Western Defense Companies Face Grim Future

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Western Defense Companies Face Grim Future

According to a new report, worldwide defense spending declined in 2012 and the outlook for Western companies is bleak.

Global defense spending shrank last year for the first time since 1998, according to a new report by the UK-based advisory firm, AlixPartners. This is consistent with other recent reports by organizations like Stockholm International Peace Research Institute’s (SIPRI).

In its 2013 Aerospace & Defense Industry Outlook, AlixPartners estimates that the aerospace and defense (A&D) industry as a whole grew by 6.8 percent in 2012, a sizeable increase from the 5.5 percent growth rate the industry experienced in 2011.

Yet this growth rate reflected the strength of the commercial aerospace sector, which the report forecasts will deliver 1,300 new jets in 2013. This growth is being fueled largely outside the Western world that has traditionally dominated the market. For example, African airlines experienced an over 7 percent increase in their traffic in 2012, and AlixPartners expects that by 2013, Asia will account for nearly a third of all new jet deliveries worldwide.

The defense sector is also shifting from the developed to the developing world, with Asian countries outspending their European NATO allies for the first time in 2012.

But in contrast to the commercial airline sector, the decline in Western military spending was steeper than the increase in defense spending elsewhere in the world, resulting in a net decrease in global military spending last year.

Overall, global defense spending was US$1.7 billion in 2012, AlixPartners estimates.

The long-term outlook for Western defense companies is fairly dim the report goes on to say. It notes that the Russian and Chinese defense markets will see some of the largest growth rates in the world in the coming years, but that these are both largely inaccessible to Western defense companies.

One of the report’s more shocking conclusions is that over the next decade it expects Chinese defense spending to achieve an 18.5 percent compound annual growth rate. Furthermore, the report notes, by 2016 China and Russian defense spending will account for about a third of the defense spending of the top five countries worldwide. This would be almost double the 17 percent Moscow and Beijing accounted for as recently as 2011.

To compensate for the decline in Western defense spending and the inaccessibility of the Russian and Chinese markets, AlixPartners expects Western defense companies to increasingly turn to emerging markets like Saudi Arabia, Brazil, and India. In doing so, the report notes, they will have to increasingly compete with Chinese and Russian companies.

A number of factors have traditionally inhibited U.S. and European defense companies’ competitiveness vis-à-vis non-Western companies in small and medium-sized non-Western markets.

The first is concern among buyers that the Western companies host countries will be unreliable in approving the sale of spare or replacement parts, particularly during times of crisis such as during an armed conflict. This factor has made India, for instance, wary of becoming overly dependent on U.S. weapon systems.

The second is cost and sophistication. With the U.S. and Western militaries in mind, many defense companies have built the most advanced systems that come at a prohibitively high cost. This may be what the U.S. military demands, and is willing to pay for, but these systems are often beyond the needs and means of countries outside the Western world. For countries in this latter category, cheaper alternatives from countries like China and Russia are more than adequate for handling the national security challenges they face.

In this sense, these defense companies would be wise to heed AlixPartners’ concluding advice: “Companies should accelerate their diversification into new and faster-growth markets. This entails more than a mere   geographic change—with the inherent supply chain challenges—and involves the tailoring of   products and services for customer segments with varying priorities and requirements.”