Mr. Burkard SCHMITT
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
'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
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,
(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.