Hey there, time traveller!
This article was published 18/7/2014 (736 days ago), so information in it may no longer be current.
The star of the show was missing from the skies above the Farnborough Air Show, Europe’s biggest aerospace get-together, which began on July 14.
The F-35 fighter, which was to have made its first appearance outside America, has been grounded after an engine fire. Not taking to the air when expected is a trait of Lockheed Martin’s jet, of course. It is years behind schedule and stratospherically over budget. Its absence was an embarrassment for Lockheed but, then again, its presence might have reminded the defence officials shopping for gear at Farnborough of the sort of complex, expensive program that they want to avoid signing up for in the future.
Arms-makers are going through a lean period. Some big contracts, such as ones to make bombers, trainer aircraft and drones, still are up for grabs in the United States, the world’s biggest spender, but even the U.S. and other rich-world governments, struggling to curb their deficits, are trying ever harder to get the most bang for the fewest bucks. The revenues of 17 of the top 20 American weapons-makers shrank in 2013.
American-led wars in Afghanistan and Iraq had helped to push global spending to a record US$1.7 trillion in 2008. Since then, according to Jane’s, the widely respected military-consulting firm, it has plunged by US$100 billion.
The good news for arms-makers is that the worst probably is over. America’s Congress has partly reversed automatic cuts it had imposed to deal with a ballooning deficit. In Europe the rate of decline is slowing. Growing wealth in emerging economies and new threats in Syria, Iraq and the South China Sea are encouraging rapid spending growth in Asia, the Middle East and Latin America.
In all, the market for military equipment — excluding China and Russia, which are largely closed to Western firms — is set to bottom out next year.
Although the Pentagon’s budget is as big as that of the next 15 defence ministries combined, its coffers no longer are bottomless. It wants more "make do and mend," upgrading existing equipment. The model here is Boeing’s venerable B-52 bomber, which has been constantly refitted and will fly on past its 90th birthday in 2042.
The Pentagon has moved away from conventional "cost-plus" contracts, which give contractors an incentive to overspend, since they are guaranteed a margin on top of whatever their costs turn out to be. In the department’s annual assessment of its own competence as a buyer, published last month, it noted that the alternative, fixed-price contracts, has not always proved better. Indeed, contractors sometimes end up with profit margins "spectacularly" higher than in cost-plus deals.
Therefore the Pentagon is seeking to create more sophisticated contracts that encourage arms-makers to find cost savings that will be shared with the taxpayer.
America is taking an interest in moves across the Atlantic, especially in Britain, to get companies to assume the ownership and upkeep of weapons systems. A 2009 deal Britain struck with B.A.E. Systems provides "strike power by the hour" for the Royal Air Force’s Eurofighter Typhoon jets. The R.A.F.’s commitment to low-cost flying was reinforced with the announcement, at Farnborough, that maintenance contracts for transporters would go to Flybe, a budget airline. Britain even contemplated outsourcing its entire military procurement recently, only to get cold feet about such a radical move.
An earlier squeeze in military spending, in the 1990s, prompted a spate of mergers, as weapons-makers cut costs by joining forces. This time the Pentagon has made it clear that it will not accept further consolidation that damages competition. In Europe political opposition hinders efforts at consolidation: Airbus’ 2012 attempt to merge with B.A.E. Systems failed for this reason.
With mergers out of the question, the big military contractors had to move quickly to prepare for the most recent round of spending cuts, slashing costs and laying off battalions of workers. Now they are looking at what else they can do to prepare for an age in which budgets have stopped falling, but defense ministries are more demanding buyers.
One answer is to find new, civilian markets for their products. Some big suppliers to the armed forces — such as Boeing and U.T.C., which owns Pratt & Whitney, a maker of airplane engines — already have even bigger civilian sides. However, the more defense-heavy firms’ past attempts at diversification into nonmilitary work were "unblemished by success," in the words of former Lockheed boss Norm Augustine.
Still, many of the things they make have civilian uses. Secure communications systems could help to protect banks and other businesses from hackers. Raytheon recently sold its Boomerang sniper-detection system to American power firms after a gunman knocked out several transformers providing electricity to Silicon Valley.
As yet, though, such contracts remain a small part of most arms companies’ businesses. Civilian cyber-security and related activities provide only around 2 per cent of Lockheed’s revenues, for example. Although weapons-makers are "essentially tech firms," as Rami Myerson of the bank Investec puts it, they may struggle to compete with nimbler Silicon Valley outfits.
Indeed, such companies are beginning to invade the defence industry’s territory.
"Warfare is going digital," observes Tom Captain of Deloitte, a consulting firm.
Tech firms have shown that they can supply robots, drones and intelligence software. Spacex, founded by tech entrepreneur Elon Musk, is taking the U.S. Air Force to court in an effort to reopen bidding for a satellite-launch contract awarded to Boeing and Lockheed.
If it is hard for military suppliers to make it on Civvy Street, it is not much easier for them to hawk their gear to new export customers.
Plenty of countries, from the Middle East to East Asia, are spending more on arming themselves with jets, missiles and tanks. China’s increasingly assertive territorial claims are prompting its neighbours to bolster their defences. The market is highly fragmented, however. Brazil, among the bigger spenders, has a defence budget only 4 per cent the size of America’s. Not only is it costly to sell to lots of smallish customers, but often they insist on some manufacturing being done locally or demand access to sensitive technology that the arms suppliers’ home governments would not allow. India, the biggest prize, is a fearfully tough customer, imposing all manner of conditions in return for arms contracts.
The competition to sell to foreign powers is fiercer than at home. Asian and Latin American countries may prefer Russian or Chinese equipment that is not quite as good as Western gear, but far cheaper. More and more countries with weapons industries of their own are encouraging their firms to seek new export markets such as Japan and South Korea.
Those arms-makers which are part of big civilian aerospace conglomerates can spread their research and development overheads across a broader base. They also have a better chance of cross-selling to the defence ministries of countries whose state airlines already are their customers. Airbus’ recent restructuring was in part aimed at achieving this. Civil aerospace is booming, giving such firms strong financial firepower. Potential buyers of their military gear will feel reassured that these companies will still be around in a decade or two, when it needs updating.
Companies that mostly make military products may find that life is harder. The turn in the spending cycle may encourage them to dream that vast, money-spinning programs like the F-35 will return, and that the good times will roll again.
However, the evidence suggests that an often-unreliable, inefficient and over-rewarded industry is at last being forced to change its ways to survive.