THE PROFITABILITY OF U.S. DEFENSE CONTRACTS: A STUDY OF IMPLICIT

RETURN ON SALES

A DISSERTATION SUBMITTED TO THE GRADUATE DIVISION OF THE UNIVERSITY OF HAWAI‘I AT MĀNOA IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF

DOCTOR OF PHILOSOPHY

IN

INTERNATIONAL MANAGEMENT

MAY 2014

By

Tanya Andrea Peacock

Dissertation Committee: Kiyohiko Ito, Chairperson Dharm Bhawuk David Bess Liming Guan Ronald Heck

Keywords: profit, contract, defense, resource

©2014, Tanya Andrea Peacock

ii

DEDICATION

To Barbara Siller

iii

ACKNOWLEDGMENTS

I am indebted and grateful to so many people who have positively influenced my career and enabled me to achieve my academic aspirations.

First, I would like to thank the U.S. Army leaders who provided me with the rare opportunity to pursue a PhD while on Active Duty. In particular, I want to thank the officers who wrote my letters of recommendation and the faculty members of the Army-

Baylor Graduate Program in Health and Business Administration for supporting this endeavor.

My deepest gratitude is extended to my committee chair, Professor Kiyohiko Ito, for his guidance and encouragement. During the past three years, he served as an excellent role model by focusing my efforts and challenging me intellectually. I am very appreciative of his time and commitment.

I also want to thank Professors Dharm Bhawuk, David Bess, Liming Guan, and

Ronald Heck for their interdisciplinary perspective, support, and positive feedback. I am very grateful for their generosity, time, and valuable contributions. They developed my critical thinking skills and allowed me to achieve a higher level of understanding.

I want to especially acknowledge my parents. They instilled my values, cultivated my work ethic, and fostered my love of learning.

My children, Nathaniel and Nicholas, are my inspiration. They have provided me with joy and purpose. In many ways, they have taught me how to become a better educator. I love them and hope to inspire them as much as they have inspired me.

Finally, I want to thank my husband, Mike, for his constant patience, support, and commitment. Without him, I could not achieve balance in my life.

iv

ABSTRACT

Using a combined resource approach, this research examines the implicit return on sales for firms with substantial U.S. Department of Defense contracts, in terms of customer and geographic segments, to assess whether multinational firms obtain tangible or intangible benefits from the contract. Publicly traded firms were selected from the Top 100

Contractors Report, Federal Procurement Data System-Next Generation, between 2006 and 2010. For the entire sample of military contractors, nonmilitary sales segments and international sales segments were profitable, but U.S. military sales segments were not.

After splitting the sample, it was found that the military sales segment was profitable for smaller firms and defense-oriented firms. Smaller firms realize greater profits from the international component of their nonmilitary sales segment, whereas large firms, defense- oriented firms, and nondefense-oriented firms realize profits from both the nonmilitary domestic and international sales segments. U.S. Department of Defense contracts are a valuable resource which may be leveraged differently to increase profitability, depending on the size and nature of the company.

v

TABLE OF CONTENTS

ACKNOWLEDGMENTS ...... iv

ABSTRACT ...... v

LIST OF TABLES ...... ix

LIST OF FIGURES ...... x

CHAPTER 1. INTRODUCTION ...... 1

CHAPTER 2. LITERATURE REVIEW ...... 4

2.1 The Resource Dependence Theory ...... 4

2.1.1 Contracts as a resource...... 5

2.2 The Resource-Based View of the Firm ...... 6

2.2.1 Contracts as a resource...... 8

2.3 Profitability of Firms with U.S. Department of Defense Contracts ...... 10

2.3.1 Segment profitability ...... 11

2.3.2 Profitability at the firm-level ...... 13

2.3.3 Profitability and the environment ...... 15

CHAPTER 3. DEFENSE INDUSTRIAL BASE OVERVIEW ...... 18

3.1 Key Terms and Definitions ...... 18

3.2 Characteristics of the Defense Industrial Base ...... 21

3.2.1 Defense industry environment ...... 24

3.2.2 Economic and military trends (2006-2010) ...... 31

3.3 The Department of Defense Contract as a Resource ...... 33

3.3.1 A combined resource approach ...... 34

CHAPTER 4. HYPOTHESES ...... 39

vi

4.1 Military and Nonmilitary Sales Profitability ...... 40

4.1.1 All companies ...... 40

4.1.2 Large and small companies ...... 41

4.1.3 Defense-oriented and nondefense-oriented companies ...... 43

4.2 Nonmilitary Domestic and International Sales Profitability ...... 46

4.2.1 All companies ...... 46

4.2.2 Large and small companies ...... 48

4.2.3 Defense-oriented and nondefense-oriented companies ...... 50

CHAPTER 5. MODEL ...... 52

CHAPTER 6. METHODOLOGY ...... 55

6.1 Data ...... 55

6.2 Dependent Variable ...... 56

6.3 Independent Variables ...... 56

6.4 Analysis...... 57

CHAPTER 7. RESULTS ...... 66

7.1 Military and Nonmilitary Sales Profitability ...... 66

7.1.1 All companies ...... 66

7.1.2 Large and small companies ...... 69

7.1.3 Defense-oriented and nondefense-oriented companies ...... 70

7.1.4 Cross-sectional analysis ...... 71

7.2 Military, Nonmilitary Domestic and International Sales Profitability...... 73

7.2.1 All companies ...... 73

7.2.2 Large and small companies ...... 75

vii

7.2.3 Defense-oriented and nondefense-oriented companies ...... 76

7.2.4 Cross-sectional analysis ...... 77

CHAPTER 8. DISCUSSION AND CONTRIBUTIONS ...... 80

8.1 Discussion ...... 80

8.1.1 Military and nonmilitary sales profitability ...... 81

8.1.2 Military, nonmilitary domestic, and international sales profitability ...... 81

8.1.3 Cross sectional analyses ...... 82

8.2 Contributions...... 82

8.2.1 Theoretical contribution ...... 82

8.2.2 Methodological contribution ...... 85

8.2.3 Practical contribution ...... 86

CHAPTER 9. LIMITATIONS AND FUTURE RESEARCH ...... 87

9.1 Limitations ...... 87

9.2 Future Research ...... 88

CHAPTER 10. CONCLUSION ...... 90

APPENDICES ...... 92

Appendix A: Firms with the largest U.S. Department of Defense contracts ...... 92

Appendix B: Growth models of net income ...... 103

GLOSSARY ...... 114

REFERENCES ...... 116

viii

LIST OF TABLES

TABLE PAGE

Table 1. Top nine industries with recurring, large U.S. DoD contracts (2006–2010) ...... 58

Table 2. Large and small firms with large U.S. DoD contracts (2006-2010) ...... 60

Table 3. Defense-oriented firms with large U.S. DoD contracts (2006-2010) ...... 62

Table 4. Correlations and descriptive statistics ...... 65

Table 5. Military and nonmilitary segment profitability ...... 68

Table 6. Military and nonmilitary segment profitability by year ...... 72

Table 7. Military, nonmilitary domestic, and international segment profitability ...... 74

Table 8. Military, nonmilitary domestic, and international segment profitability ...... 79

Table 9: Firms with the largest U.S. Department of Defense contracts, 2006-2010 ...... 92

Table 10. Effect of military sales on net income (Model 1) ...... 107

Table 12. Estimates of covariance parameters (Model1) ...... 109

Table 13. Effect of military sales on net income (Model 2) ...... 111

Table 14. Estimates of covariance parameters (Model 2) ...... 113

ix

LIST OF FIGURES

FIGURE PAGE

Figure 1. Segments of a U.S. multinational company ...... 19

Figure 2. Defense industry structure...... 29

Figure 3. Combined resource approach ...... 37

x

CHAPTER 1. INTRODUCTION

“ . . . we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex.” Dwight D. Eisenhower (1961)

“ . . . the deterioration of America’s industrial base is one of the most pressing issues in the Department of Defense today.” D.J. Atwood, Deputy Secretary of Defense (1990)

Multinational firms that conduct business with the U.S. Department of Defense are diverse, innovative partners that contribute to the economic prosperity and national security of the United States. These firms operate in a unique market environment dominated by a single customer, are constrained by regulation, and include numerous stakeholders with varying interests. Given that the U.S. Department of Defense is the largest purchasing organization in the world, spending $370 billion in services, supplies, and equipment annually (Defense Procurement and Acquisition Policy, 2013), the strategic choices made by these multinational companies with respect to profitability are of particular interest to a wide variety of stakeholders.

The resource-based view (Wernerfelt, 1984; Barney, 1991) and the resource dependence theory (Pfeffer and Salancik, 2003) provide frameworks for identifying, examining and assessing resources to predict and understand strategic choices.

Wernerfelt (1984) suggests that attractive resources enhance the ability of heterogeneous firms to generate higher returns. Pfeffer and Salancik (2003) suggest that the environment constrains the profitability of firms; therefore, firms must alter the environment to

1

capitalize on external resources. Both theories provide recommendations for the exploitation of existing resources and the acquisition of new resources.

This study contributes to the existing literature by demonstrating that a U.S.

Department of Defense contract is a resource that multinational firms seek to protect. The manner in which such firms exploit this resource indicates its high value organizationally, and reveals elements of firm strategy. Theoretically, I shed light on resource-related perspectives by integrating aspects of the resource dependence theory and the resource- based view to advocate a combined resource approach. I demonstrate that the U.S.

Department of Defense contract may be used as a resource by different types of multinational firms for predominantly tangible or intangible benefits.

Previous profitability analyses of defense industry firms were accomplished primarily from an accounting perspective and used a variety of different samples, dates, and financial measures to reach different conclusions. The lack of consensus concerning methodological techniques and resultant interpretations of profitability is worthy of investigation. From a management perspective, some questions also remain unanswered.

In what ways do multinational firms leverage a contract with the U.S. Department of

Defense to maintain or improve their global strategic position? What types of firms rely on profits from the U.S. Department of Defense? Why might a firm continue to conduct business with the U.S. Department of Defense if it is not profitable from an accounting perspective?

I use customer segments, geographic segments, and firm attributes to examine differences in the profit performance of multinational companies with large U.S.

Department of Defense contracts. Through this exploratory research, I demonstrate that,

2

although certain customer or geographic segments may not be considered profitable from an accounting perspective, firms continue to conduct business with the U.S. Department of Defense for intangible benefits. By empirically estimating the profitability of military sales, nonmilitary sales, and international sales for the largest U.S. Department of

Defense contractors, I quantify how much the contract, as a resource, contributes to firm profitability. Furthermore, I investigate the circumstances under which firms of different sizes and within different industries may leverage a contract to maintain or improve their competitive positions.

This research begins with a discussion of the theoretical framework and hypotheses. I describe a unique environment associated with a defense-related business segment and explain why a contract with the U.S. Department of Defense is considered a valuable resource. Next, models are displayed and data are reported. I empirically demonstrate that large multinational firms appear to maintain a U.S. Department of

Defense contract primarily for intangible benefits, while impeding future entrants and defending market share, whereas smaller firms may rely on the contract for income.

Similarly, I empirically demonstrate that nonmilitary sales and international sales are significantly related to profitability. I conclude by demonstrating that a combined resource approach is useful to determine the strategy of firms which conduct business with the U.S. Department of Defense.

3

CHAPTER 2. LITERATURE REVIEW

2.1 The Resource Dependence Theory

The resource dependence theory (Pfeffer & Salancik, 1978) emphasizes that resources originate from the environment. Because organizations are not self-sufficient, they must conduct transactions with other organizations to gain resources. This organizational interdependence fluctuates with the availability of resources and the demand for them. Organizations may achieve control of resources through possession, access, use, and regulation. However, the magnitude, criticality, and value of the resources change over time. Firms primarily leverage resources to increase power, but may also do so to obtain control or certainty. These goals are achieved by increasing another organization’s reliance on the firm’s resource or decreasing the firm’s reliance on an external resource.

Pfeffer and Salancik (1978) use two examples involving government to demonstrate that dependence affects organizational decisions. In the first example, they cite Aharoni (1971) who found that firms with larger sales to the government were willing to give up other investments to comply with government requests. The second example (Salancik, 1976) involved responses to governmental demands on affirmative action. Well-known firms with a larger proportion of sales to the government were expected to comply. However, the smaller firms that the government is dependent upon were less likely to comply.

Pfeffer and Salancik (1978) identify two variable dimensions that signify the importance of a resource—the magnitude of an exchange and resource criticality. The relative magnitude of an exchange is measureable by examining the total inputs or

4

outputs of the exchange, and is greater for single-product firms. The criticality of a resource is also noteworthy, because “A resource may be critical to the organization even though it comprises only a small proportion of the total input” (Pfeffer & Salancik, 1978, p. 46). The criticality of a resource measures how well an organization would function if the resource were removed or unavailable. From this perspective, the U.S. Department of

Defense contract is a resource that originates outside of a firm. The magnitude of the exchange is important to both the firm and U.S. taxpayers. The criticality of the U.S.

Department of Defense contract for a multinational firm likely differs based upon the nature of the product or service, firm diversification and associated characteristics, and industry or sub-industry.

2.1.1. Contracts as a resource

As previously stated, firms seek to gain access to external resources. A contract serves as a resource, or linkage, between a multinational firm and the U.S. Department of

Defense. According to Pfeffer and Salancik (2003), linkages provide four distinct benefits. From the perspective of a multinational firm, they provide a mechanism to transmit information between the firm and the U.S. Department of Defense, and allow the firm to gain information about the U.S. Department of Defense that affects them. The firm is also able to gain support from elements within the U.S. Department of Defense.

The resource (a U.S. Department of Defense contract) provides legitimacy to the multinational firm. These benefits are considered intangible, but if applied appropriately, may lead to tangible benefits in the form of profit.

5

The relative magnitude and criticality of the exchange increases the value of a resource. The magnitude of the exchange varies among firms. Adopting the perspective that a contract with the U.S. Department of Defense is a resource implies consideration of total inputs or an examination of sales by segment. The magnitude of the exchange is greater for firms whose primary customer is the U.S. Department of Defense.

Undiversified firms that produce highly specialized military supplies and equipment, or that have a history of working with the U.S. Department of Defense, are more likely to value the exchange and the benefits associated with the resource.

2.2 The Resource-Based View of the Firm

A seemingly ulterior point of view is the resource-based view of the firm.

According to Wernerfelt (1984), firms use internal resources to gain a competitive advantage. An internalized resource provides a firm with exploitable tangible benefits, intangible benefits, or both. Resources are attractive if their properties or modes of acquisition enable firms to gain and maintain an advantage (Wernerfelt, 1984).

Barney (1991) further extends the concept of gaining and sustaining a competitive advantage, by defining sustained competitive advantage as the period when a firm “is implementing a value creating strategy not being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy” (p. 102). A firm should possess heterogeneous and immobile resources that are rare, without substitutions, not perfectly imitable, and valuable (Barney, 1991). However, mere possession of resources is not enough—a firm must deploy them productively

(Gardner, Gino, & Staats, 2012; Teece, Pisano, & Shuen, 1997).

6

There are many intangible benefits of a resource that may be realized by a firm.

Penrose (1959) noted that firms can use existing resources, ideas, and knowledge to diversify into related products. Multiproduct firms may benefit from nonfinancial linkages (Wernerfelt, 1984). Ghemawat (1986) explains that size advantages, such as scale economies, experience, and scope economies, restrict the options of competitors.

An important aspect of the resource-based view is the concept of a blocking mechanism, described by others as a mobility barrier (Caves & Porter, 1977), resource position barrier (Wernerfelt, 1984), isolating mechanism (Rumelt, 1984), or ex post competition (Peteraf, 1993). Caves and Porter (1977) describe a mobility barrier as a mechanism to isolate similar firms in a heterogeneous industry, whereas Wernerfelt

(1984) focuses on the defensible position of a firm. Rumelt (1984) uses the term

“isolating mechanisms” to refer to information asymmetries, response lags, and property rights as impediments to imitation. A resource is valuable if it provides a firm with the ability to impede other firms from entering the market.

A firm that can internalize the advantages gained from a U.S. Department of

Defense contract may achieve a sustainable competitive advantage until another firm is able to duplicate the advantage. The structure of a contract prevents other firms from duplicating benefits by preventing them from entering the market for a prescribed time period. Thus, a U.S. Department of Defense contract is a valuable resource from the perspective of the resource-based view.

7

2.2.1. Contracts as a resource

From the perspective of the resource-based view, a U.S. Department of Defense contract is considered a resource because “a firm’s resources at a given time could be defined as those (tangible and intangible) assets which are tied semi permanently to the firm (see Caves, 1980)” (Wernerfelt, 1984, p. 172). Wernerfelt specifically acknowledges trade contracts as a resource; however, his subsequent analysis does not capture the nuances associated with the maintenance of these contracts.

One example of an intangible benefit gained from entering into a contract with the

U.S. Department of Defense is product diversification. Penrose (1959) noted that firms can diversify into related products by using existing resources, ideas, and knowledge. A multinational company may adapt products and services that contribute to the defense of the United States, such as intelligence or communications platforms, to serve nonmilitary purposes. This strategy reduces labor, overhead, and research and development costs.

Similarly, nonmilitary products and services, such as medical supplies, aircraft systems, computers, software, and engineering services, can be used or adapted to serve a military purpose. Thus, multiproduct firms benefit from nonfinancial linkages (Wernerfelt, 1984).

The supply or availability of U.S. Department of Defense contracts is neither stable nor ample. Capacity surges and technological innovations are required during periods of war. Past research (Paret, Craig, & Gilbert, 1986) has shown that military technological advances primarily occur during times of war. Large U.S. Department of

Defense contracts are limited and, therefore, a scarce resource. Once a firm enters into a contract with the U.S. Department of Defense, another contract is not usually immediately available until the end of the contract period.

8

A contract may satisfy the following resource conditions for competitive advantage: rare, without substitutions, not perfectly imitable, and valuable (Barney,

1991). A large U.S. Department of Defense contract clearly satisfies the first three attributes of variable resources. Contracts are awarded based on the needs of one influential buyer, making a U.S. Department of Defense contract a vital resource. An exact equivalent to a U.S. Department of Defense contract to access the market does not exist. Certain items may be purchased on behalf of the U.S. Department of Defense by using other procurement mechanisms, such as a Government Commercial Purchase Card or affiliation agreement; however, regulations and policies establish thresholds for purchases and govern the amount and type of item that may be purchased. Many regulations strengthen the monopsony, such as the Arms Export Control Act (2012) and the International Traffic in Arms Regulations (2009). These regulations restrict companies from exporting certain defense articles and services to foreign nations and reinforce the non-substitutable attribute of a U.S. Department of Defense contract, which are finite and considered rare. These contracts are also inimitable, particularly those that are awarded to a firm for research or product development. These contracts provide monetary benefits, as well as intangible benefits, such as continuous relationships, access to technology, inspiration for innovative solutions, and potential future returns from the sale of repair parts and/or maintenance. A relationship with the U.S. Department of

Defense provides a competitive advantage to contractors, who gain knowledge that is not immediately available to other firms. Firms that gain legitimacy are aware of security requirements and have access to decision-makers, which may benefit the firm’s future operations.

9

The final attribute, value, can be operationalized in terms of cost, reputation, and knowledge. With respect to reputation, the ability to sustain a government contract over many years is appealing, because it demonstrates customer loyalty and serves as a resource position barrier (Wernerfelt, 1984). For example, although the U.S. federal government has broad intellectual property rights (U.S. House, Committee on Armed

Services Panel, 2012), knowledge gained from the defense-related business segment can be applied to the commercial business segment. Through the dual-use technology program, the U.S. government encourages innovation and assists with research and development of products for military use (Defense Dual-Use Critical Technology

Program, 1996). Companies that develop products through the dual-use technology program, such as Global Positioning Systems and microwave monolithic integrated circuits, have a broader production base (U.S. Department of Defense, 1995). They may also benefit from increased throughput and quality.

2.3 Profitability of Firms with U.S. Department of Defense Contracts

Scholarly and governmental studies have used varying dates, samples, sample sizes, and financial measures to reach different conclusions about the profitability of firms that conduct business with the U.S. Department of Defense. Most studies examined firm profitability between 1968 and 1992 with only one study (Wang and San Miguel,

2012) incorporating data after 1999. Of the extant literature, approximately half of the studies derived samples of firms with the largest U.S. Department for Defense contracts from the Top 100 Contractors Report. Other studies used subsamples or generalized findings based upon total U.S. government sales. Profitability studies may be broadly

10

categorized as those that primarily examine profitability in terms of business segments, those that examine profitability based on attributes of the entire firm (industry or size) and those that consider the environment (war period, conflict period, or non-war period).

None of the following profitability studies considered geographical segments in their analyses.

2.3.1 Segment profitability

Various scholarly studies compared the defense-related business segment to the nondefense-related business segment of the same firm and found that the nondefense- related business segment is more profitable. Three of these studies describe the use of cost-shifting as a legal method to assign costs across segments, thereby complicating segment profitability analyses. Cost shifting may occur in the defense industry when mixed-segment firms use “legitimate cost-accounting methods that allocate overhead costs away from nonmilitary work and toward defense contracts” (McGowan & Vedryzk,

2002, p. 950). Thus, companies with both military and nonmilitary segments can shift costs, because the prices of nonmilitary products are competitively determined in the market, whereas prices for government business are negotiated in advance. The ability to legally assign or shift costs to the defense-related business segment makes a defense contract a valuable resource for a firm.

Using the U.S. Department of Defense as an example, Rogerson (1992) found that pricing practices may lead to distortions and incentivize firms to shift costs among business segments. Although the discussion primarily considers costs and overhead shifted from the commercial to the defense-related business segment, Rogerson also

11

acknowledged that costs may be shifted from the defense-related business segment to the commercial segments. Thomas and Tung (1992) used pension funds to demonstrate that overfunding a defense contract is valuable if the firm also has commercial business.

Lichtenberg (1992), using aggregate data on total sales and government sales for 9,300 industry segments from 1984-1989, also argued that cost-shifting may allow mixed- segment firms that conduct business with the U.S Department of Defense to earn normal profits on government business and achieve greater profits in the commercial segment.

Both Rogerson (1992) and Lichtenberg (1992) suggest that economic and regulatory conditions incentivize government contractors to shift costs between their nonmilitary and government segments.

McGowan and Vendrzyk (2002) examined segment profitability and found that the government segment of a firm significantly outperformed the mixed segment and the commercial segment. Comparing firms from the Top 100 Contractors Report, they found that the government segment of firms were significantly more profitable during 1984–

1989, but not significantly more profitable than other segments during 1994–1998. They also found that government contractors experienced high profitability for government work due to low competition rather than within-segment cost shifting.

Three studies considered business segments when examining profitability of firms, but also conducted subsequent analyses that focused on the profitability of the entire firm. Bohi (1971) did not directly measure segment profitability but acknowledged that separating profits according to defense and commercial business is both difficult and useful. Using a sample of 36 firms from the Top 100 Contractors Report between 1960 and 1969, Bohi examined the trend in defense industry concentration, and found that

12

defense contracts, as a percentage of total sales, declined. However, because the total amounts of the contract did not decline, he surmised that defense contractors were becoming less reliant on defense business and were diversifying in favor of commercial business. Additionally, Bohi investigated whether a correlation exists between the percentage of business attributed to defense contracts (military sales to total sales) and the profit rates of the defense contractor and found no significant correlation. He also compared the profit rates based on the net worth of 36 defense firms to the Fortune 500 largest manufacturers and did not find a statistically significant difference in profitability.

Similarly, Morse and Kramer (1985) examined the operating margin for eleven government-oriented contractors and found that the government segment was more profitable between 1980 and 1984. Using a sample of 49 major U.S. Department of

Defense contractors, they also found that U.S. Department of Defense prime contractors between 1980 and 1984 were more profitable than their like-sized, commercial-oriented competitors and less exposed to risk. Vormbrocke (1991) examined the relationship between the financial condition of defense contractors and the amount of U.S.

Department of Defense spending (1975-1990). Using 18 defense-industry firms that received the largest amount of U.S. Department of Defense contract dollars, he found that these firms experienced a declining financial position, but could not attribute the decline solely to the defense-related business of the firms.

2.3.2 Profitability at the firm-level

Other studies have investigated whether defense-oriented companies are more profitable than nondefense-oriented companies. Although many of them examined

13

industry concentration or percentage of government business, they did not specifically consider segment profitability. Given that many defense-oriented companies are diversified, without conducting segment analysis, it is not known whether the firms in the following studies are profitable due to their defense-related business segment or their commercial segment.

Agapos and Gallaway (1970) used net worth and total asset regression analysis to examine two groups of aerospace firms between 1942 and 1967 and found almost no evidence that aerospace firms were able to reap excessive profits due to positive shifts in the demand for military products.

Two studies found that defense industry firms are more profitable than nondefense industry firms. Weidenbaum (1968), using a small sample size, compared six aerospace contractors with six commercial firms with similar sales volume, but in different industries. Using net worth as a profitability measure, he found that the defense profits were excessive between 1952–1955 and 1962–1965. Stigler and Friedland (1971) used stock market performance as a measure of profitability and found that defense contractors were almost twice as profitable as all listed stocks on the New York Stock

Exchange (NYSE) during the 1950s, but had nearly the same profitability as NYSE stocks during the 1960s. There appeared to be a relationship between the ratio of defense sales to total sales and profitability, with a positive correlation during the 1950s and no correlation during the 1960s. Their study also used a sample consisting of the largest defense contractors. However, the exact industry type of the sample firms is not known.

Because firm attributes provide insight into profitability, it is important to consider different firm attributes when examining profitability. Wang and San Miguel

14

(2012) specifically considered firm size as a relevant firm attribute. Using an industry- year-size excessive profit measure to examine the top 500 recipients of U.S Department of Defense contract awards between 1950 and 2010, the authors found that defense contractors, defined as firms that conduct business with the U.S. Department of Defense, irrespective of industry type, earn excessive profits. The sample includes firms such as

Kraft Foods, Procter and Gamble Co., and PepsiCo Inc., whose primary products are not directly related to national defense. Zhong and Gribbin (2009) investigated the factors that led to the diversity of profitability among defense contractors at the firm level during

1984–1998 and found that using R&D-adjusted return on average assets, defense contractors that are innovation-oriented, influential, and willing to assume higher risks, earn more profits from the defense business. Their study did include the effect of defense sales on firm profitability by correlating the percentage of defense sales to firm total sales and profit rate. Firm attributes are important to consider, but may be difficult to identify and measure in practice.

2.3.3 Profitability and the environment

The environment is likely related to the profitability of firms that conduct business with the U.S. Department of Defense. Approximately half of the aforementioned profitability studies considered whether the United States was engaged in significant wars or conflicts when assessing profitability. Of the studies that primarily examined profitability according to segment, the studies by Rogerson (1992) and Thomas and Tung

(1992) did not discuss the operational environment. Lichtenberg (1992) examined the percentage of U.S private sector industry employment in a defense industry and found

15

that wartime employment increased in 1943 (WWII), 1953 (Korean War) and 1968

(Vietnam War), but did not specifically examine a difference in profitability as a result of these time periods. McGowan and Vendrzyk (2002) compared a relatively non-wartime period (1984-1989) with high defense spending with a conflict period (Bosnia, Iraqi no fly zone, Haiti, Kosovo) that had low defense spending. Morse and Kramer (1985) examined a period of relatively low military conflict (1980-1984).

Two studies that examined firm profitability according to segment related their findings to the operational environment. Bohi (1971) found that profit and profit rates of defense firms and manufacturing firms increased during the Vietnam War period.

Vormbrocke (1991) used a period (1975-1990) that included some conflict (end of

Vietnam War, Grenada, and Panama) and found that there appeared to be no consistent relationship between the dollar amount awarded and the financial condition of defense contractors.

Of the studies that considered profitability at the firm level, Weidenbaum’s 1968 study covered both a war period (Korean War) and a non-war period. Agapos and

Gallaway (1970) were among the first to examine profitability with respect to variation in demand according to war period (World War II, Korean War, and Vietnam War) and found that the volume of defense activity in the aerospace industry was not positively related to profits. Stigler and Friedland (1971) almost exclusively covered war periods

(Korean War and Vietnam War).

The studies that examined other factors related to firm profitability used large periods of time that encompassed many environmental conditions. Zhong and Gribbin

(2009) used a time period that included wartime (Operation Desert Storm), conflict

16

periods (Bosnia, Haiti), and non-wartime periods, but did not draw specific conclusions about profitability based upon the environment. Similarly, Wang and San Miguel (2012) examined profitability between 1950 and 2010, which included wars, conflicts, and non- wartime periods.

17

CHAPTER 3. DEFENSE INDUSTRIAL BASE OVERVIEW

Resource-related research involving firms that conduct business with the U.S.

Department of Defense is necessary to better understand firm capabilities and business practices, and to explore the challenges and advantages of the unique market in which they operate. The distinction between tangible and intangible resources is particularly important. Government agencies and interest groups regularly assess the tangible benefits associated with U.S. Department of Defense contracting, particularly in terms of profitability. In contrast, intangible benefits are present in virtually any transaction, but their value to a firm is difficult to assess. Although many techniques have been used to examine profitability, an accepted, consistent standard to assess the value of a U.S.

Department of Defense contract has not been developed to meet the needs of stakeholders.

3.1 Key Terms and Definitions

The terminology used in the extant literature, regarding firms in the defense industrial base, is inconsistent. In this study, I define defense-oriented companies as firms that produce a product and/or provide a service that is specifically related to U.S. national security. The products and/or services may or may not have civilian commercial application. Nondefense-oriented companies are defined as firms that produce a product and/or provide a service of a civilian nature (i.e., rations, petroleum, healthcare services).

In this study, the term mixed-segment firm refers to a firm that has a minimum of two customer segments: a defense–related business segment and a nondefense-related business segment. The term defense-related business segment or military segment is

18

defined as the segment of a company that is responsible for the products and services purchased by the U.S. Department of Defense for use by the U.S. military, although the products or services provided by the contractor, such as rations or sundry items, may not be unique or directly related to U.S. national security. The nondefense-related business segment, or, nonmilitary segment of a firm is defined as the segment of a company that is responsible for all other products and services sold to customers other than the U.S.

Department of Defense. Figure 1 depicts segment allocation within a U.S. multinational company.

Figure 1. Segments of a U.S. multinational company.

Other Nonmilitary Domestic International Domestic Sales Sales Sales

DoD Sales OGA Sales

Foreign Military Sales Nonmilitary sales include the following categories: other nonmilitary domestic sales, other government agency (OGA) sales, and foreign military sales. U.S. Department of Defense (DoD) sales are considered to be military sales.

19

For the purposes of this study, the term profitability refers to return on revenue.

This particular measure of company performance was selected because costs may be assigned to different segments by firms in different ways in accordance with legally acceptable accounting practices. Therefore, assignment of costs can be done subjectively and was not directly measured in this study. Instead, I used total sales and total segment sales in the model to provide an objective measurement of profitability. According to

Chen and Shimerda (1981), many profitability measures are highly correlated and the selection of one particular ratio can account for most of the other information provided by other similar ratios.

A positive return on revenue is considered a tangible benefit. The term unprofitable refers to a negative return on revenue, whereas the term not profitable refers to a return on revenue that is not positive. A firm that maintains a large U.S. Department of Defense contract over multiple years may hold a segment that is considered not profitable, because the firm is able to break even. A segment that is not profitable or unprofitable, yet held by a firm, signifies that the firm may reap advantages from the resource that are intangible but provide value.

An intangible benefit is defined as any advantage obtained from a resource that is not classified as a tangible benefit. Intangible benefits take many forms that are difficult to assess. Some of these intangible benefits, or externalities, may include cost-shifting

(Lichtenberg, 1992; Rogerson, 1992; Thomas and Tung, 1992), ability to diversify

(Penrose, 1959), access to knowledge and ideas (Penrose, 1959; Teece, 1986: Kogut and

Zander, 1993), R&D and patents (Bohi, 1971; Teece, 1986), technology transfer (Kogut and Zander, 1993), government-supplied capital (Bohi, 1971), recruiting and training

20

personnel (Bohi, 1971; Thomas and Tung, 1992), reputation (Hall, 1993), and low competition (McGowan and Vendrzyk, 2002).

3.2 Characteristics of the Defense Industrial Base

Brett Lambert, the Deputy Assistant Secretary of Defense of Manufacturing and

Industrial Base Policy for the Department of Defense, defines the defense industrial base as “an extremely diverse set of companies that provide both products and services directly and indirectly to the national security agencies, including the military” (U.S.

House, Committee on Armed Services, 2011, p. 4). He argues that the defense industrial base is not a monolithic entity, but a large, complex, and heterogeneous defense market.

The term defense industry is broadly defined as the sector of the economy that manufactures and trades products or provides services related to national security. Firms that operate within this industry vary widely in terms of size, economies of scale, geographic scope, and sub-industries. Some firms may be small and privately held, whereas others may be large, publicly traded conglomerates. Some firms operate in a monopsonistic environment, specializing in a product or service for the military. Other firms offer highly differentiated products or offer products that require little or no modifications for use in other markets. Products and services must be high quality, rendered according to specifications, and perceived as the best value compared to competitors’ offerings. Sought-after products typically incorporate advanced technology.

Because of the global nature of U.S. military operations, many firms are multinational and can effectively navigate differences in culture, business practices, and competition to remain viable in domestic and international environments. As a result, typical methods

21

for classifying defense industries are not appropriate for ascertaining the number and types of firms that conduct business with the U.S. military.

Many industries are classified using the Standard Industrial Classification (SIC)

System or the North American Industry Classification System (NAICS). The concept of

SIC codes originated in 1934 to improve statistical analyses by broadly classifying industries in terms of economic activity (Pearce, 1957). SIC codes were revised periodically to reflect the changes in industry composition and technological advancements, but primarily from a manufacturing perspective. Although still available and used by scholars and certain government agencies, the SIC system was replaced by the NAICS in 1997. The NAICS was formed in conjunction with Canada and Mexico and reflects a conceptual approach versus a production-oriented approach for classifying industries. The classification system consists of a six-digit, rather than a four-digit code to account for a greater number of sub-industries. The first two digits represent the industry sector, the third indicates the industry sub-sector, the fourth reflects the industry group, the fifth represents the industry, and the sixth digit designates the country of origin

(United States, Canada, or Mexico). In this classification system, defense is not classified as an industry, sub-industry, or industry group. Codes are self-reported based on the primary revenue-generating activity of a firm, and firms may designate multiple secondary SIC and/or NAICS codes.

Because a “defense industry” is not classified under the SIC or NAICS systems, the use of SIC or NAICS codes to identify defense-oriented companies is problematic and may vary widely according to scholar, consultant, or analyst. The relationship between the U.S. military and certain multinational firms is not always readily apparent

22

by examining SIC or NAICS codes. For highly diversified firms, the primary and secondary codes may not capture the defense-related product or service. Codes may also be very generic, failing to illuminate the military nature of a firm’s business. For example, the SIC code for a firm named, Atlantic Diving Supply, is “5091: sporting and recreation goods” (Occupational Safety and Health Administration, 1987), while its

NAICS code is “423910: sporting and recreational goods and supplies merchant wholesalers” (U.S. Census Bureau, 2012). Yet this firm is a leading producer of tactical equipment for the U.S. military, law enforcement, and defense contractors. Therefore, the sole use of NAICS or SIC codes to identify firms that provide products or services related to national security may not result in appropriate classification.

Studies by industry consultants, such as KPMG (2012), A.T. Kearney (Willen &

Ouirnet, 2013), and Deloitte (2012), use varying methods to define populations and samples of defense industry firms. All three of these consultants classify the defense industry as a component of the aerospace and defense industry; however, each uses a slightly different approach. In a recent study by KPMG (2012) that examines the forces driving aerospace and defense industries’ transformation, the total number of aerospace and defense industry firms sampled was not disclosed. Willen and Ouirnet (2013) used

NAICS codes to identify 2,700 aerospace and defense industry firms within the aerospace and defense industry supply chain. A study by Deloitte (2012), for the Aerospace

Industries Association, assessed the financial impact and contributions of the aerospace and defense industry by identifying 29 different NAICS codes shared by aerospace and defense industry firms. Of the 29 NAICS codes, only five 6-digit codes were identified as performing activities that were clearly related to the aerospace and defense industry:

23

manufacturing ammunition except small arms (332993); military ordnance manufacturing

(332995); search, detection, navigation, and guidance systems manufacturing (334511); aerospace products and parts manufacturing (33641); and military land vehicles manufacturing (336992).

It is also possible to identify defense-oriented companies by comparing the defense-related products and services captured on the United States Munitions List

(USML) and the Commerce Control List (CCL) to NAICS and SIC industry codes. The

USML, administered by the Department of State, identifies defense articles or defense services that typically do not have civilian application, whereas the CCL is administered by the Bureau of Industry and Security, Department of Commerce, and covers items and technologies with both civilian and military application. An examination of these lists provides evidence to support broad, yet not all-inclusive generalizations of certain industry environments in which a substantial number of companies conduct business with the U.S. Department of Defense.

3.2.1 Defense industry environment

Based on the classifications used by industry consultants and the regulatory requirements captured on the USML and CCL, the following industry codes were identified as directly related to national security and, therefore, the defense industry: guns and ammunition manufacturing; tank and armored vehicle manufacturing; shipbuilding; aircraft, engine, and parts manufacturing; and space vehicle and missile manufacturing.

Some products and/or services within the engineering services and information

24

technology (IT) consulting industries are directly related to national security. Therefore, firms within these industries were identified as defense-oriented companies.

The guns and ammunition manufacturing industry (NAICS 332992, 332993,

332994) consists of firms that manufacture the following four major products: small arms, small arms ammunition, other ammunition, and ordnance and accessories. This highly competitive, global industry is heavily regulated with moderate volatility and barriers to entry. The industry has been growing continuously since September 11, 2001.

Unlike other industries, it grew out of the recession and experienced substantial growth between 2009 and 2013. This industry growth has been attributed to increased military, government, and civilian sales. The wars in Iraq and Afghanistan led to increased military and government sales until 2009 when sales began to stagnate. Private sector demand offset reductions in military spending toward the end of the wartime periods, with civilian sales making up 34.8% of industry revenue in 2013 (Soshkin, 2013a).

Civilian sales increased during this time period due to concerns about rising crime rates and changes in gun control legislation. Additionally, both imports and exports have been steadily increasing since 2004. Exports have made up approximately one-third of industry revenue and exceeded the demand for imported goods. Key industry drivers include defense funding, local and state government investment, the price of steel, the trade- weighted index, and crime rates.

The tank and armored vehicle manufacturing industry (NAICS 336992) consists of firms that manufacture combat tanks, military armored vehicles, self-propelled weapons, and specialized components. This industry has high barriers to entry and is capital intensive, so it is dominated by only a few firms. Revenue is extremely volatile

25

due to a heavy reliance on defense spending. Key industry drivers include defense funding, government investment and consumption, the price of steel, plastic and resin, and research and development expenditures. As of 2013, the U.S. military made up 68% of the market, with allied governments and state/local agencies accounting for 14% and

10%, respectively. In 2010, industry revenue fell by 22.8% as a result of reduced spending on armored vehicles by the U.S. Department of Defense (Ruiz, 2013). Although domestic demand fell between 2009 and 2013, international trade increased. In 2008, imports accounted for 7.5% of domestic demand and continued to increase due to the practice of producing or coproducing parts abroad and conducting final assembly in the

United States.

The shipbuilding industry (NAICS 336611, 33662) includes building, repairing, and altering watercraft that are not designed for recreational or personal use, and includes shipyard operations and activities. This industry has high barriers to entry and competition is low. Revenue is volatile due, in part, to the fluctuating price of steel.

Although industry profitability decreased between 2009 and 2013 because of reduced defense contract demand, the industry was not substantially impacted by the recession because of long production lead times and a relatively large number of government contracts. Key industry drivers include defense funding, total value of world trade, consumer spending, the price of steel, and the demand for ocean and coastal transportation. Major markets include defense and government clients with 62.5% of industry revenue, and commercial shipping clients and exports accounting for 33.6% and

3.9% of industry revenue, respectively (Crompton, 2013). Countries such as South Korea,

Japan, and China are able to build quality ships at lower prices, and have secured a large

26

share of the global market, contributing to the existence of a global oversupply of shipbuilding capacity. Imports are limited by regulation to protect U.S. manufacturers.

The aircraft, engine, and parts manufacturing industry (NAICS 336411, 336412,

36413) consists of companies that manufacture, overhaul, convert, and develop prototypes of aircraft, engines, and propulsion systems, to include the manufacturing of related parts and auxiliary equipment. This global industry is heavily regulated. Because of high start-up costs, licensure requirements, and demand for skilled labor, there are significant barriers to entry. Drivers for demand include the federal defense budget, domestic and international airlines, aircraft, marine and railroad transportation wholesaling, and the price of steel. The industry is a net exporter, with 68.7% of industry revenue derived from exports in 2013 (Soshkin, 2013b). To offset the declining U.S. military budget, firms strive to meet foreign commercial and military demand. Between

2009 and 2013, imports grew more quickly than exports, which mainly consisted of parts, engines, and subsections of aircraft. U.S. manufacturers tend to procure foreign parts and assemble them domestically, accounting for the rise in imports.

The space vehicle and missile manufacturing industry (NAICS 336414, 336415,

336419) is closely related to the global military aircraft and aerospace industry, and consists of firms that develop and manufacture guided missiles and space vehicles, as well as parts, propulsion units, and support equipment. Key industry economic drivers include federal funding for defense and space exploration, the price of steel, and aggregate private investment.

A downward trend in defense spending began after 2010, which coincided with troop withdrawals and declining military activities in the Middle East. Although defense

27

spending declined, industry revenue increased by 16.4% in 2010, which can be attributed to the performance of major firms within the industry and the culmination of projects in

2010 and 2011 (Hoopes, 2013). Funding from other government agencies and private investment has also fallen. The space operations budget of the National Aeronautics and

Space Administration (NASA) declined in 2012 and 2013, and the number of worldwide space launches has been declining since 2009. The global financial crisis has deterred commercial customers from industry investment, and export and import levels in this industry are volatile. Exports are low and are expected to decrease in 2014 due to restrictive U.S. trade policies. Imports are also low, but are expected to increase. It was estimated that in 2013, sales to the U.S. military accounted for approximately 59% of total industry revenue (Hoopes, 2013).

Some NAICS codes are not as specific as others and contain a wide range of specialized sub-industries, sectors, or sub-sectors. Two such industries are engineering services and IT consulting. Unlike the aforementioned defense-related industries, the engineering services and IT consulting industries are fragmented and contain multinational companies that specialize in U.S. Department of Defense products and/or services, along with other firms that do not conduct business with the U.S. military or any other military or law enforcement organization. A comparison of industry structure is presented in Figure 2.

28

Figure 2. Defense industry structure.

Entry barrier Competition Concentration

Source. IBISWorld. Derived from various reports.

Engineering services (NAICS 541330) is a diverse, mature industry that includes companies that apply the principles of engineering to design, develop, and/or provide machines, structures, materials, processes, and systems. In this highly competitive and fragmented industry, most firms specialize in a particular type of engineering service.

Engineering services are characterized by a high level of technological change with a relatively moderate level of regulation. Key industry economic drivers include demand from mining and the value of private, nonresidential construction, utilities construction, and residential construction. Local and state government investment is also a key economic driver for this industry, with approximately 12.5% of industry revenue from federal government projects (Edwards, 2013a). Federal government projects include

military services such as the development of weapons, vehicles, nuclear detection and protection systems, the disposal of chemical weapons, and the design of blast-resistant buildings. Leading multinational companies within this service-based industry operate outside of the United States, with foreign activities accounting for 25% to 30% of annual revenue for the largest engineering service firms (Edwards, 2013a).

The IT consulting industry, also known as computer systems design and related services (NAICS 54151), consists of firms that write, test, and/or support custom software; design or develop software and communications infrastructure; plan and/or design integrated hardware; or manage computer systems and/or data processing facilities. This global industry is fragmented and highly competitive, with few barriers to entry. Firms within this industry have varying cost structures because they offer diverse products and services. Private sector industry demand declined in 2009 as a result of the recession; however, the U.S. government demand and investment in this industry increased between 2009 and 2013. Reduced spending by the U.S. Department of Defense and other U.S. government agencies is expected to reduce public-sector industry demand, but it is unlikely to affect overall industry demand because only 15% of industry revenue is currently generated from federal and state government markets (Edwards, 2013b).

The industry environment of firms that conduct business with the U.S. military is an important factor in determining profitability. Some firms are able to enjoy free market opportunities, whereas others are reliant upon the defense budget. The level of regulations impacts each industry and the firms that operate in them differently.

30

3.2.2 Economic and military trends (2006–2010)

When examining profitability of firms, it is important to appropriately characterize the economic environment. According to the Business Cycle Dating

Committee of the National Bureau of Economic Research (2010), the longest U.S. economic recession since World War II occurred between December 2007 and June

2009. The committee used factors such as GDP, real income, industrial production, employment, and wholesale-retail sales to identify the dates.

The period between 2006 and 2010 was a significant period for the United States military. Major combat operations in Iraq began in March 2003, and ended in April 2003, when multinational forces successfully achieved the short-term goal of regime removal.

The post–major combat period began on May 1, 2003, when the United States and the

United Kingdom, according to the United Nations Security Council, became occupying forces until June 2004. U.N. Security Council Resolution 1546 authorized a multinational force at the request of the incoming interim government of Iraq, and subsequent U.N. authorizations extended the legal basis of U.S. forces in Iraq until 2009 (Dale, 2008).

Troop levels varied significantly between 2003 and 2009, ranging from 250,000 troops during major combat operations to 135,000 troops in January 2007. In late 2006, senior leaders concluded that previous military approaches were not reducing the level of violence in Iraq. In January 2007, President Bush announced an initiative to improve

Iraqi population security, known as “the surge.” Population security was viewed as a prerequisite for economic and political progress and no longer a mutually reinforcing condition to transition responsibility to Iraqis. The number of U.S. troops in Iraq was temporarily increased and military approaches were modified to secure and hold areas to

31

set the conditions for Iraqi security self-reliance, with troop levels reaching 168,000 in

October 2007. The last surge force brigade redeployed in July 2008, and using a conditions-based approach, further force drawdowns continued until February 2009

(Dale, 2008). Because the U.S. military lacks the resources and capacity to perform certain functions, the number of troops on the ground is related to the amount of support required by multinational corporations as they assist with maintaining and sustaining the force.

Major combat operations in Afghanistan began in October 2001 to assist anti-

Taliban and anti-Al-Qaeda forces, and ended in May 2003. A surge in forces also occurred during this time. As Katzman (2014) stated,

The decision whether to fulfill the entire request was deferred to the next Administration. U.S. troop levels started 2006 at 30,000; climbed slightly to 32,000 by December 2008; and reached 39,000 by April 2009. Partner forces increased by about 6,000 during this time, to a total of 39,000 at the end of 2009—achieving rough parity between U.S. and non-U.S. foreign forces….President Obama announced a “comprehensive” strategy on March 27, 2009, including deployment of an additional 21,000 U.S. forces—most of General McKiernan’s request for 30,000 additional forces. (p. 19)

Troop levels in Afghanistan are expected to decrease to 34,000 in 2014. There are plans to maintain a residual force in Afghanistan after 2014 of about 6,000–10,000 troops, but this is highly dependent upon the forthcoming U.S. Afghanistan security agreement and the April 2014 Afghan elections.

32

Although it is likely that contract requirements increased and/or changed during the Iraq–Afghanistan war period, this study does not attempt to distinguish between normal contract requirements and contingency contract requirements. The size and type of U.S. Department of Defense contracts evolve over time due to changes in requirements and available funding. However, there are core services or functions that are routinely outsourced because the U.S. military does not have the manpower, technical skill, or manufacturing capability to provide such services internally. Companies with the largest

U.S. military contracts are those that are able to meet these standing requirements.

3.3 United States Department of Defense Contract as a Resource

The Federal Acquisition Regulation 2.101, Part 2 (2010) defines the term contract as

a mutually binding legal relationship obligating the seller to furnish the supplies or services (including construction) and the buyer to pay for them. It includes all types of commitments that obligate the Government to an expenditure of appropriated funds and that, except as otherwise authorized, are in writing. In addition to bilateral instruments, contracts include (but are not limited to) awards and notices of awards; job orders or task letters issued under basic ordering agreements; letter contracts; orders, such as purchase orders, under which the contract becomes effective by written acceptance or performance; and bilateral contract modifications (p. 26).

For the purposes of this research, I adopt a general definition of the term contract: A legally binding, voluntary agreement between two competent parties. A contract is a

33

shared resource providing tangible and/or intangible benefits to both parties. By this definition, all types of contracts are considered resources. However, contracts between multinational firms and the U.S. government, particularly the U.S. Department of

Defense, differ from other contracts because they are closely monitored by a large number of stakeholders, they encourage competition through regulation, and they may be unilaterally terminated by the U.S. Department of Defense (who can also change their terms and conditions). These resource attributes magnify challenges associated with the environment.

Resources have been operationalized in the literature from an output perspective

(e.g., products or services), or from an input perspective (e.g., knowledge and material).

Relatively few scholars, with the exception of Wernerfelt (1984), have identified a contract itself as a resource. However, an examination of the resource dependence theory and the resource-based view reveals that a U.S. Department of Defense contract is a valuable resource that firms seek to obtain and protect.

3.3.1. A combined resource approach

Competitors that seek to replicate the advantages associated with a resource must be able to correctly identify the resource. The differing perspectives of the resource-based view and the resource dependence theory, when considered separately, may not always lead to the correct identification of a resource. Consider the example of excess machine capacity. From the perspective of the resource-based view, excess machine capacity is considered an internal resource of the firm. Excess machine capacity provides the firm with the ability to diversify into related products. A firm would likely look externally to

34

find ways to exploit this internal resource and gain tangible benefits, intangible benefits, or a combination of both types of benefits.

Using the same example, from the perspective of the resource dependence theory, firms scan the environment to identify and acquire external resources to ensure organizational survival. The resource dependence theory clearly distinguishes between organizational efficiency and organizational effectiveness. Organizational efficiency is an internal measure of performance, whereas organizational effectiveness is considered an external measure of performance. Therefore, excess machine capacity would be viewed as a limitation or liability, rather than as a resource. Firms that adopt a resource dependence theory perspective would seek to alter organizational interdependence, which could lead to internal efficiencies. By entering a new market or by diversifying, a firm would alter the relationship between external organizations, and may or may not utilize excess machine capacity to improve the efficiency of the organization.

In this example, firms used different perspectives to perhaps select similar strategic options to obtain tangible and/or intangible benefits; however, the perception of what constituted a resource differed, based on the perspective of the firm. This is problematic for competitors who seek to replicate the advantages associated with a resource.

Consider the example of minimizing dependence upon an external organization, such as the U.S. Department of Defense. From the perspective of the resource dependence theory, firms would likely try to diversify into related products in order to minimize dependence upon the U.S. government. However, the internal abilities of the organization to diversify are likely heterogeneous; therefore, some firms may be able to

35

diversify easily, whereas others may find it difficult to move into related products and/or services.

From the perspective of the resource-based view, firms would not seek to diversify unless there were existing internal advantages that would allow them to gain or maintain an advantage. Therefore, the decision to diversify could have irreparable consequences, depending upon the firm’s abilities. For a competitor, it may be unclear why the focal firm would choose to diversify. However, it is known that the firm would have to be able to achieve a balance between internal resources and external resources.

Without a comprehensive resource approach, this perspective cannot be realized. In practice, the tangible and intangible benefits associated with a resource are numerous, with many different factors influencing strategic choice. Figure 3 illustrates the combined resource approach.

36

Figure 3. Combined resource approach.

Identifying a contract as a shared resource between a multinational firm and the

U.S. Department of Defense provides consistent identification of the resource itself, and may yield similar results to the aforementioned examples. From the perspective of the resource-based view, a firm will consider a contract an internal resource and seek to exploit its associated benefits externally. For example, this may be done tangibly through profits, or intangibly by exploiting knowledge, skills, and relationships to gain or maintain additional market share. From the perspective of the resource dependence theory, the contract is viewed as an external resource that is obtained from the environment. A firm will seek to maintain and internally exploit the benefits associated with the contract tangibly through profits, or intangibly by exploiting knowledge, skills, and relationships to gain additional market share. Firms identify contracts as a resource

and select the same strategic option to obtain tangible and/or intangible benefits based on the perspective of the firm.

Although these are simplified examples, they are used to illustrate how differing perspectives are related to strategic choice. They also provide evidence to support a combined resource approach. Hillman, Withers and Collins (2009) suggest that resource dependence theory requires integration with other theoretical perspectives. I posit that the integration of the resource dependence theory and the resource-based view provides a mechanism to correctly identify a resource. A combined resource perspective is useful to assess and categorize whether benefits are predominantly tangible or intangible.

An integration of both perspectives with respect to a U.S. Department of Defense contract can be explained as follows: in accordance with the resource-based view, a firm must possess distinct internal capabilities and advantages to obtain a contract with the

U.S. Department of Defense. The multinational firm and the U.S. Department of Defense enter into a relationship of symbiotic interdependence, where the output of the firm is the input of the U.S. Department of Defense (as the resource dependence theory suggests).

The multinational firm is then able to internalize the advantages of the contract, such as knowledge, information, and the reduction of uncertainty. The contract becomes a resource position barrier, barring new entrants for the duration of the contract period. The multinational firm may then capitalize on the acquired knowledge, assets, and capabilities to maintain the contract and exploit its associated advantages both internally, by sharing knowledge among business segments, and externally, by developing new relationships. A

U.S. Department of Defense contract is considered a valuable resource, because it is a medium for the exchange of tangible benefits, intangible benefits, and other resources.

38

CHAPTER 4. HYPOTHESES

From both an accounting and management perspective, segment profitability information is essential for strategic decision-making. Within the same firm, if the product, service, production, distribution, customer base, or regulatory environment differs across segments, then segment profitability indicates where to focus efforts, invest capital, and conduct strategic alignment (Financial Accounting Standards Board, 1997).

Scholars have evaluated the relevance of geographic segment data and agree that segmented financial information is vital for management decisions (Ahadiat, 1993; Chen

& Zhang, 2003; Hope, Kang, Thomas, & Vasvari, 2009). Increased influence, superior market position, and technological superiority of a multinational company are likely to manifest in profit. However, the manner in which a firm allocates costs is also indicative of how a segment is valued. Firms are not incentivized to hold business segments that are not profitable or unprofitable. Therefore, if a firm maintains a large contract with the U.S

Department of Defense over multiple years, but does not generate profit from that segment, intangible benefits must exist that provide value to the firm.

Scholars (Rogerson, 1992; Thomas and Tung, 1992; Lichtenberg, 1992,

McGowan and Vendrzyk, 2002) recognized that comparing the defense-related business segments (or military segment) to the nondefense-related business segment of the same firm could lead to incorrect conclusions. Because many multinational companies are highly diversified, the profitability of the military segment of a firm and that of the nonmilitary segment of the same firm are different. For example, a comparison of the profitability of General Electric’s consumer appliance business to the profitability of its aviation services business would yield different results. Strategic business units are

39

expected to be different within the same firm. A more accurate indication of segment profitability would be to estimate each segment individually. Given that profitable firms have multiple profitable business segments, comparing the profit levels of segments within the same firm to each other only provides value if segment profit performance is quantifiable. In this research, I quantify the profitability of firm segments and evaluate them separately, to assess the benefits associated with a U.S. Department of Defense contract.

4.1 Military and Nonmilitary Profitability

4.1.1 All companies

Although both tangible benefits and intangible benefits provide value, I expect that the nonmilitary business segment of multinational firms with large U.S. Department of Defense contracts provide a predominantly tangible benefit to the firm in the form of profit. Bohi (1971) found that during the Vietnam War, firms responded to the civilian economy, even when military demands increased. Nonmilitary products or services can be priced more flexibly in comparison with those of predetermined military products; therefore, cost savings are likely to be captured in the nonmilitary segments. Lichtenberg

(1992) also suggests that, due to cost-shifting, firms that earn normal profits on their government segment would realize greater profits in the commercial segment. Firms with

U.S. Department of Defense contracts are able to negotiate prices prior to production or service offering; therefore, the military segment may provide a steady flow of income. In accordance with the resource dependence theory, external organizations and forces, such as political action groups, non-profit organizations, and general public scrutiny, require

40

the constant revision of policies and preclude the government from pricing a contract in a manner in which all firms are able to obtain a benefit that may be perceived as excessive, even during a period of war. However, the defense-related business segment is not likely to generate negative returns; otherwise, the firm would exit the market. It is expected that the benefits associated with nonmilitary sales are tangible and quantifiable, whereas the benefits for the military segment are likely intangible. I expect that the nonmilitary segment of defense industrial-based firms is profitable, whereas the military segment may break even or is not profitable. Therefore, I hypothesize the following:

Hypothesis 1a. Military sales are not profitable for companies with large U.S. Department of Defense contracts.

Hypothesis 1b. Nonmilitary sales are profitable for companies with large U.S. Department of Defense contracts.

4.1.2 Large and small companies

The resource-based view suggests that firms are heterogeneous; therefore, an analysis considering firm size is appropriate to reveal the nature of benefits that may be related to firm attributes. According to Ghemawat (1986), larger firms, particularly first- movers, are able to exploit size advantages based on scale economies and experience effects. These firms provide insight into how different types of firms may leverage a resource. Wang and San Miguel (2012) also acknowledge that firm size should be considered when comparing firms and used total assets and total revenue to determine the

41

size of firms with large U.S. Department of Defense contracts. It is likely that the benefits gained from a contract differ for large and small firms.

Lichtenberg (1992) examined the relative profitability of commercial business conducted by government contractors and contractors without a government segment. He found that firms with a larger percentage of government sales are substantially more profitable than firms that do not conduct business with the U.S. federal government. His findings are consistent with the resource-based view; firms with valuable resources and products can earn government contracts. If the same absolute amount of contracts were awarded, larger firms in total sales would have a lower ratio of military sales in comparison with smaller firms. Because smaller firms obtain larger stable revenues through government contracts, they may earn higher profits consistently from military sales, thus extending Lichtenberg’s (1992) observation.

On the other hand, I expect that very large firms, having a low military sales ratio, do not profit as much from military contracts, because the government carefully monitors the total military expenditure for large firms (U.S. Department of Defense, 2012). As mentioned by Wernerfelt (1984), “The mathematics used by economists typically require that resources exhibit declining returns to scale, as in the traditional theory of factor demand” (p. 171). By considering a contract as a resource and assuming that it remains stable, the firm is likely to exhibit declining returns as its size increases. Yet, large firms may also be able to leverage scale and scope economies from the shared fixed production assets obtained from the military contracts; therefore, they may offset an unprofitable or breakeven military sales segment with profits from the nonmilitary sales segment. As long as fixed costs are covered, larger firms may effectively block new entrants while

42

applying technological innovations and knowledge in other products, services, or markets. Because a low government sales ratio is related to low profitability

(Lichtenberg, 1992) for smaller contractors, a high nonmilitary sales ratio implies low profitability. Therefore, it is expected that,

Hypothesis 2a. Military sales are not profitable for large companies with large U.S. Department of Defense contracts.

Hypothesis 2b. Nonmilitary sales are profitable for large companies with large U.S. Department of Defense contracts.

Hypothesis 2c. Military sales are profitable for small companies with large U.S. Department of Defense contracts.

Hypothesis 2d. Nonmilitary sales are not profitable for small companies with large U.S. Department of Defense contracts.

4.1.3 Defense-oriented and nondefense-oriented companies

In accordance with the resource dependence theory, an attribute of the contract relationship is organizational interdependence. It is expected that the degree of dependence varies with respect to industry orientation. Although defense-oriented multinational firms are dependent upon the revenue and resultant benefits provided by the

U.S. Department of Defense, the U.S. Department of Defense is also reliant upon defense-oriented firms for products and services that are innovative and of high quality in order to maintain U.S. national security. Nondefense-oriented firms are likely less reliant

43

upon the U.S. Department of Defense than defense-oriented firms, just as the U.S.

Department of Defense is likely less reliant upon nondefense-oriented firms for nondefense-related products and services. An imbalance of power between the U.S.

Department of Defense and multinational companies influences the tangible benefits derived from the contract (price).

Defense-oriented firms are reliant upon the contract as a resource because of the specialized nature of the product or service. For example, the Aerospace Industries

Association (2008) maintains that major aerospace contractors depend on government sales to expand and sustain their business bases. Defense-oriented firms are essential for the United States to meet national defense requirements and maintain technological superiority. The U.S. government influences these companies in terms of policy, which determines market structure, commerce rules, subsidies, and cost structures (Pfeffer &

Salancik, 1978). By awarding contracts to the most innovative defense-oriented firms, the

U.S. Department of Defense tries to promote healthy competition and a stable business environment, which is in the interest of the U.S. Department of Defense, the U.S. government, and all related parties. Additionally, if products, facilities, or services from the private sector are deemed critical assets of the defense industrial base, then the U.S. government assists firms with risk management and aids them by developing protective programs through regulation (U.S. Department of Homeland Security & U.S. Department of Defense, 2007). Because of the existence of a highly-interdependent relationship, I expect that military sales are profitable for defense-oriented firms.

Pfeffer and Salancik (2003) suggest that firms may reduce interdependence by adapting or attempting to alter the environment. For example, a firm may attempt to alter

44

its structure by diversifying or it may seek to influence the environment through lobbying efforts. Because many of the defense-oriented firms that hold large U.S. Department of

Defense contracts are well-established within their respective sub-industries, I expect that defense-oriented firms with the largest U.S. Department of Defense contracts have taken measures to minimize their dependence upon the U.S. Department of Defense by increasing the size of their nondefense-related sales segments, diversifying into other products and services, or by managing the environment. Therefore, I expect that nonmilitary sales are also profitable for defense-oriented firms.

Nondefense-oriented firms produce a product or provide a service to the U.S. military that is not related to national security. These products and/or services may or may not be highly specialized, and there may be many available substitutes. The U.S.

Department of Defense is less reliant upon nondefense-oriented firms, and nondefense- oriented firms are less reliant upon the government. I expect that the military segment is not profitable for nondefense-oriented companies and that these companies conduct business with the U.S. Department of Defense primarily for intangible benefits, such as market share, financial stability, or cost-shifting. I also expect that the nonmilitary segment is profitable for nondefense-oriented companies, because this segment is likely larger than the military segment and subject to fewer restrictions. It is expected that:

Hypothesis 3a. Military sales are profitable for defense industry companies with large U.S. Department of Defense contracts.

45

Hypothesis 3b. Nonmilitary sales are profitable for defense industry companies with large U.S. Department of Defense contracts.

Hypothesis 3c. Military sales are not profitable for nondefense industry companies with large U.S. Department of Defense contracts.

Hypothesis 3d. Nonmilitary sales are profitable for non–defense industry with large U.S. Department of Defense contracts.

4.2 Nonmilitary Domestic and International Sales Profitability

4.2.1 All companies

Multiple contract awards or a sustained relationship over many years with the

U.S. Department of Defense can positively reinforce a firm’s reputation and legitimacy.

The U.S. armed forces are the world’s strongest military power, with strengths in technological areas such as intelligence, surveillance and reconnaissance, and cyber operations (Parrish, 2012). A firm with a U.S. Department of Defense contract is likely to be associated with similar high-quality products and operations. In addition, innovation and technological superiority are associated with defense industry firms. The U.S. government and firms with U.S. Department of Defense contracts are codependent, and they are expected to maintain this mutually reinforcing relationship.

Obtaining a contract with the U.S. Department of Defense provides multinational companies with unique geographical advantages, from the perspective of the resource- based view. According to Penrose (1959), a firm’s productive opportunity is shaped by 46

resources, experience, and knowledge. Domestic advantages include production, technology, marketing, finance, and management (Lecraw, 1984). However, the U.S. military is also an international organization that simultaneously operates in many countries. Therefore, military contractors support the global operational needs of the U.S.

Department of Defense by providing services abroad, designing products for use in a variety of austere environments, or ensuring that products can be maintained in remote locations. The knowledge and experience gained from a U.S. Department of Defense contract positions a firm to expand abroad, because the firm is familiar with the operating environment and with applicable regulations.

Commensurate with the resource dependence theory, the factors that affect defense and nonmilitary business segments may also affect the geographic environment of multinational companies. A U.S. Department of Defense contract provides additional advantages for U.S. firms that operate abroad. Because the price of a U.S. Department of

Defense contract is negotiated in advance, firms can develop plans, both domestically and internationally, based on the expected amount of domestic revenue generated by the contract. This reliance on a domestic source of income from the U.S. government can reduce the potential financial impact of external factors associated with changing international economic and political environments.

Another benefit of a U.S. Department of Defense contract is the opportunity for a firm to participate in the Foreign Military Sales Program (Defense Security Cooperation

Agency, 2012). In this program, the U.S. government purchases defense-related items on behalf of other countries. Sales associated with this program are considered U.S. domestic sales, because the multinational company receives payment from the U.S.

47

government in advance. However, the firm interfaces with members of the foreign country, establishing relationships and gaining insight into culture, logistics, and foreign business practices.

In accordance with the resource dependence theory, firms will try to minimize their dependence upon the U.S. government by increasing nonmilitary domestic and international sales. It is expected that the multinational firms that conduct business with the U.S. Department of Defense leverage the advantages associated with the military segment and apply them to the nonmilitary domestic market. Unique relationships and experience gained from operating abroad provides similar advantages to a firm that may be realized in the form of tangible benefits in international market segments. Therefore, I expect that:

Hypothesis 4a. Nonmilitary domestic sales are profitable for companies with large U.S. Department of Defense contracts.

Hypothesis 4b. International sales are profitable for companies with large U.S. Department of Defense contracts.

4.2.2 Large and small companies

Many multinational companies operate internationally through direct nonmilitary product sales. The relationships and knowledge gained from a U.S. Department of

Defense contract may also be applied to other nondefense-related products in a diversified firm. Because nonmilitary sales are sensitive to market forces, it is likely that a large, diverse multinational company can capitalize on the experience gained through 48

the international segment, which results in a positive return on nonmilitary domestic sales. For the purposes of this study, nonmilitary sales are divided into two categories: nonmilitary domestic sales and international sales. Although the benefits associated with military contracts likely extend to both domestic and international segments, the profitability of the two nonmilitary segments may differ, depending on firm size.

Following Lichtenberg’s (1992) observation, large companies with a low military sales ratio may earn high profits from nonmilitary domestic sales and international sales, in comparison with smaller contractors with a low nonmilitary domestic sales and international sales ratio. Thus, the following is expected:

Hypothesis 5a. Nonmilitary domestic sales are profitable for large companies with large U.S. Department of Defense contracts.

Hypothesis 5b. International sales are profitable for large companies with large U.S. Department of Defense contracts.

Hypothesis 5c. Nonmilitary domestic sales are not profitable for small companies with large U.S. Department of Defense contracts.

Hypothesis 5d. International sales are not profitable for small companies with large U.S. Department of Defense contracts.

49

4.2.3 Defense-oriented and nondefense-oriented companies

The U.S. government recognizes that the defense-related technologies of defense- oriented companies are valuable resources. Many of these defense-related products and services can be used by other U.S. government entities, such as the Department of

Homeland Security. Some multinational firms may also sell related products with civilian application domestically. Because the U.S. government seeks to encourage firms to continue technological development, it is likely that these firms are compensated directly with tangible benefits.

The U.S. government seeks to protect defense-related technologies, as evidenced by the establishment of the USML and CCL, and restricts the sale of these goods and services. Multinational firms that offer defense-related products must abide by these regulations and are not able to operate in a free market system. However, the U.S. government also recognizes that defense-related technologies must be shared in order to operate effectively as part of a multinational force, so it authorizes the sale of certain defense-related products and services to allied nations. Partner nations are entrusted with these resources, and it is expected that these technologies are not resold to other nations.

The number of allied nations is finite; therefore, defense-oriented multinational firms must receive adequate compensation to promote continued research and development.

Firms specializing in defense-related products and services may be authorized to sell

“outdated” technologies or products to allied nations, or to the U.S. government through contract pricing. It is expected that few non-diversified firms with highly specialized, defense-related products exist. It is also expected that defense-oriented firms may be compensated. Therefore, it is expected that both the nonmilitary domestic and

50

international sales segments of defense-oriented firms realize tangible benefits from a

U.S. Department of Defense contract and are profitable.

Nondefense-oriented firms are not restricted by the U.S. government and may operate in a free market. In accordance with the resource-based view, these firms are able to internalize advantages associated with the contract, such as knowledge and skills, and apply these benefits to the nonmilitary domestic and international sales segments. I expect that both the nonmilitary and international sales segments of nondefense-oriented firms are profitable.

Hypothesis 6a. Nonmilitary domestic sales are profitable for defense- oriented companies with large U.S. Department of Defense contracts.

Hypothesis 6b. International sales are profitable for defense-oriented companies with large U.S. Department of Defense contracts.

Hypothesis 6c. Nonmilitary sales are profitable for non–defense industry companies with large U.S. Department of Defense contracts.

Hypothesis 6d. International sales are profitable for non–defense industry companies with large U.S. Department of Defense contracts.

51

CHAPTER 5. MODEL

To estimate the degree of profitability for each segment, I adopt an approach that is similar to those used by Hester and Zoellner (1966), Gendreau (1983), and Ito and

Rose (2010). The models are designed to assess the value of the coefficients but not to find other factors related to profitability of a firm. All else held equal, the coefficients in the equations show the degree of profitability, or the change in profits that one additional dollar of sales provides to the segment.

Firm profit was measured using total net income (NI). I examined its relationships with military sales (SM) and nonmilitary sales (SNM), the latter composed of nonmilitary domestic sales (SNMD) and international sales (SI). For example, in Hypothesis 1a, the net income’s relationship with military sales is not positive (∂NI/∂SM ≤ 0). In Hypothesis 2a, the net income’s relationship with nonmilitary sales is positive (∂NI/∂SNM > 0). The model is based on the short-run profit function, defined as follows:

(1) where NI = net income, P = unit price, C = unit cost, and Q = total sales in physical units.

From this, the firm’s profitability related to sales (i.e., the price–cost margin of the firm) is as follows:

52

where CT = total costs, ST = total sales, CT = total costs, CM = military costs, and CNM = nonmilitary costs. Note that CT includes cost of goods sold, depreciation, and interest paid. By substituting variables, where PCMM = price cost margin for military sales and

PCMNM = price cost margin of nonmilitary sales, and accounting for error ( , the following equations are derived to describe variation in net income:

For equations (2) and (3), the values of NI, SM, and SNM are observable, but the values of

CM and CNM are not. Therefore, PCMM and PCMNM are not directly observable. However, in equation (3), by use of multiple regression analyses, the coefficients β1 and β2 are used to estimate PCMM and PCMNM, respectively (i.e., they represent the estimated profitability of the military sales and nonmilitary sales, respectively). PCMM and PCMNM are endogenous variables that are related to many internal and external factors that determine profits. While these factors are indirectly related to a company’s net income, net income is directly derived only from revenues and costs. Thus, I focus on estimating

PCMM and PCMNM, rather than their determinants.

The second model that estimates the profitability of military sales, nonmilitary domestic sales, and international sales was developed as follows. U.S. firms are not 53

required to disclose international financial information based on standardized geographic segments. Therefore, the composition of countries within each geographic segment may be different and may change over time. Again, I apply the approach used by Hester and

Zoellner (1966), Gendreau (1983), and Ito and Rose (2010) to this dataset. Based on equations (1) and (2), each company’s total sales amount was separated into military, nonmilitary domestic, and international segments, with respect to the dependent variable of net income. To estimate the degree of profitability among the three segments, another model was developed that incorporates the short-run profit function. Because SNM = SNMD

+ SI and CNM = CNMD + CI, where SNMD = nonmilitary domestic sales, CNMD = nonmilitary domestic costs, and CI = international costs from the previous equation, then:

For equation (4), the coefficients β1, β2, and β3 are used to estimate PCMM = price cost margin for military sales, PCMNMD = price cost margin for nonmilitary domestic sales,

54

and PCMI = price cost margin for international sales, respectively. It is expected that

∂NI/∂SM is not positive, but ∂NI/∂SNMD and ∂NI/∂SI are positive. Again, equation (4) is used to estimate only the values of β1, β2, and β3, which are in turn affected by numerous factors that determine the profitability of a company. I focus on estimating β1, β2, and β3, rather than their determinants. I use an unbalanced panel regression analysis to estimate both models.

55

CHAPTER 6: METHODOLOGY 6.1 Data

Because of the diverse nature of firms with U.S. Department of Defense contracts and data availability, this study encompassed only the U.S. multinational companies that receive the largest share of U.S. Department of Defense contract dollars. To capture the magnitude of the exchange, in accordance with the resource dependence theory, firms were identified from the Federal Procurement Data System-Next Generation website using the Top 100 Contractors Report, which rank-orders firms according to annual sum of prime contract dollars. The time period 2006–2010 was selected to account for the drawdown of forces and the economic recession, and to capture potential industry lag effects.

The original reports show 183 unique organizations with U.S. Department of

Defense contracts for the period 2006–2010.1 Firms with headquarters outside of the

United States, universities, joint ventures, and nonprofit organizations were excluded from this study. Privately held firms were excluded, unless financial data were publicly available, leaving 62 firms (230 observations) with 35 unique six-digit NAICS codes (34 unique four-digit SIC codes). Four of the firms were not multinational organizations and therefore did not report international sales: Tesoro Corporation, Owens and Minor Inc.,

Health Net Inc., and Humana Inc., but were still included in this study. Two firms (KBR and DynCorp) reported geographical information differently from the rest of the sample, resulting in a negative value for international sales, and were excluded from the sample

(six observations). Two corporations did not report geographical information for certain years: AmerisourceBergen (2006 and 2007) and Electronic Data Systems (2009)2; these

56

three observations were eliminated from the study. Six corporations did not report geographical segment information and were also removed from the sample: AT&T Inc.

(three observations), Atlantic Diving Supply Inc. (three observations), Force Protection

Inc. (four observations), NCI Inc. (one observation), Verizon Communications Inc. (one observation), and VSE Corp (five observations), leaving 54 firms and 204 observations in the final dataset. Thirty-one firms had U.S. Department of Defense contracts across all five years.

6.2 Dependent Variable

To operationalize profitability, the dependent variable, net income (NI), was obtained from Mergent or the annual reports from each company between 2006 and

2010.3 An additional analysis of net income between 2006 and 2010 was conducted using a mixed model, random coefficients approach (Appendix B). The additional analysis is designed to provide further insight regarding the trend in net income over the studied time period.

6.3 Independent Variables

U.S. Department of Defense sales data were obtained from the Federal

Procurement Data System-Next Generation (2011). The dollar amounts for military sales were reported by the contractor and reflected the total amount of obligated dollars annually.4 Annual reports were not used to obtain the military sales data, because not all companies used a consistent reporting standard for the military contracts, making it difficult to accurately compare contract dollars (Financial Accounting Standards Board,

57

1997). For multinational companies conducting business with the U.S. Department of

Defense, revenue from military sales and/or services were considered domestic sales.5 I was not able to distinguish between revenue from products or services or from contract types using currently available data. Other variables, such as total sales and international sales data, were derived from annual reports.

6.4 Analysis

The analysis of these firms was exploratory in nature and conducted in the following manner. To draw inferences about specific characteristics of this group of firms, using the first model, I analyzed the entire sample of firms, then split the sample according to size and defense-orientation of the firm to gain additional insight. I also conducted a cross-sectional analysis of the data. Similarly, the entire sample was analyzed using the second model, and then split approximately in half according to firm size and defense-orientation. I conclude this section with an analysis of the data by each year (2006–2010).

The firms within the sample were broadly categorized using primary NAICS codes according to sectors as predominantly manufacturing firms (120 observations); professional, scientific, and technical firms (49 observations); wholesale trade firms (16 observations); finance and insurance firms (10 observations); construction firms (six observations); transportation and warehousing (two observations); and real estate, rental and leasing (one observation). Six-digit NAICS codes provide further refinement, with

59% of the observations accounting for the nine industries in Table 1.

58

Table 1. Top nine industries with recurring, large U.S. Department of Defense contracts (2006–2010) NAICS Grand Industry 2006 2007 2008 2009 2010 code Total Engineering services 541330 5 6 6 4 3 24

Search, detection, navigation, guidance, aeronautical, and nautical 334511 3 3 4 3 3 16 system and instrument manufacturing

Aircraft manufacturing 336411 3 3 3 3 3 15 Drugs and druggists’ sundries merchant 424210 2 2 3 3 3 13 wholesalers

Petroleum refineries 324110 3 2 2 3 1 11 Aircraft engine and engine 336412 2 2 2 2 3 11 parts manufacturing

Guided missile and space 336414 2 2 2 2 2 10 vehicle manufacturing

Direct health and medical 524114 2 2 2 2 2 10 insurance carriers

Computer systems design 541512 2 2 2 2 2 10 services

Total number of firms 24 24 26 24 22 120

Note. Derived from the Top 100 Contractors Report, Federal Procurement Data System- Next Generation (2006-2010) and the North American Industrial Classification System, United States. (2012)..S. Department of Commerce, U.S. Census U Bureau. Firms with headquarters located in the United States and publicly-available financial data were included.

59

In accordance with the U.S. Small Business Administration (2014, p. 1), a small business concern is defined as “one that is independently owned and operated, is organized for profit, and is not dominant in its field.” Because the Top 100 Contractors

Report includes only those businesses that received the largest U.S. military contracts, this strict definition of a small business may not hold for this sample. Instead, due to the exploratory nature of this study, multinational companies were ascertained to be small or large, relative to the sample, by rank-ordering companies based on total company sales.

Results from an independent samples t-test confirm that there is a statistically significant difference (p < .01) across all dependent variables and variable between the large and small groups.

Table 2 shows the companies that were ascertained to be large versus those that were considered small. The large companies group consisted of 99 observations with 26 unique companies, and the small companies group consisted of 105 observations with 28 unique companies (Table 2). The average ratio of military sales to total sales was 15% for the large companies, and 28% for the small companies in the sample.

60

Table 2. Large and small firms with large U.S. Department of Defense contracts (2006- 2010) Large Companies (n = 26) Small Companies (n = 28) AMERISOURCEBERGEN CORP AAR CORP BOEING CO AECOM TECHNOLOGY CORP CARDINAL HEALTH INC ALLIANT TECHSYSTEMS INC CONOCOPHILLIPS CACI INTERNATIONAL INC DELL INC CERADYNE INC ELECTRONIC DATA SYSTEMS CORP CH2M HILL COMPANIES LTD EXXON MOBIL CORP COMPUTER SCIENCES CORP FEDEX CORP COMTECH TELECOMMUNICATIONS CORP

FLUOR CORP CUBIC CORP CORP FLIR SYSTEMS INC GENERAL ELECTRIC CO GOODRICH CORP HEWLETT-PACKARD CO GREAT LAKES DREDGE & DOCK CORP

HONEYWELL INTERNATIONAL INC HARRIS CORP HUMANA INC HEALTH NET INC INTERNATIONAL BUSINESS INTERPUBLIC GROUP OF MACHINES CORP COMPANIES INC

KRAFT FOODS INC ITT CORP CORP JACOBS ENGINEERING GROUP INC MCKESSON CORP L-3 COMMUNICATIONS HOLDINGS INC

NORTHROP GRUMMAN CORP MANTECH INTERNATIONAL CORP PROCTER & GAMBLE CO NAVISTAR INTERNATIONAL CORP RAYTHEON CO OSHKOSH CORP TESORO CORP OWENS & MINOR INC TYSON FOODS INC PERINI CORP UNITED PARCEL SERVICE INC ROCKWELL COLLINS INC UNITED TECHNOLOGIES CORP SAIC INC

61

Table 2 (continued). Large and small firms with large U.S. Department of Defense contracts (2006-2010) Large Companies (n = 26) Small Companies (n = 28) VALERO ENERGY CORP TETRA TECH INC URS CORP TEXTRON INC Note. Derived from the Top 100 Contractors Report, Federal Procurement Data System- Next Generation (2006-2010). Firms classified according to total sales.

NAICS codes were examined and compared with the USML and CCL. For the purposes of this study, the multinational firms in Table 3 were identified as primarily producing defense-related products and services and are considered defense-oriented firms. Engineering and IT consulting firms were also included as defense-oriented firms; however, it should be noted that these firms differ from other defense-oriented firms because they operate in fragmented industries with low concentration. However, these firms also share similarities to other defense-oriented firms because they produce highly differentiated, specialized products (not all defense-related), and leverage rapid changes in technology to remain competitive. Interestingly, six of the nine industries that are identified as defense-related have more than one multinational firm that receives large

U.S. Department of Defense contracts each year (see Table 2). An independent samples t- test shows that there is a statistically significant difference (p < .01) across all dependent variables and the independent variable between the defense industry and non–defense industry groups. Levene’s test of equality of variances demonstrates that the variance of the defense industry group and the non–defense industry groups on net income are also significant and not equal (p < .01).

62

Table 3. Defense-oriented firms with large U.S. Department of Defense contracts (2006- 2010). Industry and Multinational Firm SIC NAICS Aircraft Manufacturing/Aerospace Products and Parts Manufacturing HONEYWELL INTERNATIONAL INC 3714 336412 AAR CORP 3721 336412 BOEING COMPANY 3721 336411 GENERAL DYNAMICS CORPORATION 3721 336411 TEXTRON INC 3721 336411 UNITED TECHNOLOGIES CORPORATION 3724 336412 ROCKWELL COLLINS INC 3728 336413 ALLIANT TECHSYSTEMS INC 3760 332993 GOODRICH CORPORATION 3761 336414 LOCKHEED MARTIN CORPORATION 3761 336414 Search, Detection, Navigation, Guidance, and Aeronautical Systems FLIR SYSTEMS INC 3812 334511 3812 339111 L-3 COMMUNICATIONS HOLDINGS INC 3812 334511 NORTHROP GRUMMAN CORPORATION 3812 334511 RAYTHEON COMPANY 3812 334511 CUBIC CORPORATION 3829 334519 Automobile Manufacturing Industry CERADYNE INC 3711 336992 NAVISTAR INTERNATIONAL CORPORATION 3711 336211 OSHKOSH CORPORATION 3711 336120 Other PERINI CORPORATION 1540 531120 GREAT LAKES DREDGE & DOCK CORPORATION 1623 237110 Services-Computer Integrated Systems Design ELECTRONIC DATA SYSTEMS CORPORATION 7371 541511

63

Table 3 (continued). Defense-oriented firms with U.S. Department of Defense contracts (2006-2010). Industry and Multinational Firm SIC NAICS CACI INTERNATIONAL INC 7373 541511 COMPUTER SCIENCES CORPORATION 7373 541512 MANTECH INTERNATIONAL CORPORATION 7373 541512 SAIC INC 7373 541330 Services-Engineering Services AECOM TECHNOLOGY CORPORATION 8711 541330 CH2M HILL COMPANIES LTD 8711 541330 TETRA TECH INC 8711 541330 URS CORPORATION 8711 541330 FLUOR CORPORATION 1629 541330 JACOBS ENGINEERING GROUP INC 1629 236210 Note. Derived from the Top 100 Contractors Report, Federal Procurement Data System- Next Generation (2006-2010). Multinational companies are arranged according to primary NAICS code. Secondary NAICS codes may be more indicative of their defense- related products and/or services.

The final sample generally follows a normal distribution. The spread of the observations for the dependent variable and military sales is relatively low compared with the other independent variables. Nonmilitary sales data have the highest variance, followed by international sales. The dependent variables and independent variables approximately follow a normal distribution, with several key exceptions. As expected with income and sales data, all variables are slightly skewed to the right. Similarly, the variables of net income, nonmilitary sales, and international sales have an extremely large kurtosis, indicating that the data are more tightly distributed about the mean.

Table 4 displays the correlation matrix and descriptive statistics for all companies within the sample. The smallest value for net income (approximately negative $2 billion)

64

was reported by Valero Energy Corporation in 2009. The largest value for net income

(over $45 billion) was reported by ExxonMobil Corporation in 2008. For this group of companies, the average military contract amount across all five years (2006–2010) was about $3.7 billion, which is much less than the average of nonmilitary sales (over $35 billion) for the same companies over the same time period. Average domestic sales across all five years (2006–2010) reached $24 billion, which is more than the average international sales of $15 billion for the same companies over the same time period.

However, the presence of the four companies in the sample that do not have international operations (14 observations) may have influenced these values.

As expected, nonmilitary sales were highly and significantly correlated with net income. International sales had the highest correlation with net income. While nonmilitary domestic and international sales were significant and highly correlated with nonmilitary sales, all three were not used simultaneously in the analysis. Nonmilitary sales were significant but not highly correlated with net income. To detect the potential presence of multicollinearity, variance inflation factors were calculated and found to be under the value of 2 for all models, indicating that multicollinearity was not a concern in this study.

65

Table 4. Correlations and descriptive statistics.

0. 1. 2. 3. 4.

NI SM SNM NMDS IS Mean SD (billions) (billions) 0. Net income (NI) 2.5 6.0

1. Military sales (SM) −0.013 3.7 6.2

2. Nonmilitary sales (SNM) 0.897** −0.098 35.4 61.8 3. Nonmilitary domestic sales (NMDS) 0.601** −0.134 0.855** 20.1 28.7 4. International sales (IS) 0.957** −0.056 0.926** 0.601** 15.4 40.3 ** Correlation is significant at the .01 level (two-tailed). n = 204

66

CHAPTER 7. RESULTS

The models are used to estimate the segment profitability of firms with U.S.

Department of Defense contracts in the Top 100 Contractors Report. This section is organized as follows. To address Hypotheses 1a through 3d, I will describe the results from the first model for the total samples, the subsamples based on firm’s attributes, and the related cross-sectional analysis. To address Hypotheses 4a through 6d, I describe the results from the second model, the subsamples, and the cross-sectional analysis. The analysis included in Appendix B complements the results by demonstrating how military sales are related to firm trajectories in net income over time.

7.1 Military and Nonmilitary Sales Profitability

7.1.1. All companies

Table 5 shows the results of estimating the first model using panel data regression. Different estimation methods—fixed effects, random effects, and OLS—are used based on the Lagrange multiplier (Breusch & Pagan, 1980) and Hausman (1978) statistics. The first two columns are based on models using the covariance matrix estimator suggested by White (1980) for the two-way fixed effects regression. It incorporates both group- and time-specific effects. The first column shows the regression results based on all companies. The model explains 97% of the variation in net income.

The coefficient for military sales was not significant (p > .10), demonstrating that the return on military sales is not significantly different from zero. The coefficient for nonmilitary sales was positive and significant (p < .01). Holding all other variables constant, for every one dollar increase in nonmilitary sales, net income increases by 14

67

cents. Therefore, the results lend support for Hypotheses 1a and 1b, that military sales are not profitable, whereas nonmilitary sales are profitable for companies with large U.S.

Department of Defense contracts.

68

Table 5. Military and nonmilitary segment profitability (standard errors are in parentheses)

Variables 0. Net income

All data Large companies Small companies Defense-oriented Nondefense-oriented companies companies 1. Military sales 0.163 0.406† 0.072** 0.057** 0.497 (0.118) (0.21) (0.017) (0.011) (0.574)

2. Nonmilitary sales 0.139** 0.146** 0.024** 0.061** 0.104** (0.01) (0.014) (0.009) (0.006) (0.007)

Constant (in billions) −3.003** −7.359** 0.083† −0.058† −3.271* (0.579) (1.646) (0.046) (0.134) (1.450)

R2 0.97 0.97 0.23

F (β1 = β2) 0.04 1.45 3.53† 0.07 0.46 Model Fixed effects Fixed effects OLS Random effects Random effects n 204 99 105 129 75

†p < .10, *p < .05, **p < .01. Standard errors in parentheses.

69

7.1.2. Large and small companies

The second column of Table 5 shows the results for the largest companies within the sample. Similar to the analysis conducted for the entire sample, a two-way fixed effects model was used based on the Lagrange multiplier and Hausman statistics. The model explains 97% of the variation in net income. Unlike the entire sample, the coefficient for military sales was not significant (p < .05) for the largest firms, but was marginally significant at p < .10. Further, the coefficient for nonmilitary sales remained positive and significant (p < .01), indicating that, for every dollar increase in nonmilitary sales, net income increases by 15 cents; therefore, the results lend support for Hypothesis

2a—military sales are not profitable for large companies with large U.S. Department of

Defense contracts; and they lend support for Hypothesis 2b—nonmilitary sales are profitable for large companies with large U.S. Department of Defense contracts.

The third column shows regression results based on the small companies group.

Based on small Lagrange multiplier statistics, heteroscedasticity-corrected OLS is reported. The coefficient for military sales is positive and significant (p < .01), lending support for Hypothesis 2c—military sales are profitable for small companies with large

U.S. Department of Defense contracts. The coefficient for nonmilitary sales is also positive and significant, lending no support for Hypothesis 2d—nonmilitary sales are not profitable for small companies with large U.S. Department of Defense contracts

These results suggest that, for every dollar increase in military sales and nonmilitary sales, the net income of the smaller companies’ increases by 7 and 2 cents, respectively. An F test of β1 = β2 is marginally significant at p < .10, suggesting that for small firms, military sales are more profitable than nonmilitary sales. The results indicate

70

that a high military sales ratio is associated with stable and reliable revenue for smaller firms. The large firms with U.S. Department of Defense contracts do not lose money from the military sales (i.e., the coefficients for the military sales variable were not negative and significant). As the resource-based view suggests, the large companies may gain intangible benefits from the military contracts as well as having fixed assets that can be used to produce other nonmilitary products; thus, the large military contract may cover the fixed cost of the nonmilitary segment’s production. In addition, being large in size implies that these companies already have unique resources and competencies that generate profits in nonmilitary segments.

7.1.3. Defense-oriented and nondefense-oriented companies

For defense-oriented and nondefense-oriented companies, due to large Lagrange multiplier statistics and small Hausman statistics, I report random effects model results that are heteroscedasticity-corrected.

For defense-oriented companies, the coefficients for military sales and nonmilitary sales were significant at the p < .01 level. For defense-oriented companies, for every dollar increase in military sales and nonmilitary sales, net income increases by

5 and 6 cents, respectively. This supports Hypothesis 3a—military sales are profitable for defense industry companies with large U.S. Department of Defense contracts; and

Hypothesis 3b—nonmilitary sales are profitable for defense industry companies with large U.S. Department of Defense contracts.

For nondefense-oriented companies, the coefficient for military sales was positive but not significant, and the coefficient for nonmilitary sales was positive and significant

71

at the p < .01 level. For nondefense-oriented companies, for every dollar increase in nonmilitary sales, net income increases by 10 cents. This lends support to both

Hypothesis 3c—military sales are not profitable for non–defense industry companies with large U.S. Department of Defense contracts; and Hypothesis 3d—nonmilitary sales are profitable for nondefense industry companies with large U.S. Department of Defense contracts.

7.1.4. Cross-sectional analysis

To investigate the return on military sales through time, I estimate separate models for each year from 2006 to 2010 (see Table 6). The OLS results are based on models using the modified covariance matrix estimator suggested by Davidson and

MacKinnon (1993). The coefficients for military sales were positive and significant at p <

.05 in 2007 and 2010 only (it was marginally significant at p < .05 in 2009). On the other hand, the coefficients associated with nonmilitary sales were all positive and significant at p < .01. While the results lend support for Hypothesis 1b, Hypothesis 1a received support only in 2006, 2008, and 2009. Interestingly, this time period is associated with the economic recession (2008–2009), whereas the military sales were profitable in 2007 and 2010, coinciding with the beginning of troop surges in Iraq and Afghanistan.

72

Table 6. Military and nonmilitary segment profitability by year (standard errors are in parentheses)

Variables 0. Net income 2006 2007 2008 2009 2010

1. Military sales 0.038 0.077* 0.072 0.076† 0.087** (0.054) (0.033) (0.052) (0.039) (0.025)

2. Nonmilitary sales 0.106** 0.103** 0.091** 0.057** 0.059** (0.014) (0.011) (0.029) (0.013) (0.018)

Constant (in billions) −0.642 −0.803† −1.161 −0.537 −0.307 (0.414) (0.346) (0.841) (0.405) (0.248) R2 0.89 0.91 0.87 0.69 0.50

F (β1 = β2) 1.11 0.22 0.08 0.11 0.23 Model OLS OLS OLS OLS OLS n 41 41 43 39 40 †p < .10, *p < .05, **p < .01

73

7.2 Military, Nonmilitary Domestic, and International Sales Profitability

7.2.1. All companies

Table 7 displays the results of estimating the second model, which examines military sales, nonmilitary domestic sales, and international sales profitability of firms with U.S. Department of Defense contracts in the Top 100 Contractors Report. The first column shows the regression results for all companies in the sample. Similar to the previous model, different estimation methods—fixed effects, random effects, and OLS— are used based on the Lagrange multiplier and Hausman statistics. The first two columns are based on models using the covariance matrix estimator suggested by White (1980) for the fixed two-way effects regression. The model explains 97% of the variation in net income. The coefficients for nonmilitary domestic sales and international sales are positive and significant p < .01 and p < .05, respectively, while the coefficient for military sales was not significant (p < .10). These results suggest that, holding all other variables constant, for every dollar increase in nonmilitary domestic sales and international sales, net income increases by 15 and 15 cents, respectively. However, military sales are not profitable, similar to the previous model’s results. These results lend support for Hypothesis 1a—military sales are not profitable for companies with large U.S. Department of Defense contracts, as well as Hypotheses 4a and 4b— nonmilitary domestic sales and international sales are profitable for companies with large

U.S. Department of Defense contracts.

74

Table 7. Military, nonmilitary domestic, and international segment profitability (standard errors are in parentheses)

Variables 0. Net Income Nondefense- Large Small Defense-oriented oriented All companies companies companies companies companies

1. Military sales 0.14 0.358 0.084** 0.059** 0.318 (0.118) (0.221) (0.017) (0.01) (0.784)

3. Nonmilitary domestic sales 0.153** 0.159** −0.009 0.038* 0.086* (0.032) (0.045) (0.009) (0.018) (0.033)

4. International sales 0.145* 0.150** 0.090** 0.073** 0.139* (0.021) (0.029) (0.013) (0.012) (0.021)

Constant (in billions) −3.313** −7.768** 0.085* 0.003 −3.404 (0.701) (1.963) (0.037) (0.140) (2.101) 2 R 0.97 0.97 0.35

F (β1 = β3) 0.01 0.82 11.91** 0.8 0.09

F (β1 = β4) 0 0.85 0.05 0.73 0.82 Model Fixed effects Fixed effects OLS Random effects Random effects n 204 99 105 129 75 †p < .10, *p < .05, **p < .01

75

7.2.2. Large and small companies

The second column shows regression results of the large company group. The model explains 97% of the variation in net income. Similar to the results for all companies, the coefficient for military sales is not significant (p > .10). The coefficients for nonmilitary domestic sales and international sales are both positive and significant (p

< .01).

They indicate that, holding all other variables constant, for every dollar increase in nonmilitary domestic sales and international sales, net income increases by 16 and 15 cents, respectively, while military sales are not significantly different from zero and are therefore not profitable. These results lend support for Hypothesis 2a—military sales are not profitable for large companies with large U.S. Department of Defense contracts, and

Hypotheses 5a and 5b—nonmilitary domestic sales and international sales are profitable for large companies with large U.S. Department of Defense contracts.

The third column shows regression results of the small company group. Unlike the results for large companies, the coefficient for military sales is positive and significant (p > .01), supporting Hypothesis 2c—military sales are profitable for small companies with large U.S. Department of Defense contracts. However, the coefficient for nonmilitary domestic sales is negative and not significant. The coefficient for international sales is positive and significant (p < .01), which does not lend support for

Hypothesis 5c—nonmilitary domestic sales are not profitable for small companies with large U.S. Department of Defense contracts. For every dollar increase in international sales, net income increases by 9 cents, which does not support Hypothesis 5d—

76

international sales are not profitable for small companies with large U.S. Department of

Defense contracts.

The results appear to reconcile the seemingly contradictory findings in the literature. Consistent with the findings of Bohi (1973), Rogerson (1992), and Zhong and

Gribbin (2009), the results based on all companies and large companies indicate that nonmilitary sales, which consist of nonmilitary domestic sales and international sales, were profitable, while the military sales were not. On the other hand, for smaller contractors whose average military sales ratio was almost twice that of large companies, consistent with the results of Lichtenberg (1992), the analysis suggests that the military segment was profitable, while nonmilitary domestic segment, particularly, nonmilitary domestic sales, was not. This lends support for the notion that larger multinational firms may maintain a U.S. Department of Defense contract as a resource position barrier, preventing new entrants into this market despite its having no positive return.

7.2.3. Defense-oriented and nondefense-oriented companies

The fourth column shows regression results of estimating the same model using defense-oriented companies. The coefficients for military sales and international sales are positive and significant (p < .01). The coefficient for nonmilitary domestic sales is also significant (p > .01). These results suggest that, for every dollar increase in military sales, nonmilitary sales, and international sales, net income increases by 6, 4, and 7 cents, respectively. These results support Hypothesis 6a—nonmilitary sales are profitable for defense industry companies with large U.S. Department of Defense contracts; and

77

Hypothesis 6b—international sales are profitable for defense industry companies with large U.S. Department of Defense contracts. It also repeats support for Hypothesis 3a.

The final column shows regression results of estimating the same model using nondefense companies. The coefficient for military sales is not significant, while the coefficient for nonmilitary domestic sales and international sales are positive and significant (p > .05). These results suggest that, for every dollar increase in nonmilitary sales and international sales, net income increases by 8 and 13 cents, respectively. These results support Hypothesis 6c and Hypothesis 6d—nonmilitary and international sales are profitable for non–defense industry companies with large U.S. Department of Defense contracts. Again, this supports Hypothesis 3c—military sales are not profitable for nondefense industry companies with large U.S Department of Defense contracts.

7.2.4. Cross-sectional analysis

I investigated the return on military sales from 2006 to 2010 using the second model (see Table 8). The modified covariance matrix estimator suggested by Davidson and MacKinnon (1993) is used to conduct the OLS. The coefficients for nonmilitary domestic sales were not significant, which does not support Hypothesis 4a. However, the coefficients for international sales were positive and significant (p < .01), supporting

Hypothesis 4b—international sales are profitable for companies with large U.S. military contracts. The F tests show that the coefficients for military sales and nonmilitary sales are not significantly different (except for 2010, when they were significantly different at p < .05). The coefficients for military sales and international sales were significantly different at p < .05 in 2006 and 2007, and p < .01 in 2008. However, they were not

78

significantly different in 2009 and 2010 (p < .05). These results are slightly different from the pooled results, likely due to the smaller sample size and varying factors associated with different years.

79

Table 8. Military, nonmilitary domestic, and international segment profitability by year (standard errors are in parentheses).

Variables 0. Net income 2006 2007 2008 2009 2010

1. Military sales 0.026 0.057 0.033 0.046 0.064* (0.050) (0.034) (0.048) (0.044) (0.029)

3. Nonmilitary domestic sales 0.036 0.035 −0.003 −0.001 0.003 (0.030) (0.027) (0.016) (0.011) (0.006)

4. International sales 0.148* 0.143** 0.143** 0.102* 0.138** (0.059) (0.05) (0.010) (0.043) (0.031)

Constant (in billions) −0.028 −0.111 0.005 0.216 −0.051 (0.316) (0.317) (0.193) (0.307) (0.165) R2 0.94 0.96 0.97 0.86 0.83

F (β1 = β3) 0.05 0.29 1.38 1.60 2.87†

F (β1 = β4) 7.22* 4.68* 12.36** 1.99 3.84† Model OLS OLS OLS OLS OLS n 41 41 43 39 40

†p < .10, *p < .05, **p < .01

80

CHAPTER 8. DISCUSSION AND CONTRIBUTIONS

8.1 Discussion

In this study, using a combined resource approach, I examined and computed the profitability of firms with substantial U.S. Department of Defense contracts in terms of customer and geographic segments. This analysis illuminates whether the benefits of a contract are tangible or intangible for heterogeneous firms with the largest U.S

Department of Defense contracts, and considers whether the benefits differ according to firm attributes.

Of the suggested hypotheses, only two were not supported. It was expected, according to Hypothesis 2d, that nonmilitary sales would not be profitable for small companies because smaller firms would rely on military sales. However, according to this analysis, both the military and nonmilitary sales segments were profitable for small companies. It appears that smaller firms are able to leverage the intangible benefits associated with a U.S. Department of Defense contract and effectively apply them to the nonmilitary sales segment in order to reap profits from both segments. Hypothesis 5d, which states that international sales would not be profitable for small companies, was also not supported. International sales were found to be profitable for smaller firms, yet the nonmilitary domestic segment was not profitable, suggesting that small firms are able to capitalize on the advantages associated with internationalization, but unable to attain profits from the nonmilitary domestic segment. This finding is interesting since firms that are profitable in the international market segment should also profit in their domestic market. Because smaller firms are profitable in their military market segment, it is likely

81

that the benefits associated with a U.S. Department of Defense contract may be easier to exploit internationally than domestically and warrants further investigation.

8.1.1 Military and nonmilitary sales profitability

According to the first model, multinational firms that value the intangible benefits of U.S. Department of Defense contracts are likely to be large and do not produce a product or service with an adaptable civilian equivalent. These firms do not generate profits from the military segment. Regardless of the manner in which the companies are grouped according to firm attributes, nonmilitary sales are profitable, even though nonmilitary sales data have the highest variance.

U.S. multinational firms that use U.S. Department of Defense contracts as a resource for tangible benefits, (i.e., with the highest profits), were smaller companies or produced products and services specific to the defense industry. From the perspective of the resource dependence theory, these firms may be more reliant upon the U.S.

Department of Defense contract as a steady source of income than other types of firms due to the magnitude of the exchange or criticality of the resources. They may also be able to leverage more power because the U.S. Department of Defense is also reliant upon these firms to provide innovative and high-quality goods and services to the U.S military.

8.1.2 Military, nonmilitary domestic, and international sales profitability

The second model reinforced the findings of the first model and provided additional insight. Similar to the first model, the military sales segments of small and defense-oriented companies were found to be profitable. By analyzing the nonmilitary

82

sales segment results geographically, it was revealed that international sales were profitable for the total sample and all subgroups classified by firm attributes (large, small, defense-oriented and nondefense-oriented). Interestingly, although military sales and nonmilitary sales were profitable for small companies in the first model, nonmilitary domestic sales were not considered profitable in the second model.

8.1.3 Segment profitability between 2006 and 2010

Examination of the cross-sectional sales segment data revealed that military sales were profitable for the entire sample of firms in 2007 and 2010. The nonmilitary sales segment was profitable for these same firms across all five years. After splitting the nonmilitary sales segment into nonmilitary domestic sales and international sales, the model revealed that international sales were profitable across all five years, but nonmilitary domestic sales were not. Military sales remained profitable only in 2010.

These years coincide with surges in troop levels in Iraq and Afghanistan, respectively.

8.2 Contributions

8.2.1 Theoretical Contribution

This research has demonstrated that a contract with the U.S. Department of

Defense is considered to be a resource that firms seek to protect. By adopting a combined resource perspective, it is possible to identify how heterogeneous multinational firms value the contract and its associated benefits.

It was found that the military sales segment was not profitable for large firms.

Therefore, it appears that larger firms value the military contract for intangible benefits.

83

Because firms are heterogeneous, intangible benefits differ among firms. From the perspective of the resource dependence theory, intangible benefits may signify that larger firms have elected to reduce reliance upon the U.S. government. It is likely that the contract is considered to be a critical resource, or firms would not maintain it. However, the criticality of the resource likely differs among firms. In accordance with the resource- based view, once the advantages of a resource have been internalized, firms have the ability to apply intangible benefits to other segments. Although larger firms have the ability to leverage size advantages, it appears that size advantages do not lead to a tangible benefit for the defense-related segment.

It was also found that the U.S. Department of Defense contract provides a tangible benefit for the defense-related segment of smaller firms. From the perspective of the resource dependence theory, it is likely that smaller firms are reliant upon the contract. According to Hymer (1976), firm advantages are usually stronger domestically than internationally. Smaller firms were able to realize tangible benefits abroad and in the military market segment, but not in the nonmilitary domestic market segment. It is possible that smaller firms may have been impacted by the recession. However, further research is required to examine whether smaller firms were able to obtain a contract based on successful international operations, as the resource-based view suggests, or whether the contract provided benefits to firms which allowed them to expand internationally, as the resource dependence theory suggests. Because smaller firms do not receive tangible benefits from the nonmilitary domestic market segment, they are reliant upon the military business segment, and therefore the U.S. Department of Defense as a resource.

84

As expected, during the latter portion of the Iraq and Afghanistan war periods, defense-oriented firms realized a tangible benefit from the U.S. Department of Defense contract in the defense-related business segment. Defense-oriented firms also realized tangible benefits in the nonmilitary domestic and international business segments. This could signify that the demand for defense-related products is likely to be rather stable. In accordance with the resource dependence theory, it also affirms the strong relationship between defense-oriented multinational firms and the U.S. Department of Defense. From the perspective of the resource-based view, defense-oriented firms may be able to leverage advantages across all customer and market segments.

Similar to large firms, nondefense-oriented firms appear to value the intangible benefits of the contract. Congruent with the resource-based view, multinational firms that value a U.S Department of Defense contract as an intangible resource may do so for a variety of reasons, such as protecting market share, establishing a resource position barrier, or shifting costs (McGowan & Vedryzk, 2002). For nondefense-oriented firms, the nonmilitary domestic and international segments were found to be profitable, indicating that these firms may not be as reliant upon the contract.

By combining the perspectives of the resource-based view and the resource dependence theory, it is apparent that the strategy used by U.S. multinational firms differs with respect to firm attributes. A contract with the U.S. Department of Defense is a resource that provides multinational firms with advantages, but the manner in which firms are able to leverage these advantages differs with respect to firm size and product/service orientation.

85

8.2.2 Methodological Contribution

Unlike other studies, this study specifically examines the nonmilitary segment of firms that conduct business with the U.S. Department of Defense according to geographical segments. I further refine the analysis by Morse and Kramer (1985) and

Wang and San Miguel (2012) by distinguishing the profitability of multinational firms that conduct business with the Department of Defense in terms of firm size.

Past studies that attempted to estimate the profitability of a government contract showed inconsistent results. Bohi (1973) and Rogerson (1992) indicated that the defense- related business segment is less profitable than the nonmilitary business segment of the same firm. However, Lichtenberg (1992) found that firms with a larger government sales ratio have higher profits than firms without government contracts. This study reconciles these seemingly opposing findings for firms that hold the largest U.S. Department of

Defense contracts.

Segment profitability is a tool that may be used by managers to evaluate where to conduct future investment. Unlike other studies, the statistical method used in this study shows how much a one-dollar increase in segment investment is related to net income.

Based on this analysis, all defense industrial base firms should seek to invest in the international segment, where the return on sales is high. Similarly, larger firms and nondefense-oriented firms should also seek to invest in the nonmilitary domestic market segment. Smaller firms and defense-oriented firms may seek to invest in their defense- related segments, but will likely have difficulty doing so as the United States transitions from a war period to a period of peace.

86

8.2.3 Practical Contribution

It is important to consider the heterogeneous nature of firms when developing regulatory and economic policies for defense industrial base firms. During the Iraq and

Afghanistan war period, smaller firms and defense-oriented firms appear to have gained a tangible benefit from a U.S. Department of Defense contract. Larger firms and nondefense-oriented firms did not lose money, but did not earn a positive return.

Therefore, firm attributes must be considered when developing or modifying corporate strategies.

The environment continues to change. As the United States transitions from a period of war to a period of peace, the profitability of defense industrial base firms should continue to be reevaluated. Based on the findings of this research, the estimated coefficients may be of particular interest when assessing regulatory and economic policies or evaluating the health of the defense industrial base.

87

CHAPTER 9. LIMITATIONS AND FUTURE RESEARCH

9.1 Limitations

Similar to other empirical studies, the findings in this study rely upon the accuracy of the available data. Multinational companies are not required to report international profits and costs to shareholders according to standardized geographical boundaries. There could be nuances associated with the classification of domestic versus international sales. I estimate them by employing a model that has been used in the literature, though it has limitations with respect to content validity of segment information. Military segment data are self-reported by the companies and are not bound by regulation. The military segment data from the Federal Procurement Data System-

Next Generation may also contain errors caused by inaccurate data entry prior to 2007

(Acquisition Advisory Panel, 2007). Sales data may also differ across companies based on differences in reporting periods (e.g., annual versus fiscal years) and contract modifications.

The presence of firms within certain industries, such as the petroleum refining industry and health insurance carriers, may have influenced the linearity and normality of the data, which may have impacted the estimated results. Because of the unique characteristics of multinational companies within the Top 100 Contractors Report, the results may not be generalizable to all companies with U.S. Department of Defense contracts, because the firms that comprise the defense industrial base sector are unified by the customer (i.e., the U.S. government), rather than size or industry segment. The cross-sectional analysis may not be as reliable due to the small sample size.

88

The limitations of this analysis are the same as those of calculating return on revenue. It reveals the financial performance of multinational firms, but does not account for their financial position.

9.2 Future Research

As stated by Wang and San Miguel (2012), it is not appropriate to evaluate the health of the defense industrial base by comparing their profitability measures to an index due to the differences in industry composition. A contract that results in high perceived corporate profits may accurately reflect a superior technology, product, or service, or it may reflect inappropriate pricing practices. A U.S. Department of Defense contract that does not result in significant corporate profits may be an effective use of taxpayer dollars, or a multinational firm may attain value from the resource from intangible benefits.

Future analyses of defense industrial base profitability should consider that the internal capabilities of multinational firms are heterogeneous and that these firms should be evaluated based upon both segment profitability and firm attributes. Therefore, other possible directions for future research include analyzing similar segment data over a longer time span or during periods of changing political and economic policy.

Multinational companies with large defense contracts could be compared to companies in the same industries that do not conduct business with the U.S. Department of Defense, or compared to firms that exclusively do business with the U.S. Department of Defense.

Scholars could analyze the impact of foreign military sales on nonmilitary profitability, if such data become available.

89

The models may also be applied at another level of analysis. Management’s perception of a firm’s resources and market structure affect corporate strategy (Caves,

1980). Segment information is valuable for making complex strategic decisions such as expansion or divestitures. According to Chen and Zhang (1993) when some segments are expected to downsize and other segments are likely to experience growth, the incremental relevance of segment data is greater. Multinational companies with greater domestic and defense-related sales could examine the possibility of expanding the firm’s domestic segment by conducting business with other U.S. government agencies.

Additional directions for further research include experimentation with different modeling techniques, or using different methods to split the data to evaluate the stability of the results. For example, case studies may provide contextual support for empirical findings, and would bring additional insight into how managers view segment profitability, resources, and benefits. In addition, case studies may reveal why certain segments are maintained by multinational firms. Future researchers could also conduct surveys which broadly categorize the reasons why firms value segments that break even or are not profitable.

This study was conducted exclusively during a period of war; therefore, additional research is required to ascertain if the results differ during a period of low-level conflict or peace. Future researchers could compare a war period to another war period or compare a war period to a period of peace or low-level conflict to examine how profit policies may have influenced the profitability of firms.

90

CHAPTER 10. CONCLUSION

This study contributes to the international business literature in several ways.

First, it enriches the extant management literature by illuminating that the U.S. military contract is a resource that can enhance the global strategy of multinational companies.

Multinational companies can leverage a U.S. military contract to gain or maintain a competitive position. Existing theories (e.g., the resource-based view, resource dependence theory) support the perspective that a large contract with the U.S.

Department of Defense is a valuable resource. The contract provides both tangible and intangible benefits to a firm, and these benefits can be leveraged to attain greater profitability in other markets.

Theoretically, this study affirms the utility of both the resource dependence theory and the resource-based view. This research fills a gap in the literature by demonstrating that the resource-based view and the resource dependence theory are not opposing or mutually exclusive theories. Instead, they are complementary viewpoints that can be used together to gain a comprehensive understanding of how multinational firms leverage internal and external resources to earn profits. By examining these theories together, stakeholders will be able to adopt an extensive and all-encompassing resource- based approach, which will provide them with a greater ontological understanding to evaluate and influence future strategic decisions and profitability.

This study is generalizable to firms that operate in different market segments by assessing profitability in different customer and geographic segments for companies with

U.S. Department of Defense contracts. The U.S. government and other organizations may find the models useful when making decisions regarding defense policies and military

91

budgets. The models could be applied to other heavily regulated industries or businesses with substantial government contracts that require effective use of government resources.

Firms become profitable by effectively managing internal resources and positively shaping the external environment. Segment profitability information, such as defense and nonmilitary, or domestic and international, is an effective way to evaluate performance. With appropriate estimation of segment profitability, firms can commit additional resources to the profitable segment and potentially improve performance.

Segment profitability information allows managers and investors of multinational companies to make effective strategic decisions to generate positive outcomes. It also provides the U.S. government with important information to assess the costs and benefits associated with military contracts, and to further develop and evaluate U.S. national and economic security policies.

In summary, this study synchronized frameworks of corporate resources with empirical findings of literature on military contractors’ profitability, using parsimonious models that may be applied at various levels of analysis to assess performance. However, more research is needed to investigate other firm characteristics that influence the profitability of multinational companies with a defense-related segment.

92

APPENDIX A. Firms with the Largest U.S. Department of Defense Contracts

Table 9. Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 LOCKHEED MARTIN CORPORATION 29,054,980,518 31,348,453,591 29,091,044,407 28,544,756,640 27,089,418,408 BOEING COMPANY (THE) 18,047,585,923 20,604,690,107 21,794,832,402 22,995,150,080 19,685,209,761 NORTHROP GRUMMAN CORPORATION 15,574,347,189 18,293,375,394 19,464,937,010 15,349,895,946 16,052,078,855 GENERAL DYNAMICS CORPORATION 14,558,853,585 15,662,063,160 14,771,896,698 13,657,725,914 11,568,473,145 RAYTHEON COMPANY 14,511,228,999 15,332,423,922 14,313,645,582 11,067,001,370 9,422,453,633 OSHKOSH CORPORATION 7,223,976,311 6,379,043,578 1,863,470,025 2,343,938,264 988,263,557 L-3 COMMUNICATIONS 6,834,329,137 6,841,410,117 6,006,831,673 6,029,594,189 4,820,846,861 UNITED TECHNOLOGIES CORPORATION 6,814,361,100 7,047,569,735 8,201,621,967 5,321,219,671 4,543,177,267 BAE SYSTEMS PLC 6,155,689,602 6,704,063,087 15,038,101,347 9,735,891,823 5,925,627,191 SAIC INC 4,862,950,839 4,338,700,255 3,881,758,597 3,600,291,896 3,116,435,222 CERBERUS CAPITAL MANAGEMENT L.P. 3,874,962,534 - - - - KBR INC 3,571,649,246 4,635,422,289 5,997,089,901 4,825,829,496 5,980,228,469 HUMANA INC 3,248,725,848 3,437,897,070 2,959,865,103 3,403,619,620 2,645,110,495 GENERAL ELECTRIC COMPANY 2,960,989,096 3,442,880,553 3,439,895,609 2,480,293,969 2,409,626,230 HEALTH NET INC 2,960,589,395 2,833,980,613 2,438,342,942 2,224,967,117 2,119,299,090 COMPUTER SCIENCES CORPORATION 2,789,942,771 2,752,215,384 2,772,927,223 2,290,958,632 1,900,982,784 BELL BOEING JOINT PROJECT OFFICE 2,752,694,557 2,620,340,066 2,801,354,948 1,901,454,598 1,110,561,993 TRIWEST HEALTHCARE ALLIANCE CORP 2,721,404,316 2,672,212,524 2,366,975,634 2,110,825,320 2,021,460,650 GOVERNMENT OF CANADA 2,653,702,764 534,792,838 754,004,617 642,682,024 548,187,636

93

Table 9 (Continued). Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 BOOZ ALLEN HAMILTON INC 2,581,724,977 2,272,314,245 1,857,118,081 1,566,129,263 1,231,221,729 ITT CORPORATION 2,551,980,239 2,740,731,493 4,182,766,765 2,204,059,768 2,306,480,820 HARRIS CORPORATION 2,526,898,953 1,442,080,726 1,807,033,159 1,508,788,143 1,411,116,393 CACI INTERNATIONAL INC 2,359,957,377 1,646,613,385 1,253,887,843 1,131,446,219 827,127,743 TEXTRON INC 2,194,238,669 1,275,116,557 2,793,285,551 2,059,843,214 958,725,656 URS CORPORATION 2,143,344,731 1,838,845,209 2,019,716,429 1,579,786,638 1,385,388,617 SUPREME GROUP HOLDING SARL 2,122,754,640 - - - - BECHTEL GROUP INC 2,105,585,976 2,297,043,828 2,033,961,610 1,341,254,838 998,290,091 ABU DHABI NATIONAL OIL CO 1,895,207,544 - 918,256,500 - 494,286,000 NAVISTAR INTERNATIONAL CORPORATION 1,867,806,085 - - - - FLUOR CORPORATION 1,847,134,882 731,234,591 672,082,320 357,168,043 - GENERAL ATOMIC TECHNOLOGIES 1,806,791,704 1,346,105,622 1,073,008,593 931,295,602 689,466,975 CORPORATION

HONEYWELL INTERNATIONAL INC 1,690,894,804 1,831,554,928 1,605,129,063 1,514,040,515 1,452,348,447 EVERGREEN INTERNATIONAL AIRLINES 1,612,054,324 1,322,675,791 1,445,897,765 1,105,610,723 1,023,465,614 ALLIANT TECHSYSTEMS INC 1,531,189,717 1,751,511,170 1,246,757,328 992,969,478 829,395,903 FINMECCANICA SPA 1,478,813,172 - 1,982,775,250 - - MANTECH INTERNATIONAL CORPORATION 1,460,591,224 642,834,351 656,970,368 327,634,538 381,588,702 FEDEX CORPORATION 1,408,687,215 - - - - ROCKWELL COLLINS INC 1,366,236,162 1,193,112,637 1,204,278,568 1,149,150,763 1,353,619,801

94

Table 9 (Continued). Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 AMERISOURCEBERGEN CORPORATION 1,307,349,144 1,262,162,352 1,270,761,741 1,455,008,752 1,322,372,832 PUBLIC WAREHOUSING COMPANY KSC 1,302,596,361 - 2,141,188,027 - - (THE)

MCKESSON CORPORATION 1,107,374,120 1,025,767,232 902,507,010 676,069,537 666,104,126 ATLANTIC DIVING SUPPLY INC 1,096,332,629 560,813,065 - 446,503,559 - MACANDREWS & FORBES HOLDINGS INC 1,080,535,708 2,726,138,648 4,712,820,926 3,360,972,194 2,137,695,311 JACOBS ENGINEERING GROUP INC 1,058,277,741 889,096,722 895,250,317 561,045,116 520,108,952 ROYAL DUTCH SHELL PLC 1,043,908,846 1,905,472,234 1,594,279,312 2,118,387,545 - BP PLC 1,032,934,975 1,691,945,021 1,719,803,124 959,186,513 677,607,532 KUWAIT PETORLEUM CORP 1,011,618,404 - - - 1,011,270,194 CARDINAL HEALTH INC 857,525,907 663,387,605 844,082,139 888,474,096 632,801,796 MASSACHUSETTS INSTITUTE OF 853,108,996 1,748,121,169 689,532,197 643,693,881 - TECHNOLOGY

ROLLS-ROYCE GROUP PLC 848,802,538 949,963,924 582,706,133 601,126,441 303,436,442 DELL INC 831,685,623 898,765,661 760,171,293 689,639,060 582,676,347 AEROSPACE CORPORATION (THE) 797,355,880 791,347,983 768,870,625 612,025,222 653,969,926 MITRE CORPORATION (THE) 787,463,002 797,001,345 753,883,279 714,639,927 660,556,094 HEWLETT-PACKARD COMPANY 783,619,381 - 1,914,397,307 - - COURT SQUARE CAPITAL PARTNERS L.P 755,954,543 - - - - SIERRA NEVADA CORPORATION 731,780,281 697,117,134 456,168,886 - -

95

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 JOHNS HOPKINS UNIVERSITY 716,268,490 603,612,651 527,344,687 502,190,492 524,399,371 MISSION ESSENTIAL PERSONNEL LLC 681,306,026 - - - - COMBAT SUPPORT ASSOCIATES 659,881,481 579,957,228 486,591,548 476,472,396 356,999,708 MOTOR OIL (HELLAS) CORINTH REFINERIES 635,327,597 - 724,853,533 431,442,560 - S.A.

FORCE PROTECTION INC 629,165,583 618,642,903 1,360,427,189 1,139,559,711 - GOODRICH CORPORATION 622,770,377 518,083,499 476,828,255 350,313,518 312,219,571 KONGSBERG GRUPPEN ASA 599,846,209 677,349,285 502,014,339 306,938,201 - APPTIS HOLDINGS INC 593,678,403 - - - - HENSEL PHELPS CONSTRUCTION CO 573,297,679 1,371,398,205 1,279,912,143 617,931,240 360,024,032 UNITED PARCEL SERVICE INC 573,230,041 - - - - SHAW GROUP INC (THE) 554,799,466 930,211,877 1,135,249,237 - 371,392,185 VALERO ENERGY CORPORATION 554,380,093 1,049,289,818 1,043,869,551 1,027,333,706 661,171,541 SRC INC 553,765,432 - 403,733,239 - - CUBIC CORPORATION 530,288,070 476,609,937 354,713,166 356,455,143 317,222,002 BALFOUR BEATTY/MCCARTHY A JOINT 529,989,439 - - - - VENTURE

QINETIQ GROUP PLC 523,505,136 - 508,612,856 - - VSE CORPORATION 517,054,284 744,048,371 900,433,718 667,906,865 314,731,228 HIGHMARK INC 510,561,893 - - - -

96

Table 9 (continued). Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 CLARK ENTERPRISES INC 507,119,205 747,985,884 443,820,559 - - NCI INC 496,200,023 - - - - BALFOUR BEATTY/DPR/BIG-D A JOINT 479,000,000 - - - - VENTURE

SERCO GROUP PLC 476,446,862 - - - - CHARLES STARK DRAPER LABORATORY 474,894,029 439,499,353 - 631,219,347 - INC (THE)

REFINERY ASSOCIATES OF TEXAS INC 473,644,807 - - 361,264,524 576,557,185 PETER KIEWIT SONS' INC 470,856,841 - - - - TASC INC 468,550,651 - - - - WALSH GROUP LTD (THE) 456,780,387 616,238,630 448,883,170 - - AAR CORP 452,326,332 - - - - AFOGNAK NATIVE CORPORATION 451,167,366 566,781,985 616,822,540 523,613,141 423,906,827 HELLFIRE SYSTEMS LLC 450,054,633 454,187,873 413,398,261 299,692,236 - EUROPEAN AERONAUTIC DEFENCE AND 439,692,636 - - - - SPACE COMPANY N.V.

INTERNATIONAL BUSINESS MACHINES 434,680,221 467,511,687 448,232,136 412,527,789 297,388,699 CORPORATION

CHEMRING GROUP PLC 427,796,492 - - - - CHUGACH ALASKA CORP 413,442,875 675,361,594 520,551,335 456,604,291 553,547,112

97

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 CARLYLE PARTNERS IV L.P. 411,348,121 - 844,826,996 - - AT&T INC 410,082,625 - 366,906,533 373,554,706 - TYSON FOODS INC 404,389,128 399,900,586 - - 322,758,851 KRAFT FOODS INC 404,310,278 417,894,292 370,697,143 348,708,450 466,704,419 BATTELLE MEMORIAL INSTITUTE 403,472,473 464,123,579 507,084,450 517,221,762 536,918,620 VERIZON COMMUNICATIONS INC 399,991,896 - - - - NANA REGIONAL CORPORATION INC 399,304,765 - 402,818,424 - - CLARK/MCCARTHY A JOINT VENTURE 393,883,000 - - - - OWENS & MINOR INC 390,248,972 - 365,861,498 348,953,929 - SK ENERGY CO LTD 378,729,847 760,801,383 - - - AGILITY - 2,010,685,577 - 1,805,282,231 - DRS TECHNOLOGIES INC - 1,884,448,151 - 1,772,582,604 1,323,319,720 BAHRAIN PETROLEUM COMPANY B.S.C. - 1,754,513,644 1,017,687,603 360,314,784 - (THE)

VERITAS CAPITAL MANAGEMENT II LLC - 1,548,270,236 - 428,379,991 315,670,785 FEDERAL EXPRESS CHARTER PROGRAM - 1,505,847,350 1,785,873,191 1,345,887,845 1,292,917,713 TEAM ARRANGEMENT

INTERNATIONAL MILITARY AND - 1,317,741,892 - 1,166,805,361 - GOVERMENT LLC

ELECTRONIC DATA SYSTEMS - 1,297,572,492 - 1,935,642,660 1,977,712,608 CORPORATION

98

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 CERBERUS CAPITAL MANAGEMENT II L.P. - 1,184,223,787 727,492,659 1,284,713,543 - INTERNATIONAL OIL TRADING COMPANY - 1,178,743,763 456,802,653 601,287,567 - LLC

HAWKER BEECHCRAFT INC - 1,015,249,513 873,897,910 311,381,581 406,096,563 GULF INTRACOASTAL CONSTRUCTORS, A - 963,520,252 - - - JOINT VENTURE

SUPREME FOODSERVICE AG - 912,510,127 647,150,278 499,785,555 - EDO CORPORATION - 879,866,268 - 1,089,774,596 437,280,229 ANTHEM HEALTH OF INDIANA INC - 750,304,989 - - - ARINC MANAGEMENT CORPORATION - 569,633,895 - 493,417,617 459,900,968 M A MORTENSON COMPANIES INC - 565,827,090 379,304,691 310,959,742 - SYRACUSE RESEARCH CORP - 543,968,723 - 390,224,903 615,049,000 PETROMAX REFINING COMPANY LLC - 539,735,943 - - - SIERRA MILITARY HEALTH SERVICES LLC - 527,348,655 - - - B P WEST COAST PRODUCTS LLC - 516,830,010 - - - CH2M HILL COMPANIES LTD - 498,159,353 474,524,562 535,805,215 378,491,479 COMTECH TELECOMMUNICATIONS CORP - 496,368,925 - - - HOCHTIEF AG - 485,832,520 - - - S-OIL CORPORATION - 481,968,023 - - - SK CHEMICALS CO LTD - 479,988,185 - - -

99

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 EXXON MOBIL CORPORATION - 471,115,672 792,319,847 927,196,355 988,105,594 SUNDT COMPANIES INC (THE) - 450,807,416 - - - CONOCOPHILLIPS - 433,007,454 - - - QATAR FUEL CO (WOQOD) - 431,866,130 - - - HARPER CONSTRUCTION COMPANY INC - 427,322,377 - - - CRITICAL SOLUTIONS INTERNATIONAL INC - 423,862,763 - - - GREAT LAKES DREDGE & DOCK - 408,316,991 - - - CORPORATION

BALFOUR BEATTY PLC - 401,211,449 - - - EMERSON CONSTRUCTION COMPANY INC - - 13,931,307,017 - - NAVISTAR DEFENSE LLC - - 4,727,948,333 - - RED STAR ENTERPRISES LTD - - 1,069,266,941 - - RO DEFENCE PROJECTS LTD - - 579,754,142 - - INTERPUBLIC GROUP OF COMPANIES INC - - 537,209,810 - - (THE)

TETRA TECH INC - - 496,234,265 508,126,109 423,280,258 FLIR SYSTEMS INC - - 493,169,035 - - AECOM TECHNOLOGY CORPORATION - - 466,802,724 384,891,344 302,692,387 PERINI CORPORATION - - 436,155,212 - - ARCTIC SLOPE REGIONAL CORPORATION - - 435,084,354 - -

100

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 CERADYNE INC - - 417,761,224 463,641,965 436,231,155 COBHAM PLC - - 368,239,839 - - DAIMLER AG - - 360,066,667 - - CLARK BALFOUR BEATTY A JOINT - - 358,475,382 - - VENTURE

WALTON CONSTRUCTION COMPANY LLC - - 358,082,428 - - TOMPKINS TURNER GRUNLEY KINSLEY A - - 346,376,818 - - JOINT VENTURE

SK HOLDINGS CO LTD - - - 623,282,323 402,650,951 INSTITUTE FOR DEFENSE ANALYSES INC - - - 603,492,323 - UNITED INDUSTRIAL CORPORATION - - - 562,431,552 559,522,358 A.P. MOLLER - MARSK A/S - - - 503,627,621 543,540,080 INTERPUBLIC GROUP OF COMPANIES INC - - - 476,999,180 291,428,154 ENVIRONMENTAL CHEMICAL - - - 456,643,427 993,582,490 CORPORATION

GE ROLLS-ROYCE FIGHTER ENGINE TEAM - - - 431,018,948 352,213,692 LLC

QINETIQ NORTH AMERICA OPERATIONS - - - 410,417,619 324,817,093 LLC

BELL HELICOPTER TEXTRON INC - - - 407,383,505 - GS HOLDINGS CORP - - - 372,207,972 356,313,452

101

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 MINA CORP LTD - - - 364,420,792 - DYNCORP TECHNICAL SERVICES INC - - - 350,962,917 405,635,195 JVYS - - - 324,060,957 - BUNDESAMT FUER BAUWESEN UND - - - 322,835,190 - RAUMORDNUNG

PROCTER & GAMBLE COMPANY (THE) - - - 312,342,857 392,806,767 EQUILON ENTERPRISES LLC - - - - 804,836,908 NATIONAL AGRICULTURAL COOPERATIVE - - - - 762,328,685 FEDERATION

PHILLIPS & JORDAN INC - - - - 707,759,130 CERBERUS PARTNER LP - - - - 560,047,106 CERES ENVIRONMENTAL SERVICES INC - - - - 454,718,957 ASHBRITT INC - - - - 445,287,311 HUNT BUILDING CORPORATION - - - - 438,163,722 MCDONNELL DOUGLAS CORP - - - - 435,424,231 NJVC LLC - - - - 369,424,539 LTD - - - - 363,313,824 KEMYONG FARM LTD - - - - 350,511,935 UBS PROVEDORES PTY LTD - - - - 343,909,940 THALES - - - - 339,815,524

102

Table 9. (Continued) Firms with the largest U.S. Department of Defense contracts, 2006–2010 (in U.S. dollars) Company 2010 2009 2008 2007 2006 DOGOG FARM - - - - 338,526,945 DATAPATH INC - - - - 331,373,966 VINNELL CORPORATION - - - - 314,571,133 TESORO CORPORATION - - - - 309,498,484 WEEKS MARINE INC - - - - 294,713,931 PROCURENET INC - - - - 292,338,891 Note: Derived from the Top 100 Contractors Report, Federal Procurement Data System-Next Generation (2006-2010).

103

APPENDIX B. Growth Models of Net Income

For the purposes of this analysis, it is assumed that firm changes in net income are part of a developmental process. Given the unique economic and operational environment and the repeated observations occurring within the dataset, a linear mixed-model approach is used to examine how the various independent variables (military sales, nonmilitary sales, nonmilitary domestic sales and international sales) are related to the change in net income of firms with the largest U.S. Department of Defense contracts between 2006 and 2010.

Using this approach and applying the methodology advocated by Heck, Thomas,

& Tabata (2014), a change in firm net income is conceptualized as a two-level analysis, with the repeated measures of firm net income specified at level 1 and random variation of the growth rates and intercepts specified at level 2. This approach is useful because the observations were likely taken on varying occasions and missing data exist. An examination of the descriptive statistics suggests that the differences in observed means are not likely the same between 2006 and 2010. For ease of interpretation, models are centered on 2006.

An examination of firm growth trajectories using the log of net income revealed that firm growth trajectories varied widely across the sample. Firms were then divided into subgroups according to the first two digits of NAICS code, defense-orientation, and size, without revealing a consistent shape in firm growth trajectories. This is consistent with the observation made by Brett Lambert, the Deputy Assistant Secretary of Defense of Manufacturing and Industrial Base Policy for the Department of Defense, who stated that firms which comprise the defense industrial base are extremely diverse.

104

Model 1. Trend in net income considering military and nonmilitary sales.

In the first model, military sales and nonmilitary sales are considered between- firm factors that likely affect growth trajectories differently. To ascertain whether the grand mean intercept for net income varies across companies, the following model is used, where π0i is the average net income across all five years and εti represents the errors in predicting average net income for companies:

Yti=π0i + εti

The average change in net income between companies is represented as:

π0i = β00 + uti

where β00 is the intercept representing the initial status mean between companies and uti represents the random differences in average net income between companies. Time is considered fixed between companies. Through substitution, I arrive at the following 4 parameter equation, accounting for the fixed-effect average net income, time as a fixed- effect linear component, the between-firm random variance, and residual variance.

Yti = β00 + β10αti + uti + εti

To account for the cross-level interactions of the between-firm variables on firm trajectories in net income, I formulate the following equations:

π0i = β01 + β01logSMi + β02logSNMi + u0i

105

π1i = β10 + β11logSMi + β12logSNMi + u1i

where military sales (logSMi) and non-military sales (logSNMi) are used to identify different subsets of firms. The variation associated with estimating the intercept and slope parameters are represented by u0i and u1i, respectively.

A logarithmic scale was used to account for the large variation in net income, military sales, and nonmilitary sales, and to examine the relative importance of the dependent variables’ effect on net income. In the dataset, seven firms (nine observations) reported a negative net income over various years. Five observations occurred in 2009, three observations in 2008, and one observation in 2006. To determine the best fit model, the following approaches were considered and tested: removing observations resulting in undefined values, setting the value for negative net incomes to zero, and not using a logarithmic scale for net income. Removing the observations with undefined values provided the model with the best fit. After transforming the variables, the following 14 parameter combined equation is obtained:

Yti = β00 + β01logSMi + β02logSNMi + β10time + β11logSMi*time + β12logSNMi *time + uti + εti

where there are six fixed effects and eight variance-covariance parameters. Of the eight variance-covariance parameters, five are variance parameters for each year at level 1 and three are random effects at level 2. The level 1 and level 2 covariance structures are consistent with a simplified covariance structure, the identify covariance structure, signifying that Mauchley’s test for sphericity holds. However, based on the AIC value, a diagonal covariance structure was selected for level 1 and an unstructured covariance

106

structure was selected for level 2. The time variable was coded as follows: 0 = 2006, 1 =

2007, 2 = 2008, 3 = 2009 and 4 = 2010.

Table 10 shows that the initial status intercept of firms varies across defense industrial base firms and is explained by military and nonmilitary sales. As expected, nonmilitary sales is significantly related to net income (βNM = .805225, p < .001). Firms with higher non-military sales tend to have a higher growth in net income. Military sales were also found to be significantly related to net income (βNM = .216225, p < .05).

However, the interaction terms were not significant. The interaction coefficients of time and nonmilitary sales indicate that the net income of firms with higher nonmilitary sales decreases over time with respect to firms at the grand mean for net income. The average linear trajectory for net income is also explained by military and nonmilitary sales.

107

Table 10. Estimates of military and nonmilitary sales fixed effects on net income.

95% Confidence Interval

Parameter Estimate Standard Error df t Sig. Lower Bound Upper Bound

Intercept -2.676727 2.190326 55.335 -1.222 .227 -7.065639 1.712186 logMil .216225 .087895 55.403 2.460 .017 .040109 .392341 logNM .805225 .070585 56.254 11.408 .000 .663840 .946609 Time .073976 .615077 29.656 .120 .905 -1.182791 1.330743 Time * logMil .005940 .023209 26.991 .256 .800 -.041682 .053561 Time * logNM -.011874 .018316 30.579 -.648 .522 -.049251 .025503 a. Dependent Variable: logNI.

108

Table 11 shows that net income increased annually for defense industrial base firms between 2006 and 2010. The significance of growth in net income varies over time with 2006 and 2008 significant at the p < .001 level, 2009 and 2010 significant at the p <

.05 level, and 2007 not significant.

The net income of individual firms may not follow the trend of the group.

Because firms with the largest military contracts operate in widely different industries, it is expected that net income differs significantly between firms. The variance components

UN (1, 1) shows variability in the initial status intercepts in 2006 (Wald Z = 4.045, p <

.001). Interestingly, the within-individual growth parameter does not vary significantly across firms, which suggests that the net income of firms changes at approximately the same rate. The Wald Z test (Wald Z = .502, p > .10) in Table 11 for parameter U (2, 2) shows that the reduction in net income within–firm variability does not significantly change over time, which supports that there was little variability in growth between defense industrial base firms.

109

Table 11. Estimates of Covariance Parameters 95% Confidence Interval

Parameter Estimate Std. Error Wald Z Sig. Lower Bound Upper Bound Repeated Measures Var: [Index1=0] .245730 .058009 4.236 .000 .154709 .390303 Var: [Index1=1] .006191 .019775 .313 .754 1.183104E-05 3.239893 Var: [Index1=2] .121448 .033875 3.585 .000 .070302 .209805 Var: [Index1=3] .332556 .101893 3.264 .001 .182416 .606273 Var: [Index1=4] .435644 .148948 2.925 .003 .222897 .851451 Intercept + Time UN (1,1) .706143 .174571 4.045 .000 .434971 1.146371 [subject = ID] UN (2,1) -.030275 .034607 -.875 .382 -.098103 .037553 UN (2,2) .005794 .011547 .502 .616 .000117 .288024 a. Dependent Variable: logNI.

110

Model 2. Trend in net income with respect to domestic and international sales

Borrowing from the aforementioned equation, nonmilitary sales (SNM) was separated into nonmilitary domestic sales (SNMDS) and international sales (SI), respectively, to assess whether nonmilitary domestic and international sales are related to firm trajectories of net income, to obtain the following equation:

Yti = β00 + β01logSMi + β02logSNMDSi + β03logSIi + β10time + β11logSMi*time +

β12logSNMDSi *time + β13logSIi *time + uti + εti

Table 12 summarizes the fixed effects estimates. There are sixteen parameters in the model. Eight are fixed effects estimates, five are variance parameters for each year at level 1, and three parameters are random effects at level 2. The grand mean intercept for net income, adjusted for military, nonmilitary domestic, and international sales, does not vary significantly across companies (p > .01) between 2006 and 2010. Military sales are significant at the p < .05 level. Both nonmilitary domestic and international sales are significantly related to net income over time (βMNDS = .394124, p = .001; βIS = .377688, p

< .001). Although net income decreases for defense industrial base firms between 2006 and 2010, time is not a significant predictor of net income. The interaction effects between time and military, and nonmilitary domestic and international sales, respectively, are not significant (p > .10).

111

Table 12. Estimates of Fixed Effects. 95% Confidence Interval Parameter Estimate Std. Error Df T Sig. Lower Bound Upper Bound Intercept -.605518 2.313680 38.432 -.262 .795 -5.287593 4.076556 logMil .191757 .091036 41.425 2.106 .041 .007965 .375550 logNMDS .394124 .114937 42.468 3.429 .001 .162248 .626000 logIS .377688 .084426 48.352 4.474 .000 .207970 .547406 Time .341470 .732505 27.023 .466 .645 -1.161446 1.844386 Time * logMil .005669 .027315 25.119 .208 .837 -.050574 .061913 Time * logNMDS -.039930 .033614 25.914 -1.188 .246 -.109035 .029175 Time * logIS .017354 .024216 26.840 .717 .480 -.032348 .067055 Dependent Variable: logNI.

112

Table 13 shows the estimates of the covariance parameters. Similar to the previous model, net income increased annually for defense industrial base firms between

2006 and 2010. The significance of growth in net income varies over time with 2006 and

2008 significant at the p < .001 level, 2009 and 2010 significant at the p < .05 level, and

2007 not significant. The variance estimates for UN (1, 1) were significant (Wald Z =

3.443, p = .001), which means that there is significant variability in the random intercept of net income between firms. The within-firm growth parameter does not vary significantly across firms and the within-firm variability is not significant across firms, which suggests that the net income of firms changes at approximately the same rate. See

Table 13.

An examination of the trend in net income complements the primary analysis by reinforcing that nonmilitary sales is a significant predictor of net income. This observation holds when separating nonmilitary sales into nonmilitary domestic sales and international sales. Although this group of firms is comprised of widely different industries, net income appears to change at approximately the same rate over time, indicating that environmental forces on net income, with respect to nonmilitary sales, are likely similar for all firms.

Although the United States experienced one of the longest economic recessions between December 2007 and June 2009, it appears that defense industrial base firms did not experience a downward trend in net income between 2006 and 2010. The growth model, with respect to the time parameter, indicates that there is no change in growth, or trend, in either military sales or nonmilitary sales between 2006 and 2010.

113

Table 13. Estimates of Covariance Parameters Std. 95% Confidence Interval Parameter Estimate Error Wald Z Sig. Lower Bound Upper Bound Repeated Measures Var: [Index1=0] .301706 .081141 3.718 .000 .178099 .511102 Var: [Index1=1] .003165 .023269 .136 .892 1.743956E-09 5742.596627 Var: [Index1=2] .115273 .033903 3.400 .001 .064771 .205153 Var: [Index1=3] .343527 .108714 3.160 .002 .184751 .638758 Var: [Index1=4] .384230 .157810 2.435 .015 .171786 .859397 Intercept + Time [subject = ID] UN (1,1) .604119 .175463 3.443 .001 .341898 1.067454 UN (2,1) -.060824 .044919 -1.354 .176 -.148863 .027216 UN (2,2) .017554 .016253 1.080 .280 .002860 .107762 Dependent Variable: logNI.

114

GLOSSARY

COMBINED RESOURCE APPROACH: An approach used to identify or examine resources and their associated tangible and intangible benefits by combining aspects of the resource dependence theory and the resource-based view.

COMMERCIAL SEGMENT: See NONDEFENSE-RELATED BUSINESS

SEGMENT.

CONTRACT: A legally binding, voluntary agreement between two competent parties.

DEFENSE-ORIENTED COMPANIES: Firms that produce products and services specifically related to U.S. national security. These firms produce products that may or may not have a civilian commercial equivalent.

DEFENSE-RELATED BUSINESS SEGMENT: The segment of a company that is responsible for the products and services purchased by the U.S. Department of Defense for use by the U.S. military, although the products or services provided by the contractor, such as rations or sundry items, may not be unique or directly related to U.S. national security. Also known as the MILITARY SEGMENT of a firm.

DEFENSE INDUSTRIAL BASE: “an extremely diverse set of companies that provide both products and services directly and indirectly to the national security agencies, including the military” (U.S. House, Committee on Armed Services, 2011, p. 4). The

Defense Industrial Base is comprised of defense-oriented companies and nondefense- oriented companies.

DEFENSE INDUSTRY: The sector of the economy that manufactures and trades products or provides services related to national security. The defense industry is comprised of defense-oriented companies.

115

GOVERNMENT SEGMENT: The segment of a firm that conducts business with one or more U.S. governmental departments or agencies. The segment may include state and/or federal agencies.

INTANGIBLE BENEFIT: Any benefit obtained from a resource that is not classified as a tangible benefit. Intangible resources take many forms that are difficult to assess.

MILITARY SEGMENT: See DEFENSE-RELATED BUSINESS SEGMENT.

MIXED-SEGMENT: A segment of a firm that conducts business, produces products, and or provides services to both U.S. government agencies (such as the U.S. Department of Defense) and commercial entities.

MIXED-SEGMENT FIRM: Firms that have a minimum of two customer segments: sales to the U.S. Department of Defense and sales to other commercial entities.

NONDEFENSE-RELATED BUSINESS SEGMENT: The segment of a company that is responsible for all other products and services sold to customers other than the U.S. military. Also known as the NONMILITARY SEGMENT or COMMERCIAL

SEGMENT of a firm.

NONDEFENSE-ORIENTED COMPANIES: Firms that produce products or services of a civilian nature (i.e., rations, petroleum, and healthcare products/services).

NONMILITARY SEGMENT: See NONDEFENSE-RELATED BUSINESS

SEGMENT.

NOT PROFITABLE: A return on revenue less than or equal to zero.

PROFITABILITY: A monetary measure of return on revenue.

TANGIBLE BENEFITS: Operationalized for this study as profitability.

UNPROFITABLE: A negative return on revenue.

116

REFERENCES

Acquisition Advisory Panel. (2007). Report of the acquisition advisory panel to the office

of federal procurement policy and the United States Congress. Retrieved from

https://www.acquisition.gov/comp/aap/24102_GSA.pdf.

Aerospace Industries Association. (2008). A special report U. S. defense acquisition: An

agenda for positive reform. Retrieved from http://www.aia-aerospace.org/assets/

report_acquisition-reform-09.pdf.

Agapos, A. M., & Gallaway, L. E. (1970). Defense profits and the renegotiation board in

the aerospace industry. Journal of Political Economy, 78(5), 1093–1105.

Ahadiat, N. (1993). Geographic segment disclosure and the predictive ability of the

earnings. Journal of International Business Studies, 24(2), 357–371.

Arms Export Control Act, 22 USC 39. (2012). Retrieved from http://uscode.house.gov/

download/pls/22C39.txt.

Atwood, D. J. (1990). Industrial base: Vital to defense. Defense, 90, 12–16. Retrieved

from http://www.disam.dsca.mil/pubs/Vol%2012-3/Atwood.pdf.

Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of

Management, 17(1), 99–120.

Bohi, D. R. (1973). Profit performance in the defense industry. Journal of Political

Economy, 81(3), 721–728.

Breusch, T. S., & Pagan, A. R. (1980). The Lagrange multiplier test and its applications

to model specification in econometrics. Review of Economic Studies, 47(146),

239–253.

117

Caves, R. E. (1980). Industrial organization, corporate strategy and structure. Journal of

Economic Literature, 58, 64–92.

Caves, R. E., & Porter, M. E. (1977). From entry barriers to mobility barriers:

Conjectural decisions and contrived deterrence to new competition. The Quarterly

Journal of Economics, 91(2), 241–262.

Chen, K.H & Shimerda, T.A. (1981). Empirical analysis of useful financial ratios.

Financial Management. 10(1), 51-61.

Chen, P., & Zhang, G. (2003). Heterogeneous investment opportunities in multiple-

segment firms and the incremental value relevance of segment accounting data.

Accounting Review, 78, 397–428.

Crompton, J. (2013). IBISWorld industry report 33661a: Ship building in the US.

Retrieved from http://clients1.ibisworld.com.eres.library.manoa.hawaii.edu/

reports/us/industry/default.aspx?entid=852.

Dale, C. (2008). Operation Iraqi Freedom: Strategies, approaches, results, and issues for

Congress. CRS report for Congress. Retrieved from https://opencrs.com/

document/RL34387/.

Davidson, R., & MacKinnon J. (1993). Estimation and inference in econometrics. New

York: Oxford University Press.

Defense Dual-Use Critical Technology Program. (1996). 10 USC § 2511.1996. Retrieved

from http://www.gpo.gov/fdsys/pkg/USCODE-2011-title10/pdf/USCODE-2011-

title10-subtitleA-partIV-chap148-subchapIII-sec2511.pdf.

Defense Procurement and Acquisition Policy. (2013). DoD-Wide Strategic Sourcing

(DWSS) program. Retrieved from http://www.acq.osd.mil/dpap/ss/dwss.html.

118

Defense Security Cooperation Agency. (2012). Security assistance management manual

(DSCA 5105.38-M). Retrieved from http://www.samm.dsca.mil/listing/esamm.

Deloitte. (2012). The aerospace and defense industry in the U.S.: A financial and

economic impact study. Deloitte Development LLC. Retrieved from http://armed

services.house.gov/index.cfm/files/serve?File_id=126226cd-bc54-4e4b-a9ec-1ea1

6e61a2dd.

Edwards, J. (2013a). IBISWorld industry report 54133: Engineering services in the US.

Retrieved from http://clients1.ibisworld.com.eres.library.manoa.hawaii.edu/

reports/us/industry/default.aspx?entid=1403.

Edwards, J. (2013b). IBISWorld industry report 54151: IT consulting in the US.

Retrieved from http://clients1.ibisworld.com.eres.library.manoa.hawaii.edu/

reports/us/industry/default.aspx?entid=1415.

Eisenhower, D. D. (1961). Farewell address. Retrieved from http://www.american

rhetoric.com/speeches/dwightdeisenhowerfarewell.html.

Federal Acquisition Regulation. (2010). Definition of words and terms (FAR 2.101).

Chicago: CCH, Inc. Retrieved from http://www.gpo.gov/fdsys/pkg/CFR-2010-

title48- /pdf/CFR-2010-title48-vol1-part2.pdf.

Federal Procurement Data System-Next Generation. (2006–2010). Top 100 contractors

report. Retrieved from https://www.fpds.gov/fpdsng_cms/index.php/reports.

Financial Accounting Standards Board. (1997). Statement of financial accounting

standards No.131, Disclosures about segments of an enterprise and related

information. Stamford, CT: FASB.

119

Gardner, H. K., Gino, F., & Staats, B. R. (2012). Dynamically integrating knowledge in

teams: Transforming resources into performance. Academy of Management

Journal, 55(4), 998–1022.

Gendreau, B. C. (1983). The implicit return on bankers’ balances. Journal of Money,

Credit, and Banking, 15(4), 411–424.

Ghemawat, P. (1986). Sustainable advantage. Harvard Business Review, 64(5), 53–58.

Hall, R. (1993). A framework linking intangible resources and capabilities to sustainable

competitive advantage. Strategic Management Journal, 14(8), 607-618.

Hausman, J. A. (1978). Specification tests in econometrics. Econometrica, 46(6), 1251–

1271.

Heck, R. H., Thomas, S. L., & Tabata, L. N. (2014). Multilevel and longitudinal

modeling with IBM SPSS. (2nd ed.) New York: Routledge.

Hester, D. D., & Zoellner, J. F. (1966). The relation between bank portfolios and

earnings: An econometric analysis. Review of Economics and Statistics, 48(4),

372–386.

Hillman, A. J., Withers, M. C., & Collins, B. J. (2009). Resource dependence theory: A

review. Journal of Management, 35(6), 1404-1427.

Hoopes, S. (2013). IBISWorld industry report 33641b: Space vehicle & missile

manufacturing in the US. Retrieved from http://clients1.ibisworld.com.eres.

library.manoa.hawaii.edu/reports/us/industry/productsandmarkets.aspx?entid=843

Hope, O., Kang, T., Thomas, W. B., & Vasvari, F. (2009). The effects of SFAS 131

geographic segment disclosures by U. S. multinational companies on the

120

valuation of foreign earnings. Journal of International Business Studies, 40, 421-

443.

Hymer, S. (1976). The international operations of national firms. Cambridge, MA: MIT

Press.

International Traffic in Arms. 22 CFR I, Subchapter M, § 120-130. (2009). Retrieved

from http://www.gpo.gov/fdsys/search/pagedetails.action?browsePath=Title+22%

2FChapter+I%2FSubchapter+M&granuleId=CFR-2009-title22-vol1-chapI-su

subchapM&packageId=CFR-2009-title22-vol1&collapse=true&fromBrowse=

true&bread=true.

Ito, K., & Rose, E. (2010). The implicit return on domestic and international sales: An

empirical analysis of U.S. and Japanese firms. Journal of International Business

Studies, 41(6), 1074–1089.

Katzman, K. (2014). Afghanistan: Post-Taliban governance, security and U.S. policy.

CRS report for Congress. Retrieved from https://opencrs.com/document/

RL30588/.

Kogut, B., & Zander, U. (1993). Knowledge of the firm and the evolutionary theory of

the multinational corporation. Journal of International Business Studies, 24(4)

625-625.

KPMG. (2012). Transformation in the aerospace and defense industry: Forces,

implications and actions. Retrieved from http://www.kpmg.no/arch/_img/

9811125.pdf.

121

Lecraw, D. J. (1984). Bargaining power, ownership, and profitability of transnational

corporations in developing countries. Journal of International Business

Studies,15(1), 27–43.

Lichtenberg, F. (1992). A perspective on accounting for defense contracts. Accounting

Review, 67(4), 741–752.

McGowan, A. S., & Vendrzyk, V. P. (2002). The relation between cost shifting and

segment profitability in the defense-contracting industry. Accounting Review,

77(4), 949–969.

Occupational Safety and Health Administration. (1987). Standard Industry Classification

Manual. U.S. Department of Labor, Occupational Safety and Health

Administration. Retrieved from https://www.osha.gov/pls/imis/sicsearch.html.

Paret, P., Craig, G. A., & Gilbert, F. (Eds.). (1986). Makers of modern strategy from

Machiavelli to the Nuclear Age. Princeton, NJ: Princeton University Press.

Parrish, K. (2012). DOD leaders: U.S. will remain world’s strongest military. American

Forces Press Service, Retrieved from http://www.defense.gov/news/newsarticle.

aspx?id=66711.

Pearce, E. (1957). History of the standard industrial classification. Executive Office of

the President, Office of Statistical Standards. U.S. Bureau of the Budget.

Washington, D.C. (mimeograph). Retrieved from https://www.census.gov/epcd/

www/sichist.htm.

Penrose, E. G. (1959). The theory of the growth of the firm. New York: Wiley.

Peteraf, M. A. (1993). The cornerstones of competitive advantage: A resource‐based

view. Strategic Management Journal, 14(3), 179-191.

122

Pfeffer, J., & Salancik, G. (1978). The external control of organizations: A resource

dependence perspective. New York: Harper and Row.

Rogerson, W. P. (1992). Overhead allocation and incentives for cost minimization in

defense procurement. Accounting Review, 67(4), 671–690.

Ruiz, B. (2013). IBISWorld industry report 33699b: Tank & armored vehicle

manufacturing in the US. Retrieved from http://clients1.ibisworld.com.eres.

library.manoa.hawaii.edu/reports/us/industry/default.aspx?entid=857.

Rumelt, R. P. (1984). Towards a strategic theory of the firm. In Competitive strategic

management, ed. R. Lamb. Englewood Cliffs, NJ: Prentice Hall.

Soshkin, M. (2013a). IBISWorld industry report 33299a: Guns & ammunition

manufacturing in the US. Retrieved from http://clients1.ibisworld.com.eres.

library.manoa.hawaii.edu/reports/us/industry/default.aspx?entid=662.

Soshkin, M. (2013b). IBISWorld industry report 33641a: Aircraft, engine & parts

manufacturing in the US. Retrieved from http://clients1.ibisworld.com.eres.

library.manoa.hawaii.edu/reports/us/industry/default.aspx?entid=842.

Stigler, G. J., & Friedland, C. (1971). Profits of defense contractors. American Economic

Review, 61(4), 692–694.

Teece, D. J. (1986). Profiting from technological innovation: Implications for integration,

collaboration, licensing and public policy. Research Policy, 15(6), 285-305.

Teece, D. J., Pisano, G., & Shuen, A. (1997). Dynamic capabilities and strategic

management. Strategic Management Journal, 18, 509–533.

Thomas, I., & Tung, S. (1992). Cost manipulation incentives under cost reimbursement:

Pension costs for defense contractors. Accounting Review, 67(6), 91–711.

123

United States Munitions List. 22 CFR 121. (2011). § 121:472-496. Retrieved from

http://www.pmddtc.state.gov/regulations_laws/documents/official_itar/ITAR_Par

t_121.pdf.

U.S. Census Bureau. (2012). North American Industrial Classification System, United

States. U.S. Department of Commerce, U.S. Census Bureau. Retrieved from

https://www.census.gov/cgi-bin/sssd/naics/naicsrch

U.S. Department of Defense. (1995). Dual use technology: A defense strategy for

affordable, leading-edge technology. Retrieved from http://www.dtic.mil/cgi-

bin/GetTRDoc?AD=ADA292882.

U.S. Department of Defense. (2012). COR handbook. Director, Defense Procurement and

Acquisition Policy OUSD (AT&L). Retrieved from http://www.acq.osd.mil/

dpap/policy/policyvault/usa001390-12-dpap.pdf.

U.S. Department of Homeland Security & United States Department of Defense. (2007).

Critical infrastructure and key resources sector specific plan as input to the

National Infrastructure Protection Plan. Retrieved from http://www.dhs.gov/

xlibrary/assets/nipp-ssp-defense-industrial-base.pdf.

U.S. House, Committee on Armed Services. (2011). The defense industrial base: The

role of the Department of Defense (H.A.S.C. 112-85). Retrieved from http://www.

gpo.gov/fdsys/pkg/CHRG-112hhrg71456/pdf/CHRG-112hhrg71456.pdf.

U.S. House, Committee on Armed Services. (2012). Challenges to doing business with

the Department of Defense: Findings of the panel on business challenges in the

defense industry. Retrieved from http://armedservices.house.gov/index.cfm/

files/serve?File_id=f60b62cb-ce5d-44b7-a2aa-8b693487cd44.

124

U.S. Small Business Administration (2014). What is SBA's definition of a small business

concern? Retrieved from http://www.sba.gov/content/what-sbas-definition-small-

business-concern.

Vormbrocke, M. J. (1991). An analysis of the relationship between the financial

condition of major defense contractors and DOD spending. Monterey, CA: Naval

Postgraduate School.

Wang, C., & San Miguel, J. (2012). The excessive profits of Defense contractors:

Evidence and determinants. Journal of Public Procurement, 12(3), 386-406.

Weidenbaum, M. L. (1968). Arms and the American economy: A domestic convergence

hypothesis. American Economic Review, 58(2), 428–437.

Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management

Journal, 5(2), 171–180.

White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a

direct test for heteroskedasticity. Econometrica, 48(4), 817–838.

Willen, B., & Ouirnet, R. (2013). New face of the A&D industry: Victors, victims and

survivors. A. T. Kearney. Retrieved from http://www.atkearney.com/documents/

10192/2510938/New+Face+of+the+A%26D+Industry.pdf/9548175b-4708-48d5

-8077-003f0d0e544c.

Zhong, K., & Gribbin, D. W. (2009). Are defense contractors rewarded for risk,

innovation and influence? Quarterly Journal of Finance and Accounting, 48(3),

61–73.

125

ENDNOTES

1 The Top 100 Contractors Report rank-orders Department of Defense global vendors by the total dollar amount obligated on an annual basis. Contracts are recorded in the Federal Procurement Data System-Next Generation (FPDS-NG) when the estimated value may be $3,000. All contract modifications must be reported to the FPDS-NG; only unclassified contracts are required to be recorded in the FPDS-NG. 2 EDS was acquired by Hewlett-Packard on May 13, 2008. The amount of the EDS contract was not added to Hewlett-Packard’s military contract value. 3 Because annual reports were used to obtain the value for net income and the start and end dates for annual reports vary across companies, it is possible that not all contracts were captured during the same calendar year. 4 In January 2007, the Acquisition Advisory panel found that agencies were entering inaccurate data into the FPDS-NG system. Subsequent to these findings, the data in the FPDS-NG are certified annually for completeness and accuracy by each department or agency, as required by the General Services Administration and the Office of Federal Procurement Policy. 5 All companies in my sample reported their military sales as domestic.

126