The Defense Market is Dying (Not) – Some Great Contrarian Opportunities over the Next 5 Years
According to Anup Shah at Global Issues, defense spending dropped half a percent from 2011 to 2012—to approximately US$1.7T a year worldwide. Many observers are projecting future declines in the defense budgets for North America and Europe of up to 10% over the next 6 years.
Offsetting this decline are defense budgets forecasted to rise up to 4% over the same period in the Asia-Pacific and Mid East North Africa (MENA) market. The net result for the global defense market is perhaps as much as a 5% drop in global spending over the next half-decade–from US$1.7T a year to US$1.62T a year.
These numbers do not show a market with the bottom dropping out–so don’t run away from it too fast!
For those planning to stay and grow in the defense business, many opportunities will arise as others exit the market in fear or significantly reduce their exposure to the sector. The next few years will present opportunities for mid-sized defense firms to expand by acquiring key capabilities with ample prospects for growth.
However, following this strategy to stronger performance in an increasingly globalized defense market will mean concentrating on some key guiding principles.
Here is AMI’s view of some of these “high yield” aids that will help you navigate future defense market conditions:
- Be international—not just in name but in deed. This means international is a core focus and company leadership is invested in expanding multi-national operations.
- Don’t view the international market as a “foreign military sales” subset to your more important or comfortable domestic market – there should be nothing “foreign” about your approach to the international market!
- Be prepared to find and enter non-traditional markets and segments in the global space to generate new revenue and offset flat or declining performance in current core markets.
- Find joint ventures or acquisitions that establish and/or grow existing in-country presence and credibility with the local customer.
- Work the offset strategy harder—make sure your market approach specifically addresses meeting bigger and harder offset targets now being set by international customers. Unfulfilled offsets are an opportunity and/or a problem—making them a priority early in the business plan helps avoid them becoming the latter.
- Help train new buyers—especially among smaller or newer customers–in defense acquisitions/life cycle support strategies. These are the two most misunderstood and mismanaged areas in the international defense market.
- Build on your in-place processes that have proved successful in the international market.
–Refine your Bid/No-Bid process to maximize wins and promote your ability to no-bid.
–Identify your “Must-Wins” at least 2 to 3 years in advance to ensure sufficient time for positioning. Allocate sufficient resources for success given higher competitive rivalry.
- In the near term, focus on modernization and upgrades of military hardware as new construction programs are scaled back or canceled in the large advanced economies.
- Be mindful of professional services growth opportunities beyond 2015 as a generational turnover is beginning to occur and will continue over the next decade.
As the United States (US) and Europe continue to reduce their respective defense budgets, one can anticipate that major armed forces restructuring efforts (and corresponding adjustments in operational capabilities) that have been underway for the past several years will continue.
In order to adapt to this new climate, there is a need for better cooperation between the continents. A recent example of this is the high-level UK-US summit to discuss the preservation of capabilities by consolidating military operations and establishing joint partnerships where practical. (See: http://www.defensenews.com/article/20130330/DEFREG02/303300006/U-K-U-S-Look-Preserve-Capabilities.)
In order to support these efforts, there must also be a corresponding consolidation of defense firms; keeping in mind that “critical skills” must be maintained. With that said, the pressing question is how does this process unfold and what approaches must be taken. The answers will be vital for the future of North American and Europe defense firm’s survival.
In Europe, the EU Strategy for 2020 is guiding much of the region’s way ahead, yet defense funding and cooperation are slow in their progression while industry consolidation still seems to be ill-defined. Although European firms view the establishment of “North American” operations as critical to their survival, restructuring in the US will preclude much more of this from being realized. However, I would expect more joint partnerships and/or international agreements as part of the way forward.
In regards to the US, Congress and the Obama Administration are still too slow in establishing a long term economic plan for the country; which is now affecting defense industries here in the US and worldwide. Representing some 25% of the World’s GDP, a stable economic plan is crucial in order to spur a turnaround of today’s continuing economic recession. Defense cuts have occurred through the Budget Control Act (US$500B over 10 years) and the recent “sequestration cuts” where indiscriminate cuts of another US$487B over the next ten years (2013-2022) is now being enforced. We can be certain a number of US defense firms are now crafting their mergers or divestment plans as we read this.
It would appear that certain key ideas should be kept in mind as we head down this path:
1. European and US defense leadership (both military and industry) must ensure critical skills and capabilities are not lost and that wasteful activities/overhead functions are pared down considerably.
2. While mergers between US, UK and European firms are less likely with defense and industrial firms in “emerging economies”, executives should still pursue joint-ventures or co-production opportunities in these regions, which can serve as a path for:
a. New designs and developments in less critical and less sensitive components and elements of defense systems.
b. Finding access to markets that have been difficult to enter.
c. Establishment of “Super Multi-National Teams”, with strong definitive agreements to collaboratively pursue major opportunities.
Each month I will be offering up ideas to stimulate change in our naval market. I welcome your comments, suggestions, and critiques. You can reach me at email@example.com, @GuyofAMI on Twitter, or on this Naval Futures site.