Five Ways 9/11 Changed the Defense Industry

On Sept. 10, 2001, Pentagon leaders were preparing to buy a generation of weapons wholly ill-suited to the actual wars that would follow.

Two weeks before hijacked airliners slammed into the Twin Towers, Boeing tested a prototype rocket that would become the centerpiece of a limited defensive shield against intercontinental missiles. Nine days after the attacks, the U.S. Air Force ordered its first 10 F-22 Raptors, stealth fighters designed to dominate Russia’s best warplanes. And on Oct. 26, just days after Vietnam-era B-52s began carpet-bombing al Qaeda and Taliban insurgents in Afghanistan, the Pentagon announced that Lockheed Martin would build the tri-service combat jet now known as the F-35.

“The ulterior purpose of that was to dissuade the Chinese from competing with us,” said Steven Grundman, who oversaw industrial policy issues at the Pentagon during the Clinton administration. “‘We're going to get so far ahead of them, particularly on some critical technologies, that we can dissuade them from even bothering to compete with us militarily’.”

But then 9/11 happened and the military’s focus changed from a nation-state enemy to a much more decentralized counterterrorism and counterinsurgency fight. Gone was the need for air-to-air fighter jets and in came the need for drones that could loiter over the battlefield for hours with high-resolution cameras that could seek out a needle in a haystack.

Of course, the Pentagon kept buying the former, even as it raced to develop the latter. Presidential administrations and Congressional lawmakers opened the funding spigots, and the defense budget ballooned from $287 billion on 9/11—about $443 billion today—to the $704 billion enacted for the current fiscal year. About one-third of each budget flowed to the defense industry to buy weapons, obtain services, and plan for the future. 

Here are some of the changes the past two decades have wrought.

A shift in focus

In 2001, the dust was settling on a decade of furious post-Cold War defense industry consolidation. Lockheed had merged with Martin Marietta, Northrop with Grumman, Boeing with McDonnell Douglas, and Raytheon with Hughes, just to name a few. Companies resized themselves around common weapons platforms as a way to lower the cost of their products, Grundman said. 

“The essential problem that industry was working out was...resizing for a post-Cold War world,” Grundman said.

Mergers and acquisitions have since continued, but the bigger trend has been big companies outsourcing more work to smaller suppliers and building less in-house.

“Even 20 years ago, you might have seen 60 or 70 cents on the dollar stay at the prime,” said Brett Lambert, a former Pentagon official who oversaw industrial policy during the Obama administration. “Now, it's completely reversed and the primes act more as pass-throughs to their suppliers.”

Urgency

The wars in Afghanistan and Iraq made it abundantly clear the Pentagon’s bureaucracy was not structured to respond to urgent battlefield needs. This led to the creation of various rapid procurement offices throughout the military, and a partial shift in overall priorities.

“The result of 9/11 was to shift focus to urgent need,” Lambert said. “When you do that there's a cost—there's a cost of future supremacy. And it's a necessary cost, but it's guided by policy.”

One of the products of this new urgency was the Mine Resistant Ambush Protected Vehicle, or MRAP, an armored troop carrier designed to withstand roadside bomb blasts. Between 2007 and 2012, Congress approved nearly $40 billion for tens of thousands of MRAPs. Credited with saving thousands of lives, especially in Iraq, they became the iconic vehicle of the post-9/11 wars.

But MRAPs were far less useful in the more rugged and roadless Afghanistan. Almost as suddenly as the MRAP production lines leapt into existence, they shut down again. The vehicle most associated with the counterinsurgency wars has little utility in the wars the Pentagon expects in the future.

“It didn't have any really enduring impact on our defense industrial base,” Grundman said.

Still, other technologies honed in Afghanistan and Iraq are expected to be mainstays in future wars. Drones, for example.

“We were absolutely working on unmanned aerial vehicles, for sure, but the COIN fight accelerated both the military application of that capability and then, in turn, it made all the difference to the formation of now a big and very sophisticated and broadly distributed capability in unmanned aerial systems,” Grundman said. “Without the COIN fight … the adoption of unmanned aerial systems would have been much slower, for sure.”

Other key areas that saw a boom in business included tactical radios and intelligence sensors, according to Byron Callan, an analyst with Capital Alpha Partners.

The modern defense executive

The defense executives at the turn of the century grew up in the Cold War and survived the downsizing of the sector in the 1990s. These executives were largely engineers with technical backgrounds. And throughout their careers, they all had a common opponent: the Soviet Union. 

“No one company was so dominant that it would distract them from what the real competitor was, which was the Soviet Union,” said Michael Bayer, president of Dumbarton Strategies.

Executives during the Cold War viewed their corporate competition much differently than today’s business leaders. Today’s executives grew up in the scarcity of the 1990s and then two decades of counterterrorism. Lacking a perceived common existential threat, their competitors for the past two decades have largely been one another.

“If I keep my eye on Boeing, rather than the Chinese, then I have a whole different view about what's going on,” Bayer said. “My view of the utility of Joint Strike Fighter is really different if I'm assessing a vis-à-vis China, or vis-à-vis Boeing, if I'm Lockheed.”

The makeup of the boards of directors changed as well. In 2001, the 56 seats comprising the boards of the five largest U.S. defense firms included just seven retired generals and admirals, according to SEC filings. Four were on General Dynamics’ board. Boeing, Raytheon, and Northrop Grumman had one apiece and Lockheed had none. Today, 13 retired flag officers occupy the 61 seats of those boards.

“I think it's important to understand that the boards of directors, and the C-suites are really populated by, I would submit, a different type of person that was there in ’01 or in ’81,” Bayer said.

As the defense budget rose in the years following 9/11, the five largest defense companies—​​Lockheed Martin, Boeing, General Dynamics, Raytheon, and Northrop Grumman—have been the prime beneficiaries, according to researchers at Brown University and the Center for International Policy. “About one-quarter to one-third of all Pentagon contracts in recent years” have gone to these five companies, a new report states. 

Another trend over the past decade: companies repurchasing stocks. Between 2010 and 2018, the six largest U.S. defense companies—Lockheed Martin, Boeing, Raytheon, Northrop Grumman, General Dynamics, and L3 Technologies—spent $163.9 billion in stock

repurchases and dividend payments, according to figures tabulated by the staff of Sen. Elizabeth Warren, D-Mass. Warren has argued against companies buying back stocks to raise their stock prices. Instead, she says firms should invest in employees and product development.

The rise of defense services

The extended fights in Afghanistan and Iraq helped create a boom in defense services firms, companies that provide workers to do jobs that, in the past, were performed by troops in the military or other government workers, from folding laundry to peeling potatoes. This was especially true in logistics.

“That was not a particularly important segment of the industry in the year 2000,” Grundman said.

COIN drove the need for service support contractors, ones who maintained drones and aircraft or performed other types of logistical functions that were eliminated when the military downsized at the end of the Cold War.

“We were trying to manage a pretty sophisticated military operation with a progressively smaller force” Grundman said.

Already, many of those service-focused companies have been restructuring themselves since the end of the Iraq war and adapting their business for the Pentagon’s China-focused future. 

“The services industry has weaned itself out of relying for all that cash on operation support and refocused itself on, let's call it, the knowledge economy of the Pentagon. “ Grundman said.

The disruptor 

One company that most disrupted the defense industry over the past two decades had nothing to do with Iraq and Afghanistan. Elon Musk’s SpaceX successfully elbowed its way into the rocket launch business.

“Why is SpaceX the interesting story of the past 20 years?,” Grundman said. “Because it disrupted the thing the Pentagon wanted the most, which was system performance, and even cost.”

Who will disrupt the next decade or two?

“A key issue for the U.S. defense sector is the degree to which new entrants can scale,” Callan wrote this week in a note to investors. Among the companies he’s watching: Anduril, Applied Intuition, C3.ai, Epirus, GoTenna, Kymeta, Palantir, Scale.AI, Shield AI, Skydio, SpaceX, Volsani, General Motors, and Microsoft.

“These companies are aiming at broader market swaths than some of the narrowly-defined ones that soared post-9/11,” Callan wrote. “Cynically, scale may be difficult if DoD is unwilling to take risk with new entrants (so far, SpaceX is the exception) and established contractors are able to defend their incumbency through relationships and lobbying prowess. Congress has a role here too.”