1. Introduction
Defence constitutes an atypical industrial sector for several reasons, most importantly for its critical role in upholding national security. As a result, it has traditionally been protected by governments to a large extent. Some instances of cross-border industrial defence cooperation occurred during the Cold War, with the development of joint projects like the Panavia Tornado and the Eurofighter Typhoon fighter aircrafts (De Vore, 2011). Far from being a widespread practice, however, this kind of cooperation was carried out on a temporary and ad-hoc basis (Bitzinger, 1994). This trend started to change by the early-1990s.
As the Cold War came to an end, the European security landscape changed dramatically. On the one hand, the main security threat looming over European NATO members progressively vanished. On the other hand, Warsaw Pact’s countries gained independence, thereby loosening their ties with the strongly centralised state apparatus of the Soviet Union. Among the several consequences that such a new environment brought about, European states started to reform their defence apparatus (Schmitt, 2000). In turn, this had a major impact on national defence industries, which were suddenly faced with a vital need to restructure in order to remain profitable and survive.
Accordingly, this paper focuses on how consolidation processes have allowed the European defence industry to restructure throughout the last decades. Delving into such processes is crucial to grasp the current state of the industry and what lays ahead. As a matter of fact, this paper aims to pave the way for an analysis of how consolidation fits in the current European defence industrial framework (...). This paper is structured as follows. In the following section, some peculiar aspects of the defence industrial sector are considered. The third section tackles the main drivers to the need to restructure in the 1990s. The fourth section provides an account of consolidation processes in the European defence industry. In the fifth and final section, some considerations are drawn concerning a potential future wave of consolidation.
Francesco Baronio - Senior Researcher, Mondo Internazionale G.E.O. - Difesa&Sicurezza
2. Peculiar Features of the Defence Industry
In order to discuss defence industrial consolidation, it is crucial to start by outlining two peculiar features of this sector. The first relates to the central role played by states. The defence market is a monopsony where governments act as sole customers and, hence, exercise a strong influence (Fiott, 2019). This has frequently resulted in high levels of state intervention and protectionism. In this regard, it is interesting to note that, while privatisation has also spanned to the defence sector, the German, French and Italian governments all still hold shares of important domestic defence contractors (Briancon, 2024). Political-strategic considerations play a key role in a highly sensitive industrial sector like defence that is tasked with providing armed forces with the essential means to safeguard national security (Schmitt, 2000). As a result, governments have traditionally played, and continue to play, a primary role in influencing how the industry restructures and develops.
A second key feature involves economic and technological factors. The defence industry is characterised by particularly high initial capital investment costs stemming from facilities and equipment costs required to develop and manufacture highly complex and sophisticated systems (Clark, 2022). High compliance costs and a deep expertise in the defence contracting regulation have to be added (Clark, 2022). Furthermore, intellectual property and the reputation of companies play a crucial role in such an atypical sector. Overall, these factors result in significant entry barriers that make it extremely difficult for new industrial players to enter the market.
3. Drivers to Industrial Restructuring in the Post-Cold War
The end of the Cold War and the new security landscape that emerged sparked major reforms in the defence apparatus of European countries. The most significant consequence of these reforms was the reduction of defence budgets (Schmitt, 2000). Defence companies faced a significant drop in military capability procurement from their national governments and had to adapt to a shrinking demand. While state orders fell, they also increasingly shifted to more advanced capabilities, reflecting the so-called Revolution in Military Affairs (RMA), which refers to the integration of modern information and communication technology into weapons systems (Meijer, 2010). Overall, the pursuit of technological superiority resulted in the significant rise of Research & Development (R&D) costs and the drop in the number of programmes developed, which put further pressure on companies that were already struggling to adapt to the decline in demand (Schmitt, 2000).
It has also to be considered that the new technologies that started to be integrated into military capabilities had generally a civil origin (Schmitt, 2000). This increased the role played by the civil industry and decreased in parallel the involvement of the state in arms production (Schmitt, 2000). Crucially, these considerations mainly apply to those states with an industrial and technological base capable of developing cutting-edge technologies and high-end capabilities. Nevertheless, following the demise of the Soviet Union, ex-Warsaw Pact countries similarly witnessed a roll-back of the state that used to play an important role in sustaining the production of military capabilities (Kiss, 2001).
In a scenario characterised by a shrinking demand of military capabilities, rising R&D costs and decreasing government involvement, competition among defence companies increased. This does not only apply to European enterprises, but also to foreign ones. At a time when the US defence industry was facing similar issues to European ones, its defence companies were strongly encouraged to restructure through consolidation with the famous 1993 “Last Supper” (Deutch, 2001). Defence giants were established, and European entities soon became too small to compete with their US counterparts (Meijer, 2010). Ultimately, this put additional pressure on European companies to restructure.
4. The Consolidation of the Defence Industry
For the reasons just outlined, in the years following the end of the Cold War, European defence companies faced an urgent need to restructure and adapt to the new scenario. Restructuring occurred in different forms, including internal rationalisation, portfolio reshaping, internationalisation towards new markets, and consolidation (Schmitt, 2000). Consolidation consists of the reduction of the number of contractors operating in an industrial sector through Mergers and Acquisitions (M&A). It constitutes an effective way for companies to improve operational efficiency, address a fiercer competition, and establish stronger entities (Stabu, 2023). In particular, when the need to reduce excess capacity arises, mergers can be crucial for companies to remain profitable, whereas being acquired by a larger entity might provide an appealing exit strategy for a smaller business that risks exiting the market (Kovacic & Smallwood, 1994; Guay, 2005; FasterCapital, 2024).
The post-Cold War environment of declining demand, increasing R&D costs, fiercer competition, and decreasing state involvement played a crucial role in driving European defence companies towards consolidation. At first, consolidation occurred at the national level, with companies consolidating specific defence sectors by means of M&As and establishing the so-called ‘national champions’ (Bitzinger, 1994). Such processes have progressed at different pace depending on the country and the sector concerned. Initially, consolidation has mainly interested Western European defence markets (Schmitt, 2000). The sectors that have first been affected were instead aerospace and defence electronics, whereas naval shipbuilding is still lagging behind today (Schmitt, 2000; Olsson, 2021).
Some relevant examples of domestic consolidation are worth mentioning. In Germany, Krauss-Maffei Wegmann (KMW) and Rheinmetall have consolidated the land sector (Baronio, 2023). Growing through domestic acquisitions, BAE Systems has consolidated large parts of the British defence industry, first in the aerospace sector and then in the electronics and land sectors (Baronio, 2023). In France, Nexter Systems (formerly GIAT Industries) has consolidated the land and ammunition sector, whereas Thales (formerly Thomson-CSF) has consolidated the defence electronics sector (Baronio, 2023). Leonardo (formerly Finmeccanica) has largely consolidated the Italian aerospace and defence electronics sectors (Baronio, 2023). It is worth noting that, in some cases, national consolidation has progressed in parallel to a partial or complete privatisation of defence enterprises. It is the case of the French GIAT Industries and Thomson-CSF, as well as of some state-controlled defence businesses that were then integrated within Finmeccanica (Schmitt, 2000; Baronio, 2023).
Eventually, consolidation has moved to the European level with national companies acquiring enterprises in other European states and merging with companies from other countries to create trans-national entities. For instance, over time the French Thales has bought companies operating in other European defence markets such as the Dutch Signaal and the British Racal (Kluth, 2017). Thanks to its strategy of internationalisation, today Thales has subsidiaries in many European countries and beyond, so therefore it can be considered as a proper European defence giant (Thales Group, n.d.). To a more regional level, M&As operated by companies like the Swedish Saab, the Norwegian Nammo and Kongsberg, and the Finnish Patria have consolidated specific segments of the Scandinavian defence industries (DefenseNews, 2016).
Furthermore, mergers of mergers have established proper trans-European companies. On the one hand, joint ventures have been created through the merger among specific divisions of different enterprises. It is the case of MBDA, a joint venture among the missile divisions of BAE Systems, Airbus and Leonardo, that has consolidated the European missile segment to some extent (Baronio, 2023). On the other hand, large-scale mergers among companies have established trans-European defence giants. Airbus (formerly EADS) was established through the merger of the French Aerospatiale-Matra, the German DASA and the Spanish CASA (Baronio, 2023). More recently, KNDS was created with the merger between the German Krauss-Maffei Wegmann (KMW) and the French Nexter (Baronio, 2023).
Crucially, the industrial landscape that has emerged with these processes is what is often referred to as “the spaghetti bowl” of the European defence industry (Béraud-Sudreau & Scarazzato, 2023). It consists of an intricate web of trans-national industrial ties and ownerships that connects defence companies in different European countries. Western Europe features the larger entities, which have also been more affected by consolidation processes (Béraud-Sudreau & Scarazzato, 2023). Nevertheless, many of its companies have large footprints in other European subregions through subsidiaries (Béraud-Sudreau & Scarazzato, 2023). Thales, Leonardo and Rheinmetall constitute fitting examples (Leonardo, n.d.; Rheinmetall, n.d.; Thales Group, n.d.). Prominent Northern European companies like Saab, Patria and Nammo also present subsidiaries in other countries in their own subregion (Béraud-Sudreau & Scarazzato, 2023). However, Central European companies find it hard to access both Western European defence markets and supply chains (Béraud-Sudreau & Scarazzato, 2023).
There are also other differences. Companies in Western Europe are generally more diversified and operate in a higher number of defence segments, thereby covering almost the entire spectrum of defence production (Béraud-Sudreau & Scarazzato, 2023). Conversely, Northern and Central European defence enterprises are more specialised. Baltic companies focus on surveillance and communication systems, sensors and Information Technology (IT) components (Béraud-Sudreau & Scarazzato, 2023). Northern European enterprises have relevant expertise in the air, naval and missile sectors (Béraud-Sudreau & Scarazzato, 2023). Instead, Central European companies are involved in small arms and light weapons production, but also in ground platforms and missiles to some extent (Béraud-Sudreau & Scarazzato, 2023).
5. Conclusion - How Will Consolidation Progress in the Coming Years?
This paper has provided a general overview of how the European defence industry has restructured through consolidation thus far. Today, we might be about to witness a new wave of consolidation. According to Briancon (2024), the current financial context of rising defence expenditures is favourable, and companies have a strong economic rationale to pursue this strategy. Although defence budgets are on the rise, European states have been rather sceptical in making solid, long-term commitments on procurement, and defence companies are thus reluctant to make large investments (Aries et al., 2023). It also needs to be considered that consolidation has generally been driven by a shrinking demand, since it represents a strategy to be better placed to address a fiercer competition (Schmitt, 2000; Stabu, 2023). However, the current environment is quite different and consolidation does not appear to be as pressing as it used to be in the immediate post-Cold War years.
Furthermore, two strong financial incentives for consolidation are low interest rates and low-priced defence stocks. On the one hand, as provided by the US Department of Defence [DOD] (2023) in a recent report, low interest rates make capital cheaper and more accessible, facilitating M&A activities by companies. Last September, the European Central Bank (ECB) raised interest rates to an all-time hike (Canepa & Koranyi, 2023). While further increases are rather unlikely, a short-term forecast of interest rates in the Eurozone does not appear to incentivise consolidation (ECB, 2024). On the other hand, as Tirpak (1998) notes, the higher defence stocks are, the more expensive are acquisitions, and, hence, the more costly it is for companies to consolidate. Since defence stocks have been rising considerably lately (Pfeifer et al., 2024), the financial incentives to consolidate might not be that strong in this latter case either.
Given the particularly high costs, corporate strategy might be guided by different considerations in pursuing a new wave of consolidation. While economic and financial factors will not likely act as game changers, political ones might. A decisive push from governments is what can effectively make meaningful M&As possible in Europe (Béraud-Sudreau, 2020; Briancon, 2024). What the consolidation history illustrates is that strong economic and financial incentives can play a key role in moving a critical industrial sector like defence away from governments. On the flipside, without significant economic and financial motives, state influence over the defence industry might be crucial in promoting a new significant wave of consolidation. The coming years will provide important clues in this regard.
6. References
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