Major Industry Trends
Defense Spending and the Global Economic Downturn
Defense spending is clearly the key determinant of the health of the defense industry. It is sensitive to the economic cycle, with democratically elected governments preferring to focus their resources on politically sensitive areas such as healthcare and welfare spending, or on measures to boost employment when their revenues come under pressure during an economic slowdown. Plainly, however, when a country is at war it has little option but to maintain defense spending, regardless of the economic circumstances, and no country is willing to sacrifice its long-term security for the sake of short-term savings.
Certainly, the US will have little option but to maintain defense spending at high levels in the next few years, given its involvement in the conflicts in Iraq and Afghanistan, as well as the “war on terror.” Furthermore, many countries will have difficulty cutting their defense spending by significant amounts in the short term. Defense programs can last for decades, and, if a project is already underway, it may be difficult for a government to cancel its order. Defense spending can also be politically sensitive. Cutting back on equipment orders may simply add to unemployment during a recession.
The US is by far the largest market for defense equipment. Many defense analysts argue that President Obama will have no option but to reduce the current record levels of defense spending in order to fund his big economic stimulus plans. This will clearly have a big impact on the overall defense market, for North America accounted for around 39% of global military spending in 2007, according to the research company, Frost & Sullivan. President Obama has proposed a 4% increase in defense spending, to US$534 billion, during the fiscal year beginning in October 2009. However, with a US$787 billion stimulus package, and billions more required to support banks, and possibly other companies, many defense analysts believe that the Pentagon’s budget, one of the largest shares of government spending, is likely to be cut.
Given that President Obama has pledged to match the previous administration’s costings for Iraq and Afghanistan until late 2010, the focus of any search for cost savings is likely to be big programs such as the US Army’s plans to modernize its forces, led by Boeing, and programs such as the F-22 Raptor. Defense spending on government contracts doubled to US$500bn under the Bush administration, and Obama is reportedly looking to reform the process of awarding tenders, in a bid to save US$40bn a year. Perhaps unsurprisingly in this environment, Lockheed launched an advertising campaign in early 2009 to promote the F-22 Raptor, perhaps in a pre-emptive strike to prevent the fighter-aircraft program from being axed.
In Europe, which does not face any obvious military threats, and is not entangled in overseas conflicts on the scale of the US, the economic crisis is already having an impact on defense spending. In March 2009, the German newspaper, Handelsblatt, reported that Germany, the UK, Italy, and Spain want to forge a deal to reduce a third-batch delivery of Eurofighter combat aircraft to save money (the German government later denied the claims). The Eurofighter program is slated to cost the German defense budget alone around US$36 billion, according to Handelsblatt. The Eurofighter consortium includes Britain’s BAE Systems, Airbus’s parent, EADS, and Alenia, a unit of Italy’s Finmeccanica. The aircraft engines are made by Rolls-Royce, MTU Aero Engines, and ITP. Also in 2009, Eastern European governments began slashing defense budgets in the wake of the economic crisis that hit the region early in the year. In March 2009, Lithuania announced a 20% cut in its defense budget, while Poland cut military spending by around US$500 million.
The recession is also having an impact on the UK, which buys more defense equipment than any other country, bar the US and China. In March 2009, a report by the UK National Defence Association warned that a shortfall in the UK’s defense budget had reached such a critical point that the government would have to scrap key orders for equipment if it did not increase defense spending. The report said that the projects at risk included orders for two new aircraft carriers (HMS Queen Elizabeth and HMS Prince of Wales), which will cost US$3.5 billion each; a replacement for the Harrier jump jet, the F-35, which will cost US$25 billion; and the replacement for the submarine-borne Trident nuclear missile, which will cost US$60–100 billion over 30 years. The global financial crisis has played havoc with the UK government’s finances, and it is doubtful whether London is in a position to increase defense spending—in November 2008, the government predicted that the budget deficit would reach 8% of GDP in 2008, but by March 2009, even this forecast appeared overly optimistic.
Global Financial Crisis Directly Affects Defense Companies
The global financial crisis that began in September 2008 is also hitting military suppliers. In February 2009, Lockheed Martin slashed its earnings forecast for 2009, while Northrop Grumman warned it would report a loss for 2008. In Lockheed’s case, the company said it would have to make up shortfalls in its pension fund, which has been hit by the financial crisis. Northrop said the fall in the stock market had prompted it to take a US$3.0–3.4bn charge in the fourth quarter, in order to write down the book value of businesses it took over in 2001 and 2002.
Market Analysis
Arms Race Developing in the Asia-Pacific Region
While defense spending is coming under pressure in many countries in the West, it is likely to accelerate significantly in Asia. Indeed, in March 2009, the Singapore Straits Times reported that Asia is expected to outstrip the rest of the world in defense spending within seven years as China and India upgrade their armed forces. The newspaper quoted the findings of Frost & Sullivan. The research consultancy had predicted that Asia’s overall defense budget would account for 32% of global military spending by 2016, or US$480 billion, up from 24% in 2007, while North America’s share of spending would fall from 39% to 29%.
China is certainly one country that will not be cutting back on its defense spending during the global recession. China clearly now intends to develop a military capability to match its new-found economic status. China’s insatiable appetite for raw materials and energy has also widened the military’s mission to protect China’s strategic economic interests overseas. The country’s naval and air forces certainly appear determined to impose their dominance in the South China Sea—through which vital oil supplies pass, and where several islands are in dispute—and in the East China Sea, where China and Japan are in dispute over mineral rights, and a number of contested islands.
In March 2009, Beijing announced plans to increase defense spending by 14.9% to CN¥480.7 billion (US$70.3 billion) in 2009. The increase is slightly smaller than the rises that have taken place in previous years, suggesting that Beijing is focusing its spending on boosting the wider economy. However, following increases of 17.8% in 2007 and 17.6% in 2008, China’s defense budget will have increased by more than 50% between 2006 and 2009. Furthermore, the US estimates that China’s defense spending is much higher than the official figures suggest because many costs, including major arms purchases, are not included in these statistics.
China has denied claims that it “hides” defense spending, and argues that its military spending is not excessive. It says that defense expenditure would amount to 6.3% of its total budget in 2009, and 1.4% of GDP, compared with 4% in the US and 2% in the UK and France. The government says that most of the increased expenditure in 2009 will be focused on improving the historically poor living conditions of soldiers in the People’s Liberation Army. In addition, the authorities intend to increase spending on “informatization,” in an attempt to close the gap on the US’s use of “smart” technology. Defense companies in the West could benefit from China’s attempts to upgrade its military technology, although it is extremely doubtful whether Washington would allow American companies to supply technology to China.
Some analysts contend that if China’s economic growth remains robust, and the country is thus able to continue to expand its defense spending significantly each year, it will pose a threat to the US’s military dominance of the globe by the mid-21st century, or earlier. In early 2009, Beijing confirmed plans to build aircraft carriers, with the apparent intent of projecting “blue water” naval power eastwards into the Pacific, bringing it into potential conflict with the US. For its part, Beijing fears that the US is trying to “encircle” China, by using India, and allies such as Japan and Australia, as proxies to contain China’s increasing military strength. China’s concerns have some validity—military ties between Washington and New Delhi, for example, are growing in a number of areas.
India is also growing into a major purchaser of US military equipment, an about-turn for a country that relied on Soviet weapons during the Cold War. In a groundbreaking deal, India agreed to buy six Lockheed C130J transport planes for around US$1bn in January 2008—New Delhi had previously procured transport aircraft from the USSR or Russia. The US is also a contender in the race to win an US$11bn deal for multi-role combat aircraft. Lockheed Martin’s F-16 and Boeing’s F/A-18 are up against the MiG-35 fighter from Russia, the French Rafale (Dassault Aviation), the Swedish JAS-39 Gripen (SAAB), and the European Eurofighter Typhoon (EADS).
In February 2009, India said that the global financial crisis would not affect the modernization of the Indian armed forces or other defense programs. Pradeep Kumar, secretary of state for defense production, was quoted as saying that, “there is no constraint of fund availability for the modernization of the armed forces, and these will go ahead as planned and as per the requirements of the forces.” Meanwhile, in March 2009, military spokesmen said that they had plans to hand out contracts worth US$30 billion in the next three to four years.
Other Major Trends
The Environment
It might appear surprising but the US military is arguably doing more to save the planet than any other organization on earth. For the US Defense Department is investing huge sums in the search to develop renewable sources of energy, as well as improving energy efficiency. The key drivers behind this trend include: national security—the US does not want to be dependent upon energy imported from politically unstable regions; cost reasons—even a 5% cut in the fuel bill would save the Department of Defense US$635m (based on the 2007 figure); and, finally, because it makes sound military sense—many lives are lost transporting fuel to the front line in vulnerable convoys.
The US military is already one of the largest consumers of renewable energy in the world, and it has set a goal that 25% of its energy should come from renewable sources by 2025. The US Air Force’s goal is that 50% of all the fuels used in domestic training flights will come from synthetic, or non-petroleum, sources by 2016. The US military is also investing heavily in solar and wind power.
Technological Advances
The military is one of the key drivers of technological advances. There are certainly some remarkable developments taking place. The F-35 Joint Strike Fighter, being developed by Lockheed Martin, Northrop Grumman, and BAE Systems, for example, features some extraordinary features. These include technology that allows the pilot to look through the structure of the aircraft. The aircraft also features voice commands that significantly reduce the pilot’s workload.
The military is also investing heavily in information technology on land. Military units constantly transmit huge amounts of data back and forth to report their position, generate situational awareness, and share information on enemy tactics. Soldiers with access to laptops, for example, can provide vital information to military commanders. Real-time management of information enables rapid decision-making, meaning that military operations can proceed quickly, possibly providing a decisive advantage during a battle.
Cyberspace: The New Battlefield
Unsurprisingly, given the new emphasis on information technology, governments around the world are investing heavily in measures to protect their computer networks from attacks, and to launch their own cyber attacks. In 2007, the Financial Times reported (September 27, 2007) that, “the Chinese military is constantly trying to penetrate the defenses of US military networks, and the Pentagon is widely believed to attempt the same operations on its Chinese counterpart.” The newspaper added: “Chinese military doctrine has emphasized the growing importance of cyberspace as a domain for war-fighting. While China still lags behind the US considerably in terms of capabilities on land, at sea, and in the air, in cyberspace it has the capability to impose great costs on the US.” Many large defense companies have already branched out into cyber-security and information-technology services.
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