Land defense industry: market shift ahead?

, by David Newman

Land defense industry: market shift ahead?
Both Macron and Merkel have pushed the idea of a joint European Army for the bloc that would be part of the wider transatlantic NATO alliance. NATO (https://www.flickr.com/photos/nato/43344877991)

As military equipment increases its complexity virtually every year, non-specialized firms are gradually pulling out of the market, while specialized firms are bagging the abandoned business. In coming years, additional concentrations may be seen in the European defense industry. If so, it will amount to an earthquake on the strategic landscape and have considerable ramifications.

The trend started at sea

If history is to be believed, we will witness, within the next decade, a deep reorganization within the small world of firms which produce the equipment used by European armed forces. Over the past fifty years, a dual phenomenon set in, in which large players absorbed smaller ones, for questions of scale and commercial fire-power, while peripheral activities were closed down and civilian producers produced civilian vessels, leaving military vessels to military shipbuilders. Large non-specialized firms such as Fincantieri gradually receded from military markets, in favor of groups specialized in military productions, such as Naval Group, which focus on integrating programs.

Breaking Defense writes: “As the Army moves away from long and cumbersome programs, companies are challenged to anticipate future requirements, develop and test mature technologies, and integrate them on platforms to mitigate high-risk gaps in mission capabilities necessary to meet current threats.“ Put simply, these large trusts are in charge of assembling the various technologies, and increasingly absorb peripheral businesses to do so. Virtually every segment on the market is following this trend, where non specialists pull out, and specialist encompass. Indeed, the failed launch of the Airbus A400, in contrast with the European builder’s flourishing civilian business, may well mean that we will have yet another example of this trend shortly.

Market consolidation: defence firms absorbing segments

Part of the phenomenon can be explained by mounting complexity. As the number of parts increased, so did the number of subcontractors, and the job of integrating these modules into one single program became so difficult that military programs could no longer be a simple subdivision of broad-spectrum engineering firms. The role has evolved from simple producer to that of integrator or project manager, with the development of “combat systems”, which will enable one platform to suit many different applications. Defense blog Army Technology reported in October of 2018 - on the merger between American technology firm Harris and defence company L3 - that “Once operational, the new establishment is expected to serve as the sixth largest military technology company in the US and one of the top ten global defence companies.” Hence L3 CEO Christopher E. Kubasik comment: “This merger creates greater benefits and growth opportunities than either company could have achieved alone.” As the old firms withdrew from these market segments, the demand for military equipment didn’t disappear - indeed, it grew, requiring critical size to meet new market expectations.

Is the EU army project the driving force?

Another partial explanation for this phenomenon is the renewed wind inflating the sails of the European common army project, recently reinvigorated by French president Emmanuel Macron and German Chancellor Angela Merkel. As reported by the Local in January of 2019, “German Chancellor Angela Merkel said closer defence ties agreed in a new friendship treaty aim to build a Franco-German “common military culture” and “contribute to the creation of a European army”. Both Macron and Merkel have pushed the idea of a joint European Army for the bloc that would be part of the wider transatlantic NATO alliance.” Such a strategic endeavor would, naturally, have immense ramifications within the industry, namely reorganizing and consolidating production means so as to ensure available parts and rationalize costs.

EU rules may be breached

However justified this trend may be on the industrial and economic level, it may run into European regulations and paint European governments into a corner. The concentration phenomenon applies to producers and will eventually break the balance of powers with clients - with a single supplier, there is little margin for negotiation. Rheinmetall is a perfect example, as it has incorporated an ever-increasing share of the German armament industry, to the point of being unavoidable in large programs. Rheinmetall has no intention of stopping there as it is now toying with the idea of acquiring Renk, the main transmission supplier for tracked vehicles. Renk currently belongs to the Volkswagen group, but the mother company is considering its sale, for strategic reasons. Should this merger-acquisition come through, Rheinmetall would acquire one of its suppliers, which also supplies competitors. This would therefore place it in a position of dominance, and it is expected that safeguards in the defense industry will be strengthened to prevent any abuse of leadership as it is now the case with EU digital competition policy. “Breaking up companies is a tool that we have available, it can be done. The thing is I have obligation to use the least intrusive tool in order to restore fair competition,” EU’s antitrust chief Margrethe Vestager said. “Since it is quite a thing to break up a company, obviously I have an obligation to try what else can be a good tool to solve the situation that we are in.”

Bad strategic news for Europe?

Is the concentration of military markets good or bad strategic news for Europe? It may be both: while the increased integration may indeed consolidate production potential, this may be a short-termed strategy - making the classic mistake of all eggs in one single basket. Indeed, historically war-torn Europe has shown what risky assets large military plants can be, as they rank very high on the list of strategic bomb-raid targets, whereas a spread-out industrial network is far more resilient. This being said, business concentrations need not amount to geographic concentration but, regardless, a breakdown in transverse services would affect the entire business, and therefore the entire industry. This risk would apply to all combat environments, air, sea and land, as the number of producers in each one has drastically fallen in recent decades. With the downfall of ThyssenKrupp and the troubles of Navantia, Europe’s capacity for military shipbuilding, for instance, is down to large French player Naval Group and Swedish outsider Saab. In addition, whichever country possesses the manufacturing capabilities would effectively have immense political leverage on its European counterparts. Finally, the European Union has been concerned, for the past ten years, that the ongoing concentration phenomenon in the defense market could lead to loss of competitiveness and job losses.

The idea of market concentration is not necessarily a bad thing for Europe, but the process may cause economic and political shifts in Europe, which will benefit some and harm others. There is still some time for States and investors to make necessary adjustments, as the legal implications of a potential abuse of dominance may slow things down.

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