Government efficiency has been in the news a lot lately. However, the new Department of Government Efficiency appears to be looking in all the wrong place and cutting costs that are marginal. A recent cut has been to government travel. While cutting travel is an easy target and something that does not require much thought or effort, it accounts for less than 1% of the federal budget. There are much bigger drivers of waste in the government. One is the exorbitant prices that the government pays for basic items. . In 1985, one headline was “Pentagon pays $640.09 per toilet cover, gives new meaning to ‘throne.’” As recently as 2018, the price to the government for a new toilet cover was an outrageous $10,000. Even adjusted for inflation the $640 toilet seat seems cheap by comparison! In 2011, there were reports of huge markups in the market for Army helicopter spare parts, including a $12.51 gear that is smaller than a dime for which the Department of Defense paid $644.75; and in 2014, the Department of Defense paid $492.17 for a straight-headed pin that cost $36.08 to make.
The United States is a capitalist economy. It does not own the means of production. As a result, it relies on corporations to design and produce it weapon systems and aerospace programs. These contractors are referred to as “equipment manufacturers” and “prime contractors.” The lead contractor on such contract is referred to as the prime. The prime contractor works with numerous several subcontractors. For simplicity, we will refer to the contractors who design and produce government systems as “prime contractors” or just “contractors.”
Recall the difference between price and cost. Price is the sum of cost and profit. Prices can be high because either cost is high, or profit is high, or because of both. Profit in government contracts is usually set as a fee that is a percentage of the cost of designing and producing a system. One way to increase this fee is to increase the cost. If fee is 10% and the item costs $100, the profit is $10. If the cost doubles, so does the profit, from $10 to $20 (in theory, the government should reduce the fee if the cost goes up, but that rarely happens in practice.) The small costs mentioned in the preceding paragraph are the direct costs of manufacturing the items. The high prices are a combination of profit and some allocation of the fixed indirect costs that the contractor allocate to these tasks. This indirect cost can be significant, as we discuss later.
One of the reasons for these high prices is a lack of competition among the contractors. As we will discuss, there are only a few viable prime contractors for development, and typically none for the production and operations of the system. A second reason is the asymmetry of incentives between government and contractors. Contractor are motivated by profit but there is nothing similar on the government side. The other key reason for high prices and long schedules is government bureaucracy.
There used to be dozens of competitors in the defense and aerospace markets. In the last few decades a great deal of industry consolidation has taken place. The result is a few large contractors. Between 1980 and 2000, 77 companies have merged into five large giant corporations – the “Big 5” – Boeing, Lockheed Martin, Raytheon, Northrop Grumman, and General Dynamics. See the graph below which shows the large amount of consolidation. As of 2015, these five companies had $80 billion of defense business and employed 500,000 people. The defense market has a few large sellers. Economists refer to the case in which there are a few sellers as an oligopoly.
The trend of consolidation continues. The $7 billion acquisition of Orbital ATK by Northrop Grumman received approval in 2018. Orbital ATK has most of the solid rocket motor manufacturing capability in the U.S. and is effectively a monopoly for large solid rocket motors. Solid rocket motors are like giant bottle rockets. Orbital ATK itself is the result of a 2015 merger between Orbital and ATK. In 2018, United Technologies acquired Rockwell Collins for $30 billion.
Breaking up these large companies into smaller ones that can compete with one another could results in lower costs to the government for weapon and aerospace systems. It will require some effort to do so, but doing so could result in getting more done with less money. The Department of Defense budget alone is over 13% of the federal budget. Achieving savings in weapon systems will thus have a bigger impact.