Global Consolidation of the Aerospace and Defense Industry: The Next Steps
Mr. John Weston
Chief Executive, British Aerospace plc.
It is a great pleasure to once again address the NATO Workshop, in the beautiful city of Budapesta city that was occupied before the arrival of the Romans in the 1st century AD, that was the seat of the Magyar kings from the 14th century, occupied by the Turks, ruled by the Hapsburgs, and eventually capital of an independent Hungary. Many mathematicians and scientists who were born in Budapest have made remarkable contributions to the world in which we now live, but, in view of my topichow we will consolidate the international defense industry in a way that will best underpin the military and political objectives of the Alliance, enhance shareholder value, and satisfy the regulators and governments of the Western worldI would like to mention just three notable men born in Budapest who may set an example for us.
The first is Enro Rubik, born in Budapest in 1944 and inventor of the Rubiks Cube, a popular toy of the 1980s. A Rubiks Cube consists of 26 small cubes that rotate on a central axis; nine colored cube faces, in three rows of three each, form each side of the cube. To play with the cube, the user twists it out of its original arrangement and then must return it to the original configuration, one of 43 quintillion possible outcomes.
While working as a professor of design, Rubik pursued his hobby of building geometric models. One of these was a prototype of his cube, made with 27 wooden blocks; it took Rubik a month to solve the problem. Eventually over 150 million of the cubes were sold, and approximately 50 books were published describing how to solve its puzzle. At times it seems that developing a strategy to consolidate the defense industry is of the same level of complexity, and perhaps we need a Hungarian of the mental agility of Rubik to solve our puzzle.
The second notable Hungarian I would like to mention is Harry Houdini, who was born in Budapest in 1874. Houdini, as you most likely know, was renowned for his escapes from ropes and handcuffs, from straitjackets and prison cells. Perhaps he could have devised an escape route for us.
The third notable scientist is Edward Teller, the Hungarian-born U.S. physicist known as the father of the hydrogen bomb. Teller was born in Budapest in 1908, and studied there and at various German universities. He left Germany in 1933 when the Nazis came to power, and emigrated to the U.S. in 1935. He became a professor at George Washington University, then joined the University of Chicago in 1942 to work on atomic fission, and later moved to Los Alamos. By the end of World War II, Teller had conceived the H-bomb, and in 1951 he was given responsibility for constructing it. Perhaps his ingenuity could help us now, but we hope we will not need his nuclear capability!
Over the last five years, British Aerospace has consistently held the view that the consolidation process in the United States and the moves preparing the way for consolidation in Europe have never been about building a Fortress Europe to compete with a Fortress America, but rather represent the first steps toward the globalization of the defense and aerospace industry. Such globalization will result over the next 10 to 15 years in an industry led by two or three key players, just as the U.S. industry is led by two or three key players today. In order to aspire to being one of those key players, British aerospace has had three options:
- Make a significant move in Europe
- Merge with GEC/Marconi (both a European and an American move)
- Make a significant move with the United States
In considering these options, we asked ourselves the following questions:
- Does the move create value?
- Can we manage the resulting entity?
- Is the solution deliverable politically and commercially?
A move with the U.S., with British Aerospace the size it is today, would effectively mean selling the company to one of the U.S. majors. This would be incompatible with British Aerospaces role in both the UK security setup and the European setup. Such a move would also not create value, because, with current security arrangements and technology transfer controls, the United States Department of Defense is not prepared to consider being dependent upon outside sources of technology, and therefore it would be necessary to keep one of everything in the United States.
Of the European options, DASA offered the best prospects of a manageable entity in which value could be created. We were unable to conclude a satisfactory commercial deal, however, and GEC Marconi emerged as the clear favorite.
A BRITISH AEROSPACE/GEC MARCONI MERGER
A merger between British Aerospace and GEC Marconi, which on its face could be deemed a national consolidation, will likely lead to that organization becoming a major global player in the industry. The organization will be anything but a UK corporation. It will have:
- Over 15,000 employees in Europe outside the UK
- 18,500 employees in North America
- 5,500 employees in Saudi Arabia
- 2,500 employees in Australia
- More sales in the United States than in the United Kingdom
- It will probably be the most international of any of the leading players in the business
- It will be at home in nine different defense markets.
Horizontal Rather than Vertical Integration
The BAe/GEC merger is primarily horizontal, combining British Aerospaces strengths in civil and military aircraft with GECs strengths in naval and space platforms; the move horizontally merges the two companies capabilities in the defense systems business. Eighty-five percent of the new companys sales will be in platforms or defense systems selling directly to the end customer; only 15% will be in electronics sold to our own prime contractor businesses and to other primes.
We intend to firmly separate the prime contract businesses from the equipment businesses, enabling the prime contractors to run open and fair competitions for subsystems and equipment. These contractors have a strong incentive to demonstrate to their customers that they are working to generate the best value for the money. Otherwise they would not be credible as prime contractors. Separating the businesses will also provide the maximum impetus for innovation and new technology development in both business sectors. This will be backed by procedures that enable the end customer to see the tendering processes.
An Anti-competition Move
GEC does not compete significantly with British Aerospace. British Aerospaces main competition comes from Boeing, Lockheed, Raytheon, Thompson, and Dassault. BAe and GEC compete head-on only in ground-based and naval radars, in a limited way in command and control systems, and in a very limited way in guided weapons.
In my view, competition in the defense business at the national level can be maintained only in businesses in which the necessary investment in technology plant and equipment is reasonably limited. With the limited post-Cold War defense budgets, full-scale competition is becoming increasingly difficult to maintain even in the United States, where defense spending is twice that of the UK, France, Germany, Italy, Sweden, and Spain combined. By allowing Hughes and Raytheon to combine, the U.S. now has effectively only one supplier of air-launched guided weapons. If they continue current policy on the JSF programwinner takes allthey will effectively have only one tactical aircraft supplier in ten to twelve years time. DOD is currently intervening in teaming arrangements for major naval programs to maintain competition, and the recent merger and acquisition activity on this front suggests that the U.S. is struggling to maintain competition in naval platforms as well. With todays number of new program starts, we will probably need to award each alternate program on a Buggins turn basis, which is hardly the basis for effective competition, to maintain two credible players in these key sectors. Future competition in aerospace and defense can be maintained only by moving to the two or three probable global players, and to a global market.
In the UK, competition for some time has been generated by allowing U.S. primes to bid directly into the UK market. The UK, of all the advanced markets with their own industry, operates the most open defense market in the world. The proportion of the UK MOD procurement budget that is spent on overseas contractors is five times the proportion that the DOD spends overseas.
BAe/GEC will have 25 to 30% of the UK market, similar to Lockheed Martins percentage of the U.S. market. During the last few years, the U.S. has won around one-third of the major systems and platform procurements in the UK, about £12 billion worth of awards. There is absolutely no reason to suppose that this will change following a merger of BAe and GEC Marconi. On the contrary, the market will become even more open. This direct access to the UK market for U.S. primes is in stark contrast to policy in the U.S., which effectively bars overseas prime contractors. U.S. business can be won only by operations based in the United States.
The merger of British Aerospace and GEC Marconi presents a real opportunity for a European-based group to become a leading global player in the aerospace and defense business. The merger will open up opportunities in the final stages of the globalization process and add operations in Europe and in the United States. It will also bring significant benefits to our customers. It will:
- Enable a stronger prime contractor to manage major high-risk prime contracts in a way that is more efficient and cost-effective than is possible today
- Combine research and development elements from nine defense markets in a way that will strengthen our ability to keep up in the defense technology race
- Enable the reduction of our cost base of upwards of £275 million per year; over time, significant results of this reduction will accrue to our customers
- The new entity will be a stronger player in the export marketplace, and the increased revenues it will produce will result in lower overheads and, therefore, reduced product costs.
The recent completion of the Aerospatiale Matra merger, and the recent announcement of the relationship between DASA and CASA, are clear indicators that the European scene is now on the move. At the Paris show, even the French industry was beginning to talk about transatlantic moves.
With a budget of $270 billion, the U.S. will struggle in the future to maintain true competition for advanced systems and platforms on a national basis. If such competition is to be preserved, we need to move not only to global companies, but to a global market. Doing so must concern not only industrialists but also governments, armed forces, and regulators. Only if we recognize that the challenges have a global dimension will we be able to find the requisite solutions. We must raise our eyes from narrow national considerations and the protection of vested interests to see the industry and market of the future, a market that may enable us to ensure that the Alliances investment in research and development is optimized to provide effective and interoperable weapons systems that will allow us to meet the peacekeeping challenges of tomorrow. Let us work to apply the ingenuity of Rubik and Houdini and the vision of Teller to find a solution. The wheel is spinning and we do not have much time.