SECTOR FOCUS: Defence

Gunning for growth: Reconnoitring prospects for the UK defence industry.

For additional content to this defence sector focus see our October digital issue or print magazine.

“The Ministry of Defence’s policy on defence industrial policy is not to have one.” This was the crisp and uncompromising statement made by one engineer and ex-serviceman while researching this sector focus on UK defence manufacturing.

It’s not an uncommon sentiment in the sector – or at least it hasn’t been.

But perhaps that is about to change.

While all of UK industry has suffered in recent years due to lack of a long term industrial policy to support its competitiveness, the defence sector has fared worse than most. It’s not hard to understand why the idea of a defence industrial policy from government represents a political minefield.

The ethics of committing to support the commercial growth of arms manufacturers and the regulation of who should (or could) end up using their products are complex problems.

On the other hand, the bare facts show that the UK defence industry turns over £22.5bn a year and directly employs over 150,000 people in Britain in highly skilled jobs.

It’s a growth export industry, and a source of technology and knowledge transfer which can stimulate growth in other sectors too.

Finally of course, the health and capability of the UK defence sector directly impacts on national security.

Britain relies on the superior capability of UK manufacturers, and those in allied nations, to equip its troops effectively and to protect its citizens from threats at home and abroad 

Under attack

Severe defence budget cuts in a post-financial crisis climate of austerity did little to nurture confidence among UK defence manufacturers that anyone in government understood or acknowledged the sector’s contributions to the economy.

The 2010 Strategic Defence and Security Review committed to slash 8% from defence spending over four years, reducing the size of the armed forces, and therefore the number of troops requiring equipment, as well as scrapping key contracts for platforms – like the Nimrod surveillance aircraft.

Those were dark days for UK defence manufacturers and trade body representatives who were frankly pessimistic about the sector’s ability to elicit government support. Sir Ian Godden, then CEO of the defence trade association ADS admitted to at a roundtable debate on the implications for defence policy of conflict in Libya in 2011, that he had “given up” trying to communicate the economic contribution of the defence sector to MoD.

He said Liam Fox, then defence secretary, had a “closed door” policy on discussion of support for the industry on which his department relies.

The reveille

Yet even as these views were expressed, UK defence policy was at a turning point.

The war in Libya in 2011 served as a “wake-up call to government” in terms of the current and future capability the UK needs according to industry commentator Howard Wheeldon.

And certainly the intervening years have been marked by improved government-industry relations – perhaps facilitated in part by the resignation of Liam Fox as defence secretary in October 2011.

Today, the defence industry is enjoying what Steve Fitz-Gerald, CEO of Marshall Aerospace Group describes as “an unprecedented period of government support” which few would have anticipated a few short years ago.

Prime Minster David Cameron has received praise from several quarters for his efforts to support the growth of UK defence exports which recorded a five year high in 2012.

Perhaps even more significant for the future resilience of the UK defence sector however, is the recent establishment of the Defence Growth Partnership (DGP).

This support organisation, made up of a collaborative team of government, industry and trade body representatives was launched in 2012, but it was only at the start of the international trade show DSEI last month, that its full executive staff were appointed (see box) and its strategic vision made public. 

Who’s Who on the DGP?

Co-chairs: Steve Wadey, MD, MBDA & Michael Fallonbusiness minister

Government & ADS leads: Huw Walters, head of aerospace, marine and defence, Department for Business Innovation and Skills; Graham

Chisnall, deputy CEO, ADS and Nick Payne, director commercial scrutiny & industrial policy, MoD

Team chairmen

Air capabilities: Nigel Whitehead, group MD, BAE Systems

Intelligent systems: Victor Chavez, CEO, Thales UK

International business: Peter Rogers CBE, CEO, Babcock

Technology & Enterprise: Sir Brian Burridge, VP, Finmeccanica UK

Value stream competitiveness: Stephen Fitz-Gerald, CEO, Marshall

Aerospace Group

Skills: Allan Cook CBE, chairman, Semta

Engagement: Bob Stoddart, president customer business – defence,

Rolls-Royce

Strategy: Paul Crawley, special advisor, MBDA

The DGP’s purpose is set out in Securing Prosperity: A strategic vision for the UK Defence Sector.

This strategy includes six core strands:

  • Skills
  • Value stream competitiveness
  • Air capabilities
  • Intelligent systems
  • Growing international business
  • Technology and enterprise

These strands represent the strategic and technical areas that government and industry have identified as fundamental to future competitiveness. They will be addressed by eight teams within the DGP – each chaired by a senior industry professional.

Prior to the announcement of the senior team for DGP, industry opinion of the body’s potential was dubious. A senior figure within BAE Systems told TM in June that, while commitment to DGP from the Department for Innovation and Skills seemed strong, he doubted the body had thorough support from the MoD.

September’s announcements have prompted more faith. Paul Everitt, CEO of ADS told that there is now a “genuine collaborative relationship…between major defence manufacturers, SMEs and the department for business as well as the Ministry of Defence and DE&S.”

Howard Wheeldon added: “I am reassured that all parts of the MoD are on side and that they are determined to play their part in making the DGP a success.”

However, some defence companies may be disappointed to learn that the value stream competitiveness element of the DGP has no remit to influence consultation on the reform of defence procurement by MoD.

“The DGP’s focus will be on making sure industry is doing what it can to make itself globally competitive,” explained Mr Everitt. “We do not see this linking to the specifics of government procurement decisions.” (See The Parliamentary Review: Defence Review of the Year for more on defence procurement reform.)

Nor does the DGP have any funding as yet and Everitt says the defence industry should not hold its breath – even though the Aerospace Growth Partnership, on which the DGP is modelled, has received financial support for its initiatives after a period of bedding-in.

“This is not about spending more money. From an industry point of view we need to think a lot more about how we use the resources we have more effectively,” Everitt commented.

SMEs and the DGP

One of the key measures of success for the DGP will be its ability to engage with the large base of SME defence manufacturers.

There are thought to be around 2,000 British SMEs in the UK defence supply chain who struggle to cope with the unique contract, market visibility and cash flow characteristics of the sector (see Finance for defence box).

Finance for defence

While Access to finance is a problem in all UK manufacturing sectors, the defence sector has some particular difficulties due the nature of its products and markets.

Jeegar Kakkad, chief economist at ADS explains: “Access to finance is a problem for the defence industry, as many banks have strict ethics policies that preclude lending to defence suppliers. “While that is their right, it is unfortunate because it starves otherwise innovative, export-oriented companies of much needed growth capital. At the very least, these banks should be more transparent about their rules so that SMEs don’t waste scarce and valuable management time.”

Kakkad urges banks to look again at the defence sector’s underlying levels of innovation and capability. “Given the political and industrial momentum behind the Defence Growth Partnership, there is an opportunity for some banks to support the long-term growth potential of the sector.”

Peter Russell, head of manufacturing at Royal Bank of Scotland, acknowledges that the defence sector can make banks overly cautious.

“I have met a number of defence based companies who raise these issues. When a bank is reluctant to support their activities on ‘policy’ grounds they have sometimes had to make alternative banking arrangements or simply been unable to raise finance.”

To mitigate the negative impact this could have on what Mr Russell identifies as “a key sector of the economy”, he advises firms seek out defence experts for their finance needs.

“Seek a bank who can properly evidence their credentials in supporting defence sector companies and is able to articulate what it can and cannot do,” he says. “No bank will want to fall foul of the stringent regulatory environment that surrounds much of this sector so companies must expect the rigour that goes with this. However, bank teams with the right level of knowledge and experience do exist.”

Jon Bell, relationship director, aerospace and defence at Barclays, agrees. “With the appropriate partner, long lasting relationships can be formed,” he comments, advising firms to be transparent so that a specialist banking teams can properly assess each company on a case by case basis and look at: the status of export and imports partners; the nature of the equipment or products; its intended and likely use; and its potential to be sold on.

Paul Lawrence, MD of AEF, a small manufacturer of connector solutions for electronic interference has been a single source supplier to the Eurofighter Typhoon for many years but explains that the expanded timescales for defence contracts mean a Typhoon order in the headlines today, can only be speculated about as a theoretical order three years down the line for a firm like his.

“All you can do is make sure you keep engaging with new technologies and get involved in development projects for new platforms as early as possible in the hope that they will turn into orders somewhere down the line,” comments Mr Lawrence.

Furthermore, although Lawrence knows that there is great potential in developing AEF’s technologies for application in unmanned systems – a growth segment – he says it is almost impossible to quantify opportunities or plan capacity and capability development because of the clamp down of classified information.

“Sometimes we get asked to develop a bespoke solution with capability across a certain environmental spectrum that can only be for use in a UAV, but we’re not told anything about the end application. That’s just the nature of defence.”

But DGP, building on existing initiatives like the Centre for Defence Enterprise, hopes to give defence SMEs greater independence and empowerment, increasing their direct market access and accelerating innovation in critical technology areas.

ADS’ community of almost 700 members SME defence firms are likely to be the first to benefit from DGP work on value chain competitiveness, but the team chair, Steve Fitz-Gerald, CEO of Marshall Aerospace Group, says he will also be looking for other engagement avenues to draw in as many innovative SMEs into the defence supply chain as possible and help them grow.

Battle half won

The DGP is not a complete solution to the challenges which face the UK defence industry in a climate of declining defence budgets in traditional markets and rapidly evolving warfare technologies. Nor does it represent a true industrial strategy.

What it does represent is a significant step change in the level of overt recognition given by government to the economic contribution of the defence industry.

A full plan for the delivery of the vision laid out in Securing Prosperity will be presented by DGP leaders at Farnborough International Air Show 2014.

This will include details on the new and existing mechanisms which will be used to tackle its priority skills, technology and market objectives.

With the Strategic Defence and Security Revue looming in 2015, it won’t be long before the resilience of these mechanisms and their effectiveness in supporting commercial independence for the defence industry, are put through a thorough test.

 

Target markets engaged

Defence budgets in the UK sector’s traditional markets are shrinking. But the same is not true the world over.

India, Turkey and the UAE have all significantly increased their defence spend since the recession. India and the UAE, along with Saudi Arabia, are now the biggest global importers of arms.

Given this, it is unsurprising that defence exports have become a strategic necessity for all Western defence manufacturers with a mind to survive in the long term.

But competition is fierce, so understanding market dynamics is essential, especially in an industry as politically and culturally sensitive and as tightly regulated as defence.

Take India, which currently holds the world’s largest defence budget.

The Indian government has plans for $250bn of defence capital expenditure in the next ten years according to research conducted by PwC.

The majority of Indian defence capex in 2011 went on aircraft (68%) followed by armoured vehicles (11%), ships (8%) and missiles (5%).  Other key areas included investment in sensors and engines.

The UK has good technology and service capability in all of these areas, but winning defence contracts in India

can be complicated according to Richard Heald, head of the UK India Business Council (UKIBC).

“No defence company operating in India can be 100% foreign owned,” he says. “This means some of collaborative enterprise or JV with a local firm is necessary.”

Furthermore: “Any defence equipment bought by the Indian government must have some percentage of its value, in manufacture or service, generated by domestic companies.”

Finally, Indian defence procurement is ruled by a so-called L1 rule which means the lowest cost bidder will usually scoop the deal. This doesn’t always sit well with the UK’s high-value-add manufacturing philosophy and it saw the UK lose out in 2012 when India decided to buy the French Dassault Sytsèmes Rafale aircraft instead of the

Eurofighter Typhoon – 37% of which is made in the UK – because it offered a lower price point.

Once these official niceties have been navigated, Mr Heald admits that the practicalities of working with Indian suppliers and partners can be “a frustration” for UK firms due to skills gaps, technical capability gaps and cultural differences.

Comfortingly however, an intriguing project is going ahead to help smooth the road for UK defence firms looking to access the cash-rich Indian market. UKIBC has linked up with ADS to take its highly acclaimed supply chain improvement and benchmarking model, SC21, to India. 

The project is in its early stages, but is supported by a number of UK defence primes and the first steering board meeting was held in August. “The aim of the venture, involving primes, training partners, the SC21 project team

and the ADS India office is to create increased UK supply chain effectiveness through the improvement of a number

of strategically important far-eastern companies, located in India,” says SC21

programme lead, Phil Curnock.