Institute for Security Studies of the Western European Union, Paris
THE INTEGRATION OF DEFENCE AND AEROSPACE INDUSTRIES IN EUROPE:
TOWARDS A EUROPEAN ARMAMENTS INDUSTRY?
PARIS, 30 March 2001
Lecture in the Cicero Foundation International Seminar 'European Armaments Industries, ESDP, and Transatlantic Cooperation'
The Current State of Play
Over the last two years, transnational restructuring of defence industries has been high on the agenda of European defence. Public debate on this issue, however, has often been characterised by a certain misunderstanding. Indeed, many analysts use the term "defence industry" when what they really mean is aerospace and, at the most, defence electronics. Only in these two areas has real cross-border consolidation taken place, leading not only to the formation of sector-specific transnational companies, but also to the creation of a truly European champion, EADS.
Other reference areas, however, have not as yet been greatly affected by interational consolidation. In land armaments the number of cross-border acquisitions is rising (see, for example, the take-over of Sweden's Hägglunds by Alvis of UK), and US investors are also entering the European market (General Dynamics, for example, became a major shareholder in Daimler Puch of Austria and recently obtained approval to acquire Santa Barbara of Spain). Nevertheless, neither the Main Battle Tank, nor the artillery or munitions sectors have started the process of international restructuring in any meaningful way. The same is true for naval shipbuilding, a sector by and large structured around national leaders that dominate their home market (BAE Systems in the UK, Fincantieri in Italy, DCN in France, etc.). The only major transnational acquisition so far has been the take-over of Sweden's Kockums submarine business by Germany's HDW (1).
Several reasons explain why 'Europeanisation' is more advanced in aerospace than in other defence industries (2):
Experience of Cooperation
Driven by high R&D costs, aerospace companies started to cooperate much earlier than their counterparts in other sectors. Over several decades, they have learned to work together and have gradually developed a dense network of joint ventures that served as an excellent base for the consolidation wave at the end of the 1990s. Land system companies and naval shipyards, in contrast, have never reached a similar degree of cooperation. During the Cold War, R&D costs in these sectors were lower and (as far as land armaments is concerned) production runs longer, making purely national programmes and production facilities sustainable. This situation changed with procurement cuts in the early 1990s. The ensuing period however, has been too short to make up for the delay taken over several decades, in particular since there were almost no intergovernmental programmes launched that could have structured industrial cooperation.
Importance of Civil Activities
Aerospace industries have military origins, but they realise today more than 70% of their turnover in the civil market. The importance of the commercial business is not only due to reduction in military orders, but also to the growth of civil aviation, in general, and to the huge success of Airbus, in particular. Airbus was in many ways the driving element for cross-border consolidation. First, cooperation within the consortium has led to a considerable degree of specialisation among the partner companies, binding them together in a core area of activity. Second, the transformation of Airbus into an integrated company implied the wider restructuring of the whole aerospace sector, including defence activities. This stands in contrast to the land systems or naval shipbuilding sectors where producers are often highly specialised, with little diversification, and rarely associated with big commercial groups (except in Germany). As a consequence, civil activities could never become a driving force for transnational consolidation.
Between 1993 and 1997, a wave of consolidation in the US led to the creation of aerospace and defence giants with turnovers several times greater than those of the biggest European groups. The only way for Europe's national champions to sustain competition with companies the size of Boeing, Lockheed-Martin and Raytheon was to pool their R&D resources, broaden their market access and reform the Airbus system. The pressure to move from cooperation to integration was all the more irresistible because competition with the US was across both the civil and defence markets. For the other defence industry sectors, in contrast, competition has been a dividing rather than a unifying factor. European shipyards rarely have to confront US competition, because American shipyards produce almost exclusively for the US Navy. On the other hand, they are in fierce competition with each other in export markets. European land armaments producers face US pressure on export markets, but they compete with each other at least as much as they do with their US counterparts.
Since the announcement of the MDD-Boeing merger in particular, European governments have actively supported the Europeanisation of their aerospace industries. For very different reasons, a similar consensus has never been reached concerning other defence industrial sectors. The Spanish and the Swedish government, for example, accepted the take-over of major land armaments producers by US investors, simply because the latter presented a better offer than the European competitors. In France, on the other hand, the government has been obliged, for political, social and legal reasons to slow down privatisation, thereby delaying cross-border restructuring.
'Europeanisation' is more advanced in aerospace than in any other sector, but even here, integration has remained until now limited to the shareholder- and senior management levels. The reasons for this are mainly political. Whereas almost all industrial high-tech assets are now organised into transnational companies, defence-related rules and regulations, R&D funding and procurement systems are still national. EADS, for example, has to deal with three different national regulatory frameworks and procurement agencies. This fragmentation makes it extremely difficult, if not impossible, for transnational aerospace companies to optimise their internal procedures and to rationalise their production in an efficient way: R&T funding is nationally earmarked and R&T policies remain uncoordinated, financing of projects is unstable because of non-harmonised budget cycles, companies are obliged to go through long and time-consuming export procedures for transfers from one site to another, etc.
In July 2000, the six major European arms producing countries made a first attempt to overcome these problems, signing a Framework agreement that aims at harmonisation of defence-related regulations and procurement policies (3). Nevertheless, a common European armaments market and a common armaments policy are still a long way off. So far, European governments have focused on reforms of their national procurement processes, which is hardly sufficient since almost all future complex weapon systems in Europe will be developed through international cooperation. At the European level, very few phases of the acquisition process are actually covered by cooperative bodies, and even the most promising initiatives like OCCAR and the Framework agreement are limited to certain areas and certain countries. Fragmentation of defence policies, markets and budgets is all the more regrettable since is a major disadvantage for both Europe's supply and demand side: It not only complicates the life of transnational defence companies, but it also creates costly duplications and weakens the purchasing power of governments vis-ā-vis the European champions. Given the shortage of public finances in general, and military budgets in particular, it is high time that European governments put all their efforts into establishment of a common procurement system and a homogeneous defence economic space.
In spite of persisting political and regulatory obstacles, industrial consolidation
in Europe will continue. In aerospace, further restructuring steps will certainly
be taken at the subsystem and component level as well as in specific areas,
such as combat mission and transport aircraft. A full scale merger between the
two European giants, EADS and BAE Systems, however, does not seem realistic
in the foreseeable future. The creation of a single European aerospace and defence
prime could be perceived as a step towards the creation of a fortress Europe
which, in turn, would undermine attempts of both BAE Systems and EADS to gain
access to the American defence market.
Therefore, the big European primes will probably prefer to reinforce their transatlantic links through specific and programme specific arrangements. Transatlantic cooperation will certainly also grow at the subsystem and component level (where industrial ties are already important).
Consolidation of naval shipbuilding and land armaments will also continue. Due to different market conditions, however, the restructuring process in these sectors will probably follow a different path than in aerospace. The creation of a big transnational prime contractor for land armaments, for example, is rather unlikely, since there are no common commercial activities that could promote transnational integration and very few intergovernmental programmes that could structure cross-border consolidation. Moreover, the lack of harmonisation of military requirements is even more pronounced in land armaments than in aerospace. Last but not least, market fragmentation, a dispersed industrial system and a lack of political backing for European arrangements makes it much easier for US companies to take-over land system producers than it was the case in aerospace (4).
In spite of the recent consolidation wave, Europe's defence industrial landscape remains extremely complex and differs widely from one sector to the other. A really European industry exists, at best, in aerospace. Consolidation will certainly continue, but following a specific path in each sector.
In many ways, the ball is now in the court of governments. European transnational companies can only fully exploit their technological strength if an appropriate framework and an up-to-date demand side exists. The traditional intergovernmental ad hoc approach towards armaments cooperation is far too complicated and inefficient to cope with new industrial, financial and technological realities. Facing severe budget constraints, European governments will have to start thinking the unthinkable: The European Commission, for example, should be involved in the process, at least for certain regulatory and technology issues; integrated European institutions should be established throughout the procurement cycle; an EU budget line should be created for certain common projects; etc. If Europe wants to have both a competitive Defence Industrial Base and well equipped armed forces, a common procurement system and a common defence economic space must become a top priority for all relevant political authorities.
(1) Christophe Cornu, "Fortress Europe - real or virtual?", in: "Between cooperation and competition: The transatlantic defence market", edited by Burkard Schmitt, Chaillot Paper 44, Institute for Security Studies, Paris, January 2001.
(2) Burkard Schmitt, "From cooperation to integration: Defence and aerospace industries in Europe", Chaillot Paper 40, Institute for Security Studies, Paris, July 2000.
(4) Jan Joel Andersson, "Cold War dinosaurs or high-tech arms providers? The West European land armaments industry at the turn of the millennium", Occasional Paper 23, Institute for Security Studies, Paris, February 2001.