carry out policies mandated in
June 1994 by the Secretary of Defense to develop performance-based
solicitation requirements and expand the use of nongovernment standards
or specifications.

An assessment of the effect of recent acquisition reforms on DOD’s
weapons procurement process and the broader defense industrial base
would supplement the information presented here. To date, however, an
independent assessment of the effect of DOD acquisition reform initiatives
or programs on the issues discussed in this report has not been




19
 DOD awarded Alliant Tech Systems, Boeing, Lockheed Martin, and McDonnell-Douglas $30 million
each to develop a concept for the EELV, within some specific boundaries it has defined. In
December 1996, DOD selected Lockheed Martin and McDonnell-Douglas to proceed to preengineering
manufacturing, scheduled to last 15 to 17 months, at the end of which DOD will select a single
provider. DOD stated that a single provider may be defined as a consortium, joint venture, or a teaming
arrangement.



Page 22                                                 GAO/PEMD-97-3 Defense Industry Trends
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                          conducted.20 We believe this is an important area for future evaluation,
                          given the potential for reform initiatives to reduce or contain costs and
                          facilitate efficiency improvements.


Defense Companies After   Some defense contractors among the top 100 receiving the largest dollar
the Cold War              amount of DOD prime contract awards in 1994 have grown in the post-Cold
                          War budget environment, while others have not shown growth. (We detail
                          the financial indicators in appendix IV.) DOD finds that most of the defense
                          firms it has assessed have been profitable in the drawdown.21 Assessments
                          of a random sample of small California aerospace businesses that supply
                          goods or services to large military aircraft programs show that between
                          1992 and 1995, 94 percent were still in business while 3 percent had either
                          merged or been acquired.

                          Officials at the major defense contractors we visited, the defense industry
                          experts we interviewed, and the annual reports from major defense
                          contractors we reviewed indicate that, in order to survive and remain
                          viable in the funding drawdown, the top companies have, among other
                          things, been (1) attempting to gain market share and to be more
                          competitive for future defense business through mergers and acquisitions;
                          (2) reorganizing and restructuring internally, in ways that involve job
                          losses and layoffs, and reconfiguring job duties; (3) reducing their
                          supplier-subcontractor base; (4) engaging in team concepts or entering
                          joint ventures in which several firms subcontract with one another;
                          (5) expanding defense markets to broaden the international customer base
                          and increase sales; or (6) selling the defense business segments that are
                          not core business units or that do not represent niche markets, as well as
                          exiting segments of the defense industry.22


                          20
                           Examples of recent GAO acquisition reform work is reported in U.S. General Accounting Office,
                          Acquisition Reform: Comparison of Army’s Commercial Helicopter Buy and Private Sector Buys,
                          GAO/NSIAD-95-54 (Washington, D.C.: March 1995); Acquisition Reform: Military-Commercial Pilot
                          Program Offers Benefits but Faces Challenges, GAO/NSIAD-96-53 (Washington, D.C.: June 1996);
                          Acquisition Reform: Regulatory Implementation of the Federal Acquisition Streamlining Act of 1994,
                          GAO/NSIAD-96-139 (Washington, D.C.: June 1996).
                          21
                           In DOD’s assessment of companies in the conventional ammunition segment, it found that they were
                          not profitable. However, in its report, DOD stated that the nature of the analysis used would overstate
                          companies that were not profitable.
                          22
                            For item 4, examples of existing team arrangements and joint ventures include the production and
                          development of the F-22 fighter aircraft (Lockheed Martin and Boeing); the V-22 Osprey tilt-rotor
                          transport rotorcraft (Bell and Boeing); and the Crusader, a tracked self-propelled artillery system
                          (UDLP as prime contractor with General Dynamics, Lockheed Martin, Perkins Engines, and Teledyne
                          Industries). For item 6, see also U.S. General Accounting Office, Defense Contractors: Pay, Benefits,
                          and Restructuring During Defense Downsizing, GAO/NSIAD-96-19BR (Washington, D.C.:
                          October 1995).



                          Page 23                                                  GAO/PEMD-97-3 Defense Industry Trends
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For various reasons, defense manufacturers have not given emphasis to
converting their products or capabilities to commercial ones.23 Officials at
Lockheed Martin have noted that if defense businesses understand
commercial markets, they may be able to produce competitive commercial
products, but officials at Booz-Allen and Hamilton have emphasized that
producing competitively for the commercial sector is different from
producing for the defense sector. The production process and
infrastructure that have been set up to serve DOD’s customers are markedly
different from those of commercial companies manufacturing competitive
products for the average consumer. Further, some industry experts
suggest that there are no commercial markets for converted military
products. However, an official at a large defense firm noted that Rockwell
International corporation achieved success in establishing a commercial
market for Global Positioning System (GPS) receivers. In responding to this
issue, however, some top defense firms have survived by investing in
mergers and acquisitions and by reorganizing and downsizing their
companies.

The defense industry experts and major defense contractors we spoke
with agreed that companies that choose to stay in a post-Cold War defense
industry must remain viable and competitive. They indicated that while
industry consolidation can help them do this, the heart of consolidation is
the reduction of overcapacity. Overcapacity increases costs through
excess, underutilized overhead. When fewer dollars are available,
companies must reduce costs in order to remain competitive. DOD also
views the elimination of excess capacity as a means of achieving some
cost-savings.

Booz-Allen and Hamilton has pointed out that while mergers and
acquisitions have the potential to produce cost savings, particularly
administrative savings, cost-savings benefits associated with consolidation
are limited if excess production capacity is not reduced. They note that
reduction of excess product design capability, as well as general
production capacity, should be addressed in consolidation decisions.
Booz-Allen and Hamilton also notes that cost-savings are minimized to the
degree that merging companies or segments have dissimilar business.
Similarly, internal company reorganization, teaming, and joint ventures
may not result in any real savings if excess production capacity is not
eliminated. Increasing foreign military sales might help spread out
overhead costs normally charged to DOD but only as long as production

23
 See U.S. General Accounting Office, Defense Conversion: Capital Conditions Have Improved for
Small- and Medium-Sized Firms, GAO/NSIAD-94-224 (Washington, D.C.: July 1994).



Page 24                                               GAO/PEMD-97-3 Defense Industry Trends
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lines remain open for weapons to be purchased by international
customers.

Although DOD’s industrial assessments have all claimed that consolidating
the defense industry will produce cost-savings, our past work, our review
of research from DOD and the private sector, and our discussions with
industry consultants and defense contractors all suggest that this
assumption should continue to be studied, tested, and validated.

There are efforts to study costs and savings associated with specific
defense business combinations. Section 818 of Public Law 103-337
requires DOD to provide the Congress with the projected amounts of costs
and savings for defense contractor mergers or acquisitions when DOD is
asked to reimburse the contractor for the costs associated with company
restructuring. At the time we completed our work, under this provision,
DOD had so far certified restructuring payment for three business
combinations: United Defense Limited Partnership between FMC
Corporation, Defense Systems Group, and Harsco Corporation, BMY
Combat Systems Division; Martin Marietta Corporation purchase of
multiple business entities of GE Aerospace; and Northrop Corporation
purchase of Grumman Corporation. Further, under section 818, GAO has a
requirement to report to the Congress on restructuring costs. At the time
we completed our work, we had issued two reports under this provision.24
Aside from reimbursements for restructuring costs, section 818 does not
provide for analysis and validation of the type of broad cost-savings claims
that appear in some of DOD’s published industrial assessment reports.
Moreover, in both reports, we found that defense contractor’s estimates of
savings associated with business consolidation activity, submitted for
official DOD review and certification, were greater than the estimates DOD
could later verify. Finally, we have also reported that although contractors
have been reducing overhead rates by consolidating facilities and by other
means, they have been projecting future increases in overhead rates.25

Vertical integration in defense industry was pointed out, by one external
reviewer and DOD officials who reviewed a draft of this report, as an
emerging issue of interest or concern for the defense industry linked to
recent defense industry consolidation activity. Vertical integration can

24
 See Defense Contractor Restructuring: First Application of Cost and Savings Regulations,
GAO/NSIAD-96-80 (Washington, D.C.: April 1996), and Defense Contractor Restructuring Costs:
Projected and Actual Savings From Martin-Marietta Acquisition of GE Aerospace, GAO/NSIAD-96-191
(Washington, D.C.: September 1996).
25
 See Overhead Costs: Defense Industry Initiatives to Control Overhead Rates, GAO/NSIAD-95-115
(Washington, D.C.: May 1995).



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                  occur in multiple ways. Vertical integration that occurs when major prime
                  contractors acquire control of key components that make up the systems
                  they sell has recently received attention. Industrial concentration that
                  occurs through the acquisition of lower-tier firms by prime contractors
                  can create the opportunity for contractors to freeze out of the market
                  competitors that do not have access to these particular components. An
                  external reviewer noted that vertical integration can allow prime
                  contractors to shut out as sellers traditional second- and third-tier
                  component suppliers who normally sell to the prime contractors.

                  A DSB task force on vertical integration convened in September 1996, at the
                  request of the Under Secretary of Defense for Acquisition and Technology.
                  The task force is expected to issue a report in 1997.26 We note that the
                  effect on lower-tier smaller suppliers is considered by one industry leader
                  as a relevant issue in assessing vertical integration. In our work, we were
                  limited in our ability to obtain comprehensive data about smaller
                  subcontractors in the post-Cold War defense industry. However, we
                  believe that the effect of defense industry consolidation is fully
                  understood by reviewing the state of the smaller defense subcontractors in
                  addition to the larger prime contractors. Given that small suppliers may
                  typically concentrate on making one or a handful of products, compared
                  to a broader mix among the primes, industry activity that limits the market
                  for small suppliers may exert a disproportionate impact on them.


                  We provided copies of a draft of this report to the Department of Defense.
Agency Comments   To obtain DOD’s comments, we met with officials from the Offices of
                  Deputy Under Secretary of Defense for Industrial Affairs and Installations;
                  Under Secretary of Defense, Comptroller; Secretary of the Air Force,
                  Acquisition Research and Engineering; and Assistant Secretary of the
                  Navy, Research Development and Acquisition. Further, we conducted
                  follow-up work on DOD’s comments with officials from the Office of
                  Program Evaluation and Analysis; Directorate of Defense Procurement;
                  and Office of the Assistant Secretary of the Army, Research, Development,
                  and Acquisition.

                  Officials conveyed to us that DOD planning, execution, and review of these
                  matters is routinely at much lower levels of detail. From these levels, DOD

                  26
                    The Department of Justice and the Federal Trade Commission have a role in reviewing proposed
                  mergers and acquisitions for antitrust activity. In the proposed merger of Lockheed and Martin
                  Marietta, for example, the FTC saw potential anticompetitive effects from the vertical integration in
                  the production of navigation devices and military aircraft and, as a result, the companies agreed to
                  restrictions on the merger with the intent of maintaining competition.



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determines that a particular issue may be indicative of a broader problem.
DOD officials stated that there were differences between the level and type
of analysis we used to depict the data trends and the level and type of
information they readily have at hand to manage and evaluate the agency’s
programs, which hampered their ability to provide a complete and timely
review.

The scope of the work we report here is consistent with the terms of the
congressional request. Our ability to present the data trends was greatly
challenged by the fact that neither DOD nor other executive agencies
maintain in a single office or location the information required to address
the issues raised by the congressional request. It was necessary for us to
obtain data and information from multiple executive agencies and to adopt
methodologies based on existing or commonly used practices of executive
agency offices and other knowledgeable groups so that we could furnish
and present the data. DOD officials did not disagree with the data sources
we used. However, where they identified additional data sources relevant
to the issues discussed in the report, or had questions that we could
resolve concerning the information presented, appropriate changes were
incorporated in the text.

DOD  officials indicated that their office of Program Analysis and Evaluation
compiled reports that would have been useful in determining the
disbursement of procurement dollars across industry, although we did not
use them. We determined that the data referred to were produced under
the Defense Economic Impact Modeling System. During our earlier data
collection work, we determined that data from this source were
insufficient in scope relative to other survey-based data collected by DOD’s
Washington Headquarter’s Services on DOD procurement outlays.

DOD  noted that the pre- and post-CICA DD350 data we report are based on
different measures that DOD collected about the use of competitive
procedures in DOD procurement contracting. DOD’s pre-CICA data we
present (1977-85) are data DOD collected, consistent with the reporting
requirements and data elements relevant to track competitive contracting
procedures within the period (see appendix III, table III.1). Similarly, DOD’s
available post-CICA data (1986-94) are those consistent with and relevant to
track DOD’s results pertaining to the current laws and regulations
governing competitive procurement procedures (see table III.1). We
believe it is relevant and informative to present the data elements that are
consistent with and representative of the laws and reporting requirements




Page 27                                    GAO/PEMD-97-3 Defense Industry Trends
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to track competition that were in place in the pre-CICA time period and in
the post-CICA time period.

Major contributors to this report are listed in appendix V. If you have any
questions concerning this report or need additional information, please
call me at (202) 512-3092.




Kwai-Cheung Chan
Director of Program Evaluation in Physical
  Systems Areas




Page 28                                   GAO/PEMD-97-3 Defense Industry Trends
Page 29   GAO/PEMD-97-3 Defense Industry Trends
Contents



Letter                                                                                            1


Appendix I                                                                                       34

The Government,
Industry, and
Research Contacts We
Made
Appendix II                                                                                      36
                        The Data Analysis                                                        36
Objectives, Scope,      The Data Limitations                                                     43
and Methodology
Appendix III                                                                                     44
                        Employment                                                               44
Data on Employment,     Productivity                                                             47
Productivity, and       Competition                                                              48
Competition
Appendix IV                                                                                      65

U.S. Defense
Companies After the
Cold War
Appendix V                                                                                       70

Major Contributors to
This Report
Tables                  Table II.1: Major Hard Goods Defined by DOD Claimant Program             37
                        Table III.1: Pre- and Post-CICA Measures from the DD350 Used             49

Figures                 Figure 1: DOD’s Total, Procurement, and RDT&E Budgets,                    9
                          1945-95
                        Figure 2: Yearly Percentage Growth and Decrease in DOD’s                 10
                          Defense Procurement Budget, 1945-95




                        Page 30                                GAO/PEMD-97-3 Defense Industry Trends
Contents




Figure 3: DOD’s Procurement Contract Awards by Major                     11
  Program, 1975-94
Figure 4: DOD’s RDT&E Contract Awards by Major Program,                  13
  1975-94
Figure 5: Average Dollars DOD Awarded Using Competitive and              19
  Noncompetitive Procurement Methods, 1977-85
Figure 6: Average Dollars DOD Awarded Using Full and Open                20
  Competition and Other Than Full and Open Competition, 1986-94
Figure III.1: Ratio of Nonproduction to Production Workers in            46
  Defense-Concentrated Industries, 1975-92
Figure III.2: The Relationship Between DOD Budgets and                   47
  Productivity in Defense-Concentrated Industries, 1975-91a
Figure III.3: Dollars Awarded Using Competitive and                      50
  Noncompetitive Procurement Methods for Electronics and
  Communications Equipment, 1977-85
Figure III.4: Dollars Awarded Using Full and Open Competition            51
  and Other Than Full and Open Competition for Electronics and
  Communications Equipment, 1986-94
Figure III.5: Dollars Awarded Using Competitive and                      52
  Noncompetitive Procurement Methods for Ammunition, 1977-85
Figure III.6: Dollars Awarded Using Full and Open Competition            53
  and Other Than Full and Open Competition for Ammunition,
  1986-94
Figure III.7: Dollars Awarded Using Competitive and                      54
  Noncompetitive Procurement Methods for Weapons, 1977-85
Figure III.8: Dollars Awarded Using Full and Open Competition            55
  and Other Than Full and Open Competition for Weapons, 1986-94
Figure III.9: Dollars Awarded Using Competitive and                      56
  Noncompetitive Procurement Methods for Aircraft, 1977-85
Figure III.10: Dollars Awarded Using Full and Open Competition           57
  and Other Than Full and Open Competition for Aircraft, 1986-94
Figure III.11: Dollars Awarded Using Competitive and                     58
  Noncompetitive Procurement Methods for Missiles, 1977-85
Figure III.12: Dollars Awarded Using Full and Open Competition           59
  and Other Than Full and Open Competition for Missiles, 1986-94
Figure III.13: Dollars Awarded Using Competitive and                     60
  Noncompetitive Procurement Methods for Tanks, 1977-85
Figure III.14: Dollars Awarded Using Full and Open Competition           61
  and Other Than Full and Open Competition for Tanks, 1986-94
Figure III.15: Dollars Awarded Using Competitive and                     62
  Noncompetitive Procurement Methods for Ships, 1977-85




Page 31                                GAO/PEMD-97-3 Defense Industry Trends
Contents




Figure III.16: Dollars Awarded Using Full and Open Competition            63
  and Other Than Full and Open Competition for Ships, 1986-94
Figure III.17: Number of Defense Contractors From the End of              64
  World War II to 1994
Figure IV.1: Financial Indicators of Three Top Defense                    66
  Contractors: Falling Corporate Sales, 1975-95
Figure IV.2: Financial Indicators of Three Top Defense                    67
  Contractors: Falling Cash Flow, 1975-95
Figure IV.3: Financial Indicators of Four Top Defense                     68
  Contractors: Rising Corporate Sales, 1975-95
Figure IV.4: Financial Indicators of Four Top Defense                     69
  Contractors: Rising Cash Flow, 1975-95




Abbreviations

AIA        Aerospace Industries Association
BLS        Bureau of Labor Statistics
BUR        Bottom Up Review
CAIV       Cost as an independent variable
CBO        Congressional Budget Office
CICA       Competition in Contracting Act
DIB        Defense industrial base
DOD        Department of Defense
DOL        Department of Labor
DSB        Defense Science Board
EELV       Evolved Expendable Launch Vehicle
FASA       Federal Acquisition Streamlining Act
FTC        Federal Trade Commission
FYDP       Future-years defense plan
GPS        Global Positioning System
IPT        Integrated product team
JDAM       Joint direct attack munition
JPATS      Joint Primary Aircraft Training System
OSD        Office of the Secretary of Defense
PA&E       Office of Program Analysis and Evaluation
RDT&E      Research, development, test, and evaluation
TASC       The Analytic Sciences Corporation
TOA        Total obligational authority
UDLP       United Defense Limited Partnership
WHS        Washington Headquarters Service


Page 32                                 GAO/PEMD-97-3 Defense Industry Trends
Page 33   GAO/PEMD-97-3 Defense Industry Trends
Appendix I

The Government, Industry, and Research
Contacts We Made

Government Offices      Bureau of Labor Statistics
                          Employment Projections
                          Producer Price Indexes
                          Productivity and Technology

                        Congressional Budget Office

                        Congressional Research Service

                        Department of Commerce
                          Bureau of the Census
                          Business and Industrial Analysis
                          Industrial Resource Administration

                        Department of Defense
                          Defense Contract Audit Agency
                          Defense Contract Management Command
                          Defense Logistics Agency
                          Directorate for Information Operation and Reports
                          Economic Security/Industrial Affairs
                          Office of the Comptroller
                          Program Analysis and Evaluation


Defense Contractors     Lockheed-Martin
                        McDonnell-Douglas
                        Teledyne Industries


Industry Associations   Aerospace Industries Association
                        American League for Exports and Security Assistance
                        Electronics Industry Association
                        National Association of Manufacturers
                        National Coalition for Advanced Manufacturing
                        National Security Industrial Association


Research Groups and     Booz-Allen & Hamilton
Consultants             Brookings Institution
                        Business Executives for National Security
                        Center for Strategic and Budgetary Assessments1

                        1
                         Formerly known as the Defense Budget Project.



                        Page 34                                          GAO/PEMD-97-3 Defense Industry Trends
Appendix I
The Government, Industry, and Research
Contacts We Made




Center for Strategic and International Studies
Lehman Brothers
Office of Technology Assessment
Rand Corporation
The Analytic Sciences Corporation




Page 35                                  GAO/PEMD-97-3 Defense Industry Trends
Appendix II

Objectives, Scope, and Methodology


                    The six key questions and the data we used to answer them are outlined in
                    this appendix. Because our approach was at a macro-level, we used as a
                    general rule the data sources that were the most comprehensive with
                    respect to 1975-95 and the defense industries we examined (aircraft,
                    guided missiles, tanks, shipbuilding, ammunition and ordnance, and
                    electronics and communications equipment).


                    1. What are the trends in DOD’s total, procurement, and RDT&E budgets?
The Data Analysis
                    We obtained our information on DOD’s budgets from DOD’s Office of the
                    Comptroller and from DOD’s Future Years Defense Plan (FYDP). We present
                    the budget figures in terms of either total obligational authority or outlays,
                    depending upon availability. We used outlays when they could be made
                    available to us in a timely manner. They generally represent cash
                    payments. “Total obligational authority” is a financial term that DOD uses to
                    express the value of the direct defense program for a fiscal year. We
                    transformed all FYDP budget figures from current dollars to constant-year
                    dollars to correct for inflation, using 1995 as the base year. We used DOD
                    deflators in adjusting current-year dollars to constant dollars. Where DOD’s
                    Office of the Comptroller sources reported constant dollar (fiscal year
                    1995) budget figures, we used them.

                    Budget figures from 1945 to 1995 reflect both peacetime and wartime
                    spending. DOD’s Office of the Comptroller could provide the incremental
                    costs (that is, outlays) associated only with the Vietnam War and the
                    Desert Shield and Desert Storm conflicts. The aggregate incremental costs
                    for Vietnam were $110.6 billion from 1965 to 1976 and include the
                    transition period. The aggregate incremental costs for Desert Shield and
                    Desert Storm were $1.9 billion from 1990, projected to 1998. That they
                    appear to have been considerably less than those for Vietnam may be
                    partly because the Persian Gulf war was much shorter but also because
                    DOD received for it offset payments from foreign nations that totaled at
                    least $48.4 billion.

                    2. What are the trends in the dollar amount of DOD procurement and RDT&E
                    awards to defense manufacturers and subcontractors over time?

                    We used data from publicly available reports provided by DOD’s
                    Directorate for Information, Operations, and Reports, Washington
                    Headquarters Service (WHS), on the dollar amounts of obligations for prime




                    Page 36                                    GAO/PEMD-97-3 Defense Industry Trends
                                       Appendix II
                                       Objectives, Scope, and Methodology




                                       contract awards and RDT&E awards for each category of major hard goods
                                       that DOD purchased. (See table I.1.)

Table II.1: Major Hard Goods Defined
by DOD Claimant Program                Program                       What it includes
                                       Aircraft                      Complete aircraft, including helicopters;
                                                                     Airframe assemblies and spares;
                                                                     Aircraft engines and parts, propellers and hubs,
                                                                        instruments and parts, jet engines and parts used
                                                                        without major modification on guided missiles;
                                                                     Electrical equipment;
                                                                     Accessories including gun turrets, bomb racks and
                                                                        releases, rocket launchers, fuel tanks, droppable
                                                                        aircraft tanks, tires and tubes, control wires,
                                                                        servo and other control mechanisms;
                                                                     Special jigs, dies, and fixtures for fabricating only a
                                                                        specific model;
                                                                     Maintenance tools peculiar to the aircraft and to the
                                                                        engine;
                                                                     Ground handling equipment;
                                                                     Assist takeoff other than droppable units;
                                                                     Mobile training units;
                                                                     Flight simulators
                                       Missiles and space systems    All missile and space system parts and related equipment
                                                                        procured from prime contractors;
                                                                     GFE electronic equipment;
                                                                     Special jigs, dies, and fixtures;
                                                                     Booster cases;
                                                                     Ground handling and launching equipment;
                                                                     Target drones
                                       Ships                         Construction of vessels of all types, including assault
                                                                        boats and tracked amphibious vehicles such as LVTs;
                                                                     Ship parts;
                                                                     Ship armor not procured as weapons;
                                                                     Shipborne deperming and degaussing equipment;
                                                                     Aircraft catapults and arresting gear;
                                                                     Floating cranes, floating drydocks, bridge erection boats,
                                                                        and production equipment procured as part of and
                                                                        mounted on floating equipment;
                                                                     Special jigs, dies, and fixtures;
                                                                     Total cost of services, civilian labor, and ship parts used
                                                                        in conversion, repair, overhaul, and modernization
                                       Tanks/automotive: combat      Tanks and self-propelled gun motor carriages;
                                       vehicles                      Other combat vehicles;
                                                                     Combat vehicle parts;
                                                                     Special jigs, dies, and fixtures;
                                                                     Modification, private or government
                                                                                                                      (continued)




                                       Page 37                                          GAO/PEMD-97-3 Defense Industry Trends
Appendix II
Objectives, Scope, and Methodology




Program                       What it includes
Tanks/automotive:             Trucks, ambulances, passenger cars, buses,
noncombat vehicles               motorcycles, and other motorized vehicles, including
                                 wheeled amphibious vehicles;
                              Power-driven decontaminating trucks;
                              Trailers and semi-trailers;
                              Truck tractors;
                              Repair, maintenance, and other special-purpose
                                 noncombat vehicles;
                              Bicycles;
                              Prime-contractor-furnished repair, rebuild, production,
                                 and service equipment;
                              Special jigs, dies, and fixtures;
                              Other accessories and parts;
                              Modification, private or public
Weapons                       Small arms, automatic weapons, mortars, artillery, guns,
                                 rocket and grenade launchers, and pyrotechnic
                                 projectors, including those mounted on vehicles, ships,
                                 and aircraft;
                              Flame throwers;
                              Smoke generators, land;
                              Torpedo tubes;
                              Harpoon protection nets and depth-charge protectors;
                              Wholly optical, electrical, or mechanical fire control
                                 equipment, including binoculars, bomb sights, other
                                 optical equipment, stop watches, and fire control
                                 mounts;
                              Nonelectronic portions of electronic fire control equipment;
                              Special jigs, dies, and fixtures;
                              Deperming and degaussing equipment
Ammunition                    Rockets, bombs, mines, grenades, torpedoes, depth
                                charges, and other ammunition and demolition material
                                and pyrotechnics;
                              ATO units (droppable only) and fuel;
                              Rocket and guided-missile fuel;
                              Machine-gun links;
                              Ammunition parts;
                              Chemicals used in bombs, flame throwers, smoke
                                generators, and ammunition;
                              Special jigs, dies, and fixtures
                                                                             (continued)




Page 38                                          GAO/PEMD-97-3 Defense Industry Trends
Appendix II
Objectives, Scope, and Methodology




Program                         What it includes
Electronics and                 Electromagnetic radiating and nonradiating
communications                     equipment except that which radiates in the visible
equipment                          spectrum,including radio equipment used
                                   for telegraph, telephone, teletype, facsimile,
                                   television, and IFF signals;
                                Radar equipment, Radiac, and Infrared;
                                Electronic and electro-mechanical computers;
                                Radiation aids to aircraft control and navigation, including
                                   control of guided missiles, fire bombing,
                                   armament, and related electro-mechanical types;
                                Radiation countermeasures;
                                Meteorological and sonar equipment;
                                Equipment for magnetic amplifiers, detecting noise and
                                   interference, and transmitting and receiving
                                   intelligence and ancillary equipment such as
                                   antennas and headphones;
                                VT fuzes and guided bombs such as Tarzon and Razon;
                                Special jigs, dies, and fixtures;
                                Electronic fire control equipment

Source: Adapted from Department of Defense, “Commodities and Services Reported on DD Form
350,” Procurement Coding Manual (Washington, D.C.: October 1994).



WHS collects information on DOD prime contracts and RDT&E (contract
obligations) awards from Department of Defense Form 350 (DD350),
“Individual Contract Action Report.” The DD350 form is used to collect
data on contract statistics within DOD. The data gathered by means of the
DD350 are used for reporting the size and distribution of DOD contracting
actions; types of contracts used; numbers and amount of contracts placed
with categories of contractors such as small, small disadvantaged, and
women-owned small business concerns; the extent competed and other
essential facts about contract actions. Prior to 1982, the DD350 was
completed only on contracts greater than $10,000. Since 1982, it has been
completed for contract actions greater than $25,000. The data reported on
the DD350 may be subject to operational errors in reporting, collecting, or
coding the data for entry into database or other electronic formats. We did
not assess possible operational errors or other errors in the reporting
procedures followed by WHS.

WHS publishes information on awards to subcontractors from the
information it receives from participants in DOD’s mandated
subcontracting program. This information is collected on Standard Form
(SF) 295. The 1978 Amendments to the Small Business Investment Act of
1958 (15 U.S.C. 637(d) (1994)) require business firms that have received a
contract in excess of $500,000, or a contract in excess of $1 million for



Page 39                                            GAO/PEMD-97-3 Defense Industry Trends
Appendix II
Objectives, Scope, and Methodology




construction, to establish a small business and small-disadvantaged
business subcontracting program. The nature of DOD’s reporting
procedures makes it possible to determine aggregate amounts of awards
to subcontractors but not what the awards are made for. These data are
not classified by procurement program or weapon system in published
sources that aggregate the data. Because DOD subcontractor awards are
given to large and small businesses, this information cannot be used to
make generalizations about a given “tier” of the defense industry. In
addition, as stated above, we did not assess operational errors or other
possible errors in the data collection and reporting procedures followed
by WHS.

3. What are the trends in indicators of employment, productivity, and
competition over time?

In developing methods to address these issues, we interviewed and
consulted with knowledgeable experts in the defense industry from the
private and federal sectors as well as defense contractors on trends in
employment, productivity, and competition. Given the scope of our work,
the most comprehensive employment data were available from the Annual
Survey of Manufacturers series published by the Bureau of the Census.
The macro-level quantitative data we used were indicators of productivity
and data that are relevant to the evaluation of competition. For
productivity, they included the value of production output in
defense-concentrated industries from DOL’s Bureau of Labor Statistics
(BLS). From DOD offices and AIA records, we obtained limited information
on units produced for some defense sectors. For competition, it included
dollars spent on procurement contracts awarded using competitive and
other than competitive procedures identified on the DD350 form and
retrieved from DOD’s DD350 database. We describe these measures in
detail.

The employment and productivity data were defined according to separate
defense-concentrated industry groups—a cluster of one or more
manufacturing industries identified by a four-digit Standard Industrial
Classification code.1 DOD, Commerce, and DOL, as well as private research
firms that study trends in defense industry, refer to them as
“defense-dependent” or “dominant” industries because a large proportion
of their output is purchased for defense purposes. For example, in 1985,
shipbuilding, ammunition (except small arms ammunition), ordnance (not
elsewhere classified), and aircraft and missile engines industries produced

1
 Excluding data from AIA and DOD’s Office of Program Analysis and Evaluation (PA&E).



Page 40                                              GAO/PEMD-97-3 Defense Industry Trends
Appendix II
Objectives, Scope, and Methodology




75 percent or more of their output for defense. Nondefense related output
produced by these industries may be purchased by commercial
companies, other U.S. government offices, or international companies.
When we conducted our work for this report, aircraft, guided missiles,
ammunition and ordnance, tanks, electronics and communications
equipment, and shipbuilding and repairing were the principal
defense-concentrated industry groups identified by defense industry
researchers in federal agencies and private research organizations.

The value of production output in defense-concentrated industries is
measured by productivity indexes that we obtained from the Bureau of
Labor Statistics (BLS) Office of Productivity and Technology. The index BLS
provided—the constant-dollar value of production output per hour—is
derived by dividing an index of the value of production (shipments,
revenue, or sales) in each of the manufacturing industries by an index of
aggregate employee hours. This is a standard measure of productivity used
in BLS’ program of productivity measurement and technology studies. The
limited data on procurement or production rates we used came from
reports prepared by AIA and DOD’s Office of Economic Security and PA&E.

Extant data from DOD’s DD350 database gave us information about the
competitive nature of procurement contracts awarded for major weapon
systems or components. We retrieved and analyzed data from the blocks
of information on the DD350 that specifically indicated the extent of
competitive procedures used to award contracts in pre- and post-CICA time
periods (see table III.1). These data provide an indication of the processes
DOD uses (that is, competitive or noncompetitive) in awarding weapon
procurement contracts to defense contractors. We did not determine the
degree to which these processes are reliable indicators of competition or
noncompetition within the defense industry.

4. How are employment productivity and competition related to indicators
of defense spending?

The available quantitative data permitted us to provide a limited response
to this question. We developed methods that made use of existing
information and we supplemented the quantitative data with information
we collected from the experts we spoke to and our review of existing
literature.

Our quantitative method for examining the relationship between
indicators of defense spending and productivity over time involved



Page 41                                   GAO/PEMD-97-3 Defense Industry Trends
Appendix II
Objectives, Scope, and Methodology




generating correlation coefficients between available measures of defense
budgets and the BLS productivity indexes.2 For example, we correlated the
productivity indexes for the tank industry with DOD’s budgets for tank
procurement for the years available. We used the same approach in
examining the relationship between indicators of defense spending and
defense-related employment: correlating the available measures of total
employment in the defense-concentrated industrial sectors from Census
with the total dollar amount of contracts awarded for procuring major
hard goods (see table I.1 for the categories of major hard goods) over the
period of our study (data were available only for the period 1975-91). We
also conducted the analysis using DOD budgets (FYDP, TOA) as an indicator
of DOD spending linked to defense-concentrated industrial sectors.

An important issue in selecting appropriate measures of employment in
defense-concentrated industrial sectors and an indicator of spending (that
is, outlays) linked to those sectors was selecting measures that were
independent from one another. For example, in the course of our work we
discovered that data on defense-related industry employment reported in
DOD’s series of reports on national defense budget estimates (also known
as the “green book”) is not independent from data on procurement outlays
also reported in these series. The lack of independence between the two
data sets calls into question the validity, or accuracy, of any correlational
analysis done using this data and, of course, any resultant correlation
coefficient observed.

Given available data, we were unable to develop a comparable quantitative
method for addressing the relationship between competition and levels of
defense spending over time. Our interviews on these relationships with
defense contractors and defense industry experts supplemented the
quantitative information on defense industry competition that we were
able to obtain.

5. What are the trends in the financial indicators of major defense
contractors over time?

Considerable variability characterizes the methods used to determine
appropriate financial indicators or financial viability. For example, defense
industry analysts at the Center for Strategic and Budgetary Assessments
indicate that there are at least 12 ways to conduct financial assessments of

2
 Correlational analysis provides one indication of how two or more variables are related. A correlation
coefficient provides an indication of the strength and direction of a linear relationship. The procedures
used to generate a correlation coefficient make it impossible to determine whether changes in one
variable cause changes in another variable. More analysis is required to reach such conclusions.



Page 42                                                   GAO/PEMD-97-3 Defense Industry Trends
                       Appendix II
                       Objectives, Scope, and Methodology




                       the defense industrial base. We interviewed Wall Street business analysts,
                       reviewed the procedures DOD recommends for conducting financial
                       assessments, and spoke with defense contractors and industry experts.
                       They agreed that financial viability is best assessed with multiple
                       indicators. We used sales and cash flow because they are conventional
                       indicators and because information on them could easily be retrieved from
                       Standard and Poor’s COMPUSTAT database.3 Other measures or variables
                       from company income statements that can be used to analyze financial
                       viability include gross income, operating income, and net income.

                       Our sample of defense companies included those among the top 100 that
                       received the largest dollar amount of DOD prime contract awards in 1994.
                       So that most of the defense industries would be represented, we included
                       companies that have business units in one or more of the defense industry
                       segments.

                       6. What is the relationship between indicators of defense spending and
                       indicators of the financial status of major defense contractors over time?

                       Our focus was predominantly on trends in the financial status of
                       companies in the last several years of the recent defense spending
                       reduction. We supplemented the information on corporate sales and cash
                       flow from Standard and Poor’s database with reviews of DOD’s
                       assessments of the financial state of major defense companies since the
                       end of the Cold War. We also incorporated into our review the
                       perspectives of Wall Street experts and defense contractors.


                       When we collected our information, data for all years and industries in our
The Data Limitations   study were not available; our depiction of trends in some years and
                       industries may therefore be incomplete. Existing data sources do not
                       collect or specifically identify comprehensive data on DOD’s
                       subcontractors or large defense contractors. Therefore, unless we have
                       indicated otherwise, we could not define the data by the size of a business
                       or its position in the defense industry “hierarchy.” Unless noted otherwise,
                       potential error introduced by estimation or modeling procedures or in the
                       data collection or reporting procedures used by the offices that provided
                       original data used in our work may be reflected in findings generated with
                       those data.



                       3
                        DOD told us that it prefers operating income (after depreciation) as a performance measure relative
                       to cash flow.



                       Page 43                                                 GAO/PEMD-97-3 Defense Industry Trends
Appendix III

Data on Employment, Productivity, and
Competition

               In this section, we present the results of the correlational analysis
Employment     conducted on the available measures of employment in
               defense-concentrated industrial sectors obtained from Census and defense
               spending linked to those sectors obtained from DOD’s records of contract
               awards for major hard goods procurement.

               Correlational analysis provides one indication of how two or more
               variables are related. The possible range of a correlation is –1 to +1. A
               correlation of zero means that two numbers (variables) are not correlated.
               A negative correlation means that large values of one number are
               associated with small values of another number. A number correlated with
               itself returns a correlation of 1. A correlation coefficient provides an
               indication of the strength and direction of a linear relationship. In this
               case, the observed correlation coefficient allows us to determine the
               strength of the relationship between indicators of defense industry
               employment and defense spending over a specific time period. The
               procedures used to generate a correlation coefficient, by themselves,
               make it impossible to determine whether changes in one variable cause
               changes in another variable. More analysis is required to reach such
               conclusions.

               Declining defense-related employment since the post-Cold War spending
               reduction began has been described.1 We statistically compared total
               employment in the defense-concentrated industrial sectors where data
               were available (aircraft, ammunition and ordnance, shipbuilding,
               electronics and communications equipment, and tank manufacturing) to
               an indicator of defense spending linked to those sectors (total amount of
               contract awards for major hard goods procurement) for the years data
               were available (1975-91). The observed correlation, r = .27, indicates that
               the strength of the relationship is not large and is less than values
               considered moderate in size.2

               In addition to the limits of correlational analysis stated above, other
               factors limit the ability to generate definite determinations or
               generalizations about the relationship between defense spending and
               defense industry employment. At minimum, they include the absence of
               fully comprehensive data on DOD spending specifically attributed to the



               1
               See U.S. General Accounting Office, Defense Sector: Trends in Employment and Spending,
               GAO/NSIAD-95-105BR (Washington, D.C.: April 1995).
               2
                We also conducted analysis using defense budgets (FYDP, TOA) as a second indicator. The resultant
               correlation was slightly higher (r = .36).



               Page 44                                                GAO/PEMD-97-3 Defense Industry Trends
Appendix III
Data on Employment, Productivity, and
Competition




“defense industrial base” and the use of estimation or modeling
procedures to generate defense industry employment data.

Census documents provided additional data about employment trends in
defense-concentrated industrial sectors from their annual surveys of
manufacturers, which include numbers of all employees as well as
production workers in defense-concentrated industries.3 From these data,
we calculated the ratio of nonproduction employees to production
workers. Figure III.1 shows the trends in these ratios for 1975-92.




3
 Commerce defines “all employees” as “all full-time and part-time employees on the payrolls of
operating manufacturing establishments.” Production workers are “workers (up through the
line-supervisor level) engaged in fabricating, processing, assembling, inspecting, receiving, storing,
handling, packing, warehousing, shipping (but not delivering), maintenance, repair, janitorial and
guard services, product development, auxiliary production for plant’s own use (power plant, etc.),
recordkeeping, and other services closely associated with these production operations” at the
establishments covered by its survey. The available Census reports did not separately report figures
for nonproduction workers. To arrive at a figure for nonproduction workers, we subtracted the
number of production workers from the number of all employees.



Page 45                                                   GAO/PEMD-97-3 Defense Industry Trends
                                                          Appendix III
                                                          Data on Employment, Productivity, and
                                                          Competition




Figure III.1: Ratio of Nonproduction to Production Workers in Defense-Concentrated Industries, 1975-92a

Ratio
2.5




 2




1.5




 1




0.5




 0
        1975   1976   1977   1978   1979   1980   1981    1982     1983      1984    1985     1986   1987   1988   1989   1990   1991   1992

                                             Missiles Aircraft Elec.-Comm.   Tanks    Ships   Ammunition




                                                          a
                                                            Ratios greater than 1 indicate more nonproduction workers relative to production workers. As
                                                          ratios approach 1, the number of nonproduction and production workers is more equal.


                                                          Production workers have consistently been fewer than nonproduction
                                                          workers in the guided missile industry: in all years, the ratios of
                                                          nonproduction to production employees are consistently greater than 1.
                                                          Moreover, ratios of production to nonproduction workers in the guided
                                                          missile industry are considerably higher than in all other industries. In
                                                          more recent years, the ratios have increased in the missile, aircraft, tank,
                                                          and ammunition manufacturing industries, indicating that the split
                                                          between production and nonproduction workers is widening. In 1993, TASC
                                                          reported that the defense sector employed a high proportion of engineers
                                                          and technicians and relatively few production workers. Officials whom we
                                                          interviewed at Lockheed-Martin also indicated that there are no major
                                                          defense companies in the manufacturing business anymore.



                                                          Page 46                                                         GAO/PEMD-97-3 Defense Industry Trends
                                                      Appendix III
                                                      Data on Employment, Productivity, and
                                                      Competition




                                                      To provide an indication of the relationship between trends in BLS’
Productivity                                          productivity indexes (value of production) and trends in DOD’s budgets, we
                                                      compared them statistically through a correlational analysis. Figure III.2
                                                      shows the correlation between BLS indexes of productivity and trends in
                                                      DOD’s procurement budgets for five industries. During 1975-86, budgets
                                                      increased along with the value of production (the correlation coefficients
                                                      are all positive). For more recent years for which data were available
                                                      (1987-91), the value of production continued to increase but defense
                                                      budgets did not (the correlation coefficients are all negative).4



Figure III.2: The Relationship Between DOD Budgets and Productivity in Defense-Concentrated Industries, 1975-91a

Correlation coefficient
  1




0.5




  0




-0.5




 -1
                     Aircraft   Ammunition-ordnance              Elec.-Comm.                   Ships           Tanks

                                          Increasing budgets, 1975-86    Decreasing budgets, 1987-91




                                                      a
                                                          The productivity index is based on all employees.




                                                      4
                                                       The data for shipbuilding are an exception.



                                                      Page 47                                                 GAO/PEMD-97-3 Defense Industry Trends
              Appendix III
              Data on Employment, Productivity, and
              Competition




              The shipbuilding and repairing industry data differ from those of the other
              industry groups. The strength of the relationship between budgets and
              productivity is weaker, and the direction of the relationship in recent years
              is positive. There could be any number of reasons for this, ranging from
              disparities in the data to unique aspects of shipbuilding. However, the
              nature of the data we were provided and the statistical technique we
              applied do not permit us to specify explanations. We simply note that
              there is some apparent difference.


              There are multiple ways of defining, conceptualizing, and measuring
Competition   competition. The data that were available on competition permit a limited
              discussion and presentation of information about this issue. We were able
              to develop methods that allow us to address the extent of the use of
              competitive and noncompetitive procedures used in major systems
              procurement from data reported on the DD350. From the available
              information, we determined the total dollar amounts associated with these
              processes for procurement of the major hard goods listed in table I.1 for
              the time period and scope covered in our work.

              Among other data elements, the DD350 provides data on the processes
              (competitive or noncompetitive) that DOD has used in awarding
              procurement contracts for weapons. Because DOD is the primary, and in
              some cases only, buyer of weapons produced by U.S. defense contractors,
              the processes and patterns it uses in purchasing goods and services are
              relevant to understanding the potential effect on business practices of
              defense firms and the broader defense industrial base. However, because
              competition is a multifaceted concept, and we did not determine the
              extent to which the DD350 measures of competition are reliable or valid,
              this information should be considered an indicator of DOD’s use of
              competitive or other than competitive processes.

              As reported on the DD350, DOD’s pre- and post-CICA definitions, used as
              guides in our work, are shown in table III.1.5 Pre- and post-CICA definitions
              and categories differ because of the 1985 enactment of CICA.6


              5
               The data elements described in table III.1 were the primary retrieval criteria used to extract data from
              the DD350 database. Secondary criteria included the DOD claimant program numbers for the
              categories of major hard goods listed in table I.1 (that is, aircraft; missile and space systems; ships;
              tanks/automotive; weapons; ammunition; and electronics and communication equipment).
              6
               In 1985, the Competition in Contracting Act (CICA) was passed, producing changes in the way goods
              and services are procured in DOD and other federal agencies. Fiscal year 1986 is the first full year for
              which the DD350 database contains information on the new categories of information required by
              CICA provisions.



              Page 48                                                   GAO/PEMD-97-3 Defense Industry Trends
                                  Appendix III
                                  Data on Employment, Productivity, and
                                  Competition




Table III.1: Pre- and Post-CICA
Measures from the DD350 Used      Period            Procedure                                    Definition
                                  Pre-CICA          Extent of           Competitivea             Design technical competition;
                                  (data             competition in                               Price competition
                                  available,        negotiation
                                  1977-85)
                                                                        Noncompetitiveb          Catalog or market price;
                                                                                                 Follow-on to design and
                                                                                                   technical competition;
                                                                                                 Follow-on to price competition;
                                                                                                 Other
                                  Post-CICA         Solicitation        Full-and-open            Competitive proposal;
                                  (data             procedures          competitionc             Sealed bid;
                                  available,                                                     Combination
                                  1986-94)
                                                                        Other-than-full-and-     Authorized by statute;
                                                                        open competitiond        Authorized resale;
                                                                                                 Essential research and
                                                                                                    development capability;
                                                                                                 Follow-on contract;
                                                                                                 International agreement;
                                                                                                 Mobilization;
                                                                                                 National security;
                                                                                                 Patent and data rights;
                                                                                                 Public interest;
                                                                                                 Standardization;
                                                                                                 Unique source;
                                                                                                 Only one source, other;
                                                                                                 Unsolicited research proposal;
                                                                                                 Urgency;
                                                                                                 Utilities
                                  a
                                    Data for this category were extracted from data element 18, “Extent of Competition in
                                  Negotiation,” subitems 1 and 2 for competitive, on a pre-1983 version of the DD350. This data
                                  element is the same as data element C5, “Extent of Competition in Negotiation,” on the
                                  October 1983 version of the DD350.
                                  b
                                   Data for this category were extracted from data element 18, “Extent of Competition in
                                  Negotiation,” subitems 3 through 6 for noncompetitive, on a pre-1983 version of the DD350. This
                                  data element is same as data element C5, “Extent of Competition in Negotiation,” on the
                                  October 1983 version of the DD350.
                                  c
                                    Data for this category were extracted from data element C9, “Solicitation Procedures,” subitems
                                  A-C for full and open competition, on the May 1985 version of the DD350.
                                  d
                                   Data for this category were extracted from data element C9, “Solicitation Procedures,” subitem
                                  N, other than full and open competition, on the May 1985 version of the DD350.



                                  The DOD data show that, on average, in 1977-94, more money was
                                  associated with major systems procurements that were awarded using
                                  DOD’s other than competitive procedures compared to competitive ones
                                  (see figures 5 and 6). In our analysis, we found not only greater average



                                  Page 49                                                GAO/PEMD-97-3 Defense Industry Trends
                                                 Appendix III
                                                 Data on Employment, Productivity, and
                                                 Competition




                                                 dollar amounts associated with other than competitive procurement
                                                 procedures but also more money spent on other than competitive
                                                 contracts for electronics and communications equipment, ammunition,
                                                 weapons, and aircraft in every year of the past 18. With exceptions in a few
                                                 years, we found the same trend for procurement contracts for missiles,
                                                 tanks, and ships. These trends are detailed in figures III.3 through III.16 for
                                                 each procurement program and separately for pre- and post-CICA time
                                                 periods.



Figure III.3: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Electronics and
Communications Equipment, 1977-85


                                     Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)
$20




$15




$10




 $5




 $0
      1977             1978   1979           1980             1981               1982      1983   1984       1985

                                                    Competitive Noncompetitive




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                                              Appendix III
                                              Data on Employment, Productivity, and
                                              Competition




Figure III.4: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Electronics
and Communications Equipment, 1986-94


                                      Post-CICA Data: Solicitation Procedures
FY 1995 $ (billions)
$20




$15




$10




 $5




 $0
      1986             1987   1988       1989               1990                1991         1992   1993       1994

                                     Full and Open Competition Other Than Full Competition




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                                               Data on Employment, Productivity, and
                                               Competition




Figure III.5: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Ammunition, 1977-85



                                     Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)

$5




$4




$3




$2




$1




$0
     1977              1978   1979          1980             1981                1982      1983   1984        1985

                                                   Competitive Non-Competitive




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                                            Data on Employment, Productivity, and
                                            Competition




Figure III.6: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Ammunition,
1986-94


                                       Post-CICA Data: Solicitation Procedures
 FY 1995 $ (billions)




 $4




 $3




 $2




 $1




 $0
      1986              1987   1988      1989                1990                1991         1992    1993        1994

                                      Full and open competition Other Than Full Competition




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                                              Data on Employment, Productivity, and
                                              Competition




Figure III.7: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Weapons, 1977-85


                                 Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)
 $3




$2.5




 $2




$1.5




 $1




$0.5




 $0
       1977            1978   1979         1980             1981               1982   1983   1984       1985

                                                  Competitive Noncompetitive




                                              Page 54                                         GAO/PEMD-97-3 Defense Industry Trends
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                                              Data on Employment, Productivity, and
                                              Competition




Figure III.8: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Weapons,
1986-94


                                     Post-CICA Data: Solicitation Procedures
FY 1995 $ (billions)
 $2




$1.5




 $1




$0.5




 $0
       1986            1987   1988        1989               1990              1991          1992   1993       1994

                                     Full and open competition Other than full competition




                                              Page 55                                                GAO/PEMD-97-3 Defense Industry Trends
                                                 Appendix III
                                                 Data on Employment, Productivity, and
                                                 Competition




Figure III.9: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Aircraft, 1977-85



                                     Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)
$40



$35



$30



$25



$20



$15



$10



 $5



 $0
      1977             1978   1979            1980             1981               1982     1983   1984       1985

                                                     Competitive Noncompetitive




                                                 Page 56                                           GAO/PEMD-97-3 Defense Industry Trends
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                                               Data on Employment, Productivity, and
                                               Competition




Figure III.10: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Aircraft,
1986-94

                                     Post-CICA Data: Solicitation Procedures
FY 1995 $ (billions)
$25




$20




$15




$10




 $5




 $0
      1986             1987   1988        1989              1990               1991          1992   1993       1994

                                     Full and open competition Other Than Full Competition




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                                                 Data on Employment, Productivity, and
                                                 Competition




Figure III.11: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Missiles, 1977-85



                                     Pre-CICA Data: Extent of Competition in Negotiation
FY 1995 $ (billions)
$25




$20




$15




$10




 $5




 $0
      1977             1978   1979            1980             1981               1982     1983   1984       1985

                                                     Competitive Noncompetitive




                                                 Page 58                                           GAO/PEMD-97-3 Defense Industry Trends
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                                              Data on Employment, Productivity, and
                                              Competition




Figure III.12: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Missiles,
1986-94


                                     Post-CICA Data: Solicitation Procedures
FY 1995 $ (billions)
$14



$12



$10



 $8



 $6



 $4



 $2



 $0
      1986             1987   1988       1989               1990               1991          1992   1993       1994

                                     Full and open competition Other than full competition




                                              Page 59                                                GAO/PEMD-97-3 Defense Industry Trends
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                                                     Data on Employment, Productivity, and
                                                     Competition




Figure III.13: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Tanks, 1977-85



                                     Pre-CICA Data: Extent of Competition in Negotiation
FY 1975 $ (billions)
$6




$5




$4




$3




$2




$1




$0
     1977              1978   1979            1980              1981               1982    1983   1984       1985

                                                      Competitive Noncompetitive




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                                                Data on Employment, Productivity, and
                                                Competition




Figure III.14: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Tanks,
1986-94

                                     Post-CICA Data: Solicitation Procedures
FY 1975 $ (billions)
$4




$3




$2




$1




$0
     1986              1987   1988       1989               1990               1991          1992   1993       1994

                                     Full and open competition Other than full competition




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                                                 Data on Employment, Productivity, and
                                                 Competition




Figure III.15: Dollars Awarded Using Competitive and Noncompetitive Procurement Methods for Ships, 1977-85


                                      Pre-CICA Data: Extent of Competition in Negotiation
 FY 1995 $ (billions)
 $14



 $12



 $10



  $8



  $6



  $4



  $2



  $0
       1977             1978   1979           1980             1981               1982      1983   1984        1985

                                                     Competitive Noncompetitive




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                                            Data on Employment, Productivity, and
                                            Competition




Figure III.16: Dollars Awarded Using Full and Open Competition and Other Than Full and Open Competition for Ships,
1986-94

                                      Post-CICA Data: Solicitation Procedures
 FY 1995 $ (billions)
 $14



 $12



 $10



  $8



  $6



  $4



  $2



  $0
       1986             1987   1988      1989                1990                 1991        1992   1993        1994

                                      Full and open competition Other than full competition




                                            In recent years, the amount of money associated with DOD competitive and
                                            other than competitive contracts has declined for most procurement
                                            programs. At the same time, the gap between money awarded on
                                            competitive and other than competitive contracts is getting smaller. The
                                            only exception to this is contract dollars DOD spent on aircraft
                                            procurement, as shown in figure III.10. The split between dollars spent for
                                            competitive and other than competitive aircraft procurement has actually
                                            increased in recent years, such that increasingly greater amounts of money
                                            are associated with aircraft procurement contracts that DOD awards with
                                            procedures it defines as other than competitive.

                                            In addition to data trends on the processes DOD uses to award
                                            procurement contracts, another indicator related to understanding
                                            competition in defense industry is the number of businesses available to
                                            enter into competition. In the post-Cold War, there has been a decline in
                                            the number of independent defense contracting businesses, either through
                                            business combinations or exiting the defense business. From a broader



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                                                Data on Employment, Productivity, and
                                                Competition




                                                historical view, figure III.17 shows that there are clearly fewer contractors
                                                today than 50 years ago, at the end of World War II.



Figure III.17: Number of Defense Contractors From the End of World War II to 1994a


Number of contractors
40

                                                                      36




30

                                    26


                22

20

                                                                                                   16




10                              9
                                                    7
                                                                                   5

                                                                                                                2

 0
                     Missiles            Aircraft                   Ships and submarines                Tanks

                                                        End WW II   1994



                                                a
                                                  The data for missile contractors are from about 1960 to the present. All information obtained from
                                                Lockheed Martin.




                                                Page 64                                                  GAO/PEMD-97-3 Defense Industry Trends
Appendix IV

U.S. Defense Companies After the Cold War


              There is some consensus that the top defense firms have come through the
              post-Cold War funding reduction well and that they remain profitable. The
              Wall Street analysts whom we spoke with indicated that the forecasts for
              defense companies are not as bad as the companies perceive. Analysts at
              Lehman Brothers indicated that companies are more pessimistic than
              necessary about future growth, given DOD’s plans to increase defense
              spending in the outyears. It is important to note, however, that many
              companies have suffered difficult reorganization and employee loss as
              they have made the transition to decreased defense spending.

              Still, companies have not all been equally affected, and some variability in
              the financial indicators of the top companies suggests that the period of
              reduction has been less painful for some companies than for others. We
              selected financial indicators to examine—sales and cash flow—after our
              discussions with Wall Street defense business analysts, defense
              contractors, and experts from the private sector and after reviewing DOD’s
              work in this area. Other measures or variables from company income
              statements that can be used to analyze financial viability include gross
              income, operating income, and net income.

              The companies that we report data for are companies among the top 100
              that received the largest dollar volume of DOD prime contract awards in
              1994. Figures IV.1 and IV.2 show multiyear trends for five top defense
              contractors whose corporate sales and cash flow fell, while figures IV.3
              and IV.4 show multiyear trends for four top defense contractors whose
              corporate sales and cash flow rose or remained stable.




              Page 65                                   GAO/PEMD-97-3 Defense Industry Trends
                                           Appendix IV
                                           U.S. Defense Companies After the Cold War




Figure IV.1: Financial Indicators of Three Top Defense Contractors: Falling Corporate Sales, 1975-95


$ (billions)
$12




$10




 $8




 $6




 $4




 $2




 $0
       1975                 1980                        1985                   1990                    1995

                                          Avondale General Dynamics   Litton




                                           Page 66                                       GAO/PEMD-97-3 Defense Industry Trends
                                             Appendix IV
                                             U.S. Defense Companies After the Cold War




Figure IV.2: Financial Indicators of Three Top Defense Contractors: Falling Cash Flow, 1975-95

$ (billions)
  $2




$1.5




  $1




$0.5




  $0




-$0.5




  -$1
        1975                1980                          1985                          1990             1995

                                    General Dynamics United Technologies Westinghouse




                                             Page 67                                           GAO/PEMD-97-3 Defense Industry Trends
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                                           U.S. Defense Companies After the Cold War




Figure IV.3: Financial Indicators of Four Top Defense Contractors: Rising Corporate Sales, 1975-95


$ (billions)
$25




$20




$15




$10




 $5




 $0
       1975                 1980                          1985                  1990                   1995

                                             FMC     LM      Loral   Northrop




                                           Page 68                                       GAO/PEMD-97-3 Defense Industry Trends
                                          Appendix IV
                                          U.S. Defense Companies After the Cold War




Figure IV.4: Financial Indicators of Four Top Defense Contractors: Rising Cash Flow, 1975-95


$ (billions)
  $2




$1.5




  $1




$0.5




  $0
        1975                1980                      1985                  1990                  1995

                                           FMC   LM     Loral   Raytheon




                                          The sales and cash flow figures shown are the amounts reported for that
                                          year. Sales and cash flow may appear to be better for some companies
                                          than for others for many reasons. A detailed assessment of this issue was
                                          beyond the scope of our work. However, we can suggest explanations
                                          such as how diversified a company is, the range and number of defense
                                          segments that some companies have (for example, General Dynamics is
                                          involved in shipbuilding and tank manufacturing), transactions associated
                                          with business combination or divestiture activity (for example, Lockheed
                                          Martin; Northrop-Grumman; General Dynamics; other acquisitions by
                                          Raytheon, Loral, FMC), and other profitable business segments companies
                                          have with other federal agencies or offices, commercial clients, and
                                          foreign companies. Some of the largest changes shown in the figures
                                          reflect merger and acquisition activity, such as the growth in sales and
                                          cash flow for Lockheed Martin and the declining sales and cash flow for
                                          General Dynamics.



                                          Page 69                                       GAO/PEMD-97-3 Defense Industry Trends
Appendix V

Major Contributors to This Report


                     Carolyn M. Copper, Project Manager
Program Evaluation   Penny Pickett, Communications Analyst
and Methodology      Venkareddy Chennareddy, Referencer
Division
                     Other noteworthy contributions to the work were made by Winslow
Acknowledgments      Wheeler, who contributed to the project’s early direction, and Robert
                     Copeland, who contributed to the study design.




(973421)             Page 70                                  GAO/PEMD-97-3 Defense Industry Trends
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