Loren Thompson at the Lexington Institute had an interesting essay last week on his Early Warning blog about Carl Icahn's proposed merger between Navistar and Oshkosh. As his title goes, he argues that the "Truck Merger Could Undermine Army Competition Strategy For Vehicles". Even though I don't agree with all the analysis, I'll recommend reading it, as I think that it is well thought through. Loren doubts that Icahn can realize the synergies for which he hopes—a point that I've separately argued to a number of journalists and financial analysts who have called about the issue. He also thinks that the Army is enjoying working with commercial truck builders, as the procurement folks there believe that "companies that operate in the commercial marketplace are more efficient and responsive, capable of tapping economies of scale not available to the military's captive supplier base." I have repeatedly argued this point myself as well. His last paragraph (reproduced below) proffers an interesting opinion about how this could evolve:
That reasoning isn't necessarily wrong, but it ignores the loss of control implied for the Army customer. When you are by far the biggest source of demand for a company's products, then you can pretty much dictate the terms of the relationship. When you are only one of many customers, you have less influence over how managers and investors choose to deploy their capital. In the case of Mr. Icahn, he doesn't much care what the long-term consequences of combining Oshkosh and Navistar might be for the price and performance of Army vehicles, because he is motivated by near-term financial results. The fact that submerging Oshkosh into the Navistar culture will give the Army fewer competitive options in the future is fine with him; that's how you get pricing power. So even before the Army's strategy of relying more on commercial sources for its vehicles has fully coalesced, the marketplace is sending a signal that there may be consequences service officials hadn't considered.
Oshkosh may not yet be submerged. There is first to be, as Lawrence Garfield once put it, "a good old-fashioned proxy fight." And for convincing shareholders that not all is wrong, the Milwaukee Journal-Sentinel usefully reports today in an article's headline, Oshkosh Contract to Turn Profit Sooner than Expected. So the company in Wisconsin is pulling up a bit.
But this is where I diverge from Loren's opinion. There is still gross overcapacity in the military truck industry in the US. Oshkosh's low bid for the FMTV contract may yet prove to have knocked BAE Systems out of that business without actually knocking out Oshkosh as well. And General Dynamics has absorbed Force Protection. But there are still market exits to come. Whether that's a combination of Navistar with Oshkosh, or some other combination, is yet to be seen. Either way, the manufacturers need to recover some pricing power for the health of the industry overall. It's rather like the Feds' weird attitude about airline ticket prices: constantly scrutinizing merger deals for "anticompetitive" potential, and then wondering why the companies are repeatedly filing Chapter 11 papers. In the long run, that's just not good for anybody.
Regarding Thompson's statement that "When you are by far the biggest source of demand for a company's products, then you can pretty much dictate the terms of the relationship," it is my experience and observation that the opposite is true. The contractors more often than not know and act as if they have DoD over a barrel - they know that PM's want to "win" and will range in their behavior from swimmingly cooperative to morose urgency about preserving the industrial base and everything in between.
Negotiating 101 demands that you be willing to walk away from any deal and the vendor's know that we usually never are.
Posted by: Dave Foster | 10 January 2012 at 12:18