Lockheed's new Pentagon deal makes a bad bargain worse

In a recent earnings call Lockheed Martin described what may prove to be a highly consequential shift in Pentagon contracting.

CEO Jim Taiclet outlined a new “commercial-like” arrangement with the Department of Defense under which Lockheed would receive compensation even if the government altered procurement plans or reduced anticipated production quantities. Presented as a mechanism for stabilizing supply chains and accelerating weapons production, the arrangement effectively transfers additional market risk from the weapons maker to the taxpayer.

In practice, the new model appears to guarantee that Lockheed can expand production capacity with reduced exposure to the kinds of commercial uncertainties that normally discipline private firms. At a moment when Washington is once again invoking great-power competition to justify extraordinary military expenditures, the arrangement deserves scrutiny.

Far from a simple contracting innovation, the new approach represents another step in the long evolution of America’s military-industrial system towards an ever more corporatist order in which profits remain private while risks fall on the public.

Since World War II, Pentagon procurement has operated through a variety of contract structures designed to balance speed, innovation, and cost control. During wartime mobilization, “cost-plus” contracts became commonplace because they allowed rapid industrial expansion without requiring firms to shoulder uncertain financial risks. Under a cost-plus arrangement, contractors are reimbursed for expenses and then paid an additional fee or profit margin. The logic was straightforward: if the government needed ships, aircraft, or missiles quickly, firms had to be assured they would not be ruined by unforeseen production costs.

In practice, however, the model institutionalizes perverse incentives by allowing firms to profit from rising costs rather than containing them. Cost overruns, schedule delays, and expanding program scope become part of the business model itself. Indeed, a 2005 Government Accountability Office report found that the Pentagon had paid contractors an estimated $8 billion in award and incentive fees “regardless of acquisition outcomes,” despite chronic performance failures across major acquisition programs. (A limited audit conducted in 2024-25 suggests the problem very much persists.)

In the decades after 1945, procurement reforms periodically attempted to reintroduce market discipline through fixed-price contracts, competitive bidding, and tighter oversight. Even so, the defense sector remained structurally insulated from many normal commercial pressures because its primary customer was, and remains, the federal government itself.

The arrangement now described by Lockheed appears to move a step further. Rather than merely reimbursing firms for production costs, the Pentagon is effectively offering guarantees against changes in future procurement decisions. In other words, if Lockheed expands manufacturing capacity or restructures supply chains in anticipation of large orders, the government may compensate the company if those plans later change.

As Taiclet put it in the earnings call: “If, for whatever reason, the government decides the production rate won’t be as high in year five, six, or whatever, or there is a change in Congress that changes how this agreement can be appropriated, then there are reach-back or clawback mechanisms to make the company whole.”

Such agreements resemble “take-or-pay” contracts sometimes found in energy markets, but their application in the defense sector raises unique concerns because the state itself creates the demand in question. The government is not merely regulating a market or purchasing from one among many buyers; it is underwriting the market’s existence.

Washington and the defense industry will almost certainly defend this shift as a pragmatic response to geopolitical realities. American officials increasingly argue that the United States must rebuild its “defense industrial base” to prepare for prolonged competition with China, continued proxy warfare in Eastern Europe, and direct warfare in the Middle East. Defense executives likewise contend that unpredictable procurement cycles discourage long-term investment in factories, labor, and supply chains.

If firms fear that Congress may reduce orders after they commit capital, they will be reluctant to expand production capacity rapidly enough to satisfy Pentagon demands. From this perspective, guaranteeing recovery payments simply reduces uncertainty and allows firms to scale up more efficiently.

There is, however, another way to interpret the arrangement. By insulating major contractors from downside risk, the government weakens one of the few remaining mechanisms that encourages cost discipline and prudent investment. In ordinary markets, firms that misjudge future demand bear the consequences of those decisions. That possibility is not a flaw in capitalism; it is one of the principal means through which resources are allocated rationally.

Yet the modern defense sector operates according to a different logic. Major firms enjoy a customer with effectively unlimited borrowing capacity, extraordinary political incentives to continue spending, and now apparently a willingness to compensate producers even when anticipated demand fails to materialize.

The danger here is not simply waste, although waste is inevitable under such conditions. More troubling is the moral hazard created when corporations know that the state will absorb losses associated with strategic miscalculations or overexpansion. With such choice architecture in place, firms are likely to become even more aggressive in lobbying for weapons programs, even more willing to overpromise production capabilities, and even more invested in maintaining perceptions of a permanent geopolitical crisis.

In the modern military-industrial space, a small number of giant firms dominate, and Lockheed Martin already occupies an extraordinarily privileged position within this ecosystem. The company derives the overwhelming majority of its revenue from government contracts, particularly from the U.S. federal government and allied states operating within the American security architecture, and is one of the world’s most profitable defense contractors. Washington now appears willing to provide even greater insulation from commercial uncertainty.

The broader implications extend beyond Lockheed itself. Once such arrangements become normalized, other contractors will inevitably demand the same treatment. The result will be an arms industry virtually detached from competitive pressures altogether — a sector in which firms receive guaranteed demand, guaranteed reimbursement, and now potentially guaranteed compensation even when procurement assumptions prove incorrect. At that point, the distinction between nominally private corporations and state-managed enterprises becomes increasingly difficult to sustain.