GLOBAL DEFENSE MARKET
International Sales Unlikely To Offset U.S. Budget Cuts
With little hope of growth in the Pentagon’s budget, U.S. defense contractors are seeking to broaden their international customer base and increase worldwide sales.
But increased military spending in the Middle East and Asia-Pacific is unlikely to make up for flattened spending by the United States, and contractors will face increasingly crowded competitions as companies around the globe try to ramp up exports.
“Global economic growth in a lot of these countries may be slow in the coming years, and although foreign sales are going to continue to increase, it’s going to be less of an increase than we’ve seen in the past,” said Nayantara Hensel, an economist at the National Defense University.
Part of the problem is that the United States spends so much on its military that there are no nations with comparable defense budgets that contractors can target, said Dan Darling, an international military market analyst at Forecast International.
The United States spent $682 billion on its military in 2012, according to data from the Stockholm International Peace Research Institute. That’s more than four times the estimated defense expenditures of China, the number-two spender.
It’s not all bad news. While most markets will flatten or contract, there will be continued growth in unmanned aerial vehicles and cybersecurity, two fields where U.S. defense companies are leading innovation, experts agreed.
Even weathly countries with technologically advanced militaries lack UAVs and the industrial base to build them, Darling said. “In Europe, the French are purchasing the Reaper. They’re still playing catch up.” The only country able to compete with U.S. technological standards in the UAV realm is Israel, with companies such as Israel Aerospace Industries, he added.
The demand for remotely controlled technologies will branch out from aircraft to include ground robots and unmanned underwater vehicles, he said.
Large defense primes also are likely to invest money in developing cybersecurity products and services that can be sold to civilian markets, said Sandy McKenzie, a partner in the McLean Partnership, a London-based consulting group. For instance, Detica, a BAE Systems subsidiary specializing in cybersecurity, is looking for potential employees with experience in the financial services, retail, pharmaceutical and energy industries in order to better target those customers.
“To some extent, these companies need to be thought of not as aerospace and defense companies but as IT and technology companies,” he said.
Ultimately, the defense industry will continue to be a significant contributor to the U.S. economy, but budget cuts are not likely to be completely mitigated by international sales,
Hensel said. That means an expansion to commercial sectors is vital. “I think there’s real risk of attenuation of skill sets unless we see defense contractors moving more toward commercial markets and developing commercial uses for military products,” she added.
While it’s unlikely that large defense contractors will merge, it’s possible that primes will partner on programs to reduce risk and pool research-and-development funding. For instance, Boeing and Saab announced in September that the companies were considering working together on a replacement for the Air Force’s fleet of T-38 trainer aircraft.
“Boeing and Saab have formed partnerships in the past in the commercial sector, but we haven’t seen it so much in the military sector,” Hensel said. Such ventures will likely become more pervasive among other companies as well.
Many militaries around the world find themselves in a similar predicament to the United States, which must balance the demand for new aircraft or other equipment with a shrinking budget, Heidi Grant, deputy under secretary of the Air Force for international affairs, said at the Air Force Association’s annual conference in September.
Grant urged industry to consider exportability during product development. “It benefits all of us by bringing down acquisition and sustainment costs for all participants while contributing to interoperability and increased sales,” she said.
The single best region for U.S. defense companies to focus is the Asia-Pacific, Darling said. Not only is it the focal point of the nation’s defense strategy, the region is a hotbed of economic growth and includes countries that are allies or strategic partners.
Darling predicts defense spending in the region will increase 37 percent in the next five years. The problem is that 38 percent of that growth is emanating from China, a market that is closed to U.S. military exports.
India plans to spend $100 billion on military modernization in the coming decade, including increasing its warships from 127 to 150 and doubling its air force, Hensel said. However, the country’s slow economic growth and falling currency values could make such investments difficult.
That could affect the country’s plans to buy Lockheed Martin C-130J cargo aircraft, Airbus A-330 aerial refueling planes, assault rifles, howitzers and torpedoes, she said.
And unlike countries such as Japan and South Korea, which, as allies of the United States, tend to favor U.S. platforms and technologies, India’s military arsenals are supplied by a wide range of nation-states, including France, Russia and Israel, Darling said.
“They’ll see what they can maximize in terms of tech transfer and lowest price while getting what they want in terms of technology to match up with peer competitors,” he said.
“They’re not just going to become a wholesale U.S. customer, that’s for sure. They’re always going to play everybody off against each other, find the best possible deal. And right now everyone is trying to get into that market except for China,” he added.
Volatility stemming from North Korea, regional territorial disputes and political changes are driving greater military investment in South Korea and Japan.
South Korea currently is seeking new jet fighters. Originally, Boeing’s F-15 Silent Eagle was set to win that competition against Lockheed Martin’s F-35 and the EADS Eurofighter Typhoon. Boeing was the only company with an aircraft within South Korea’s budget, but the country cancelled the competition and rejected Boeing’s bid in the hopes of procuring a fifth-generation fighter aircraft.
EADS officials have said they will continue to compete for the contract, but Darling believes the Korean government will select an American aircraft. “I don’t know what they told EADS to make them believe they had a shot, but it was almost inevitable that the European manufacturer was not going to get that contract,” Darling said.
Japanese defense policy, meanwhile, has become more hawkish under its new prime minister, Shinzo Abe. The government’s interim defense report released in July called for the creation of an expeditionary, Marine Corps-like unit. The country wants to partner with the United States on cybersecurity and improve naval and air-superiority capabilities so it can more easily protect its small, isolated island territories. Japan is also considering the purchase of UAVs for surveillance, the report said.
The Australian government has proposed growing its defense budget over the next decade from about 1.5 percent of its gross domestic product to 2 percent. That will be quite a leap, Darling said.
Countries like Indonesia and Malaysia will boost spending in coming years as they modernize their aging weapon systems, Darling said. “Indonesia is a country that, despite a small [base] budget, they’re greatly increasing their defense budget largely due to a relatively healthy
Spending in the Middle East will also continue to be on the rise, though at a slower rate than past years, said a report released by Forecast International in February. Darling, who authored the report, projected a 14 percent spending increase from 2013 to 2017. Saudi Arabia, Israel, Iraq and the United Arab Emirates will be the region’s top buyers, responsible for two-thirds of expenditures.
Although the Middle East, especially Iraq, has huge growth potential, the political situation could shake up how much defense spending its citizens permit.
“The question is, will the growth in the Middle East continue if, due to political tensions, greater portions of the budget are used for other purposes?” Hensel said. “You saw this particularly during the Arab Spring with Saudi Arabia and how it had to enact certain reforms in an effort to make the populace more content.”
For this reason, there are already fewer opportunities to sell to Egypt and Bahrain, Darling said.
Many countries, such as Saudi Arabia and the United Arab Emirates, will likely continue to spend a large part of their gross domestic products on defense. “These have been markets that have been successful for U.S. defense contractors,” Hensel said.
The UAE is likely to maintain defense spending in part because offset agreements — in which some of the work is done in-country — increase employment and help diversify its oil-based economy, she said.
Although Saudi Arabia has already contracted for many of its armored vehicle and aircraft needs, the country is examining how best to modernize its navy and could soon be in need of new ships or maritime technologies, Darling said.
Iraq is rebuilding its entire military and will especially be on the lookout for new air-defense and air-superiority technologies, he said. The country wants a fleet of 96 fighter jets, but so far has only bought a total of 36 F-16s, leaving open the possibility for more purchases. It could also seek out surface-to-air missile systems and howitzers, he said.
Since peaking in 2008, defense spending in Europe has declined by about $127 billion, a 34-percent reduction. Forecast International predicts European defense expenditures will remain flat for the next five years.
European nations will continue purchasing, but at a much lower volume, Darling said. With its own industrial base feeling the pain of decreased budgets, European Union countries will most likely support domestic manufacturers.
“That would narrow the opportunities for outside countries to penetrate those markets unless it’s an off-the-shelf procurement, something they immediately need and simply don’t have the technology harnessed, which in a lot of cases would be UAVs,” he said.
Hensel agreed that the European market likely will weaken. To save money going forward, countries may collaborate on joint purchases or training. For instance, the European Union is offering a $132.7 million incentive to countries that launch a joint UAV program.
“The drawback on this is that sometimes this can work very slowly, and we’ve already seen some stalling among the EU countries in the bilateral talks between the U.K. and France on the medium-altitude, long-endurance UAV program,” she said.
Topics: Business Trends, International