ANALYSIS GLOBAL DEFENSE MARKET
New Rivals Ending Western Defense Market Dominance
During that time, Western suppliers came to dominate the international defense marketplace. In 2015, they accounted for 59 percent of all sales to accessible markets, divided between U.S. sales at 45 percent and Europe with 14 percent. Yet that position is under threat. Since 2010, the supply of Western-built defense systems has actually been on the decline, according to data from Avascent Analytics, down from just over 62 percent five years ago. If current trends accelerate, the world’s most popular aircraft four decades from now — or even much sooner — may not be American or European at all.
Between now and the mid-2020s, Western defense suppliers face unprecedented competition in international markets that they once considered virtually their private hunting grounds. One factor is China’s growing technological competence and political clout. In 2013, NATO member Turkey courted Chinese defense suppliers to supply the HQ-9 air and missile defense systems for its T-LORAMIDS program; Ankara has also acquired drones made by Chinese firms. Saudi Arabia, one of America’s largest customers of high-end military hardware, also reportedly purchased Chinese Caihong drones built by Chengdu Aircraft Design and Research Institute — including an armed variant.
Other buyers include Iraq, United Arab Emirates and Egypt. Another factor is the desire among many longstanding defense customers in the Middle East and Asia to go it alone rather than depend on occasionally touchy Western governments.
Some of this shift is also Washington’s own doing, due to overwrought and complicated export controls that constrain U.S. suppliers. As an example, U.S. officials refused to offer America’s cutting-edge systems like the F-35 to any Gulf allies, a policy that also safeguards Israeli military superiority.
The larger technological, political and strategic forces reshaping the global defense market, however, are now beyond any one nation’s control. An increasing number of customer nations are now able to satisfy defense requirements “internally” from domestic industries, aided by years of technology-transfer deals.
That leaves U.S. and European defense firms in the difficult position of needing to defend relationships with core customers while preparing for a world in which historical supply patterns may no longer hold.
A case in point is Leonardo-Finmeccanica’s recent partnership with Singapore’s Nanyang Technological University on next-generation composites and aerodynamics research for helicopters. “This agreement is an exciting opportunity for Leonardo-Finmeccanica to expand the scope of its activities in Singapore, a strategic country where we are fully committed to strengthen a long-term partnership, not just for helicopters but also in other sectors,” said Mauro Moretti, CEO of Leonardo-Finmeccanica.
How fast the defense market evolves will depend on a myriad of factors, but the two most important are strategic and economic in character.
Some of the competitive change in the international defense market can be traced to the ability of countries like China or India to grow their own indigenous defense industries with a mix of domestic and foreign know-how. The motivations between strategic or economic grounds can blur, and often it is both. For Israel and Taiwan, which face existential threats and uncertainty about access to the global defense supply chain during military crises, being militarily self-sufficient is an issue of national survival.
This drives these nations toward an export-oriented high-tech and innovative defense technology sector during peacetime, as well. South Korea, for example, can be counted among the nations that will emerge as a more significant exporter of ships, submarines and aircraft during the next decade.
Domestic economics matters a great deal as well. In South America, Brazil is a rising player owing to its Gripen co-production partnership with Saab as well as Embraer’s bold steps into the competitive missionized aircraft market. In the Middle East, at the same time that Saudi Arabia is snapping up Chinese drones, Riyadh is also doing something equally disruptive, at least from a Western defense sector point of view: making a concerted political effort to build a domestic defense industry.
In April 2016, Saudi Arabian officials said they intend to source as much as half of the Kingdom’s defense procurement needs from domestic suppliers. “We have already begun developing less complex industries such as those providing spare parts, armored vehicles and basic ammunition,” Saudi officials wrote in describing the Vision 2030 plan. “We will expand this initiative to higher value and more complex equipment such as military aircraft.”
This new policy will help Riyadh take advantage of large public expenditures on national defense as a means of economic development and the establishment of post-petroleum national industries.
To be clear, this desire to develop domestic industry is not limited to Middle Eastern or Pacific nations. The Canadian defense procurement process involves Ottawa not only assessing technical solutions and price, but also the economic “value proposition” companies are offering as part of their proposals.
The legacy of the F-16 is an apt touchstone for exploring the future of the global defense market. It underscores that the cornerstones of a nascent defense sector are the political desire to enforce technology transfer agreements and stringent offset pacts with foreign suppliers in key areas such as advanced avionics or outright platform production. As a weapon system, the single-engine jet is an emblem of American military power. For allies, it has also been a stepping stone to developing defense industrial capabilities derived from the West’s premier military power. Countries such as Turkey did not just acquire the aircraft for their air forces but also insisted as a condition for sale that their domestic industries play a substantial role in the supply chain. Beyond the United States, four nations build components of the F-16s they operate: Belgium, Netherlands, South Korea and Turkey.
Western suppliers are not alone in having to juggle economic value, defense technology control and military relationships as they pursue business around the world. Technology sharing is also the price of doing business for Russian and Chinese defense suppliers. India’s state-owned Hindustan Aeronautics Ltd., for example, owes much of its capabilities to a series of partnerships with Russian firms. Similarly, ties between Pakistan Aeronautical Complex and Chinese aerospace entities, including the Chengdu Aircraft Corporation that is currently developing China’s fifth-generation J-20 heavy fighter, go back to the 1990s when the two nations worked on Pakistan’s JF-17 fighter aircraft.
The expectation for Western firms, as well as Chinese and Russian defense suppliers, is that such relationships and transfer agreements will become even more demanding in the years ahead in terms of the share and sophistication of the domestic content requirements. Customer nations will begin to source at home — or sell abroad — their own increasingly sophisticated components and systems. On one hand, it is offered as a way into a market. From another perspective, this risks over time beginning to “crowd out” foreign suppliers looking to make a direct sale to previously accessible markets.
As an example of this crowding out, India’s defense industry grew nine percent annually from 2010 to 2015 as spending climbed by double digits and policies such as “Make in India” took hold. The result is that local sources accounted for more than half of annual defense spending over the past five years. South Korea is another nation that, as of 2015, spends more than half of its budget domestically — up from less than 40 percent in 2010. So too for Japan, which spent 70 percent of its equipment budget on domestic suppliers in 2015.
The future strength of China’s overall economy will heavily influence another key variable in the global defense trade: research-and-development investment. Beijing’s hearty commitment to military modernization for the People’s Liberation Army is yielding an increasingly broad arsenal of equipment being offered for sale on the global market. Down the road, China’s own export control policies regarding advanced systems such as stealth fighters will be acutely important for Western defense firms and military leaders assessing the proliferation of technologies to allied and non-aligned nations alike.
The same can be said for Russia’s current crop of military capabilities. Recent reinvestment and modernization indicate a refreshed commitment to defense technology as a discriminating strategic advantage. The twist, however, is that these technologies are not retreads of Soviet Bloc systems. Russia’s finely calibrated aggression through military interventions in Crimea, Ukraine and Syria depends on newfound competency with unmanned sensor systems, electronic attack equipment, long-range land-attack cruise missiles and precision-guided ground-attack munitions, among other vexing capabilities being operationally tested in some of the most strategically brittle regions today.
Globalization profoundly reshaped sectors such as automobiles and personal technology. As the phenomenon catches up to the defense industry, Western defense companies can be confident their record of supporting their nation’s allies around the world is a foundation for the future. That future, however, will be little like their recent past.
Seeing that the world is changing is one thing, but letting go of the comfortable defense export paradigm of the past half century is another. The sensible course is to holistically reconsider fundamental assumptions about what it takes to lead in the 21st century global defense market amid new political-military relationships, intensifying competition and novel commercial tactics.
A recent observation by Secretary of Defense Ashton Carter at the U.S. Naval War College about deriving military advantage from quickly developing and acquiring technologies also applies to defense exporters: “The future is going to go to those who are agile, creative, up to date, competitive.”
It is this reworked approach toward innovative industrial relationships that may emerge as one of the most interesting avenues for Western defense firms and allow them to stay one step ahead of the change underway. The tradition of Western technical leadership still has value, even if it is diminished when restrictions can prohibit deep partnerships. The new market leaders will understand that they are no longer engaging in sales but deepening relationships that will, in most cases, also lead to developing a future competitor. In the end, that may be the ultimate legacy of the 40-year history of the F-16. ND
Doug Berenson is a managing director at Avascent Analytics where he studies global
defense markets. Daniel Yoon and August Cole contributed to this report.
Photo: Air Force