Industry Summary

The armed forces industry has changed enormously over the last 30 years. In 1989, with the Cold War still raging, global defence spending tipped $1,300 billion. However, as US-Russian relations thawed and the world settled into a period of relative peace, defence spending dropped by almost a third, to $800 billion in 1996. In the US, the world’s largest defence market, and to some extent in Europe, the cutback on spending led to rationalisation and consolidation amongst suppliers.

Now defence spending is on the increase again. The most recent set of figures reveals that global defence spending has risen 37% over the last decade to a post-Cold War high of $1,204 billion in 2006. The dramatic increase in defence spending is due to several factors.

The first of these is fear. Since terrorists crashed two planes into the World Trade Centre on September 11th 2001, governments fear similar attacks happening in their back yards. As national security has flown to the top of political agendas, more money has been made available to strengthen military defences. On top of this, rising mineral and fossil fuel prices have allowed the likes of Russia and Saudi Arabia to spend more on defence. Then there are the emerging superpowers - India and China - who have both demonstrated a willingness to spend more on defence as their economies have grown.

What proportion of the defence budget is spent on the army, the navy or the air force depends on the specific needs of each force at any given time. For example, the ground-centric nature of the war in Iraq saw the US army’s slice of the 2006 defence budget increase by $12 billion in 2006 to $112 billion, taking it above the navy’s $111 billion but not the air force’s $130 billion.

Whichever regiment feels the benefit, there is little doubt that such an increase in defence spending is great news to military suppliers. The US is by far the biggest spender on defence, accounting for almost two fifths of the world’s defence spending. The latest figures reveal that of the $439.3 billion the US spent on defence in 2007, $84.2 billion went on procurement, with $73.2 billion on research, development, testing and evaluation and $12.6 billion on military construction. By anyone’s reckoning, that’s an enormous amount of money’s worth of contracts available to suppliers in the industry.

The market

As military systems have grown in complexity and cost over the last few years, the defence industry has consolidated and is now dominated on both sides of the Atlantic by a handful of large companies: Lockheed Martin, Northrop Grumman, Boeing, Raytheon and General Dynamics in the US and BAE Systems, EADS, Thales and Finmeccanica in Europe. This has led to a situation where many of these companies are suppliers, customers and partners as well as competitors, all at the same time.

Traditionally nation states liked to keep defence production within their own boundaries but the current trend is towards cooperation between the major industrial powers, which has seen European companies picking up more contracts in the US and vice versa. Lockheed Martin, EADS and Thales, working together to produce the COBRA radar system, is just one of many examples of pan-Atlantic cooperation between the defence giants.

The increased cooperation between companies is finance driven. In an increasingly globalised economy, US companies are looking to the international market to maintain their revenues, profits and share prices; whilst European companies are attracted to the potential financial rewards in the US which, as the most dynamic market in the world, will have an annual defence budget over $500 billion by the end of the decade.

Army suppliers

Land-based weapons like handguns, machine guns, tanks and armoured personnel carriers are the most important pieces of machinery in any army’s arsenal. The top-end of the supply market for global armies is dominated by the major defence companies but, the smaller the weaponry being produced, the more fragmented the market becomes.

General Dynamics became the world’s biggest manufacturer of land-based armoured vehicles when they paid $1.1 billion for General Motors Defence in 2003. The company employs over 80,000 people worldwide and in January 2007 its Canada-based land systems arm won a $76.5 million contract to supply 169 RG-31 mine-protected vehicles to the US army.

Another defence giant, Lockheed Martin, has worked with the US army since before the First World War. The company, which last year bagged a $120 million contract to supply the army with five, next generation radar systems, also supplies logistics and training to air and missile defence, air-to-air and air-to-ground missiles and rockets and close combat weapons systems to the US army.

BAE Land Systems is the through-life capability partner to the British army, providing anything from Challenger tanks to indirect fire systems to small arms, mortar and tank ammunition. This year BAE won a £70 million contract from the Ministry of Defence to upgrade the power train of 400 FV430 series vehicles for the British Army.

However, when it comes to the manufacture of smaller weaponry like handguns, machine guns and grenades, the majority of producers are small and often found in third world countries where parts and labour are cheap. International trade in small weapons like AK-47s is substantial but regulation is flimsy, which is why many legitimately-made weapons fall into the hands of guerrilla forces.

Recruitment

In the post-Cold War peace boom between 1990 and 2001, employment in the UK defence industries declined by almost 50%, from 550,000 to 295,000. Even though there has been a resurgence in defence spending since 2001, employment has not returned to Cold War levels. The 2007 figure of 310,000 defence industry employees reflects the fact that technological advances have paved the way for less labour intensive production methods.

However, the global picture is more encouraging. Lockheed Martin now employs approximately 140,000 people worldwide compared to 125,000 in 2003, General Dynamics has increased from 69,400 people worldwide to 82,000 and Force Protection, specialists in manufacturing IED-proof armoured vehicles, have had to increase the capacity of their HQ from 87,000 sq ft in 2003 to over 400,000 sq ft to cope with their increase in staff numbers and R&D space.

Plenty of employment opportunities exist within the US army. Military chiefs announced in October that they wanted to add 74,000 soldiers by 2010, swelling the ranks of the world’s largest army to 547,000. However, with the May draft missing its targeted 5,500 soldier goal by 12%, congress chiefs have been urged to fast track a bill that will allow the army to conscript foreign nationals into the force.

Army recruitment figures for the UK are slightly misleading. Although the latest figures show that during the 2005/06 financial year recruitment increased by 9%, with 11,400 new soldiers joining the army, the success is tempered by a lack of retention. In the same period, Conservative shadow defence minister Mark Harper reported that 14,000 troops had left the army, meaning the force had actually shrunk in size.

The future

In the short term, prospects for the defence industry look very healthy. With President Bush sending an extra 21,000 US troops to Iraq in 2007 and the threat of terrorism ever-present, the west’s new fixation with defence spending looks set to continue. China has increased its defence spending every year for the past decade, including a leap of nearly 18% this year, whilst India continues to modernise what is one the largest military forces in the world.

However, the medium to long term picture is more difficult to decipher. Britain withdrew over 2,000 troops from Iraq in 2007 and, with public opinion turning against allied occupation and the huge cost of sustaining the war effort, it is anticipated that allied nations will scale down their operations in Iraq in the not too distant future. Should no other major conflicts arise, the US’ enormous defence spending will become harder to justify.

Whatever increases in spending may come from China and India, as owners of two fifths of the global market, the US is key to the future of the defence sector. Early indications are that the US is looking to scale back its defence spending, with Pentagon projections showing the defence department R&D budget falling from $72.5 billion this year to $71.2 billion in 2011, an 11.6% fall after expected inflation.

Whether budgets ultimately fall or merely fail to increase at the rate they are now, any reduction in available finances, especially from the US, would be sure to halt the progress of the big defence companies and may even force them to consolidate further.