CRA publishes Grundman on “The Monopsonist’s Dilemma: Implications for the Defense Industry of Better Buying Power at the Pentagon”

1 October 2010 • 0 Comments

At a press conference in September 2010, then-US Secretary of Defense Robert Gates and his acquisition executive, Ashton Carter, announced Carter’s issuance of direction for how the Pentagon would set out to achieve productivity growth in its acquisition of weapons and procurement of services. The details of the new direction are contained in a 17-page memorandum, dubbed Better Buying Power. In this issue of CRA Insights that was first published in October 2010, Steve Grundman, a former US Deputy Under Secretary for Industrial Affairs, appraises the significance of Better Buying Power to the defense industry. His appraisal is keyed to the invocation of “buying power” in the initiative’s title, which calls to mind the balance of market power between buyers and sellers that microeconomists ascribe to industrial structures in which many sellers face a single buyer—monopsony. Better Buying Power certainly reads like the monopsonist’s playbook for defense in the 21st century.

Consequently, Grundman believes Better Buying Power is the most important expression of US defense-industrial policy since July 1993 when then-Deputy Secretary William Perry convened the captains of industry for what came to be called the “last supper,” a meal over which he issued direction that set in motion the Darwinian restructuring of industry which ensued across the following decade. This Guidance is instead addressed to the cadre of acquisition professionals who work for Carter and ostensibly directs only buyers’ procurement practices; however, like Perry’s direction, its successful implementation would change many of the key tenets of doing business with the Pentagon, including those that drive competitive advantage, financial performance, and the structure of industry.

A central direction in the Guidance is to promote competition by implementing various tactics that would limit the scale, scope, and duration of individual contract opportunities. The Guidance also implies a change to the customary business model of defense procurement. It moves away from a model characterized by level-of-effort resource management and predictable margins over long contract durations and toward one that relies for high returns on more flexible assets, risk management practices, and responsiveness. At the same time, Carter clearly understands that he can not induce private firms to undertake projects if their expected returns do not cover their cost of capital. The tension between these competing objectives illustrates the classic dilemma faced by a customer with market power who wants to drive prices as close to marginal cost as possible while concurrently incentivizing commitment, quality, and innovation.

The prospect of a customer determined to make better use of its buying power also presents suppliers with dilemmas. On the one hand, who’s to argue with the merit in a smarter Pentagon advancing business practices that incentivize both the military departments and defense contractors to squeeze out non-value-added programs, capabilities, practices, and activities? On the other hand, in circumstances where budgets are not growing, competition becomes the primary mechanism of those incentives, so the distribution of efficiency gains will not be uniform. There are sure to be winners but also losers.

The memorandum’s anodyne headings and arcane details disguise an initiative of profound significance for the defense industry. Successfully implemented over time, it will demand of industry much more than the simple belt-tightening that has comprised the initial responses. It challenges prevailing business models, and in turn, the very structure of the industry. Even now, a year following its promulgation, it remains hard to know the exact course of Better Buying Power’s ultimate impact on industry, not least because its implementation is fraught with uncertainties and its specific implications for programs and companies will vary. Regardless, this very direct, detailed, and personal expression of how the secretary and Deputy Secretary-designate want the market for defense goods and services to work marks some kind of post-Iraq War inflection from the trajectory of defense-industrial policy that was last so clearly set 17 years ago.


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