The experience from the late 1990s and early 2000s indicates that several factors need to be present for consolidation to occur: (a) a shrinking demand; (b) a lack of competitiveness; and (c) the political will of European governments.
This SIPRI Essay gives an early glimpse at where these three factors stand after the ‘great lockdown’. It proposes that the European arms industry may be at the outset of a larger consolidation movement. Although consolidation would be the most cost-effective way to restructure during an economic crisis, arms companies are still assessing the current climate. Overall, political will remains the key driver of any change in this sector.
The impact of the lockdown on the European arms industry
In response to the lockdown during the first half of 2020, arms companies across Europe implemented a wide range of measures. Companies halted or reduced production, and in cases where production has restarted, it is yet to resume at pre-crisis levels. Nonetheless, the European arms industry has not been as affected as other economic sectors. This is in part due to the arms industries’ reliance on long-term government contracts that are not (yet) in jeopardy. In the short-term, governments in France, Germany, Norway and Spain are preparing to implement sector-specific economic recovery plans.
However, delays and potential cancellations in domestic and export orders could have a more long-term impact on the sector. In particular, potential cuts to military spending throughout Europe over the coming years may cause uncertainty. This was the case after the 2008 economic crisis which—according to SIPRI’s Military Expenditure Database—was followed by five years of military spending cuts across Western and Central Europe. Moreover, the current pandemic could shift government’s priorities away from defence and towards healthcare and crisis contingency. At the same time, threat perceptions are higher today than they were in 2008–2009 which may act as a justification for governments to maintain high levels of military spending.
The first factor for industry consolidation—a shrinking demand—may not be present in European countries in the short-term, but it cannot be ruled out for the mid- to long-term given the magnitude of the current economic crisis.
Adapting to competition: Movements of consolidation in US and Europe
In a highly competitive environment, companies undertake mergers and acquisitions to gain an advantage over their competitors. Through consolidation they expect to generate economies of scale and expand their customer base and product lines.
Prior to COVID-19, a new mega-merger trend had started in the arms industry of the United States. In 2015, Lockheed Martin acquired Sikorsky from United Technologies Corp. (UTC). This was accelerated under President Donald J. Trump’s Administration and companies tried to move ahead of their competitors to gain shares in the large-scale US modernization program.
During 2018, UTC acquired Rockwell Collins, Northrop Grumman acquired Orbital ATK and General Dynamics acquired CSRA. In 2019, Harris Corp. and L3 Technologies merged, while Raytheon and UTC formed Raytheon Technologies in 2020.
The scale of some of these mergers and acquisitions was significant. For example, the merger between L3 Technologies (the 12th largest arms sales company in 2018) and Harris Corp. (the 17th largest) involved more than 48 000 personnel. As for Raytheon (the 4th largest) and UTC (the 11th largest), they combined a total revenue of $94 billion in 2018 (€80 billion in current prices) and employed more than 300 000 people. Three decades after the US arms industry’s ‘last supper’, new giants were born.
European companies actually had begun to form new partnerships before their transatlantic counterparts, reacting to both increased competition on the global market due to the rise of new arms suppliers such as South Korea or Turkey and contracting domestic demand following the 2008 economic crisis. However, contrary to their US rivals, European firms did not undertake mega-mergers and instead launched joint ventures or joint holdings. These are a more limited form of transnational consolidation, as in such instances national companies’ activities remain separate and not fully integrated.
This was the case in the land domain. There were indeed some acquisitions—for example in 2014, French state-owned Nexter bought Mecar and Simmel Difesa—but these companies represent only around €210 million of revenue and 470 employees; and €36 million of revenue and 170 staff, respectively. More importantly in 2015, the German company Krauss Maffei Wegmann (KMW) and Nexter created KNDS, a joint holding company—a key driver behind this change was global competition, as noted by Nexter’s CEO. Integration between the two groups remains minimal, however, maintaining a ‘separate but together’ structure.
In the United Kingdom, however, the land sector is almost entirely transnational: after Rheinmetall’s purchase of 55 per cent of BAE System’s combat vehicle units, all vehicle manufacturers are now partly foreign-owned, except for the firm Supacat. In the naval sector, Naval Group and Fincantieri created a joint company called Naviris in January 2020. Although one of the reasons for its creation was precisely competition in the global arms trade, the two firms were still rivals in some markets, such as Egypt for example.
There have been no new attempts to largescale restructuring in the aerospace sector after the failed merger in 2012 between EADS (Airbus) and BAE Systems, €49.1 billion of revenue and 133 000 employees and €23.8 billion of revenue and 93 500 employees, respectively.
Airbus has since consolidated its defence activities, notably through divesting from its defence electronics branch, which became Hensoldt in 2017. BAE Systems, in the meantime, reinforced its US presence and recently announced its aim to purchase businesses made available from the UTC–Raytheon merger for more than $2 billion (€1.8 billion in current prices). The failed merger demonstrates that governments remain in the driving seat of the most strategic arms industrial dynamics, even though both companies advocated for the deal at the time.
Besides BAE System’s growing US footprint, European arms companies have not yet reacted to the creation of new giants in the US military market. Given the novel characteristics of the pandemic, these companies will likely need more time to adjust to the repercussions of the crisis before making new structural decisions.
COVID-19: Political will shapes the arms industry’s future
No matter how difficult the current economic downturn is, or how prominent the competitiveness issue becomes, preserving national arms-industrial capabilities will likely remain at the top of European decisionmakers’ agendas. In this respect, the pandemic caused by COVID-19 could either prompt European governments to push for increased consolidation of the European arms industry or, on the contrary, to protect their domestic industries at any cost.
The crisis caused by COVID-19 could have two contradictory effects. On the one hand, calls for increased solidarity and efficiency may prevail. This would push European companies towards greater cooperation and integration in the armament sector—thereby increasing interdependence. One indication of a step in this direction is the July 2020 agreement for €7 billion for the European Defence Fund (EDF) in the European Council’s 2021–27 budget.
Although the figure was lower than the originally proposed €13 billion, it was still higher than the compromise of €6 billion that was on the table prior to the pandemic. However, although the Commission seemed to have industrial restructuring in mind as a long-term goal for the EDF and its precursor instruments and stated that they should foster competitiveness ‘including by consolidation where appropriate’, this is not necessarily the opinion of individual governments. In a joint letter, the defence ministers of Germany, France, Italy and Spain did not directly call for industrial consolidation and rather saw the EDF as a way to ‘incentivize cooperation’ and that it could offer a ‘more efficient allocation of resources’.
But the supply chain concerns caused by the current pandemic could have the opposite effect. Indeed, it may act to reinforce trends of autonomy or even the renationalization of industries. Despite steps taken for joint procurement programmes, such as the two rival future combat air system projects; Tempest (Italy, Sweden and the UK); and the Future Combat Air System (Germany, France and Spain) or the Main Ground Combat System (France and Germany), governments could still decide to prioritize their domestic manufacturers, to support national industries instead of promoting cross-border cooperation.
Arms procurement processes usually span years and any outcomes are unlikely to be known in the short-term. The looming prospects of shrinking demand and the intensification of competition could prompt European arms firms to consolidate further in the coming years. But what will determine the restructuring of the sector in Europe remains political will. If consolidation is seen to be the only way for governments to sustain their arms industry in a constrained economic environment, they are likely to pursue that option.
About the author
Dr Lucie Béraud-Sudreau (France) is Director of the Arms and Military Expenditure Programme.
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