The defense industry is largely oligopolistic, with the federal government the sole customer, or "monopsonist" (McConnell, 1991). The industry consists of relatively few very large contractors and many small satellite subcontractors which cluster around them. The business of a contractor in defense work comprises research and development and/or production. The work can vary from exploratory studies, costing thousands of dollars, to extensive production programs involving billions and requiring broad subcontracting arrangements. In practice, the firm that does the research and development often contracts the production work as well.
As much as 75% of the annual dollar value of all prime military contracts -- those awarded directly by the government -- are awarded to less than one hundred companies. Even though the government usually stipulates subcontracting provisions in such prime contracts, the small supporting firms are more vulnerable to fluctuations in the defense market than the principle concerns (Byrns, 1987). When military spending is on the decline, as it is currently, the larger companies tend to reduce subcontracting in order to increase in-house work; this enables them to maintain their staffing and facility levels at the same level, even though the overall output required of the company has been reduced.
In many prime defense contracts, research and development is the primary element (Wilson, 1983). In commercially directed research and development, the goal of any project is anticipated profit, and such firms spending money on research and development undertake some element of risk. This is not the case, however, for research and development that has been contracted by the federal government. The federal government guarantees a "fair and reasonable" profit for contracted research and development. Furthermore, the government is the sole buyer and user of the products that are created -- the government al...