Index

Defense Trade: Contractors Engage in Varied International Alliances
(Letter Report, 09/07/2000, GAO/NSIAD-00-213).

Pursuant to a congressional request, GAO provided information on U.S.
and European defense contractors' business alliances, focusing on: (1)
the types alliances companies are establishing and their reasons for
forming alliances; (2) why companies prefer certain types of alliances
over others; and (3) whether U.S. laws, regulations, policies, and
practices influence a company's decision to form an alliance of its
choice or a type of alliance.

GAO noted that: (1) U.S. and European defense companies create teams,
joint ventures, and subsidiaries and sometimes merge with or acquire one
another in order to compete worldwide for the sale of military weapons
systems; (2) two or more companies form a team by negotiating an
agreement to work together to pursue a particular government
procurement, with one company acting as the primary contractor and
others as subcontractors; (3) in contrast, a joint venture is typically
a separate legal entity, either a partnership or a corporation, that two
or more companies form to pursue a discrete market; (4) a subsidiary is
different from both a team and a joint venture because it is wholly
owned by one company and is physically located in another country so
that it may pursue that country's defense business; (5) defense
companies form these alliances and subsidiaries to access and increase
their competitiveness in other markets; (6) large U.S. companies prefer
to engage in flexible alliances whenever possible; (7) U.S. defense
contractors said they prefer teams to other alliances because teaming
allows companies to choose new partners in each market in which they
wish to compete, increase company capabilities without forming permanent
relationships, and access unique technology needed to meet military
requirements; (8) however, European governments are not always receptive
to teams because they perceive them as alliances led by U.S. companies
using U.S. technology that consign European participants to a subsidiary
role; (9) U.S. companies see significant disadvantages with joint
ventures because the U.S. often abandons multilateral programs before
completion and all governments supporting the joint venture make
decisions that adversely affect its operational efficiency; (10) large
U.S. defense companies do not favor merging with or acquiring major
European dense companies; (11) however, European acquisitions of small
and medium U.S. defense companies are common because they provide access
to the U.S. defense market, which is the world's largest; (12) companies
GAO reviewed do not consider the U.S. legal and regulatory environment
to be a major impediment to forming an alliance or a principal
determinant of the type of alliance chosen; and (13) U.S. companies are
concerned with the effect a slow technology transfer process can have on
the operation of an alliance and with the effect that a regulation that
requires foreign governments to seek U.S. consent before transferring
purchased alliance products to third parties may have on future alliance
sales.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-00-213
     TITLE:  Defense Trade: Contractors Engage in Varied International
	     Alliances
      DATE:  09/07/2000
   SUBJECT:  Defense industry
	     Foreign governments
	     Joint ventures
	     Defense procurement
	     Foreign military sales
	     International trade
	     Technology transfer
	     Foreign corporations
	     International trade regulation
	     Department of Defense contractors
IDENTIFIER:  NATO

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Testimony.                                               **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO/NSIAD-00-213

National Security and
International Affairs Division

B-285807

September 7, 2000

The Honorable James M. Inhofe
Chairman
The Honorable Charles S. Robb
Ranking Minority Member
Subcommittee on Readiness and Management Support
Committee on Armed Services
United States Senate

Together, the United States and Europe saw defense spending decline over 20
percent after the end of the Cold War. As the Department and Ministries of
Defense purchased fewer weapon systems, defense companies on both continents
looked increasingly to each other's market for additional sales. To gain
political advantage when competing in the other's market, U.S. and European
contractors began forming transatlantic business alliances. To better
understand these alliances, we surveyed four large U.S. contractors,
reviewed four weapon system programs being executed by two of these
contractors, and studied three foreign-owned U.S. companies. We used the
results of our review to address your questions regarding (1) the types of
alliances companies are establishing and their reasons for forming
alliances; (2) why companies prefer certain types of alliances over others;
and (3) whether U.S. laws, regulations, policies, and practices influence a
company's decision to form an alliance or its choice of a type of alliance.

U.S. and European defense companies create teams, joint ventures, and
subsidiaries and sometimes merge with or acquire one another in order to
compete worldwide for the sale of military weapon systems. Generally, two or
more companies form a team by negotiating an agreement to work together to
pursue a particular government procurement, with one company acting as the
primary contractor and others as subcontractors. In contrast, a joint
venture is typically a separate legal entity, either a partnership or a
corporation, that two or more companies form to pursue a discrete market. A
subsidiary is different from both a team and a joint venture because it is
wholly owned by one company and is physically located in another country so
that it may pursue that country's defense business. Defense companies form
these alliances and subsidiaries to access and increase their
competitiveness in other markets.

Large U.S. companies prefer to engage in flexible alliances whenever
possible. U.S. defense contractors said they prefer teams to other alliances
because teaming allows companies to choose new partners in each market in
which they wish to compete, increase company capabilities without forming
permanent relationships, and access unique technology needed to meet
military requirements. However, European governments are not always
receptive to teams because they perceive them as alliances led by U.S.
companies using U.S. technology that consign European participants to a
subsidiary role. Companies that want to satisfy European governments' desire
for greater industrial participation form joint ventures in which companies
share risk, decision-making, work, and, to the extent their governments will
allow, technology. However, U.S. companies see significant disadvantages
with joint ventures because the U.S. government often abandons multilateral
programs before completion and all governments supporting the joint venture
make decisions that adversely affect its operational efficiency, such as
directing the companies to divide work according to each country's
investment rather than according to each company's skills.1 Subsidiaries are
not a favored approach because in the fragmented European market a
subsidiary in one country has no impact on market access in another country.
Neither have large U.S. defense companies favored merging with or acquiring
major European defense companies.2 One company said that it has not pursued
such combinations because they would be unlikely to reduce operating costs
since large non-recurring costs would be incurred in moving sizable
manufacturing facilities and there would likely be political opposition to
such a move. However, European acquisitions of small and medium U.S. defense
companies are common because they provide access to the U.S. defense market,
which is the world's largest. As of April 2000, 26 of the largest foreign
defense companies own 197 U.S. subsidiaries engaged in the U.S. defense
market, according to Department of Defense records.3

Companies we reviewed do not consider the U.S. legal and regulatory
environment to be a major impediment to forming an alliance or a principal
determinant of the type of alliance chosen. However, U.S. companies are
concerned with the effect a slow technology transfer process can have on the
operation of an alliance and with the effect that a regulation that requires
foreign governments to seek U.S. consent before transferring purchased
alliance products to third parties may have on future alliance sales.

In written comments on a draft of this report, the Department of Defense
agreed with our findings.

Between the end of the Cold War and fiscal year 2000, the U.S. government
reduced the Department of Defense research and development and procurement
annual budgets by about $60 billion. In response to decreased demand in the
U.S. defense market, U.S. defense companies consolidated, merged with other
companies, and sold off less profitable divisions and business segments
unrelated to the company's core competency. For example, today in the United
States there are 5 large defense companies that in 1990 were 33 separate
businesses. In addition to consolidating, companies are placing greater
emphasis on international sales to make up lost revenues.

European companies, also faced with their governments' declining defense
spending, began forming alliances within Europe, in part, to gain access to
other countries' defense markets. As companies merge and establish
long-term joint ventures for product development, it becomes increasingly
difficult to keep track of the multiplicity of relationships. Figure 1
provides a snapshot of one European company's complex shareholder structure.

Company

aSEPI is a Spanish state-owned industrial holding company.

Source: French Armament Procurement Agency, Ministry of Defense.

To access defense markets in Europe, U.S. companies have learned that they
have to involve European countries' defense companies in the production of
items being sold. This involvement allows European governments to build
public support for the purchases. Governments leverage their weapon
acquisitions to preserve defense jobs and make their defense companies more
competitive in the global market by structuring competitions so that work
sharing and technology transfer are competitive discriminators.

Initially, European governments required offsets that created or preserved
jobs in return for purchasing weapon systems produced outside of their home
country.4 An offset could be directly related to the weapon system being
purchased,for example, buying parts for the weapon system from companies in
the purchasing government's country. But offsets could also be assisting the
country's commercial businesses with marketing their products or helping the
country develop its infrastructure. Offsets are still common today and, in
some cases, have resulted in European companies becoming long-term suppliers
to U.S. contractors.

European countries spend far less than the United States on research and
development. For example, in 1997, the United States spent $32.2 billion on
defense research and development compared with the combined spending of
France, Germany, Italy, and the United Kingdom of $7.1 billion. Therefore,
larger European countries have come to want more from
U.S.-European business alliances than workshare. They also want technology
that will make their defense companies more competitive in the global
marketplace. Technology transfer is widely used to fulfill offset
obligations and may be a key factor in a country's acquisition decisions. It
provides European governments with a technology infusion that enables their
companies to produce more advanced weapon systems for the export market,
which is responsible for a significant portion of some countries' defense
industry sales.

Many governments on both continents are increasingly showing support for
transatlantic alliances. On February 5, 2000, the U.S. Department of Defense
and the United Kingdom Ministry of Defense signed a Declaration of
Principles in support of defense industry integration, and the Department of
Defense is in discussion with other European countries on this subject.
Because the United States expects to fight jointly with its North Atlantic
Treaty Organization allies in future conflicts, it wants to ensure that each
country's military forces bring compatible equipment to the battle. The
Department of Defense believes that the best way to ensure that U.S. and
allied equipment can work together is to have U.S. and European defense
companies jointly develop weapon systems. If U.S. and European governments
also jointly fund development programs, each country's weapon system costs
should also decline because each would be responsible for only a portion of
total development costs. In addition, Department officials believe that
close ties between U.S. and European defense companies ensure companies
access to each other's defense market.

Defense companies must consider various statutes, regulations, and other
legal requirements when considering transatlantic alliances. Among other
things, these laws, regulations, and other legal requirements are meant to
ensure fair competition, establish a preference for or require use of a
domestic source, regulate imports and exports, and protect national
security. Table 1 lists important U.S. statutes, regulations, and other
legal requirements and briefly explains the purpose of each.

  Laws and implementing documents               Primary purpose
                                     These laws:

                                     Require parties to large mergers to
                                     report their plans to the Federal
 Antitrust Laws                      Trade Commission and the Antitrust
                                     Division of the Department of Justice;
 Clayton Act
                                     Prohibit acquisitions that
 Hart-Scott-Rodino Act               substantially lessen competition or
                                     tend to create a monopoly; and
 Sherman Act
                                     Prohibit acquisitions, mergers, and
                                     joint ventures that cause unreasonable
                                     restraints of trade or monopolize a
                                     market.
 Domestic Source Laws

 Buy American Act                    These acts either establish a
                                     preference or a requirement for
 Berry Amendment                     acquiring domestic articles, supplies,
                                     and materials for public use.
 Other statutory restrictions
                                     These acts and regulations control the
                                     import and export of military goods
                                     and services and goods that may have
                                     both commercial and defense uses.

                                     The Arms Export Control Act
                                     establishes U.S. policy that allows
                                     international programs and projects
                                     for cooperative exchange of data,
                                     research, development, production,
                                     procurement, and logistics support to
                                     achieve specific national defense
                                     requirements and objectives of mutual
                                     concern. The act also established the
                                     need for export regulations that
                                     reduce the international trade in
 Import/Export Laws and Regulations  weapons and lessen the danger of
                                     regional conflicts.
 Arms Export Control Act
                                     The International Traffic in Arms
 International Traffic in Arms       Regulations define the type of defense
 Regulations                         articles and services that require the
                                     Department of State's approval for
 Export Administration Act           export, the entities that may request
                                     such approval, the general policies
 Export Administration Regulations   and procedures related to exports, and
                                     the criminal penalties for failing to
                                     comply with the regulation.

                                     The Export Administration Act
                                     implements the U.S. government's
                                     export control licensing and
                                     enforcement system for goods that may
                                     be used for both commercial and
                                     defense purposes. Although the Export
                                     Administration Act expired in 1994,
                                     the export control process under that
                                     act continues under the authority of
                                     an executive order.

                                     The Export Administration Regulations
                                     implement the Export Administration
                                     Act.
                                     Together the Executive Order and
                                     Amendment establish the interagency
                                     Committee on Foreign Investment in the
                                     United States and give the President
                                     the power to act upon the Committee's
                                     recommendations. The Committee is
                                     responsible for reviewing the
                                     voluntary notices of foreign companies
                                     that intend to merge with, acquire, or
                                     take over U.S. companies and
                                     submitting to the President any
                                     recommendations that a foreign company
                                     suspend or abandon its purchase of a
                                     U.S. firm. The President is empowered
                                     to act upon Committee recommendations
                                     and may also order the divestiture of
                                     a foreign company's ownership in a
                                     U.S. company.

 National Security Legal             The Manual prescribes requirements,
 Restrictions on Acquisitions and    restrictions, and other safeguards
 Mergers                             necessary to prevent unauthorized
                                     disclosure of classified information
 Executive Order 11858               released by U.S. government Executive
                                     Branch departments and agencies to
 Exon-Florio Amendment               their contractors. It provides that
                                     before a foreign-owned company may
 National Industrial Security        access classified information,
 Program Operating Manual            measures must be taken as necessary to
                                     remove the possibility of unauthorized
                                     access or adverse effect on classified
                                     contract performance by a foreign
                                     owner. The level of access granted
                                     without restrictions depends on the
                                     type of mitigation employed to offset
                                     foreign ownership, control, or
                                     influence. Foreign-owned U.S. firms
                                     operating under a trust or proxy
                                     agreement do not have any access
                                     limitations, while firms operating
                                     under a special security agreement can
                                     access information above the secret
                                     level only if the government
                                     contracting activity prior to the
                                     award of a classified contract
                                     determines that it is in the national
                                     interest to allow the firm access to
                                     such information.

Source: GAO analysis of U.S. statutes, regulations, and other legal
requirements affecting transatlantic alliances.

Our survey and case studies show that defense companies are engaging in
various types of alliances to gain transatlantic market access and become
more globally competitive. Six of the seven companies in our study are part
of project-based teams, joint ventures, subsidiaries, or mergers and
acquisitions, while a representative of the seventh said that the company
recently signed an agreement with a European company that provides for
teaming when opportunities arise. Large U.S. contractors said that when they
compete for business in foreign markets, they form the type alliance that is
most likely to result in market access and yield the greatest return on
their investment. Officials from European-owned U.S. companies told us that
European companies purchase U.S. defense companies to acquire new product
lines, capabilities, and advanced technology that enhance access to the U.S.
defense market. Table 2 displays the number of teams, joint ventures, and
subsidiaries in which the three large U.S. contractors included in our
review that established alliances and subsidiaries are engaged.

                                        Teams  Joint ventures Subsidiaries
 Number of reviewed companies engaged
 in this type alliance                  3      3              2
 Aggregate number of alliances formed
 by these companies                     115a   26             3b

aThis number is an estimate rather than a precise count because one
contractor said that his company does not maintain a centralized database
that includes all teams of which the company is a part.

bIncorporated marketing offices are not included as subsidiaries.

Source: GAO analysis of contractor data.

Large U.S. contractors said that they prefer to engage in alliances that
give them maximum flexibility. However, the companies said that to access
certain markets or compete for certain procurements they must sometimes
engage in less flexible linkages.

Teaming offers more flexibility than other types of alliances. Because
teaming agreements are negotiated, they may contain any provisions to which
the parties can agree. Prime contractors said they often try to limit the
life of the team to an individual procurement because if a contractor wants
to sell its product in more than one market, it gains an acquisition
advantage by choosing different subcontractors in each of the markets.
Teaming is also a way of temporarily adding capabilities that make a company
more competitive. One large U.S. contractor said that teaming with a
European company with product expertise different from its own allows it to
compete for sales in parts of the U.S. market in which it is not a leader
without making an investment to acquire that capability. Another said that
governments sometimes require capabilities in their weapon systems that only
one company can deliver. For example, the U.S. Army requires that the
computer system being developed for a reconnaissance vehicle that it and the
United Kingdom are jointly funding be able to communicate with computer
systems of command vehicles. Only one company possesses this technology; as
a result, the joint venture initiated a nonexclusive teaming arrangement
with the company.5

However, according to the Department of Defense, teaming arrangements are
not always acceptable to European governments and companies. At a time when
European governments are insisting on performing a larger portion of a
program's work and sharing more U.S. technology, a Department official said
European governments and their contractors are less receptive to alliances
in which U.S. companies lead programs, thereby retaining most U.S.
technology, and relegate European participants to subcontractor status.

U.S. and European companies may form joint ventures when their governments
are jointly procuring a weapon system and want their countries' contractors
to work together as partners to develop and/or produce the system. U.S.
companies also engage in transatlantic joint ventures to gain an advantage
when competing for European acquisitions. Joint ventures are advantageous
because governments see them as a way that companies can work together as
equals, sharing jobs and technology. However, contractors said government
actions sometimes make joint ventures less attractive alliances.

Unlike a team, a joint venture typically does not place one company in a
leadership position. Instead, the companies share risks and assets in joint
pursuit of a discrete market, often a specific weapon system program. We
studied two joint ventures that companies formed because their governments
wanted one to cooperatively develop and produce an air and missile defense
system and another to develop a reconnaissance vehicle. U.S. and European
governments are jointly funding both systems. In these joint ventures, the
participants share decision-making, program risks, technology (to the extent
allowed by individual governments), and program work. Representatives of one
U.S. company that is located in the United Kingdom said that United Kingdom
joint ventures are likely to be more common in the future because the
government is moving toward having one contractor support a system from
cradle to grave. The representatives said that this concept requires a
contractor to make a large, long-term capital investment in facilities,
equipment, and personnel, and companies will likely want to form joint
ventures to share these risks.

Contractors said joint ventures are not the most advantageous transatlantic
linkage because the U.S. government often abandons programs that the
ventures support before completion and U.S. and European governments often
decide which companies should form a joint venture, as well as requiring
that their companies' work share equal their country's program investment.
Of the two programs in our study executed by joint ventures, the Department
of Defense has decided not to provide future funding for one and did not
plan long-term funding for the second until the program had been in place
for 3 years. Joint venture contractors also told us that companies work
together best if they are allowed to decide who will compose an alliance
because they look for partners that complement their capabilities. Companies
also want to decide what percentage of work each participant will perform so
that work may be allocated efficiently. One contractor representative said
that, when a joint venture must ensure that each country receives work share
equal to its investment, work cannot always be assigned to the company best
able to perform the tasks.

Of the four large U.S. defense companies in our sample, two have
subsidiaries in Europe. We reviewed one subsidiary established in the United
Kingdom by each company. Representatives of these subsidiaries said that
because of their permanent presence and the number of local citizens they
employ, they are better able to compete with the United Kingdom's large
contractors. However, being located in the United Kingdom does not guarantee
that a subsidiary will be treated more favorably in all respects than other
foreign sellers. In addition, contractors said that because the European
defense market is fragmented, establishing subsidiaries is not always an
efficient use of capital.

In some regards, subsidiaries are treated no differently than other foreign
companies. For example, the United Kingdom treats foreign-owned subsidiaries
as it does all other foreign sellers in regard to offsets. The United
Kingdom's policy is that any company selling defense goods to the United
Kingdom must provide an offset if the goods being sold include components
valued at more than about $15 million that are not produced in the United
Kingdom. Therefore, if a subsidiary does not plan local production of a
substantial portion of a weapon system that the United Kingdom is
purchasing, it must subcontract work to United Kingdom defense companies,
transfer technology, or perform some other defense activity that benefits
the government.

Contractors said that it is sometimes difficult to make a good business case
for establishing a subsidiary. Because Europe is made up of many different
countries, each with its own defense budget and acquisition process, a
subsidiary in one country does not ensure access to the defense markets of
other countries. The contractors told us that if a country's defense budget
is small and potential profits from likely sales are limited, or if product
pricing is dependent upon large infrastructures, as in the aircraft
industry, a subsidiary is likely not feasible.

A complete picture of the status of U.S. and European mergers and
acquisitions cannot be drawn because little data is available on the number
of European defense companies that U.S. companies have acquired as
subsidiaries.6 But available data shows that no large U.S. and European
defense contractors have merged or acquired one another7 and foreign
acquisitions of smaller U.S. contractors are common.

Large U.S. companies in our sample cited several obstacles to mergers and
acquisitions among large U.S. and European defense contractors. One
contractor said that despite over-capacity on both sides of the Atlantic
consolidation of manufacturing operations does not appear practical because
of the large nonrecurring cost of moving work and the political opposition
such a move would create. This contractor also said that the complex
interlocking ownership structure of European companies makes it difficult
for a U.S. company to reduce costs through consolidation because the
European companies have negotiated and contracted work share and established
long-term supplier relationships for most products. Other contractors
pointed out that U.S. antitrust laws would likely prevent consolidations of
large U.S. and European contractors because the size of consolidated
companies would give them a competitive advantage. Finally, a representative
of one contractor said that his company is not financially able to acquire
European companies and is not interested in being acquired.

Records maintained by the Office of the Secretary of Defense show that, as
of April 2000, 26 of the largest foreign defense companies own 197 U.S.
subsidiaries engaged in the U.S. defense market. Purchasing U.S. companies
is advantageous because it increases the European owners' access to the
largest defense market in the world by providing them with new and
profitable product lines and increased capability. Access to U.S. funded
technology and acquisition programs are also powerful incentives driving
this trend of foreign acquisitions. But purchases can be expensive and, in
some cases, market access is limited.

Our case studies show that European companies often enter or expand sales in
the U.S. market by acquiring a U.S. defense company. A foreign company
principally involved in food processing and real estate investments acquired
a U.S. company that is a diversified manufacturer of commercial and defense
products and a leader in certain niche markets. The acquisition provided the
European buyer with an entirely new endeavor and new market. In another case
study, a foreign company acquired a U.S. electronics company that
complemented its systems integration capabilities, expanded its market, and
provided more of a presence in the United States. The acquirer expects that
the synergies between the companies will allow it to obtain a leadership
position in the aerospace and defense industry.

Our study also shows that a European company may access U.S. technology and
eliminate competitors in the global market through the acquisition of U.S.
companies. For example, through one case study we found a European company
that acquired two U.S. companies manufacturing a product that is critical to
U.S. national security, closed their operations, and moved specialized
hardware and software to the European company's facilities. According to
Department officials, these actions allowed the European company to narrow
the U.S. technological lead in this product, which reduced its competition
in the world market. Industry experts also said the foreign company obtained
unique technology from one of the acquired companies that enabled it to win
a recent U.S. military contract over its remaining U.S. competitor. In
addition, the foreign company later acquired another U.S. company
manufacturing a similar product and moved that company's operation to
Europe.8 These actions, according to Department officials, allowed the
European company to narrow the technological lead that the United States
held in this product.

Even though foreign acquisitions of smaller U.S. companies are common, our
sample shows that such consolidations can be expensive because foreign
companies pay large sums of money to acquire U.S. companies and incur
additional legal fees to transfer company ownership and comply with U.S.
laws. Table 3 shows the approximate cost in then-year dollars of the foreign
acquisitions of U.S. companies in our review.

           Dollars in millions
 Acquisitiona Purchase cost  Legal feesb
 #1           $5             $0.085c
 #2           704            3.000
 #3           1,100          2.000
 #4           10,000         d

aOne company that we selected as a case study was acquired by a foreign
company that was in turn acquired by another foreign company. Therefore, we
reviewed two acquisitions for one of the case studies.

bLegal fees include fees for filing with the antitrust review authorities
and with the Committee on Foreign Investment in the United States, if
applicable.

cThis acquisition did not undergo an antitrust review or a review by the
Committee on Foreign Investment in the United States.

dAccording to a company executive, the company's records do not separate
legal fees from other transfer costs. Total transfer costs were
approximately $158 million and included legal fees, investment banker fees,
consultant fees, and other costs.

Source: GAO analysis of contractor data.

Although purchasing a U.S. defense company enhances market access, it does
not ensure full access to the U.S. defense market. Department of Defense
policy does not allow foreign-owned U.S. defense companies to execute
contracts that require access to information above the secret level unless
the government contracting authority determines that the release of such
information advances U.S. national security interests and the owners of the
information approve its release. This policy prevented a United
Kingdom-owned U.S. company in our sample from bidding on Navy and Air Force
contracts worth in excess of $123 million.

U.S. companies in our sample said U.S. laws and regulations are neither the
principal determinant of whether they form an alliance nor the reason one
type of alliance is chosen over another. Rather, the companies regard the
legal and regulatory environment that the United States has designed to
protect national security and foreign policy interests as a cost of doing
business. However, companies said these laws, regulations, and policies may
increase the complexity of establishing an alliance, increase start-up and
operational costs, impact an alliance's ability to operate efficiently, and
prevent the synergy expected from a business consolidation.

To meet the requirements of antitrust laws and to prevent future reviews or
a directed divestiture for national security reasons, many alliances provide
antitrust agencies and the Committee on Foreign Investment in the United
States with substantial amounts of information regarding their intended
alliances. Foreign-owned U.S. defense companies in our sample said gathering
this information requires a significant amount of time and increases
start-up costs. However, according to a Department of Justice official,
antitrust laws have not stopped any foreign and U.S. companies from forming
alliances and records show that the President at the recommendation of the
Committee has only prohibited one foreign company from purchasing a U.S.
defense company.9 Because companies combine all legal fees in their
financial records, only one company in our study was able to approximate the
cost of filing these antitrust and national security documents. It estimated
that it expended about $400,000 to prepare information for the consideration
of the Committee on Foreign Investment in the United States and about
$100,000 to prepare information for antitrust agencies. Neither the
antitrust agencies nor the Committee required the company to provide
additional information that would have increased costs.

Foreign-owned U.S. companies also said that preventing foreign owners from
using their ownership to obtain unauthorized access to export- controlled
and classified technology, as required by the National Industrial Security
Program Operating Manual, is a continuing expense. Companies reported that
costs for security personnel, record keeping, Board of Directors fees and
meeting expenses, and legal fees necessary to protect U.S. technology from
disclosure range from about $31,000 to $295,000 per year.10

Sales

Most alliances in our sample view technology transfer laws, regulations, and
policy as exacting a higher cost than other elements of the legal and
regulatory environment on an alliance's operation. Joint ventures,
subsidiaries, and teams, which execute programs that depend upon sharing
U.S. technology, expressed concern with the time that it takes the U.S.
government to approve the export of technical data to foreign companies that
participate directly or indirectly in the alliance. Subsidiaries also
expressed concern with the effect retransfer restrictions could have on
future sales in the market they were established to access.

Before a U.S. company participating in an alliance can share with the
alliance's foreign participants many technologies owned by the U.S.
government or the company, it must, according to the International Traffic
in Arms Regulations, obtain approval of a technical assistance agreement
from the State Department. The agreement identifies the U.S. technology that
the U.S. government is willing to allow the parties to the agreement to
share. Because many programs being executed by transatlantic alliances are
leveraging U.S. technology, work is slowed or cannot begin until the State
Department approves the agreement. Table 4 displays data provided by
contractors on the length of time that the State Department required before
approving technical assistance agreements for programs included in our
sample.

           Average approval time for    Average approval time required to
           basic agreement              change a basic agreementa
 Program 1 107                          70
 Program 2 95                           Not reported
 Program 3 74                           58

Note: Only three of the programs that we reviewed required technical
assistance agreements. The fourth program required a manufacturing license
that the State Department approved in 95 days.

aChanges may include adding or deleting parties with whom data may be
exchanged or changing the scope of the data that may be shared.

Source: GAO analysis of contractor data.

The time the United States requires to export technology is even greater if
an alliance needs access to government-owned rather than
company-owned technology. Department of Defense Directive 5230.11, which
implements U.S. policy for the disclosure of classified military information
to foreign governments and international organizations, and Directive
2040.2, which regulates the international transfer of technology, goods,
services, and munitions, require the Department of Defense to review
government-owned classified and export-controlled unclassified information
and approve its release to foreign parties.11 A joint venture in our sample
reported that during the 27 months after the State Department approved its
request for a technical assistance agreement, the Department of Defense
required an average of 131 days per document to make a disclosure
decision.12 Department of Defense foreign disclosure officials said the
decision process was lengthy because (1) the joint venture requested a large
number of documents, many of which were sensitive;
(2) the joint venture failed to provide all required information when
requesting data; (3) reviews of requested information by its owners were
sometimes lengthy; and (4) the Department did not provide officials with a
Technology Assessment/Control Plan13 that it requires be used as the basis
for foreign disclosure decisions.

Subsidiaries also expressed concern that retransfer restrictions that the
U.S. government places on weapon systems sold to foreign governments may
reduce the subsidiary's ability to compete for future business in the
European market. The U.S. International Traffic in Arms Regulations require
recipients receiving U.S. exports of all defense articles and services to
obtain the written approval of the U.S. Department of State before
transferring those articles and services to third parties. Representatives
of subsidiaries said that this regulation sometimes prevents them from
successfully competing with European firms. For example, one large U.S.
company with a subsidiary in the United Kingdom that competed to develop and
produce an air-to-air missile for the United Kingdom believed that it could
not be competitive with European companies unless it received relief from
this regulation. Because the United Kingdom plans to sell the selected
missile as the munition on an aircraft that it is manufacturing and will
export to other countries, a retransfer restriction would require the United
Kingdom to seek U.S. permission each time it wants to sell the aircraft. In
cases such as this, the Department of Defense sometimes agrees in writing to
allow the resale of the item in question, in this case the missile, to a
select group of countries. However, because exports are under the control of
the State Department, the Department of Defense can only provide firm
assurance that it will not oppose disclosure of the incorporated technology
to the named countries, not that the State Department will agree to allow
the missile to be resold to the countries.

Companies in our sample said technology policy has the potential to prevent
or diminish the synergy that alliances expect from business combinations. A
foreign-owned company in our sample and its parent that produce similar
military items want to share their knowledge and expertise. However, because
it is Department of Defense policy to prevent foreign owners from using
their ownership to obtain unauthorized access to export-controlled and
classified technology, the two companies find it difficult to learn from one
another and often find themselves in competition. Similarly, representatives
of a joint venture that is leveraging U.S. government-owned technology said
that some of the technology the United States released to the joint venture
is restricted to U.S. access only. The representatives said that because
this restriction prevents the free flow of information it undermines the
functioning of the joint venture's
U.S.-European contract teams. However, another company in our sample
realizes synergy without sharing export-controlled or classified data. A
representative of a United Kingdom company said that its purchase of a U.S.
company will boost operating performance and competitiveness through the
synergies and opportunities available to the combined companies. The
combination builds on the U.S. company's cost management and financial
control skills and the United Kingdom company's large-scale project
management and systems integration skills.

The U.S. and European defense companies that we reviewed are trying to
maintain flexibility so as to increase their sales in a market that has seen
little to no growth globally. Their goal is to seek alliances that best
increase their ability to sell products to other governments. In this
dynamic environment, the U.S. companies have preferred alliances, such as
teams, that they can easily abandon should the alliance be unsuccessful in
competing for new business or should an alliance with other companies offer
greater potential for increased sales and revenues. Foreign companies
included in our review, seeking to increase their share of the largest
defense market in the world--the U.S. market--have been willing to establish
a more permanent presence. As these U.S. and European companies focus on
quickly gaining market share, they are more willing to test different types
of alliances. While the companies we reviewed do not consider the U.S. legal
and regulatory environment to be the driver in their choice of an alliance,
they do find that some laws and regulations, particularly those related to
technology transfer, affect an alliance's operation. However, in this
rapidly changing environment, it is difficult to determine the full effect
U.S laws, regulations, policies, and practices may have on future linkages.

The Department of Defense agreed with a draft of this report and provided
technical comments. The Department's written comments are reprinted in
appendix I. The Department's technical comments have been incorporated as
appropriate.

We examined the integration of the U.S. and European defense industries by
surveying four large U.S. defense contractors, examining four programs two
of these companies are executing, and studying three foreign-owned U.S.
companies. We cannot statistically state that the conditions we found in our
review apply to all U.S. and European industry alliances. However, our aim
was not to project our findings to the universe of transatlantic alliances,
but to illuminate trends in today's changing business environment. To
further ensure that these trends are representative, we discussed them with
Department of Defense officials tracking transatlantic linkages and an
industry expert familiar with today's business landscape.

We judgmentally selected contractors that are included among the largest
diversified U.S. defense companies and programs that are executed by various
types of transatlantic alliances, including joint ventures, teams, and
subsidiaries. The three foreign-owned U.S. companies were judgmentally
selected to include different technologies and various European countries.
We did not audit financial or licensing data provided by companies or
programs and cannot attest to its accuracy.

To determine the types of alliances formed between U.S. and European defense
companies, the impetus for forming these alliances, companies' reasons for
choosing certain types of alliances over others, and the influence that the
U.S. legal and regulatory environment has on decisions to form alliances, we
analyzed survey responses and information collected from defense companies
included in our review. We also analyzed U.S. laws, regulations, and
policies to determine how they might affect transatlantic linkages and
compared our results to the companies' responses and documentation.

To accomplish our analysis, we held discussions with and collected
information from the Office of the Under Secretary of Defense for
Acquisition, Technology, and Logistics, Washington, D.C.; Office of the
Under Secretary of Defense for Policy, Washington, D.C.; Office of the
Assistant Secretary of Defense for Command, Control, Communications, and
Intelligence, Washington, D.C.; Defense Security Service, Alexandria,
Virginia; Defense Threat Reduction Agency, Arlington, Virginia; Defense
Intelligence Agency, Washington, D.C.; National Ground Intelligence Center,
Charlottesville, Virginia; Army Counterintelligence Center, Fort Meade,
Maryland; Department of Defense General Counsel, Washington, D.C.; U.S.
Department of Justice, Washington, D.C.; Defence Export Services
Organisation, Ministry of Defence, London, England; and the U.S. Embassy,
London, England. We also collected documents from and held discussions with
U.S.- and European-owned U.S. defense companies included in our review.

We conducted our work from October 1999 through June 2000 in accordance with
generally accepted government auditing standards.

We are sending copies of this report to other interested congressional
committees; the Honorable William Cohen, Secretary of Defense; the Honorable
Louis Caldera, Secretary of the Army; the Honorable Richard Danzig,
Secretary of the Navy; and the Honorable F. Whitten Peters, Secretary of the
Air Force. We will make copies available to others upon request.

Please contact me at (202) 512-4841 if you or your staff have any questions
concerning this report. Major contributors to this report are
Barbara Haynes and Erin Baker.

Katherine V. Schinasi
Associate Director
Defense Acquisitions Issues

Comments From the Department of Defense

(707453)
(707453)
  

1. Governments take these actions when the joint venture is formed to
execute a
government-to-government cooperative program.

2. Little data is available on the number of European companies that U.S.
companies have merged with or acquired.

3. According to an official in the Office of the Secretary of Defense, the
office estimated the largest foreign defense companies based on each
company's reported sales dollars.

4. Offsets are commercial or industrial benefits that a company offers a
foreign government as an inducement or condition for the purchase of
military goods or services. See Defense Trade: European Initiatives to
Integrate the Defense Market (GAO/NSIAD-98-6 , Oct. 29, 1997).

5. Teaming agreements may be exclusive or nonexclusive. An exclusive
agreement precludes the teaming partners from joining with other contractors
to pursue the same procurement.

6. A Department of Defense representative said the Department could use its
contract database to develop a partial list of U.S. subsidiaries in Europe.
However, the list would be limited to subsidiaries to whom the Department
awarded contracts with a value of
$25,000 or more over the last 5 years.

7. Although no mergers or acquisitions have occurred between large U.S. and
European defense companies, at least one large U.S. company is considering
selling one of its divisions to a European buyer.

8. The European company acquired this U.S. company after the Congress
enacted the Exon-Florio Amendment to the Defense Production Act in 1988. The
European buyer voluntarily notified the Committee on Foreign Investment in
the United States of its intended acquisition of the U.S. company and stated
in the notification that the business might be moved to Europe. The
Committee did not recommend to the President that this acquisition be
suspended.

9. A number of potential mergers or acquisitions have been withdrawn or
restructured during the course of a review by the Committee on Foreign
Investment in the United States. In addition, in one case a foreign company
agreed to voluntarily divest a U.S. company already acquired.

10. All companies executing classified contracts incur continuing expenses
for security personnel. However, foreign-owned U.S. companies may incur
additional expenses because the National Industrial Security Program
Operating Manual requires each company to establish a permanent committee of
its Board of Directors, known as the Government Security Committee, to
ensure that the company maintains policies and procedures to safeguard
export controlled and classified information with which it is entrusted. The
Manual further requires the appointment of a Technology Control Officer and
the development and approval of a Technology Control Plan.

11. The National Security Decision Memorandum formulates U.S. national
policy governing decisions on the disclosure of classified military
information to foreign governments and international organizations. The
Memorandum is implemented by National Disclosure Policy-1, an interagency
document, that is implemented within the Department of Defense by Directive
5230.11. However, the National Disclosure Policy does not regulate the
disclosure of six classes of information. Other national disclosure policies
determine the release of national intelligence data, counterintelligence
operational information, communications security information, nuclear
information, sensitive compartmented information, and strategic planning and
guidance. Other national committees or U.S. government officials make
disclosure decisions on these classes of information.

12. The average release time does not include consideration of documents for
which decisions were pending or documents whose release the Department
denied.

13. A Technology Assessment/Control Plan itemizes all sensitive U.S.
classified and unclassified articles, commodities, or technical data that
may be transferred under a proposed international agreement, assesses the
risk to U.S. national security of such transfers, and identifies the foreign
technologies that the United States is likely to acquire as a result of a
proposed agreement.
*** End of document. ***