Anticipating Restructuring in the European Defence Industry

Anticipating restructuring in the European defence industry

Overview of the study coordinated by Dr. E. Waelbroeck-Rocha at BIPE, with contributions from Professor Dr. H. Wulf, Dr. P. Wilke, Mr. O. Bergstrom, Mr. D. Sellier, Mr. F. Bruggeman and J. Ganczewski

December 13&14, 2007

Developments during the past decade and present industry structure Defining the defence industry Overview of demand trends: budgets, procurement, R&D expenditure, trade, competitiveness and market access conditions Trend in employment Organisation of supply and changes therein: activities covered, key European defence producers, production location and country specialisations, trend in M&A, ownership structure, cross-border collaboration Challenges Outlook Key factors influencing the future Possible future scenarios Anticipating change: examples of innovative practices

The defence sector is not a clearly defined industrial branch: In the literature, “defence” companies are said to produce “weapon systems”, “defence products”, “military equipment”, “arms” or “dual- use goods”, as well as components of these products and associated services The term “dual-use” indicates that the defence sector borders with other sectors (civil aviation, vehicles, ship building, electronics, IT and others) As illustrated on the next page, companies can be prime contractors (lead system integrators, platform producers and producers of weapon systems), sub-contractors (producers of sub-systems or major components) and third tier contractors (producers of components), usually SMEs, often producing dual-use goods SMEs involved in defence produce small arms and ammunitions, low calibre artillery, military vehicles, small ships, military electronics, subsystems for weapons and components Many defence producers – mainly large but also some small - are involved at several levels of the supply chain

LEAD SYSTEM INTEGRATORS

Aeronautics Space & missiles Land defence Naval industry System developers System developers System developers System developers Prime and platform and platform and platform and platform contractors assemblers assemblers assemblers assemblers

Engines / propulsion manufacturers

Tier 1 Specialised systems producers Complete sub-systems contractors (electronics, …) producers & assemblers

Tier 2 Electrical & electronic Mechanical Metal working, Etc… contractors equipment engineering casts & moulds

Tier 3 Commodity General service Basic economic contractors suppliers suppliers infrastructure

Prime contractors produce weapon systems: These are mainly large companies specialised on defence production and services Some are Lead System Integrators, i.e. assemble defence systems from several defence domains (ex: aircraft carrier), others are specialised in only one area (aerospace for example) Examples in the EU are BAE Systems (UK), EADS (Netherlands), Thales (France) and Finmeccanica (Italy), the later specialised in helicopters and armoured vehicles, and Saab (Sweden) for fighter aircraft, Nexter (France) and Krauss-Maffei-Wegmann (Germany) in major battle tanks, Thyssen Krupp (Germany), Fincantieri (Italy) and DCNS (France) in naval vessels. Tier 1 contractors produce complete sub-systems or major components. Often, these are also risk sharing partners: These are often specialized firms (engines, electronics,…), subcontracted by the prime contractors. Examples are Rolls Royce (UK), Groupe Safran (France), MTU (Germany) and Indra (Spain) Tier 2 contractors produce components and supply services Usually small and medium enterprises (SME) or subsidiaries of the major defence producers (prime contractors and sub-contractors), these often produce dual-use goods or services These companies are not always listed as defence producers since they operate at the margin of the defence sector Tier 3 contractors are commodity suppliers or supply generalist services. This level also includes all providers of « general economic infrastructure » services (transport © BIPE 2007 network and services, communications, externalised training, etc.) 5 Final report overview Many sectors and sub-sectors are involved along the supply chain. Some are highly specialised, others are commodity producers

The example of an aeronautics cluster

Assemblage et Composants PRODUITS Rénovation Entretien Construction aéronautiques (Niveau 6) maintenance SERVICES CLES aéronautique Pompes, Fabrication de Robots, Equip. électriques Equipement de MACHINES ET Compresseur, levage moteurs et turbines Syst. hydrauliques Machines outils et électroniques manutention EQUIPEMENTS Fabrication et Transformation de Fabrication Fabrication de Injection de PRODUITS rechapage de matières plastiques de verre plat et de Céramiques pneumatiques fibres de verre avancées plastiques INTERMEDIAIRES Peintures, Produits Huiles, Cables, tuyaux, Colles, adhésifs Vernis d’entretien Lubrifiants Petit matériel

Caoutchouc Industrie textile/ Production des Matériaux INDUSTRIES Naturel et confection Industrie du bois Plastiques de base d’emballage DE BASE synthétique Forge, Laminage, Aluminium Métaux ferreux emboutissage, Profilage, Ferro-alliages estampage tréfilage

Services de Services aux INDUSTRIES ET Bureaux d’étude Logistique SERVICES DE transport entreprises SUPPORT Services Marketing/ Design, R&D Distribution aéroportuaires Publicité transport Services financiers

INFRASTRUCTURE Universités, Fédérations ÉCONOMIQUE DE Infrastructures de Laboratoires de Evironnement Transport centres de professionnelles, institutionnel BASE formation recherche syndicats

« Risk- and revenue-sharing » is a system whereby the development costs of new systems or equipments is distributed across the prime contractor and its « partners » Under this system, prime contractors delegate the responsibility for conceptualising, designing, developing and producing the new system, as well as the responsibility for financing the development costs The associated expenditures are, by nature, investment costs, yet in accounting terms these are considered to be operating costs (there are activation methods) The costs are paid back by the prime contractor to the risk-sharing partners as sales are realised: the partnership, therefore, also implies commercial risk sharing For the partner, the depreciation (and reimbursement) of expenses is therefore uncertain, both in terms of the amount of pay-back and in terms of the duration of the financing For major defence projects, development costs are typically financed by Governments

European: Changing role of force Î new demand mix Stagnant or declining overall defence budgets within the EU Shrinking national defence procurement Comparatively low spending on R&D

Global: Lack of dynamism of world market demand Difficult entry conditions in the more dynamic markets

The past trend in military expenditures has shaped the present structure of the European defence industry and the restructuring process that took place during the last decade and a half in the EU: As a result of the ‘peace dividend’ in the first half of the 1990s, the defence industry suffered from the reduction of procurement orders (both national procurement as well as arms exports). World military expenditure decreased from a total of over 1 trillion US $ at the end of the Cold War to less than 800 billion US $ in the mid 1990s The eastern European countries also suffered from the break-up of the Warsay Treaty After an adjustment period, world military budgets have constantly increased. They reached 1.2 trillion US $ in 2006. Combined EU MS’ military expenditures amount to below €200 billion annually, of which more than €80 billion worth of procurement, R&D and maintenance expenditure In contrast to the United States, procurement expenditure in the EU has remained fairly stable in recent years. The increase of procurement budgets in Europe between 2000 and 2006 was minimal The US military budget amounts to US $550 billion, more than double the combined defence budget of the 27 EU countries

in billion US $ (constant) 1200

1000

800

600 World total EU 400

200

0 1985 1990 1995 2000 2006

Source: SIPRI

in billion US $ (2005 prices and exchange rates)

140

120

100

40 Note: NATO-Europe is not a 20 single entity, hence the 0 trend illustrated reflects 2000 2001 2002 2003 2004 2005 2006 the sum of national Source: SIPRI budgets

USA NATO-Europe

Budget share of world Defence expenditure total defence budgets per capita (in US$) US 47% 1 383

EU 22% 425

Rest of the world (165 countries, including 31% China, Russia, India and Japan)

Possible trend in the EU-27 total defence budgets between 2006 and 2015, in billion € at constant 2006 prices 300

+ 2,0% s t share 250 budge fence tant de + 0,5% on cons Based 200 Based on trend-defence budget shares

150

100

- 2006 2015 Source: national statistics, BIPE forecast © BIPE 2007 14 Final report overview The defence budget shares currently vary susbstantially across the EU-27

Defence budget as a % of GDP per country, in 2006 and two assumptions for 2015

4.5

3.5

2.5

1.5

0.5

a d a s n y ia y s ia a ce nia lic r n u ain um lt om n ari TAL Italy lan b an ania p i str urg eece d g O o vaki atvia and nland S g Ma Gr ng Fra T ma P lo L rm i mb Ireland Bul erl Swede Esto F Cypr ithu Bel Au Ki Portugal Ro Denmark S th HungaSlovenia Ge L d Luxe te ech Repu Ne Uni Cz Source: national statistics, BIPE forecast

© BIPE 2007 Share of GDP in 2006 Share of GDP in 2015 - no change Share of GDP in 2015 - trend growth in budget 15 Final report overview At best, the defence budgets will amount to 255 billion € in 2015, at 2006 prices

By 2015, depending on the trends in national budget spending, the share of expenditures on defence will be between 1.6% and 2.1% of total EU-27 GDP This is equivalent to an annual growth of total defence budgets between 0.5% and 2% in real terms The total value of 2015 budget at 2006 prices will at most be 250 billion € A figure of 221 billion €, barely 5% above the 2006 level in real terms, is, however, also possible

RTD expenditures are an investment into the future R&T expenditures are a subset of R&D spent which apply to expenditure for basic research, applied research and technology demonstration for defence purposes In 2005, the EU countries spent approximately € 2.2 billion on defence RTD. In 2006, the figure increased to € 2.5 billion This amounts to one-sixth of the US RTD expenditure on defence On average, the EU Member States allocate 1.14% of their military budget to RTD expenditures, compared with 3.31% in the United States

Source: EDA

Note that the EU is not a single entity but composed of 27 separate markets – which increases the gap with the USA

European companies play a major role in world trade: combined EU exports of all MS (before correction for intra-EU trade) presently account for close to 25/% of the world total The global arms trade dropped considerably after the end of the Cold War The western European countries were not affected to the same extent as other producers, especially from the former Soviet Union and eastern Europe. The latter countries suffered both from the decline in world trade and from the collapse of the Warsaw Pact Total arms transfers fluctuated in the mid 1990s and early 2000s. Since 2002, the trend is again clearly upward oriented. Based on official sources1, the value of arms exports was over 15 billion US $ in 2005 (the last year of reporting).

1: EU Member States governments © BIPE 2007 20 Final report overview Trends in arms exports by the main EU producing countries (Germany, France, UK, Netherlands, Italy, Sweden, Spain)

SIPRI trend indicator, in million US $ (major conventional weapons only) 40

25 global 20 EU 15

5 Note: the EU is not a single entity. EU 0 data applies to the sum of country 2 4 9 0 9 0 figures 1988 1990 1 1994 1996 1998 2000 2002 2 2006 SIPRI data refer to actual deliveries, allowing for comparisons between transfers of different weapons. SIPRI uses a trend-indicator value and not the actual financial value of a transfer.

10% 30% USA Rus s ia 31% EU Others

29%

The shares in world markets (including sale of used weapons) of the US, Russia and the EU Member States are of comparable size

In million € 2004 2005 2006

France 6952 3711 3978

UK* 2975 3016 2384

Germany 1129 1630 1164

Sweden 780 925 1129

Netherlands 406 682 808

Spain 624 419 845

Italy 480 831 970

EU total 9938 8912 9555

Source: Official Journal of the EU: 7th, 8th and 9th Annual Report on Arms Exports •For the UK = value of licenses; all others : value of exports •http://www.consilium.europa.eu/cms3_fo/showPage.asp?id=408&lang=en&mode=g#exp4

One indication of the relative competitiveness of EU-based defence producers is the origin of imports of major equipment An analysis of the origin of imports of three categories of major conventional weapons (naval vessels, combat aircraft and major battle tanks) shows that US companies have a technological dominance in certain areas of the defence sector, but not in all The European Defence Technology Industrial Base (EDTIB) seeks to address some of those concerns It is not only the technological dominance of the US industry which is responsible for the imbalance in transatlantic trade. It is also due to trade restrictions in the United States (US Buy America Act) which make entry into the largest defence market of the world difficult for foreign firms The US dominance is also reflected in the fact that European companies have captured only a small margin of the US procurement market, while US companies won about one quarter of the European market

Naval Vessels Combat Aircraft Major Battle Tanks

EU EU EU 2 Non-EU Non-EU Non-EU 52 8 9 779 102

From 2001 to 2006, more than half of the imported naval vessels (national production not included), two-thirds of all imported combat aircraft and only 2 of a total of 781 major battle tanks were imported from non-EU countries.

A range of political and legal guidelines have been designed, and institutions founded, to improve coordination, internationalise procurement and encourage competition: In 1991, the Maastricht Treaty laid the ground for an Intergovernmental Arms Agency, OCCAR was created More recently, the EDA has been formed The joint efforts to coordinate procurement, increase competition and overcome protectionism have included, among others: the Letter of Intent (LoI), the Framework Agreement, the Harmonisation of Military Requirements (HMR), the European Headline Goals the creation of a joint 55 million € Joint Investment Programme on Force Protection The Code of Conduct to establish a voluntary, non-binding intergovernmental regime However, despite all efforts, one is far from a Single European Defence Market Still less than one fifths of procurement is spent in collaboration projects in which at least two EU members participate.

Article 296 TEC allows Member States to derogate from Internal Market rules when their essential security interests are at stake: Article 296(1)(b) allows for measures "connected with the production of or trade in arms, munitions and war material", specified in a list. According to a court ruling Article 296(1)(b) TEC "is not intended to apply to activities relating to products other than the military products identified on [that] list". As a result, Europe's defence sector remains fragmented at national level, with 27 different customers and 27 different regulatory frameworks. Article 296 creates extra costs and inefficiencies, and thus has a negative impact on the competitiveness of Europe's Defence Industrial and Technological Base as well as on Member States' efforts to equip their armed forces adequately.

Part of employment Direct employment Direct employment in tier 2 contractors, in prime contractors, in tier 1 contractors, linked to the exclusively exclusively related to defence contracts related to defence activities defence activities Other Direct employment employment Direct employment in tier 1 contractors, in tier 2 in prime contractors, In civilian activities contractors In civilian activities

Indirect employment = employment in related (tier 3 and higher) industries

In 2003, the direct employment in defence industries in the EU-27 was estimated at approximately 750,000 employees, less than half the employment level at the end of the Cold War (1.5 million in 1993) The ASD estimates total employment in aerospace (incl. civilian aeronautics), and defence at 594 000 in the EU-27 in 2005. This, however, mainly covers the prime and tier 1 contractors. In the Defence Communication, the EC quotes 300,000 employees, based on the ASD estimate, of which 98 000 are employed in land defence industries; 63,000 in the naval industries and 150 000 in military aeronautics industries Bottom-up calculations indicate that the above numbers underestimate employment in subcontractor and related industries. For example: In the UK, official figures indicate 170 000 direct jobs in defence industries, plus 140 000 indirect jobs, totalling 310 000 jobs in 2005 In the Midi-Pyrénées region of France, there are more than 1,000 industrial SMEs working as subcontractors. Of the 94 000 jobs in the region, 50 000 are subcontracted jobs. In the Navantia shipyard (Ferrol), in Spain, there are 2 500 jobs in companies subcontracted by Navantia, which itself counts 5,560 jobs in 2005, a ratio of 1 to 2.

The next side shows the estimated number of jobs directly or indirectly concerned by trends in the defence industry. The figures are bottom-up estimates and subject to revisions, given the difficulty in allocating employment between defence and civilian activities within a given company In summary, one estimates that there are approximately 405 000 jobs in prime and tier 1 defence companies that are directly involved in the production of defence industry products, and 418 000 jobs in the civilan part of the prime and tier 1 companies. There is likely to be another 350 000 jobs in tier 2 companies, i.e. working on the production of goods and services used by Tier 1 and prime contractors, and close to 470 000 additional employments in related industries (essentially commodity goods and services producers). In total, 1 644 000 persons are concerned, directly or indirectly, by trends in defence markets and European defence production Use of I-O tables indicates an average employment multiplier of 0.45 in equipment goods producing industries, used to estimate the employment estimate in Tier 2 and higher companies Tier 2 employment directly related to defence production is based on an multiplier of 0.4, and that in civilian activites of 0.45. The figure are consistent with estimates for France and the UK. © BIPE 2007 31 Final report overview Estimated employment by type of activity in EU-27

Employment Direct employment Direct employment in tier 2 contractors, in tier 1 contractors, in prime contractors, linked to defence: defence only: defence only: 162 000 193 500 211 500 Other Direct employment employment Direct employment in tier 1 contractors, in tier 2 in prime contractors’ in civil production: Contractors: civil production: 256 500 188 000 160 700

Indirect employment = employment in related (tier 3 and higher) industries 470 000

Based on the BICC data, the decline in employment was particularly pronounced in the second half of the 1990s. The process has slowed down considerably in recent years: reductions are now due to efficiency gains in the production process Different groups of countries can be distinguished: 1st block : relatively stable employment levels between 1993- 2003 y Greece, Finland, Denmark 2d block: major drop in employment between 1993-1998, followed by further reductions between 1998 and 2003 y This block includes the LoI countries (except Sweden), plus Belgium 3d block: continuous reduction in employment throughout the period: y In the eastern European countries, employment in the defence industries decreased in the range of 50-90 % y Poland, Slovakia and Estonia were the worst hit

France Greece 100 United Kingdom 90 Finland 80 Germany 70 Denmark 60 Italy 50 40 Austria 30 Spain 20 10 1993 Portugal 0 Sweden 1998 2003

Netherlands Belgium

Poland Bulgaria

Slovakia Romania Estonia Hungary Czech Republic

Estimated workforce, in thousands 1993 1998 2003 1993 1998 2003

France 345 266 240 Estonia 60 25 10

United 380 280 200 Finland 10 10 10 Kingdom Netherlands 18 10 10 Germany 160 95 80 Slovakia 75 20 7 Poland 120 70 50 Belgium 15 8 6 Italy 50 35 26 Portugal 9 5 5 Sweden 34 26 25 Denmark 5 5 5 Bulgaria 75 27 25 Austria 4 3 3 Spain 50 25 20 Hungary 7 2 2 Romania 60 26 18 1522 971 772 Czech Republic 30 18 15 n. a.: Cyprus, Ireland, Malta, Latvia, Lithuania, Luxemburg, Greece 15 15 15 Slovenia

* All countries listed are members of the EU in 2007. Source: BICC Conversion Survey 2005, pp. 167-168

Employment in UK defence industries, in thousand

1997/98 2000/01 2001/02 2002/03 2003/04 2004/05 Total 340 300 295 305 315 310 employment: Direct 160 155 155 165 170 170 Indirect 180 145 140 140 145 140 Employment from MoD equipment expenditure: 145 135 140 160 155 150

Direct 70 70 75 85 85 80 Indirect 75 65 65 75 70 70 Employment from MoD Non- equipment expenditure: 95 95 95 85 95 90

Direct 50 55 55 50 55 55 EmploymentIndirect 45 40 40 35 40 35 from defence exports: 110 70 60 60 65 65 Source: MoD/DASA (2006). Defence Statistics 2006, Direct 45 30 30 30 30 35 TSO, London © BIPE 2007 Indirect 65 35 30 30 30 35 36 Final report overview In most countries, the fall in employment in defence industries was much more pronounced that that of total manufacturing employment

Trend in employment in France – 1993 = 100 110

100

Defence Industry in France Metal-working industries in France Industry total (excl. Energy) 80

60 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Skill shortages are starting to develop in the eastern European countries, due to ageing of the workforce and emigration patterns The age structure of workers in industry is skewed to the right, as for other manufacturing sectors: there will be a high number of departures for retirement The defence sector employs a comparatively high share of technical and high-skills level, which are also in short supply due to overall socio-demographic changes and relative lack of attractiveness of industrial sectors compared to services

% of workforce 35%

30% Engineers & white collar 25% workers

20% Total salaried employment

15% Blue-collar 10% workers 5%

0% 0-25 25-35 35-45 45-55 55-65

Source: based on the Labour Force Surveys, INSEE © BIPE 2007 39 Final report overview Defence industries employ personnel with comparatively high skill levels

Composition of employment in aeronautics and defence, by skill level

Graduates, engineers, managers etc.; 28% Others; 34%

Manual workers; 38%

Source: ASD

The large variety, high technicity and rapidly rising production cost of defence equipment and systems The dominance of (often national) champions, highly dependent on trends in national procurement budgets The high dependence of certain regions on defence activities The transition phase which the industry in eastern Europe is going through (Past and future) M & A patterns The growing concentration of the industry The particular ownership structure (with governments as major shareholder in France and Italy) Mixed experiences with cooperation

The defence sector is very diverse The companies are engaged in the production of: small arms/ammunition artillery aircrafts electronics engines missiles military vehicles ships space services (incl. support, training, …) Etc. … plus all the inputs (products and services) and equipments (machinery, buildings, infrastructure) that are used at some stage during the production process

There are 30 EU based companies amongst the top 100 arms producing companies in the world (excluding Chinese companies) With a turnover of approximately US $ 84 billion in 2005, the 30 largest EU companies accounted for 29% of the total turnover of about US $ 290 billion of the top 100 companies. Among the top 10 arms producing companies there are four EU-based companies: BAE Systems (UK), Finmeccanica (Italy), EADS (headquartered in The Netherlands) and Thales (France).

Ranking in top 100 Number of EU- based companies 1 – 10 4 11 – 25 5 26 – 50 6 51 – 100 15

The top 100 arms producing companies in the Share of turnover, in % world (excluding Chinese companies) have 8% had an annual turnover (arms production and arms exports) in 2005 of about US $ 290 billion. 29%

63% Among these major arms producing companies are 30 EU based companies, with USA EU a turnover of approximately US $ 84 billion or Others 29% of the total of these top 100 companies.

BAE Systems Finmeccanica EADS Thales DCNS Rolls Royce SAFRAN Dassault Saab Rheinmetall

020406080100

Defence sales 2005 - Source SIPRI

Among the top ten EU defence producers, only DCNS has no civil production; the other companies (BAE Systems, Finmeccanica, Thales, Dassault and Saab) have a share of defence production of over 50%.

Two principal conclusions can be drawn from company statistics: (1) EU based defence production is of global importance (2) The high percentage of arms sales of the 40 US companies (63% of the total) highlights the US dominance in the defence sector. In addition to the major defence producers, there are literally hundreds of companies engaged in defence production, with location throughout the EU

(Sweden) 2,110 m.$

(UK) 34,980 m.$

(Netherland) 14,620 m.$ (Germany) 6,520 m.$

(France) 25,870 m.$

(Italy) 18,240 m.$ (Spain) 1,640 m.$

©Source: BIPE 2007 SIPRI Data base weiter49 Final report overview BAE SYSTEMS 23230 Major Arms Producing Rolls Royce 3470

QinetiQ 1550 Companies in the UK Smiths 1450 arms sales of top companies, m. US$ VT Group 1170

Cobham 1010

Devonport Management (KBR) 800

GKN 740

Babcock International Group 610

Ultra Electronics 490

Meggitt 460

34,980

Military expenditure in the UK (in million US $ at constant 2005 prices and exchange rates) 1997 2002 2006 Share of GDP in 2006

48276 50949 59213 2.7 %

Defence Industry Employment in the UK (1993 – 2003)* workforce in thousands 1993 1998 2003

380 280 200

SAFRAN (consolidated, March 2006) 2707 Companies in France Dassault Aviation Groupe 2210 arms sales of top companies, m. US$ Eurocopter Group (EADS) 2120

CEA 1710

Nexter Industries (formerly GIAT) 910

SMA (SAFRAN) 410

Areva (CEA) 380

Military expenditure in France (in million US $ at constant 2005 prices and exchange rates) 1997 2002 2006 Share of GDP in 2006

51926 51257 53091 2.5 %

25,870

Defence Industry Employment in France (1993 – 2003)* workforce in thousands 1993 1998 2003

345 266 240

29781 34459 29891 1.9 %

Defence Industry Employment in Italy Major Arms Producing (1993 – 2003)* workforce in thousands 1993 1998 2003 Companies in Italy arms sales of top companies, m. US$ 50 35 26 Finmeccanica 9800

Agusta Westland (Finmeccanica) 2850

Selex Sensors & Airborne Systems (Finmeccanica) 1380

Alenia Aeronautica (Finmeccanica) 1120

Selex Communications (Finmeccanica) 680

Fincantieri 610

Avio 530

Selex Sistemi Integrati (Finmeccanica) 470

MBDA Italia (MBDA Europe) 410

Oto Melara (Finmeccanica) 390 18,240

MBDA (BAE Systems, UK/EADS, W. Eur.,/Finmeccanica, Italy) 4080

EADS Space (EADS, Netherlands) 960

Military expenditure in the Netherlands (in million US $ at constant 2005 prices and 14,620 exchange rates) 1997 2002 2006 Share of GDP in 2006

9147 9344 9751 1.5 %

Defence Industry Employment in the Netherlands (1993 – 2003)* workforce in thousands

1993 1998 2003

18 10 10

ThyssenKrupp 1240

Krauss-Maffei Wegmann 750

Diehl 720

MTU Aero Engines 610

DaimlerChrysler, DC 500

MTU Friedrichshafen (DC) 500

MAN 460

6,520

Military expenditure in Germany (in million US $ at constant 2005 prices and exchange rates) 1997 2002 2006 Share of GDP in 2006

40854 40604 36984 1.4 %

Defence Industry Employment in Germany (1993 – 2003)* workforce in thousands 1993 1998 2003

160 95 80 © BIPE 2007 back54 Final report overview Military expenditure in Spain (in million US $ at constant 2005 prices and exchange rates) 1997 2002 2006 Share of GDP in 2006

10599 11483 12328 1.1 %

Defence Industry Employment in Spain (1993 – 2003)* workforce in thousands 1993 1998 2003

50 25 20

Major Arms Producing Companies in Spain arms sales of top companies, m. US$

Navantia 970

Indra 670

1,640

Saab 2110

2,110

Military expenditure in Sweden (in million US $ at constant 2005 prices and exchange rates) 1997 2002 2006 Share of GDP in 2006

5780 5833 5271 1.5 %

Defence Industry Employment in Sweden (1993 – 2003)* workforce in thousands 1993 1998 2003

34 26 25

Defence industries in the eastern European countries have distinct features Before 1990, defence industries in EE countries were direct elements of military strategy of the Warsaw Treaty, The location of production and tasks of the individual producers, factories and industries were defined in the frame of the Warsaw Treaty’s military strategy This resulted in a high level of country specialisation in the production of elements of final products and systems, divided and distributed across factories and countries Economic factors and market aspects did not play a primarily role

Since the, the main problems of defence industries in the eastern European member states have been: difficulties in adapting to the new political and economic context after the break-up of the Warsaw Treaty lack of internal EE countries experience in conducting restructuring and privatisation changes on such large scale the consequences of actions by international competitors perceived at attempting to eliminate potential internal and international competition The restructuring process is not yet completed. The eastern European countries’ defence industries are still in “transformation shock”

The Polish defence industry was the most important producer amongst the EE countries All the factors previously mentioned influenced the present situation of the Polish defence industry Employment in the sector decreased by approximately 60% during the 1990s The first years of restructuring and the privatisation process led to important decreases in production, increased unemployment and social problems As elsewhere, the restructuring and privatisation process is not completed: Over the past years, several future industry concepts and organisation structures were evaluated by various industrial and professional organisations, and by administrative bodies Discussions led to the recent publication of the Strategy of consolidation and support of development of Polish defence industry in 2007-2012, approved by the Polish government on 31.08.2007.

The objectives are to: Ensure that the state security requirements in the sphere of armament, army equipment and weapons defined within the framework of the national security strategy and taking into account EU membership obligations, can be met Secure the participation of the national defence industry in R&D programs Increase exports to the world markets, and achieve a significant position in the future European defence industry

In the short term, this implies the following objectives: adjusting defence production capacity and R&D work to national and export potential Increasing the diversity of supply of modern army equipment and weapons Financial and technological reinforcement of the defence industry Strengthening the position of Polish producers on internal and international markets as well as in relation with financial institutions Modernizing the technology and the defence products Co-ordinated policies with respect to defence R&D work Moving up the value added chain (increasing the value of defence industry exports) Co-ordination of commercial and marketing activities, Rationalisation of production costs Stabilising employment

Target export value between 360 to 520 million € Value of R&D work : between 125-130 million € Target share of deliveries of army equipment and weapons produced in Poland in total purchases by the Polish Ministry of Defence : 59% in 2006, coming down to 34% in 2012. The decrease is due to the execution of international agreements on deliveries already signed by the Ministry Increase in the number of factories consolidated within the frame of BUMAR GROUP (the national champion) : from 15 entities at present to 36 by 2012. This denotes a strong consolidation trend.

The size and diversification of the defence industry in the EU is clearly a reflection of the size of the military budgets: The United Kingdom has the largest defence budget among the EU countries, closely followed by France In Germany, the third largest spender on defence in the EU, the budget is considerably smaller The fourth largest spender is Italy These four countries account for two thirds of the EU’s defence budgets

Many small and mediums sized companies are engaged in defence production, both in the main producing countries and in other EU countries such as Austria, Belgium, Czech Republic, Denmark, Finland, Greece, Poland and Portugal These companies produce small arms and ammunition, low calibre artillery, military vehicles, small ships, military electronics, and subsystems for weapons and components. Often they are not classified as defence producers since they are usually diversified companies with non-defence (dual-) production. A similar pattern of concentration as with the largest defence producers appears in the regional distribution of the different defence sectors in Europe. The four top producing countries, UK, France, Italy and Germany, are the home base for companies from all sectors of defence: small arms/ammunition; artillery; aircraft; engines; electronics; military vehicles; missiles and ships. However, a large number of SME are engaged in all sectors of defence production; they operate from countries across the EU.

The example of the helicopter production sites of Eurocopter and Agusta Westland illustrates the diversity and distribution of production sites and employment.

Source: Fondation pour la Recherche Stratégique

A general process of consolidation is under way: In contrast to other industrial branches, M&As took place primarily at national level during the early 1990s. National champions were formed in several EU countries. Typical of this process of consolidation largely along national lines in the EU, is the land defence sector, as well as naval industry. Acquisition activity has recently accelerated in the EU, at a time when it has slowed down in the United States. The primary reason for the acquisition of defence companies during the early phase in the 1990s was their uncertain future as a result of the end of the Cold War and the reduced budgets. In the US, the consolidation process started earlier. Wall Street played an instrumental role in the restructuring process. Big companies (Northrop Grumman and Lockheed Martin) were formed.

As a result of mergers and acquisitions along national lines, the leading producers offer equipment that is not necessarily standardised, since each pursues its own technology lines. There are too many and too small companies to survive. For example, after the commercial failure of the Leclerc tank and drastic reduction in orders by the French government, GIAT (France) cut its staff by 85% over 15 years (from 18,000 employees in 1990 to 2500 in 2006). The situation, which had become a financial disaster for the state, was sorted out in 2006. Some European states are turning to foreign countries to satisfy their munitions needs. Financial difficulties of firms has allowed U.S. industry and financial investors to acquire several outstanding companies of the ground weapons industry at low prices (Bofors, Mowag, Santa Barbara).

The first European corporations were formed during the second half of the 1990s. Typical examples are: EADS = Aérospatiale-Matra, DASA, CASA and a number of smaller companies. The merger was made possible by an agreement between the French and German governments, which encouraged the merger Thales = Thomson CSF, Racal, Signaal in addition to a number of companies from the US, UK, Canada, South Korea, South Africa, Australia, Brazil and West European countries: this is a model of growth through acquisition BAE followed a different approach, centered on the US market It is of interest that not only companies based in the EU were acquired, but from a wide range of countries.

1985 1986 1987 1988 1989 1990 199 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Matra Haute Technologie (France) 1 Aerospatiale (France)

Aerospatiale Matra (France)

Siemens Defence Electronics (Germany) MBB/Germany AEG/Germany Dornier/Germany MTU/Germany

DASA (Germany)

CASA (Spain)

EADS

Patria Industries, 27 % (Finland) Astrium (UK) Siemens Unit (Germany) Racal Instruments (USA) Nokias professional mobile radio buisness (Finnland)

Source: SIPRI Yearbook 2006

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 TDA Amemenis (Western Europe) Arieem (France) Racal (UK) Samsung Electronics detence unit, 50 % (South Korea) Pillington Optronics, 10 % (UK) Shorts Missiles Systems (Canada) ADI, 50 % (Australia) African Defense Systems (South Africa) Sextant in-Flight Systems (USA) Avimo, 25 % (UK) Embraer, 6% (Brazil) Pilkington Opironica, 40 % (UK) Dassault Electronique (France) Aerosperlic´s military electronics units (France) Sectant Avionique, 50 % (France) Signaal HSA (Netherlands) Pilkington Opironics, 50 % (UK) Link-Miles (UK) Radilon MEL (UK) Wiloc Electric (USA) GE/RCA (USA)

Thomson SA Thales

Source: SIPRI Yearbook 2006

BAE Systems (UK) chose a different approach: The company pursued a strategy of a forceful entry into the US defence market by acquiring US defence producing companies. BAE Systems now employs 35,000 people in the United Sates. By far the largest acquisition in the defence sector in 2005 was that of United Defence (USA) by BAE Systems, a deal worth US $ 4192 million. This was the largest acquisition of a US defence company by a non-US buyer. As a result, this British company is now the sixth-largest contractor of the US Department of Defence

One should, however, note that BAE is a defence specialist ,whereas EADS and Boeing have a mix of military and civil business

1977 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Siemens Plessey Systems (Germany) Saab, 35 % (Sweden) BAeSEMA (UK) STN Atlas Elekt., 49 % (Germany) LFK, 15 % (Germany) AWADI (Australia) Y British Aircraft Corp. (UK) Heckler & Koch (Germany, divested in 2002) Hawker Siddeley Av. (UK) Roval Ordnance (UK) Hawker Siddeley Dy. (UK) Reflectone (UK) Scottisch Avierlion (UK) SD-Scicon (UK)

British Aerospace BAE Systems

Marconi Electronic Systems (UK) Lockheed Martin Control Systems (USA) Lockheed Martin AES (USA) Watkins Johnson (USA) Ferntornierics (USA) Condor Pacifics (USA) Piper Group (UK) Advanced Power Tech. (USA) MEVATEC (USA) Alphatech (USA) Commercials electronics unit of Boeing (USA) Digital Nierl Holdings (USA) Practical Imagineering (USA) Source: SIPRI YearbookSTI Government Systems 2006 (USA) Alvis (UK) © BIPE 2007 72 Final report overview Aerosystems International (UK) United Defense (USA) Four factors explain the acceleration in M&A activity in the 1990s

1. Governments in the EU have encouraged mergers in certain cases (EADS and its family of companies); in other cases governments try to prevent foreign (non- EU) investment. 2. There is a trend to invest in expanding sectors. This is particularly the case in areas which are affected by the outsourcing and privatisation strategies of traditional military functions, such as services, logistics, information technology and the so called network-centric programmes: to increase market shares, companies seek to acquired smaller specialized companies. 3. There is a desire of non-US companies to access the lucrative US market by acquiring US-producing companies. This has proved more successful than the direct export of military goods to the United States. The reverse process also takes place. US-based companies have been actively acquiring EU-based companies. 4. Private equity groups (financial investors) have begun to purchase defence producing companies. There are several outstanding examples. In 2005 the private equity group EQT (Sweden) bought MTU Friedrichshafen (Germany) from DaimlerChrysler (Germany). This transaction has been a source of political tension in Germany. It included also the Off-Highway Division of Detroit Diesel (USA) and was valued at approximately US $ 1.9 billion.

Buyer Company Acquired company Seller company Deal value (country/region) (country) (country) ($ m.)

Cinven (W. Europe) Avio (Italy) Carlyle Group (USA) 3 400

Kongsberg (Norway) Navtek (Norway) … …

Norwegian Governmen Nammo (Norway) Saab (Sweden) … and Patria (Finland)

Saab (Sweden) Ericsson Microwave Systems Ericsson (Sweden) 550 (Sweden)

Thales (France) Alcatel´s satellite unit (France) Alcatel (France) 825

VT Group (UK) Hotel and Catering Training Company ECI Partners (UK) 18 (UK)

VT Group (UK) Lex Vehicle Solutions (UK) RAC (UK) 156

QinetiQ (UK) Graphics Research (UK) … 2

Avio Group (Italy) Philips Aerospace Electronics Royal Philips (Netherlands) … (Netherlands)

EADS (W. Europe) Professional Mobile Radio business Nokia (Finland) …

Source: SIPRI Yearbooks 2006 and 2007 © BIPE 2007 74 Final report overview List of recent mergers within Western Europe (2)

Buyer Company Acquired company Seller company Deal value (country/region) (country) (country) ($ m.)

EQT (Sweden) MTU Friedrichshafen (Germany) and the DaimlerCrysler (Germany) 1 900 off-highway division of Detroit Diesel Corporation (USA)

Finmeccanica (Italy) Datamat SpA (Italy) … 171

Krauss-Maffei Wegmann (Germany) MAN-Mobile Bridges (Germany) MAN-Technologies (Germany) …

MBDA (W. Europe) LFK (Germany) EADS (W. Europe) …

Rheinmetall (Germany) Arges (Austria) … …

Smiths Group (UK) Farran Technology (Ireland) … 31

Snecma (France) Sagem (France) … …

Thales (France) TDA Armements (W. Europe) EADS (W. Europe) …

ThyssenKrupp Technologies Atlas Elektronik (Germany) BAE Systems 172 (Germany) and EADS (W. Europe)

Source: SIPRI Yearbooks 2006 and 2007

West European acquisitions of companies based in North America

Buyer Company Acquired company Seller company Deal value (country/region) (country) (country) ($ m.)

BAE Systems (UK) United Defense (USA) … 4 192

Chelton Microwave Corporation Defense & Space unit Remec. Inc. 260 (UK)

EADS (W. Europe) Talon Instruments … …

Kongsberg (Norway) Gallium Software (Canada) … 26

QinetiQ (UK) Apogen Technoligies (USA) … 288

QinetiQ (UK) Planning Systems Inc. (USA) … 42

Ultra Electronics (UK) Audiopack (USA) Privately held 60

VT Group (UK) Cube Corporation (USA) … 26

BAE Systems (UK) National Sensor Systems (USA) … 9

GKN (UK) Stellex Aerostructures (USA) Carlyle Group (USA) …

Meggit (UK) Firearms Training Systems … … (USA)

Rolls Royce (UK) Data Systems & Solutions SAIC (USA) 59 (USA)

ThyssenKrupp Service Alcoa´s Aerospace Service … … (Germany) Business (USA)

Source: SIPRI Yearbooks 2006 and 2007 © BIPE 2007 76 Final report overview List of transatlantic mergers (2)

North American acquisitions of West European-based companies

Buyer Company Acquired company Seller company Deal value (country/region) (country) (country) ($ m.)

Carlyle Group (USA) NP Aerospace (UK) Reinhold Industries (UK) 54

Eaton Corporation (USA) Aerospace fluid and air division Cobham (UK) 270

L-3 Communikations (USA) SAM Electronics (Germany) … 150

Lockheed Martin (USA) INSYS Group Limited (UK) … …

Rockwell Collins (USA) Teldix (Germany) Northrop Grumman (USA) 22

Stewart & Stevenson Automotive Technik (UK) … 47 Services (USA)

Esterline Technologics (USA) Wallop Defence Systems (UK) Cobham (UK) 59

Lockheed Martin (USA) HMT Vehicles (UK) Privately held …

L-3 Communications (USA) Advanced Systems Architectures … … (UK)

L-3 Communications (USA) Magnet-Motor (Germany) … …

L-3 Communications (USA) Nautronix Defence Group (UK) Nautronix Holdings (UK) 65

L-3 Communications (USA) TRL Electronics (UK) … 169

Source: SIPRI Yearbooks 2006 and 2007

© BIPE 2007 77 Final report overview As a result of the consolidation process, the degree of concentration has significantly increased 90 Share of arms’ sales of the top 100 defence producers 80 70 60 50 40 top 20 top 15 30 top 10 20 top 5 10 0 1990 1995 2000 2005 The result of this concentration process can also be seen in the turnover of companies. In 1990 the top 5 defence producing companies of the world accounted for 22% of the total arms sales of the top 100 companies. This figure has doubled now to exactly 44

This is the case in particular in France, Italy and Spain Elsewhere, governments are progressively reducing their stake in the defence companies Private funds have entered the sector US companies have also increased their presence in Europe through acquisitions

% CA Effectif 2006 Défense 2006 (*) 100% 12 459 100% 2 491

4 719 46,5% 4 296

50% 68 000

20% 61 357

25,4% 116 848

38% 12 086

(*) Etat: 75% à partir de début 2007 © BIPE 2007 80 Final report overview What will be the Fate of Public Ownership in Italy and Spain?

Source: Fondation pour la Recherche Stratégique

A few projects have been highly successful. However they have often been used to pursue national procurement or industrial aims. A few positive and negative examples are listed below. The juste retour principle, often applied in collaborative projects, leads to inefficiencies and higher cost, since the placement of a procurement orders is largely based on the percentage of finances in the project of the participating countries rather than selection of the most economic or technically most competent supplier.

Positive collaboration seems to happen: in helicopters with the NH 90 and Tiger, and with the Anglo- French helicopter package in missiles with the Meteor and, to a lesser extent, PAAMS in transport aircraft with the A400M in satellites with the Galileo

EADS/Eurocopter, EADS/Eurocopter Deutschland, Augusta (Italy) Fokker (Netherlands) and OGMA Portugal) cooperate in development and production.

Source: Fondation pour la Recherche Stratégique

Often, the stage of collaboration is not reached and national programs prevail The number of duplications (with higher cost and inefficiencies) of weapon systems is high: Four main battle tanks are being built, There are 16 national programmes for armoured fighting vehicles (AFV), Three combat aircraft programs are being pursued, despite heavy competition from the USA Duplications in development are particularly frequent in IT- and Command and Control Systems

The combat aircraft sector illustrates the failure in European cooperation. The lack of joint political will and the dominance of national ambitions lead to multiple programs (Gripen, Eurofighter, Rafale) and diffused R&D spending. The results are increased program costs, slipping deadlines, export sales difficulties.

Source: Fondation pour la Recherche Stratégique

The following slides present a summary of the situation across the key segments of defence industries: Aerospace Naval industry Land / ground forces y Of which: armoured vehicles y Of which : munitions Missiles and electronics

The aircraft/space industry is the most Europeanized industry segment. The consolidation process has taken place over many years and was accelerated by financial needs. However, looking at the non-military (Airbus, space) and the military sector (fighter aircraft, missiles, military electronics) it becomes clear that the civil part is more European than the defence part. Despite present problems in the structure of Airbus Industries and its production process, Airbus has established itself on the basis of reimbursable aid from the member states as a competitive producer of a family of civilian aircraft. The question is: can Airbus serve as a model?

There are some distinct differences in the arms ‘market’: defence is not really a market, products are essentially sold domestically by one supplier to one customer Governments are customers and shareholders in the enterprises economic considerations are often overruled by political interests (although this is to some extent the case in Airbus Industry as well) state protectionism has often favoured national programs the civilian aircraft market has constantly grown; defence has experienced fluctuations in demand

Source: Fondation pour la Recherche Stratégique

Although the naval sector is undergoing significant technological changes, the concentration process has largely proceeded along national lines : about two dozen shipyards are engaged in the design, development and production of military vessels. Four major groups of national champions have emerged in UK, France, Germany and Spain. In contrast to the United States, where vertical groups (integration of platform and systems producers) have been formed, the shipyards in Europe operate horizontally at the national level. Cooperative programs in the EU exist on bi- or tripartite levels (Fremm, CVF/PA2 and others). A typical example of a most recent national decision is the procurement of four frigates Type 125 in 2007 for a value of 2.6 billion € in Germany. A European solution, possibly along the lines of Airbus or EADS in the aerospace sector, is not on the agenda, neither is there a development of transnational programs which involve more than two or three countries.

Financial constraints might accelerate the need for consolidation This seems within the realm of possibility: not long ago, a joint British-French aircraft carrier – a symbol of the states’ sovereignty – would have been inconceivable Similarly, rationalisation is required to reduce overcapacities: The capabilities to develop and produce naval vessels are larger than actual demand. It is both difficult and costly to retain such facilities during gaps in development and production

ITALY National Champions Finmeccanica 100% Fincantieri FRANCE Technicatome SEMT Pielstick WASS

AMS Aker Yards Wärtsilä Schneider Jeumont UK Devonport Rolls-Royce DCN CMN Vosper Thornycroft Babcok Rosyth 100% MOPA2 37% 25% 50% Flagship TNF Armaris Training Fleet Support 37% 50% Thales Underwater 100% THALES BAE Systems Systems

100% 50%

50% ET E A D S Marinesystème

OEP GERMANY 25% 100% SWEDEN 35% ThyssenKrupp TKMS HDW Saab 75% 100% 100% Kochums Celsius

Preussag Atlas Electronics B&V NL Babcock Borsig 100%

Daimler-Chrysler Royal Schelde RDM TNN (Signaal) MTU Lürssen MAN SPAIN e INDRA systemas Abeking&Rasmussen Siemens l 100% SEPI d NAVANTIA

The structure of the producers of equipment for the ground forces is similar to the naval industry. Governments often opted for national solutions to retain advanced technologies in this sector, and secure jobs. The development and production on the national level of major battle tanks, armoured vehicles, artillery and small arms and ammunitions was affordable in large EU countries. There is a clear lack of Europeanization of industry and lack of cooperative projects. Procurement of armoured vehicles has slowed down in recent years and the industry is in economic difficulties. There are too many and too small companies to survive. Major companies exist in France, Germany (2), Italy and the UK.

USA United Defense

Sweden Bofors

Hägglunds

United Kingdom Alvis BAE Systems

GKN

Vickers

Royal Ordnance Krauss-Maffei VSEL Wegmann Germany Krauss Maffei

Wegmann Rheinmetall Landsysteme GmbH Rheinmetall

Thyssen Henschel

Krupp MAK

IWKA

KUKA

Austria Arges

France GIAT GIAT

Panhard

Italy Oto Melara Oto Melara Breda Meccania (Finmeccania)

Source: Fondation pour la Recherche Stratégique

Similar to the area of aerospace, the defence electronics and the missile/propulsion industry is more Europeanized Cross-border mergers and bi- and multilateral joint ventures have facilitated the Europeanization process

Dynamit Nobel SIG Arms International AG RUAG

49% Oerliken Contraves 100% 51% Rheinmetall Nitrochemie Wimmis

ITALY Diehl Stiftung&Co Taurus Systems

80% 67% Euromissile WASS Bodenseewerk 100% LFK 100% Otobreda GERMANY division 20% Europaams 37.5% ALLEMAGNE

100% E A D S 66% 33% Finmeccanica 33% 33% 100% Eurosam Euro- Art 33% Selex 25% Italie UKams

UK 37.5% MBDA 0% ASTRIUM 50% R.O. R.O. Roxel SAFRAN rocket THALES motor SAGEM 100% 50% CTA 50% 100% 50% BAE Systems NEXTER TDA RGR 33% 33% THALES UK SNPE SME FRANCE

100% 75% 6% Indra 0% 100% SEPI

40% Bayern Chemie / Protac 10% 40%10% EMEO

60,2% 50.9% SPAN - Empressa Portu. Defesa Spel SA 19,9% Eurenco 19 ,9% PORTUGAL

35% 60% Saab SCANDINAVIA Nexplo Indus.

27.5% 26.8% 15% 40% 45% 27.5% Raufoss Technology Nammo Sweden AB Patria Industrie

Kongsberg 100% Akers Krutbruk United Defense Bofors Defense AB Gruppen ASA Source: Alpha

Source: Fondation pour la Recherche Stratégique

ITALY Marconi Mobile Fiat Spa 45.76% 100% Elsag E A D S Otobreda UKInsys Ltd division Dassault Aviation FRANCE 100% SAFRAN GKN 50% 100% 100 SELEX Finmeccanica Sogitec 100% Aerosystems 50% SAGEM DS Intemis 0% 50% 50% 50% Ellectronica 50% MOSS 50% DCI BAE Systems Shorts 50% ET 45% 10% 0% RACAL 100% Marinesystème DCNS Helisim 0% ATLAS Avimo THALES Electronics 49% Ex-STN EADS 51% Gmbh 35% Armaris Rheinmetall Diehl Stiftung&Co 45% 50% 100% 4.25% Thyssen Krupp 51% Diehl Avionik INDRA 75% SEPI Zeiss Optronik 49% Abeking&Rasmussen RUAG Navantia

33.3% Edisoft 33.3% Empressa 100% 100% SIGNAAL Portu. Defesa Orbital Sciences NL 50% Samsung Thales ( STC ) 35% 50% TRS 30% Saab Saab S&E 50% ADT 100% Ericsson TCAS SPAIN- Terma A/S Microwave 50% PORTUGAL Raytheon L-3 com GERMANY Source: Alpha

SCANDINAVIA

Outline

¾ Persistent primarily national procurement strategies : although in principle in favour of joint procurement – national procurement authorities often favour national entrepreneurs ¾ Strict national rules hindered or prohibited foreign ownership of defence companies ¾ The juste retour principle in collaborative projects results in suboptimal procurement ¾ Differences in arms exports complicates marketing ¾ Securing jobs at home is used to legitimize cost-inefficient procurement ¾ The management of cross-border collaboration projects is cumbersome, which leads to cost and time overruns ¾ The frequent recourse to Art. 296 has de facto prevented the implementation of the Single Market in the defence sector

The creation of the Regime on Defence Procurement and adoption of the EDTIB Strategy are important steps towards the creation of the European Defence Equipment Market and the strengthening of the European defence industry

• Continued downward pressure on defence budgets (due to perceived trade-offs with social welfare expenditures) Rising input cost of equipment, and rising cost of R&D for new weapon systems Rising input costs for military personnel for an AVF There has been a major change in the security situation, leading to a new required equipment mix At the political level, despite intensive efforts, there is still no integrated or unified European defence market The EU member states do not have the financial means to sustain the full spectrum of a defence technology industrial base. This means continued downward pressure on defence budgets (due to a preference for social welfare spending) At the industrial level, the defence industry is – with a few outstanding exceptions, most notably EADS and BAE Systems – still geared towards national procurement At the technical level, the defence technology and research base is inadequate in most defence sectors to allow for national solutions. The new security risks have accelerated the race for innovations, resulting in increased demand for R&D resources. © BIPE 2007 105 Final report overview Summary of the key challenges for the future (2)

At the social level, the defence sector has experienced drastic reductions in employment. This process has slowed down in recent years. Additional job losses are, however, expected given the changing overall context. At the legal level, a range of political and legal guidelines have been designed and institutions were founded to improve coordination, to internationalise procurement and encourage competition. Art. 296 allows Member to derogate from general EU rules on a case-by-case basis when their essential security interests are at stake. The frequent recourse to Art. 296 has de facto prevented the implementation of the Single Market in the defence sector. In Eastern Europe, specific challenges are linked to the breakdown of supply chains after the fall of the Berlin Wall, and the new national defence strategies which put priority on national autonomy and restoring supply chains New technology will be coming on stream over the coming 25 years Supply-side changes are underway: mergers, privatisation, outsourcing, growth of services markets, etc. Competitive threat from US and emerging competition from China, Japan, Russia, Korea, India (both primes and suppliers), and Israël EC/EDA Policy on development of a EDEM and on EDTIB calls for major changes EDA debate on ways to mitigate adverse impact of offsets on fair competition in the EDEM, and EDTIB Risk of new threats

Duplication of research and development efforts Unnecessary duplication of capacities in the defence industry, hence inadequate utilization of the potential for rationalization Lack of standardization of military equipment, resulting in avoidable costs Inefficiency and increased cost resulting from limited competition A weak Europe in global markets

Despite recent restructuring, the concentration and consolidation process in the EU is incomplete. Continued duplication of capacities and duplication of weapon programs leads to inefficiencies If concentration continues on the national (or the bi-lateral) level, protected industries will become uncompetitive The collaboration experience is mixed Further restructuring will imply social costs (notably job losses)

Result: difficult choices must be made

Further consolidation increases the risk of domestic (national or EU) monopolies, oligopolies or duopolies with the consequences on the rate of dependence, inefficiencies and higher costs Government control will be reduced through outsourcing of traditional military functions The financial logic and shareholder value concept raise questions regarding the reliability of the delivery of defence products Governments remain torn between national and EU preferences on one side (with possibly higher cost but job security) and competition (with dependence on outside suppliers and job losses at home)

The consequences for employment – and in particular for employment at local level – vary depending on the future development of the industry Employment in the defence industries is often located in areas that are highly dependent upon it. The location of plants has usually been determined historically by security concerns and kept away from urban centres. Thus, local communities can heavily depend on developments in the activity in defence facilities and factories Employment is also often highly skilled, very specialised. In particular one finds a higher proportion of engineers and scientists and higher levels of qualification than on average for industry. Although past experience indicates that most persons find a new job relatively easily after having been made redundant, this is not the case for all. For those who do find another job, this may not be an equivalent job (lower pay for example), entailing costs in terms of purchasing power and/or quality of life. To assess the social costs, it is essential to take into account the possible inter- changeability of workforce between the defence, security and civilian sectors and to compare blue and white collar workforce ratios in the various sectors (land, aerospace, naval) Increased geographical mobility of the workforce may also be required as a result of the restructuring and consolidation process.

Developments during the past decade and present industry structure Defining the defence industry Overview of demand trends: budgets, procurement, R&D expenditure, trade, competitiveness and market access conditions Trend in employment Organisation of supply and changes therein: activities covered, key European defence producers, production location and country specialisations, trend in M&A, ownership structure, cross-border collaboration Challenges Outlook Key factors influencing the future Possible future scenarios © BIPE 2007 111 Final report overview The nine steps of the scenario building exercise

1. Definition of “underlying structural trends” 2. Identification of key stakeholders 3. Identification of structuring variables for the future 4. Identification of the possible objectives of the stakeholders 5. Rank the objectives for each stakeholder 6. List shared objective and identify areas of conflict 7. Map the influences / dependencies between players 8. Analyse results 9. Identify key questions for the future, and discuss their consequences

Governments of major producing (exporting) countries Governments of client (=importing) countries Local governments US Government Governments of competing producing countries (Russia, Japan, China, India) NATO European organisations and regulators: EC, EDA, OCCAR, LoI, etc. Private financial investors Foreign investors, with regulatory control System integrators Platform producers and assemblers Specialised subcontractors Commodity contractors Workers’ representatives, trade unions

Common foreign and security policy (CFSP) European Industrial policy for defence industries National industrial policies for defence industries Value and trend in (intra- and extra-EU) defence procurement Access conditions to non-EU markets Competitor strategies (risks related to new entrants) Ownership, control and conditions of access to key technologies Access to key competencies (HR) Structure of the industry portfolio (civil vs defence) Degree of aversion to risk of (private) financial investors (venture capital, restructuring funds, pension funds,...) Financial investors' time horizon and expected rate of return on investment Overcapacity problems / restructuring Efficiency (and amount) of R&D expenditure Labour market trends, risk of skill depletion/shortage, attractiveness problems, etc.

Geo-political: No major crisis, civil war or other in the world Continued unrest in Middle and Far East regions Europe continues to intervene in crisis prevention, but with a progressively growing share of civilian means European CFSP/ESDP stance: Accepted by all nations but not necessarily fully in place over forecast horizon (5-7 years) General macro-economic assumptions: Single assumption on world growth, exchange rate, oil prices, demographic growth in Europe

General macro-economic assumptions (cont.): Government budgets remain under constraint due to ageing and social agendas There are increased concerns over homeland security Labour markets become tense The effective age of retirement in industry remains below the legal retirement age Skill shortages develop in certain areas; immigration does not address all the needs: y Across countries: workforce ageing in eastern Europe is a major source of concern y Across skills : a high retirement rate is expected in all industrial sectors Î need for skills when size of cohorts falls

Trend in labour force - 2005-2035, in %

Slovakia Poland Latvia Hungary Czech Republic Estonia Roumania Slovenia Lettonia Bulgaria

-30 -25 -20 -15 -10 -5 0

Assumptions specific to Defence Defence budgets and the value of European defence procurement fall as a share of GDP Budgetary pressures lead to increased outsourced services; Increased emphasis on security New equipment mix Equipment costs grow rapidly No significant growth in defence export markets, due to growing competition on the world scene and the relocation of some activities There are a number of regions of US influence which remain difficult to penetrate for European producers Investment in new markets is mainly taking place through partnerships End of the « revolving door » policy between the defence industry and defence (or other) ministries

Result : budgetary pressures and rising equipment costs lead to heigthened intra-EU and extra-EU competition

Examples of objectives: Achieve European security of supply through acquisition of majority or golden share of strategic supplier companies Achieve national security of supply through acquisition of majority or golden share of strategic supplier companies Establish rules for European defence procurement Achieve security of supply through location of production facilities in "friendly" zones Fight for national autonomy with respect to choice of investments, programmes and procurement expenditure Defend the national champions' status of strategic companies (majority or full government ownership)

25 Dominant actor Govt or primarily Relay actor Producing country US Govt 20

High Govt of competitor countries European 15 Financial Investor Intl Orga. Explaining the Present Spec. contractor 10 Govt of a Major producer Primarily Trade unions

Degree influence of Client country

Low Local Gvt 5 Dependent Neutral actor Capa. contractor actor 0 0 5 10 15 20 25 30 Low High

National strategies dominate in terms of industrial organisation Duplication of capacity, inefficiency of overall R&D spent Commodity contractors are not the key focus of (national or EU) public policies Small role of workers unions and local government

Explaining the Present Overcapacity and loss of technology race Î loss in competitiveness, loss in mkt share vis-à-vis US counteracted by delocalisation of selected activities and high compensations to be paid to get contracts abroad, reduction in production, plant closure etc. Need for some positions / priorities to change, new alliances to be built Scenarios will be differentiated based on which alliances are built, and how the relative positioning of the key players changes

Various entry levels are possible : Demand trends and procurement policies Changes in the organisation of supply Changes in shareholding structures Degree of « anticipation » and preparation of change versus « real-time » crisis management

We focus on scenarios which reflect different strategies – actions - of the stakeholders

National procurement Early shift to harmonised continues to dominate European procurement

Direct employment effect Direct employment effect

Indirect employment effect Indirect employment effect No anticipation of change / real time crisis management

Direct employment effect Direct employment effect

Indirect employment effect Indirect employment effect Anticipation

A Single European Procurement Agency is created, which: Coordinates European procurement (as an interim step to a longer term approach of centralised European defence procurement, for several types of expenditures) Simplifies controls on intra-EU equipment circulation Defines a harmonised EU framework for, and regulates, offsets Is complemented by a European Small Business Act or an equivalent to this, which succeeds in achieving increased concentration at Tier 2 and higher levels Grants European preference: y To retain specialised know-how y To avoid too rapid internationalisation of capital (from US, China, …) y For security of supply reasons Indirectly (or directly?) fosters the extension of dual firms by opening access to contracts to companies primarily in civilian area This goes along with a re-organisation of armed forces at EU level, lowering the overall equipment needs of a coordinated EU defence force

Regions play an increasing role in industrial development, through decentralisation and the subsidiary principle Innovative financing of capital investments are put in place which facilitate mergers at lower tier levels EU policy centres on promoting a pooling of technological capabilities between the major producing countries, in order to: Ensure that synergies are developed between national defence R&T spending Generate economies of scale in development and production through dual- use technologies and applications Coordinated R&D efforts mean: Reduction in overall financial spent (no duplication of efforts) This allows for the development of new programs, and to the allocation of part of the saving to other (non-R&D related) purposes (such as training, or financial assistance to industrial redeployment in affected regions, …) The reduction in overall amount of R&D spent implies a rationalisation of the test and expertise centres

Acceleration of restructuring along pan-European lines: Mainly in the naval and land defence sectors, but also in electronics and aerospace (future of Finmeccanica, for example), including at lower tier levels Progressive Europeanisation of ownership leading to redeployment of activities along national lines, through market driven changes in regional and country specialisations: Emergence or strengthening of regional defence « clusters », their strength depending on the degree of anticipation and support Weakening of others, requiring transformation Improved ability to negotiate better transatlantic defence trade cooperation and technology transfer conditions, leading to a slower decline or an improvement in European producers’ world market shares R&D efforts are re-deployed: less duplication of programmes, less waste of resources Improved transatlantic cooperation, including through JV, partnerships or acquisitions This is especially true if improved conditions for transatlantic defence trade are put in place (history shows that because of the persistence of national strategies, US and other non-EU producers were able to increase their presence in Europe and increase competition for EU producers in other countries) The ability to reap economies of scale in development and production increases the price competitiveness of equipment, which improves Europe’s world market share Complementarity between civilian and defence markets (becomes) develops Yet, there is no shortening of development cycles, and no major change in terms of the cyclicality of demand

Employment in the EU defence industries falls There is a risk of skill depletion, which goes against the objectives of the Single European Procurement Agency and overall policy objectives National governments’ efforts are redeployed Alliances between the trade unions and regions are needed in order to minimise the negative consequences at local level

Budgetary savings are oriented towards training, facilitating mobility, supporting new business creation, R&D etc. Employment declines, but anticipatory action increases the likelihood for workers that were made redundant to find another job or start a new business The risk of skill depletion is much less than in the first variant One foresees an important role of the trade unions and/or regional governments to enhance the attractiveness of regions for «industrial defence and/or high tech clusters», and support the transformation of regions in decline The defence producers have more autonomy and control of the value chain: they become relay agents (note: this is already the situation in the UK, but it develops elsewhere)

25 Dominant actor Relay actor Gvt producer US Gvt 20

High Competitor Gvt Lenders 15 Equity owners Intl Orga.

Spec. contractor 10 Gvt client Major producer DegreeDegree of of influence influence Trade unions

Low Local Gvt 5

Dependent Neutral actor Capa. contractor actor 0 0 5Low 10 15 20 High 25 30 Degree of dependence © BIPE 2007 129 Final report overview Scenario 2 key assumption: National Procurement strategies continue

Budgetary pressures and rising equipment costs lead to heigthened price competition Competition between mainly exporting and mainly importing countries leads to intense intra-EU competition amongst defence producers, and heightened competition with non-EU producers The EU market penetration of non-EU producers increases. Offsets are granted to the client countries, adding to existing overcapacitites Restructuring continues to be organised primarily along national lines Duplication of R&D efforts and new programmes continues Eventually, some capacities are closed and markets become more Europeanised, but with higher penetration of non-EU capital Market failures in labour markets lead to state intervention to ‘correct’ such failures

Under pressure from their clients, the large (tier 1) producers transfer some of the pressure onto their suppliers: Delegation of R&D responsibilities (and associated risk) Increase in payments delay, fragilisation of the financial situation of tiers 2 and higher New funding resources are sought for : the capital of firms is opened to private investors; the penetration of foreign capital increases (Financial) markets drive the restructuring of the European defence industry base in the mainly importing countries Governments resist in the mainly producing countries, leading to a persistence of overcapacities and increased spread between companies at different tier levels

Employment falls Risk of skill depletion Limited room for manœuvre for national governments to redeploy their efforts due to intense price-competition and high cost of sustaining national defence industry The role of financial investors rises, starting from the (mainly importing) countries, and from high tier levels, moving progressively up the value chain : this leads to a search for financial efficiency and increased cost effectiveness: activities are relocated in non-EU countries, leading to further falls in employment

Employment declines, but anticipatory action increases the likelihood for workers made redundant to find another job or start a new business The risk of skill depletion persists but is less than in previous scenario One sees trade unions and regional governments playing an important role in this scenario, in order to enhance the attractiveness of regions for «defence clusters» and to support transformation of regions in decline Financial players also see their role increased : this leads to a search for financial efficiency, cost effectiveness, and a globalisation of production sites : some (non sensitive) capacities are relocated in non-EU countries, but less than in the previous scenario © BIPE 2007 133 Final report overview Positioning of the stakeholders in the National Procurement Scenario

25 Dominant actor Relay actor Gvt producer US Gvt 20

Competitor Gvt US funds 15 Equity owners Intl Orga.

Spec. contractor 10 Gvt client Major producer DegreeDegreeDegree of of of influence influence influence Trade unions

Local Gvt 5

Dependent Neutral actor Capa. contractor actor 0 0 5 10 15 20 25 30 © BIPE 2007 134 Final report overview Degree of dependence Comparison of the trend in employment in the different scenarios : possible outcomes

Total defence and civil-related industrial employment, direct and indirect, in 000 EPC = European Procurement Convergence

1 640 -30% EPC, no anticipation

time

2007 2007+2-3 years 2007+4-5 years 2007+8-10 years © BIPE 2007 135 Final report overview Comparison of the trend in employment in the different scenarios : possible outcomes

Total defence and civil-related industrial employment, direct and indirect, in 000 EPC = European Procurement Convergence

1 640 EPC, anticipation -30% EPC, no anticipation

time

2007 2007+2-3 years 2007+4-5 years 2007+8-10 years © BIPE 2007 136 Final report overview Comparison of the trend in employment in the different scenarios : possible outcomes

Total defence and civil-related industrial employment, direct and indirect, in 000 EPC = European Procurement Convergence

1 640 EPC, anticipation -30%

-50% EPC, no anticipation

Natl proc, no anticipation

time

2007 2007+2-3 years 2007+4-5 years 2007+8-10 years © BIPE 2007 137 Final report overview Comparison of the trend in employment in the 4th scenario with anticipation

Total defence and civil-related industrial employment, direct and indirect, in 000 EPC = European Procurement Convergence

1 640 EPC, anticipation -30%

-50% EPC, no anticipation

Natl proc, no anticipation

Natl proc with anticipation

time

Various instruments are available to help prepare restructurings The next section outlines some of these, and presents examples of « good practices » of anticipation, to fuel the discussion Although there are clear national features that need to be taken account of, the examples show that there are some commonalities of measures, and a number of ideas worth building on Measures also involve different stakeholders Preparation of anticipation needs concerted efforts and coordinated actions : this will be the objective of the next months

Anticipatory actions, designed to prepare the changes to come Development of a permanent ability to change Improvement of forecasting ability Social dialogue Preventive actions, designed to reduce risks and limit damage when changes occur Early warning and transparency of decisions taken Decisions on the number of people and types of skills concerned by restructuring Selection of employees impacted by the decisions/measures taken Preventive management of the effects of lay-offs on persons and regions

Curative actions, aimed at helping actors to manage the residual consequences of change Repair actions, to eliminate the dangers to which individuals and regions are exposed to after dismissal (ex post): y Support actions aimed at individuals y Redeployment actions for the affected regions Evaluative actions, aimed at measuring the results obtained and organising exchanges between stakeholders, to favour learning Norm-referenced assessments as results measurement Quantitative and qualitative assessments, as piloting tools Feedback as learning tools

Among the causes of restructuring are: Mergers Plant or research centre closure Shift in technology or product Companies are not identical in the face of restructuring: Differences in size, resources, sectors, independence or dependence on companies at other levels of the supply chain all influence the way the social consequences of a given event

Stakeholders potentially impacted by restructuring are: The company’s employees and managers The employees of companie up- or down-stream from the company, since these can also be at risk

Stakeholders that need to be involved in the anticipation of restructuring include all of the above, plus: y Trade unions y Training centres and the education system y Regional authorities y ….

The objective of anticipatory action is to achieve constant readiness for change. This involves developing what is needed for/maintain ability to/ adapt to change when restructuring occurs : Trust, mutual knowledge, actors’ networks, coordination between actors, regional and local development strategies, employability, aids to small businesses to increase their resistance to change Many of the « good practices » in this area are schemes which were not originally designed to anticipate change, but which have nevertheless proved to be extremely useful to minimise the consequences of restructuring.

The UK Union Learning Representatives (LRS) experience, aimed at enhancing employability The Swedish Validation Centre Experience, to acknowledge skills and competencies Other approaches include the « recognitiion od work-derived experience » in France (Validation des Acquis de l’Expérience – VAE), and the lifelong learning approach privileged in the UK Work time arrangements and changes in work organisation, to reduce the negative effects of business cycles Financial support schemes The German Working Time Accounts’ scheme, to retain skilled employees

The objective of preventive action is to prevent risks for companies, workers and regions or territories that are related to the consequences of the restructuring announcement Examples of good practices in this area include: The Luton partnership committee experience in dealing with closure The Cap Compétences experience in managing change and contractors These experiences show that creative and voluntary actions are useful to reduce negative spill-over or ex post effects of restructuring

The objective of curative actions is to manage the consequences of restructuring. Different schemes exist across the EU: Transfer companies in Germany Forem reconversion units in Belgium Job security councils in Sweden Transitional professional contracts and Redeployment contracts in France Outplacement units, in most EU member states Among these, two are quite innovative: The Swedish Job Security Council experience to deal with outplacement at sectoral level The French redeployment contracts which limits the spill-over effects of restructuring on a territory

There is a clear lack of information on the effectiveness and efficiency of the different schemes This is an obvious area of improvement

Two examples of innovative schemes at company level are ground breaking and inspiring: The Thales Agreement The Saab experience These schemes are more appropriate for large, integrated, groups Their extension to multi-country settings remains to be tested Their application to smaller companies probably implies the involvement of other stakeholders, such as regional authorities, training structures etc.

The Agreement covers 3 main themes: Retirement for older workers Anticipation of change Managing change The rationale for the Agreement is as follows: y Business climate and companies or markets change require qualitative and quantitative adjustments in terms of employment. Anticipation of these changes, development of social dialog, employees’ disposal to secure their job course. The very notion of prevention is a major axis of this agreement. Anticipating change is to commit oneself to identify possible danters, to prevent their consequences and to seize opportunities when appearing. Therefore, being on anticipation entails allowing everyone to prepare for his or her future career by a better information, mobility promotion and access to training enhancement.

Set-up of a commission of 10 trade union representatives and 10 representatives of management, responsible for: Mapping of group employment by trade and social category Prospective (3-year) analysis of HR needs by professional family, based on an outline of group strategy and industrial choices List of units, local labour markets and activities under threat for the coming 3-years Long-term analysis of technological changes, ages pyramids by trade and list of trades (business segments) which need adaptation plans Identification of bridges between trades

Anticipatory measures include: Voluntary participation to training schemes, and annual professional development meetings Provision of career audits after 5-years in the company, every 10 years Skill audits for employees at times of change Mobility enhancement measures Foster professional mobility through the skills audits, training, work derived experience validation and guardians to help employees during their move

Increased worker adaptability through active employment management: The third chapters details what has to be done when economic problems are forecast or when technological change entails change in employment and skills Two mains types of tools are described: y Information and consultation procedures y Measures that may be chosen by the employees on a voluntary basis The objective is to avoid social plans and reduce the negative social consequences of restructuring

Although it is too early to draw conclusions on the degree of effectiveness of the agreement… Lessons learned include: The importance of permanent social dialogue Mutual trust needed to allow transparency in information sharing Anticipation therefore requires both technical skills and expertise, and the use of social dialogue as a tool to develop shared diagnose and shared responses, thereby increasing their acceptability by the various interests represented.

A major competence shift was required in 2003 in order to adapt to changing markets, due to the downward trend in defence markets and the high potential of civil production This implied a need to develop new skills and a need to hire workers with new competencies, while workers with obsolete skills were to be phased out The objective was that 200 workers would voluntarily leave the company (10% of the total workforce). Eventually, the number of resignations increased to 500, while 100 recruitments took place.

Information of all workers, on the need for change and objectives of the programme Training of the managers, to help them to move from a directive management style to a leadership style involving coaching The objective of coaching was to get employees to make their own choices Managers were explicitly told not to point out any employee Organisation of eight bilateral meetings between each employee and his/her manager, over a five months period Development, by each employee, of an action plan (to be completed at the latest 3 months after the last meeting), covering: The conclusions of the previous conversations with the managers The individual’s choice for the future

Around 400 employees chose to leave the company: 60 were offered early retirement, 42 accepted it 18 of the employees leaving the company were considered to be « key contributors »: a quarantine agreement was reached to prevent them from starting competing activities in the first 2 years Others were offered a 12 months programme with full salary and preparation to take another job Management estimates that the costs were 25% below what would otherwise have been the case Trade unions were not directly involved in the process, but invited to provide feedback on employees’ concerns and opinions on the process Again, trust and extensive pre-paration was needed to achieve results

There is a need for more precise data on employment levels in defence industries, by tier level, in all EU-27 countries, as well as a mapping of employment concentrations There is also a need for up-to-date (i.e. frequently updated) estimates of future Europe-based employment levels in the defence companies, based on announced restructuring and reorganisation plans There is a need for a continuous monitoring of the social consequences of restructuring, through the development of ad hoc indicators on: What is the transition period? Which skills are transferable and which are non-transferable? What share of displaced workers find a new job within 3 months, 6 months, 1 year, etc.? Is the qualification level in the new job equivalent? What are the wages in alternative occupations/jobs? What is the share of persons moving to civil versus other defence activities? Etc. : An appropriate typology has to be developed, based on past experience)… …in order to be better able to assess the effectiveness of different approaches of anticipation and managing change, and the associated costs