UK’s £22bn defence sector must adapt as revenues tighten

LONDON // No one really likes to talk about the business of war, but for the United Kingdom the defence industry has an important role in the economy.
Last month, a record 1,600 companies from around the world flocked to London's International Defence and Security Exhibition to display their military wares and to meet potential buyers of these arms.
Britain's companies were proudly displaying their goods – as befits some of the biggest defence manufacturers in the world including BAE Systems, Roll-Royce and Qinetiq.
The British industry employs 300,000 people, including the supply chain, and has a turnover of £22.1 billion (Dh130.02bn). It has a fifth of the world's defence spending and is the second-biggest supplier of defence and arms, behind the US.
But the UK's defence businesses are facing a tough time with cutbacks to military budgets at home and abroad. The decision by Britain's parliamentarians to back down from a military strike in Syria and the gradual withdrawal from Iraq and Afghanistan also hinders the defence sector, to the extent that the British industry's major selling point around the world – that its wares are battle-tested – is no longer so much the case.
These problems come just when the British government needs to promote defence as an industry as part of its efforts to rebalance the whole economy away from financial services and towards manufacturing.
"This is a huge period of adjustment for the defence industry and it will undoubtedly lead to a change of emphasis for some companies,' says Howard Wheeldon, an independent consultant to the defence industry.
"While the next few years will undoubtedly be tough, I believe governments will recognise that there is a limit to how much you can go on cutting defence capability."
Dismay at the extent of UK defence cuts, which will see army numbers fall from more than 100,000 to about 80,000, was highlighted at the Conservative Party conference this month when Philip Hammond, the defence secretary, was heckled by a retired army colonel.
The government has hinted that it sees the future of Britain's defence industry in aerospace and intelligent systems – the electronics and software that go into military equipment. At the party conference, Mr Hammond said the country would build a new "cyber strike force" costing up to £500 million. However, that is scant consolation to the workers who build warships, tanks and aeroplanes for the military.
The gloom comes on the back of some very good years. Huge orders to sell Typhoon and Hawk military aircraft to Middle East nations have helped the British defence industry to achieve its biggest increase in exports for five years last year.
According to figures released by UK Trade & Investment in June, defence exports surged by 62 per cent to £8.8bn last year, easily outstripping growth in the global defence market of 45 per cent.
A large part of the expansion is down to two deals struck by BAE Systems – a £1.6bn sale of Hawk training jets to Saudi Arabia and a £2.5bn order for 20 Typhoon and Hawk aircraft placed by the Omani ministry of defence.
"Our biggest manufacturers are probably in the best condition they have been in for maybe 30 years from a financial and management point of view, says Mr Wheeldon.
"But whilst they are lean, fit and still very profitable the outlook for those that are less engaged in defence exports or that have a large business servicing older equipment will see an adverse affect on margins."
There is increasing talk, too, from ministers of buying "off the shelf" to cut the cost of procurement – this has sent a chill through the industry.
BAE System's strategic response to the budget pressures in the UK and US has been to target international markets increasingly. "In 2012 we reported order intake of £11.2bn in those markets, up from £4.8bn the previous year," a BAE spokeswoman says. Besides the £2.5bn contract with Oman, it recently won a £426m contract to upgrade and deliver combat vehicles for Norway.
"The industry is always prepared to adapt and change and is brilliant at doing it but it does need the support and trust of those in government. If we don't invest more in research and technology to create more product opportunities in the future, and if we fail to buy the product that we have developed for our own armed forces, no one will buy it from us," Mr Wheeldon says.
Not all defence companies are in the same boat. Those that have concentratred on providing maintenance and training to the armed forces, such as Babcock, an engineering company that refits and repairs the UK navy's submarine fleet and a lot of its ships, look in a better position.
Babcock, which has offices in Oman providing aircraft maintenance and marine training, sold its US services business, VT Holdings, last year for £61m, a decision that looks increasingly wise.
"While the size of the armed forces is diminishing that is a concern," says the chief executive Peter Rogers.
"But it does give us the opportunity to refurbish, where they may have bought new – and to retrain."
Last month, UK ministers launched a joint initiative with the industry in a bid to safeguard skills and jobs but details about the partnership is sparse.
Michael Fallon, the business minister, did tell the industry it must adapt.
"Customers' needs are changing in an uncertain world; competition is fiercer and technology is evolving rapidly," he said.
Mr Wheeldon says while the Typhoon and Hawk have been the successful products of international collaboration, it may be that concerns over affordability will see a lull in international partnerships.
However, there is some hope that Britain can retain its leading global position.
"For every country that is cutting back on defence spending there is another increasing it," says Mr Wheeldon.
"China, Russia, India, Brazil, Chile, Argentina, Iraq, Algeria, Indonesia, Japan, South Korea, Pakistan, Malaysia and Australia, to name but a few are, or have been, increasing the amount they spend on defence."
The UK's major markets are likely to continue to be Saudi, Oman, India and perhaps in future Malaysia, the UAE, Qatar and Bahrain.
Also, partnerships with other countries will remain important. For Britain's defence businesses it is no longer simply a case of selling a product to a country. They have to invest in that country, perhaps allowing the product to be built there and offer the ability to train personnel as well.
"The UK has a long pedigree in training of armed forces and the states in the Gulf want to do things in the right way," says Mr Rogers.
Rakesh Sharma is the chief executive of one of the smaller UK defence companies, Ultra Electronics. Ultra has quadrupled its market value in the past decade and has benefited by selling into the niches where governments are still spending, including battle-space IT, communications and cyber warfare.
Mr Sharma is pragmatic about cuts, believing that ministers in the UK have made the best of difficult times. He also says some adversity will help to improve the sector's health.
"I am a great believer in competition, it forces companies to innovate and control their cost-base. This is a great foundation to compete on a global stage," he says.
Ultra has been preparing for some time for the current environment. "About five years ago we recognised that we needed to extend our geographic profile and started an export drive outside of the UK and US and continental Europe.," he says.
"Over the last two years we have seen significant success in our exports."
Ultra recently won a breakthrough contract in Indonesia and has been growing in China and India.
The company has also established a presence in the UAE and Oman. In the UAE it is a joint venture partner with Emirates Advanced Investments in Al Shaheen, providing training programmes. 
In Oman it is a joint venture partner with Omani Investment Corporation in Ultra Electronics Ithra. Through this venture Ultra supplies IT infrastructure to the new airports in Muscat and Selalah. 
"We hope to increase our investment and presence in the region but one has to build trusted relationships before contracts are awarded," Mr Sharma says.
"Luckily, we started five years ago."
business@thenational.ae