Defense Conversion: Will It Prove Successful?*

Declining defense budgets have led to a shrinkingU.S. defense industrial base and one that is more dependent on global sales and purchases. Because the U.S. economy is so large, defense downsizing is not having a devastating impact on the Nation as a whole, although certain regions of the countryhave been adversely affected. Unlike the defense downturns that occurred after World War II and the Korean and Vietnam conflicts, the current situation is not cyclical; that is, because the threat to national security is considerably less than it wasduring the Cold War, an upturn in defense spending is unlikely to occur anytime in the foreseeable future.

Most large industrial firms that were once heavily dependent on business from the Pentagon have had to make some major adjustments. Ingeneral, these defense prime contractors have chosen one of three courses: downsizing, concentrating on the defense business, or conversion.

Most firms have chosen to downsize. For example, companies like McDonnell-Douglas are much smaller thanthey used to be. The cutback in R&D performed by downsizing firms is reflected in National Science Foundation (NSF) data that show an $8 billion decline in the level of Federal R&D funds spent by industry between 1987 and 1993.

Other companieshave chosen to stick with the defense business and are even acquiring divisions and units shed by the downsizing firms. For example, in the early 1990s, Loral and Martin Marietta bought the defense-related businesses of other large defensecontractors. The defense business is still profitable, and foreign customers are becoming more numerous. Therefore, those companies that have always been leaders in certain markets will continue to survive and thrive. There will just be fewer ofthem.

The third group of companies consists of those firms attempting defense conversion, i.e., shifting from military to civilian-related activities. What is meant by the term defense conversion is actually diversification. It usually involvesfinding civilian uses for technologies previously developed for the military. Defense companies diversifying into new markets include Westinghouse, TRW, and Hughes. Although these companies have always had a substantial presence in the civiliansector, they are attempting to find new commercial markets for products and services that were initially developed for military use. Examples of these products include weather satellites and air traffic control systems. In addition, the Government iscurrently supporting these diversification efforts with programs such as the Technology Reinvestment Project. (See Defense-Related Issues in this chapter.)

Smaller companies that served as subcontractors on large defense projects are also facedwith transition into a peacetime economy. They are finding fewer opportunities because prime contractors are reducing the number of subcontractors and are now competing more often for small projects, business they would not have considered biddingfor in the past. Downsizing is not an option for these firms, because they are already small. Diversification is their only choice if they want to survive.

Another group of companies gaining prominence as a result of defense downsizing are spin-offfirms. These are companies that got their start using new technologies developed by large companies that did not want to commercialize the new technologies. Examples include a company that took sonar technology developed by a large defense contractorand used it to develop equipment to monitor environmental pollution. Another successful company used encryption technology (developed for the National Security Agency) to make electronic tags to monitor hospital patients. It is too soon to tell howsuccessful overall defense contractors will be diversifying into new markets. The disruption in R&D activities and labor markets caused by the end of Cold War hostilities, however, is likely to be at least somewhat mitigated by the ability of some ofthese companies to take advantage of burgeoning commercial opportunities.

* Most of the information in this section came from Pages, 1993.