Commentary in The Deal by Albert A. Foer opposing the acquisition of Newport News Shipbuilding Inc. by General Dynamics Corp

Nov 11 2001
Commentaries

The Deal.com, Nov. 6, 2001 (by permission)

Military-Industrial Complexities

by Albert A. Foer

Current anxiety over the limited availability of vaccine for anthrax focuses attention on an obvious downside of government dependence on a single supplier: If the program isn't accomplishing what is desired, the country has no alternative at hand - at any price.

Against the backdrop of Sept. 11 and bioterror, the Department of Justice has filed suit to stop a merger that would have yielded another security-related monopolist.

Newport News Shipbuilding Inc. and General Dynamics Corp. are the only two U.S. companies that build - or can be expected in the foreseeable future to build - nuclear submarines. Both General Dynamics and Northrop Grumman Corp. want to buy Newport News. On Oct. 23, the Justice Department's Antitrust Division took action to block General Dynamics.

At first blush, this appears to be a no-brainer from an antitrust perspective. Were General Dynamics to win the bidding, it would close a merger to monopoly.

There should be no need to rehash the arguments against monopoly. Monopolies generally charge high prices, shift the monopoly overcharge from the pockets of consumers to the pockets of shareholders, are inefficient and either do not innovate or channel innovation to their own benefit. Where competition is a viable alternative, it tends to lead to lower prices, greater efficiency and more innovation.

But the submarine merger presents a problem for the military-industrial complex and the public that is, indeed, complex.

The complexity arises from the low rate of procurement of submarines since the end of the Cold War. Congress is authorizing and the Navy is beginning construction on only one new nuclear submarine a year. This pace is considered too slow to be a viable basis for competitive awards to two independent shipyards.

Congress realized that once a shipyard is closed, it will be enormously difficult and expensive to develop a second shipyard. To keep two yards working during what was perceived to be a temporary period of reduced need for new subs, a compromise was worked out in 1997.

Called "teaming," it turns the shipbuilding into an equilateral joint venture in which, in effect, each company separately builds assigned sections of a sub, and the parts are then assembled into a finished whole. Each shipyard retains the capability to do final assembly, but each has become specialized in certain parts of the job.

We are now at the front end of constructing the Virginia-class attack submarine. It is anticipated that 30 of these will eventually be built, but the first four will be assembled under the teaming contract. Each sub takes about six years to complete.

Whether teaming will continue and whether the pace will expand to two or more new authorized subs per year will depend on the funding Congress and the Navy will make available, and this will depend largely on predicted security needs.

The Navy's publicly available shipbuilding plan calls for authorization of one Virginia-class ship per year through 2005, the end of the planning horizon associated with the 2001 budget. Analysts outside the Navy, however, have calculated that build-rates of two and then three ships per year will be necessary beginning around the middle of this decade to maintain today's 55-ship fleet of attack submarines.

Advocates of a General Dynamics acquisition cite substantial efficiencies from merging the two shipyards, and misplaced concern about a monopoly. In fact, they say, teaming already amounts to a "virtual merger." We have already been living with a monopoly, they urge, and any effort to take the teaming apart and restore two fully functioning shipyards will be costly and unlikely to lead to sustained real competition.

The degree of teaming here is unusual, but it falls short of a true merger. For example, the two companies continue to compete vigorously through their engineers for contracts to perform research and development on undersea warfare and "product improvements." Moreover, it is likely the presence of two companies means each is always subject to the threat of potential competition, which motivates efficient performance.

Even with teaming, there can be useful competition. While it is true there would be expenses if the teaming were brought to an end after the first four Virginia-class subs are completed, there would also be benefits for the government to have two companies competing. Experience shows that in general, if a market is large enough to sustain more than one efficient competitor, innovation is more likely, experience curves are steeper and costs will be lower if there is competition.

In other words, although there are static efficiencies favoring a monopoly, there are dynamic efficiencies favoring a duopoly. Duopoly is almost always a better alternative than monopoly, which requires a higher level of regulation and oversight to protect the public.

We, as members of the public at large, are not in a position to answer the crucial questions of fact and prediction upon which an intelligent national decision about a General Dynamics merger should rest. Nor are we able to say that the competing bid for Newport News by Northrop Grumman should or should not be approved. Ultimately, the Defense Department, as the sole buyer, or its principal, the Congress, must decide how much future demand there will be for attack submarines.

Everyone agrees nuclear submarines constitute a keystone system in our arsenal. Everyone agrees that if you let one of the shipyards close, the probability is that there will never be a second shipyard capable of making submarines employing nuclear propulsion.

It would seem that the burden should be on those advocating a monopoly to demonstrate that there is no more than a very low probability that we will purchase more than one new submarine per year, going out 10 to 20 years. Otherwise, the dynamic benefits of competition should prevail.

We would not want to find ourselves out there in the future suddenly facing a dramatically changed national security environment, or one that puts critical national industrial capabilities of the country at risk, and find we had made a decision in the heat of 2001 that made sense from a short-term, fiscal perspective, but made no sense from a long-term, industrial-strategic perspective.

As the Justice Department apparently concluded, it is never desirable to put all your eggs in one basket, if you have a choice.