DOMINION GLOBALIZATION WORKSHOP

Aerospace

Dennis Encarnation

Harvard University

For more information, please contact me at www.encarnation.com

Aerospace 1. Two Views of Globalization, Revisited a. A “Flat” World: The Rise of -Based Companies & Topics: Asia-Based Operations b. A “Mountainous” World: Continued Trans-Atlantic Dominance

2. Aerospace Value Chain a. Downsteam: Sales & After-Market b. Midstream: Manufacturing & Systems Integration c. Upstream: R&D, Design,

3. Multi-Tiered Supply Chains a. Primes: A World of ‘Coopetition’ b. Tier 1: ‘Coopetition’ vs. Specialization c. Below Tier 1: Asia outside TWO VIEWS OF GLOBALIZATION

THE EMERGING CONCENSUS the world is flat it’s a borderless world where geography matters less and less with increased geographic dispersal of assets, capabilities and wealth where our choices-- business, cultural, economic, political, technological, social --are converging GARMENTS: A FLATTER WORLD

the garment trade is highly segmented, with Asia generally competing for volume & generally competing for price… ELECTRONICS: A FLATTER WORLD RANKING AMONG THE FORTUNE GLOBAL 500 COMPANIES, 2007 (revenues in US$ billion) 12. (US) 176.7 192. Tyco (US) 37.7

37. () 106.1 200. Motorola (US) 36.6

38. Samsung (Korea) 106.0 210. Mitsubishi Electric (Japan) 35.5

41. Hewlett-Packard 104.3 218. Cisco Systems (US) 34.9

46. IBM (US) 98.8 261. Sharp (Japan) 29.9

48. (Japan) 98.3 292. Flextronics () 27.6

67. LG (Korea) 82.1 325. Alcatel-Lucent () 24.6

72. Matsushita (Japan) 79.4 332. Apple (US) 24.0

75. Sony (Japan) 77.7 342. (France) 23.7

88. (Finland) 69.9 344. Quanta Computer (Taiwan) 23.7

91. Toshiba (Japan) 67.1 363. Asustek Computer (Taiwan) 23.0

106. (US) 61.1 375. Emerson Electric (US) 22.6

132. Hon Hai (Taiwan) 51.8 383. Sumitomo Electric (Japan) 22.2

136. Microsoft (US) 51.5 386. Onex () 21.9

149. Fujitsu (Japan) 46.7 436. Whirlpool 19.5

174. NEC (Japan) 40.4 438. Ricoh (Japan) 19.4

188. Intel (US) 38.3 459. Sanyo (Japan) 18.2

197. Philips () 37.0 489. Xerox (US) 17.2

189. Canon (Japan) 38.1 499. Lenovo () 16.8

Nearly half of the world’s largest electronics companies are based in Asia… TWO VIEWS OF GLOBALIZATION

THE EMERGING AN ALTERNATIVE CONCENSUS PERSPECTIVE the world is flat a very “mountainous” it’s a borderless world world, with deep “valleys” where geography matters globalisation is about less and less making borders work with increased geographic where geography matters dispersal of assets, more & more capabilities and wealth with increased geographic where our choices-- concentration of assets, business, cultural, economic, capabilities and wealth political, technological, social globalisation means more --are converging choices, not less QUESTION: UPSTREAM VALUE ADDED

WHAT INDUSTRIES HAVE A HIGH DEGREE OF INDUSTRIAL CONCENTRATION IN THE NORTH ATLANTIC REGION?

WHY? PHARMACEUTICALS: TRANS-ATLANTIC CONCENTRATION

RANKING AMONG THE FORTUNE GLOBAL 500 COMPANIES, 2007 RANK COMPANY NAME HQ LOCATION REVENUES (US$ billion) 1. JOHNSON & JONHSON USA 61.1 2. PFIZER USA 48.4 3. GLAXO SMITH KLINE UK 45.4 4. ROCHE GROUP 40.3 5. SANOFI AVENTIS FRANCE 40.0 6. NOVARTIS SWITZERLAND 39.8 7. ASTRA ZENECA UK 29.6 8. ABBOTT LABORATORIES USA 25.9 9. MERCK USA 24.2 10. WYETH USA 22.4 11. BRISTOL-MYERS-SQUIBB USA 20.0 12. ELI LILLY USA 18.6 Source: Fortune, 2009. Not one Asian- or BRIC-based pharmaceutical company appears among the 500 largest companies PHARMACEUTICALS: TOP 10 TRADERS

PHARMACEUTICALS

TOP 10 EXPORTERS, 2006 TOP 10 IMPORTERS, 2006 (US$ billion) (US$ billion) 1. EU (25):INTRA 190.9 1. EU (25):INTRA 155.9 EXTRA-EU 73.0 EXTRA-EU 38.1 2. USA 25.9 2. USA 39.3 3. SWITZERLAND 25.1 3. JAPAN 8.2 4. CHINA 3.8 4. CANADA 7.8 5. CANADA 3.5 5. AUSTRALIA 5.5 6. JAPAN 3.3 6. 3.9 7. SINGAPORE 2.9 7. TURKEY 3.2 RE-EXPORT 0.6 8. INDIA 2.8 8. MEXICO 2.8 9. AUSTRALIA 2.5 9. BRAZIL 2.5 10. ISRAEL 2.0 10. CHINA 2.3 Source: WTO, 2008. AEROSPACE: TOP 10 TRADERS

AIRCRAFT & SPACE VEHICLES PLUS ASSOCIATED EQUIPMENT

TOP 10 EXPORTERS, 2005 TOP 10 IMPORTERS, 2005 (US$ billion) (US$ billion) 1. USA 49.8 1. GERMANY 19.4 2. FRANCE 24.5 2. USA 16.6 3. GERMANY 19.3 3. FRANCE 11.1 4. CANADA 8.0 4. CHINA 6.6 5. ITALY 3.4 5. CANADA 5.3 6. BRAZIL 3.3 6. INDIA 5.0 7. SPAIN 2.8 7. JAPAN 4.8 8. SINGAPORE 1.5 8. SINGAPORE 3.8 9. JAPAN 1.4 9. SPAIN 3.2 10. NETHERLANDS 1.1 10. ITALY 3.0

Source: UNCTAD/WTO, International Trade Centre, 2007. Sales, $B* 2007 How do you explain the continued geographic concentration geographic continued the explain you do How

Boeing AEROSPACE: TRANS-ATLANTICCONCENTRATION

EADS

Lockheed Martin 2007 COMPANIES, AEROSPACE 20 TOP Northrop Grumman BAE Systems in the aerospace industry? aerospace the in General Dynamics Raytheon commercial aircraft (including financing), components & subsystems. & components financing), (including aircraft commercial & services information government space, & defense for *Revenues United General Electric Finmeccanica Thales L-3 Communications Honeywell

Rolls Royce

Dennis J. Encarnation & Associates, 2008. Source: Annual Reports; Bombardier Goodrich

Alcatel Dassault

Mitsubishi Embraer MILITARY SPENDING: TOP 10 MILITARY SPENDING (US$ billion & % of US$1,367 billion, 2006) RANK COUNTRY MILITARY % GLOBAL BUDGET MILITARY (US$ billion) SPENDING 1. USA 644 47.5% US Alliances* 307 22.6 2. CHINA 122 9.0 3. RUSSIA 59.1 4.4 4. UK 55.1 4.1 5. FRANCE 45.3 3.3 6. JAPAN 41.1 3.0 7. GERMANY 35.7 2.6 8. 25.4 1.9 9. 23.7 1.7 10. INDIA 22.3 1.6 Note: *Multilateral (NATO) and bilateral (Australia, Japan, S. Korea) alliances. Sources: International Institute for Strategic Studies, 2006; US Department of Defense, 2007. WEALTH & MILITARY SPENDING, 2007

2007 GDP AT PPP FX RATES 2006-07 MILITARY BUDGETS (US$ trillion) (US$ billion) WORLD 64.9 WORLD 1,367 EU 14.7 US ALLIANCES 307 1. USA 13.8 1. USA 644 2. CHINA 7.0 2. CHINA 122 3. JAPAN 4.3 3. RUSSIA 59 4. INDIA 2.8 4. UK 55 5. GERMANY 2.8 5. FRANCE 45 6. UK 2.1 6. JAPAN 41 7. RUSSIA 2.1 7. GERMANY 36 8. FRANCE 2.0 8. SAUDI ARABIA 25 9. BRAZIL 1.8 9. SOUTH KOREA 24 10. ITALY 1.8 10. INDIA 22

Source: IMF & World Bank, April 2008; US Department of Defense, 2007. The Geographic Concentration Of Wealth & Of Military Spending is Highly Correlated--8 Of The Top 10 Are The Same-- Suggesting that Military Security is Essential for Economic Growth MANUFACTURING

Aerospace 1. Two Views of Globalization, Revisited a. A “Flat” World: The Rise of Asia-Based Companies & Topics: Asia-Based Operations b. A “Mountainous” World: Continued Trans-Atlantic Dominance

2. Aerospace Value Chain a. Downsteam: Sales & After-Market b. Midstream: Manufacturing & Systems Integration c. Upstream: R&D, Design, Engineering

3. Multi-Tiered Supply Chains a. Primes: A World of ‘Coopetition’ b. Tier 1: ‘Coopetition’ vs. Specialization c. Below Tier 1: Asia outside Japan AEROSPACE VALUE CHAIN

Where do Asian & BRIC-based companies play in this value chain?

Where do they hope to play in the future? DOWNSTREAM: ASIAN PROMINENCE

Most aerospace products are sold commercially, where the Asia- Pacific region is emerging as the largest geographic market MIDSTREAM: MANUFACTURING

In marked contrast to the electronics industry, very little aerospace manufacturing has moved to low-cost countries in Asia and elsewhere. MIDSTREAM: SYSTEMS INTEGRATION

Value-Added outside the is limited, but growing…. : GEOGRAPHY OF CONTROL & LOCATION

Boeing Commercial & Defense Products: Systems Integration & Final Assembly IN-HOUSE integration Boeing Commercial & Defense Products before 787:

GEOGRAPHY OF CONTROL OF GEOGRAPHY Subassemblies, Parts & Components Boeing: 787 Subassemblies, OUT-SOURCE Parts & Components

ON-SHORE distance OFF-SHORE

GEOGRAPHY OF LOCATION UPSTREAM: INDIA AS A CASE STUDY

Source: Dennis J. Encarnation & Associates, LLC, 2009.

India hopes to leverage its large market downstream for more work upstream, especially in R&D, Engineering, IT, and Manufacturing MANUFACTURING

Aerospace 1. Two Views of Globalization, Revisited a. A “Flat” World: The Rise of Asia-Based Companies & Topics: Asia-Based Operations b. A “Mountainous” World: Continued Trans-Atlantic Dominance

2. Aerospace Value Chain a. Downsteam: Sales & After-Market b. Midstream: Manufacturing & Systems Integration c. Upstream: R&D, Design, Engineering

3. Multi-Tiered Supply Chains a. Primes: A World of ‘Coopetition’ b. Tier 1: ‘Coopetition’ vs. Specialization c. Below Tier 1: Asia outside Japan A MULTI-TIERED SUPPLY CHAIN

Where do Asian & BRIC-based companies play in this value chain?

Where do they hope to play in the future? Only 1 Asian company and only 1 BRIC-based company figures company BRIC-based 1 only and company Asian 1 Only Sales, $B* 2007

Boeing AEROSPACE: TRANS-ATLANTIC

EADS prominently Lockheed Martin 2007 COMPANIES, AEROSPACE 20 TOP Northrop Grumman BAE Systems General Dynamics

Raytheon in the global supply chain chain supply global the in commercial aircraft (including financing), components & subsystems. & components financing), (including aircraft commercial & services information government space, & defense for *Revenues United Technologies General Electric Finmeccanica Thales L-3 Communications Honeywell

SUPPLY CHAIN SUPPLY Rolls Royce

Dennis J. Encarnation & Associates, 2008. Source: Annual Reports; Bombardier Goodrich Alcatel

Dassault

Mitsubishi Embraer

GLOBALIZATION THRU LOCAL CONTENT: MHI Mitsubishi Heavy Industries

FY2006 Financial Results (FY Ending 3/31/06) Executive Management Sales - $26.0B Kazuo Tsukuda, President Operating Profit - $627M Hideaki Omiya, President Ship-Building Aerospace Power & Ocean Systems Systems Development

2006 Sales – $3.9B 2006 Sales – $6.3B 2006 Sales – $2.0B • Defense Aircraft & Aeroengines • Tactical Fighters Machinery & Mass & • Helicopters Steel Medium-lot • Commercial Aircraft Components Structures Machinery • Aircraft Engines • Guided Weapon Systems 2006 Sales – $4.8B 2006 Sales – $7.1B • Space Systems • Launch Vehicles Other • International Space Station 2006 Sales – $608M Japan’s largest defense contractor for a half century GLOBALIZATION THRU LOCAL CONTENT: ALENIA Finmeccanica Executive Management 2006 Preliminary Financial Results Pier F. Guarguaglini, Chairman and CEO Sales = $15.7B Giorgio Zappa, COO Op. Profit = $1.1B Chairman & CEO, Alenia COO, Finmeccanica Defence Aeronautics Space Defence Electronics Systems

2005 Sales = $2.5B 2005 Sales = $917M 2005 Sales = $4.1B 2005 Sales = $1.5B • GIE ATR (50%) • Telecommunications • Avionics • Missiles • Civil Aerostructures • Components & • UAVs • Land, Air & Naval • Modifications subsystems • Land & Naval C2 Weapons Systems • Military , • Satellites & Services • Radar Systems • Underwater weapons Training & Combat A/C • Space Mission Mgmt & sonar

Energy Helicopters Transportation

2005 Sales = $961M 2005 Sales = $3.1B 2005 Sales = $1.5B • Agusta Westland (50%) • Bell Agusta Aerospace Co. (50%) Protecting the Home Market GLOBALIZATION THRU LOCAL CONTENT: NORTHROP

Northrop Grumman 2006 Financial Results Executive Management Sales - $30.1B Ronald Sugar - Chairman & CEO Operating Profit - $2.5B

Electronic Information Systems Aerospace Ships & Services

2006 Sales=$6.6B 2006 Sales=$5.6B 2006 Sales=$11.3B 2006 Sales=$5.3B 2006 Margin=11.3% 2006 Margin=9.1% 2006 Margin=8.7% 2006 Margin=7.4% • Aerospace Sys. • Air Combat Systems • Government IT • Aircraft Carriers • C4ISR & Naval • Airborne Early • Enterprise IT • Surface Combatants Sys. Warning/Electronic • Technical Services • Amphibious & • Defensive Sys. Warfare • Commercial IT Auxiliary • Navigation Sys. • Airborne Ground • C2 & Intelligence • Submarines • Gov’t Systems Surveillance/Battle • Missile Systems • Commercial & Int’l • Space Sys. Management • Technical & Mgmt • Services • Civil Space Svcs • Missile & Space Defense Joint Bid with EADS for • Satellite Comm. US Tankers, • ISR • Radio Systems Trading Market Access • Technology for Product Offering GLOBALIZATION AS REGIONALIZATION: EADS

2006 Financial Results EADS Executive Management Sales = $49.6B Louis Gallois, Co-CEO Earnings = US$501M (vs. US$3.6B in 2005) Thomas Enders, Co-CEO To CEO

Defense & Military Airbus Security Astrium Transport Systems Aircraft 2006 Sales = $31.6B 2006 Sales = $7.4B 2006 Sales = $4.0B 2006 Sales = $2.8B Airbus Integrated • Eurofighter (43%) • Astrium • CASA Military Company (80%) • Dassault (45.7%) • Arianespace (22.9%) • Commercial Aircraft • Defense Electronics • Satellite Systems • Airbus Military Company (A400M) Other • MBDA (50%) • Ground Stations • Support, Services, • Space Transportation Eurocopter 2006 Sales = $1.6B Training • ATR (50%) • Secure 2006 Sales = $4.8B • EFW Communications • Military Helicopters • SOCATA • Civil Helicopters • SOGERMA A microcosm of the macro dynamics of EU integration GLOBALIZATION THRU INVESTMENT & JOINT PROGRAMS: BAE

2006 Financial Results Executive Management Sales = $26.8B BAE Systems Dick Olver, Chairman Operating Profit = $2.1B Mike Turner, CEO Ian King, CEO Electronics, International Commercial Land & Programmes Intelligence Systems & Aerospace Armaments & Support Partnerships

2006 Sales = $5.7B 2005 Sales = $5.9B 2006 Sales = $7.8B 2006 Sales = $4.1B 2006 Sales = $3.4B Air Systems Airbus (20%) • Information • Information • Eurofighter • A380 development Systems Systems Customer • JSF • Wing design and • Controls • Armored Support & • Nimrod transport • Technology combat Solutions Services vehicles • Hawk • Wingtips, leading edges, ailerons, • Information and • Naval gyros 2006 Sales = $6.2B Sea Systems airbrakes production Electronic • Missile • Type 45 SOLD Systems launchers Integration HQ & Other • Astute • Artillery • Underwater • C41SR systems Business Weapons • Intelligent • Future Carrier munitions 2006 Sales = $532 Structure is the servant of strategy GLOBALIZATION AT BAE: US ACQUISITIONS

2004 Financial Results Executive Management Sales = $24.7B BAe Systems Dick Olver, Chairman Operating Profit = $1.9B Mike Turner, CEO Chris Geoghegan, COO Steve Mogford, COO Mark Ronald, COO North Programmes Commercial Aerospace America International Partnerships

2004 Sales = $5.3B 2004 Sales = $5.3B 2004 Sales = $5.0B Air Systems Airbus (20%) • Information 2004 Sales = $3.5B Systems • Eurofighter • A380 development Customer • Controls • JSF • Wing design and Support & • Nimrod transport • Technology Services Solutions • Hawk • Wingtips, leading edges, ailerons, • Information and 2004 Sales = $4.1B Sea Systems airbrakes production Electronic • Type 45 Systems Integration • Astute Avionics • Underwater Weapons Structure is the servant C4ISR of strategy 2004 Sales = $2.0B REVERSE TREND, GLOBAL TO LOCAL: LOCKHEED

2005 Financial Results Lockheed Executive Management Sales = $37.2B Martin Robert J. Stevens, Chairman, President & CEO Operating Profit = $3.0B

Integrated Information Electronic Space & Aeronautics Systems Systems Systems Technology Solutions Services

2005 Sales = $11.7B 2005 Sales = $10.6B 2005 Sales = $4.1B 2005 Sales = $6.8B 2005 Sales = $4.0B 2005 Margin = 8.5% 2005 Margin = 10.5% 2005 Margin = 8.8% 2005 Margin = 8.9% 2005 Margin = 8.8% • Combat Aircraft • Missiles & Fire Control • Management & • Launch Services • Federal • Air Mobility • Maritime Systems & Data Systems • Commercial Technology Svcs • Aeronautical R&D Sensors • Mission Systems Satellites • Department of • Simulation, Training & • Government Energy Support Satellites • Gov’t & • Systems Integration - • Strategic Missiles Commercial IT Owego • Ground Systems • Aerospace Svcs • Transportation & Geographic Sales, 2005 (%) Security Solutions •US Government, 51% Not seeking to • LM Canada •US Classified, 20% become a “global •Foreign Governments, 19% enterprise for •US Commercial, 7% aerospace leadership” •Foreign Commercial, 3% Sales, $B* 2003

Boeing GE SUPPLIERS: 1 TIER SPECIALIZED

EADS consolidated theaerospace industry, creating a new #4 with aspirations forbeing#1 or#2 Lockheed Martin A GE-Honeywell merger would have further Northrop Grumman BAE Systems

Raytheon General Dynamics

General Electric GE + Honeywell + GE United Technologies Thales

Rolls Royce (including financing),components&subsystems. information services&commercialaircraft *Revenues fordefense&space,government Bombardier Finmeccanica L-3 Communications Goodrich Alcatel

Dassault Mitsubishi Embraer RESTRUCTURING TODAY: A FEW TRENDS Expansion into The New Entry of Adjacencies Nationalism Adjacent Players Case: Trans-Atlantic Case Study: Global Case Study: India Servicing a large Sovereign funds & Tata installed base state banks no prior defense or aero- space experience except in IT Commercial: GE-Ae service Middle East oil exporters: shops Mubadala, SAGIA, etc. By 2011: sole supplier of 787 floor beams, & potential Military: Boeing’s ISS, from Russia: Vneshtorgbank’s JV partner for Boeing Canada to the Netherlands 5% equity stake in EADS (to Korea) State-owned Mahindra New products in enterprises Indian defense contractor, new geographies Russia: Consolidation of mainly for combat & supply across regions several enterprises in United vehicles to the Army Aviation Corporation (UAC) partner of choice for BAe BAe’s acquisition of Sanders Systems as it expands in the US defined the future India: HAL’s resurgence of aerospace M&A thru offsets platforms into India Finmeccanica’s acquisition State Aid, Revisited Larsen & Toubro of DRS Technologies in the Indian defense contractor, US is the largest to date Exim financing or not to buyers: airlines mainly for ships and weapons GE’s acquisition of Smith to the Navy For R&D: GE-Global Aerospace in the UK potential supplier to Boeing illustrates the reverse trend Research Centre-