2012 Global aerospace and defense industry outlook: A tale of two industries

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Nov 18, 2013 (3 years and 6 months ago)

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February 2012
2012 Global aerospace and defense
industry outlook:
A tale of two industries
2
Contents
Overview

Sector updates:
Commercial aircraft production

Air traffic control

Defense

Business jet and general aviation


County updates:
United States
Brazil
Canada
China
India
France
Germany
Japan
Mediterranean countries
United Kingdom

Trend updates:

Mergers and acquisitions
Talent

Diversifying portfolio

Contracting process

Overall outlook for 2012

Contacts
3
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3
Overview
The Deloitte Touche Tohmatsu Limited (DTTL) Global
Manufacturing Industry group’s 2012 outlook for the
global aerospace and defense (A&D) industry is a tale of
two industries. On the one hand, the commercial aircraft
industry is looking up, just coming off its best year ever
for production and its second best year for orders
1
. On the
other, parts of the defense industry are declining due to
decreased military spending principally in the United States
(U.S.) and Europe
2
. Overall, the financial performance of
1 Deloitte United States (Deloitte Development LLP), “2010 Global
Aerospace & Defense Industry Performance Wrap-up,” 12 July 2011.
2 Ibid.
Figure 1: Top 20 global A&D companies’ first nine months 2011 versus 2010
Company
2011 Revenue
year over year
(YoY) percentage
change
2011 Operating
profit YoY
percentage
change
2011 Operating
margin YoY
percentage
change
Boeing
2.98%
9.80%
6.62%
EADS
3.59%
10.92%
7.07%
Lockheed Martin
4.19%
-1.23%
-5.20%
General Dynamics
-1.40%
0.24%
1.67%
Northrop Grumman
-6.28%
15.10%
22.82%
United Technologies*
9.53%
16.28%
6.16%
Raytheon
0.64%
10.76%
10.05%
Finmeccanica
-5.20%
-178.52%
-182.82%
GE Aviation*
8.74%
7.21%
-1.41%
Thales
-0.54%
NA
NA
Safran
7.20%
NA
NA
L3 Communication
-2.37%
-6.90%
-4.64%
SAIC
-1.24%
-42.19%
-41.46%
Textron
8.42%
12.89%
4.12%
Bombardier
Aerospace*
15.04%
12.95%
-1.82%
Goodrich
14.90%
26.05%
9.70%
Oshkosh Corporation
-20.58%
-68.91%
-60.85%
Honeywell
Aerospace*
10.47%
10.35%
-0.11%
ITT Exelis*
2.63%
-11.11%
-13.39%
Dassault Aviation
-28.71%
NA
NA
Total
3.49%
-3.73%
-5.25%
* Partial company results based on A&D activities.
Note: The above companies represent the largest A&D companies (based on 2010 annual data) for which quarterly performance financials are
available.
Source: DTTL Global Manufacturing Industry group analysis from the first nine months of 2011 data for the U.S. companies and analogous
documents for the European companies.
the top global A&D companies in 2012 is expected to
hold its own and be in line with 2011 performance (see
Figure 1), with the decline in defense revenues offset
by cost-cutting and aggressive growth actions taken to
maintain operating margins
3
. Continued global economic
challenges coupled with revenue gaps and cost pressures
may result in margin contraction for some industry players.
The sector is likely to undergo more streamlining of its cost
structure, divestiture of noncore assets, and additions of
gap filling, as well as game-changing acquisitions. Expect
to see more aggressive competition for the fewer large
3 DTTL Global Manufacturing Industry group analysis, January 2012.
4
defense programs of record, as well as growth in commercial
aircraft backlogs and a capacity challenge for suppliers to meet
commercial aircraft and regional jet producers’ increasing
requirements.
The A&D industry is becoming more global due to
heightened competition, growing travel demands, and
security requirements in emerging markets. Globalization
provides opportunities for lower cost and for technologically
advanced product introductions, as these can be designed and
manufactured anywhere, anytime, largely due to the Internet
and digital product definition, design, and manufacturing
software. Globalization is also affecting product selections, in
that military and commercial customers alike are requiring that
value be “offset” by placing work in their countries of origin.
This tendency is likely to continue, as traditional countries are
pressured to keep their jobs at home, but is balanced by the
need for companies to grow revenues and continue to reduce
labor costs. The trend in the industry toward globalization is
also marked by new market entrants, some of which receive
government financial support that may potentially invite World
Trade Organization consideration in future years. Expect to see
more governmental scrutiny and compliance requirements on
acquisition practices in the areas of anti-bribery, anti-money
laundering, and ethical business practices to provide a level-
playing field of competition.
In the past, the A&D industry has experienced program
management challenges, resulting in delayed schedules and
missed budget commitments. Among other reasons, these
program management struggles could have been due to
intense competition, which would have necessitated optimist
pricing, cost, and delivery plans. A closer look at several large-
scale programs that have missed their commitments in the
last few years reveals many root causes, including the use of
immature technologies, lack of appropriate levels of systems
engineering discipline, and a plethora of complex engineering
changes. Other causes for the overruns include inadequate
supplier business maturity, capacity, and performance, as well
as optimistic scheduling with poor time and resources
planning for contingencies. In 2009, one-time impairment
charges amounted to an estimated US$10.5 billion, while
in 2010 this amount was significantly reduced to an
estimated US$1.7 billion, suggesting that troublesome
programs are behind for now, and that the industry is
learning to manage programs more efficiently.
4
This
positive trend likely continued into 2011 and will probably
also continue into 2012.
What lies ahead in 2012 for commercial aircraft
production?
The commercial aircraft industry is likely entering a
prolonged upcycle of orders and production, as demon
-
strated by recent Boeing and Airbus announcements
of plans for increased production, the first delivery of
the B-787 Dreamliner, and the progress of new aircraft
programs underway globally
5
. Market forecasts of top
large commercial aircraft manufacturers describe an expec
-
tation of between 26,900 and 33,500 commercial aircraft
to be produced over the next 20 years
6
. The difficulty in
keeping commercial airlines profitable, principally due to
the increasing cost of fuel, is generating requirements
for more fuel-efficient aircraft. This is driving demand for
derivative aircrafts that are equipped with next generation
engine technology. The sales order success of the Airbus
320NEO and the Boeing 737MAX have demonstrated
that industry technology innovations can create significant
product demand.
Advances in efficiency jet-engine propulsion is one of the
most significant technological innovations that have come
4 Deloitte United States (Deloitte Development LLP), “2010 Global
Aerospace & Defense Industry Performance Wrap-up,” 12 July 2011.
5 Aviation Week and Space Technology, “Analysis: Airbus, Boeing Must
Weigh Production Increases With Care, ” 30 August 2011;Flightstory,
“Boeing 787 Dreamliner – Date for First Delivery,” 26 August 2011.
6 Airbus, “Global Market Forecast 2011-2030,” June 2011, www.
airbus.com/company/market/forecast/; Boeing, “Current Market
Outlook 2011-2030,” copyright 2011, www.boeing.com/commercial/
cmo/.
5
to the commercial aviation market in the last two years,
specifically with the Pratt & Whitney PurePower Geared
Turbofan (GTF), as well as the CFM LEAP-X jet engines
7
.
Because the price of jet fuel continues to impact the ability
for global airlines to make a profit, the introduction of
new jet power plants, which lowers fuel consumption is
an industry game changer. With a claimed fuel-efficiency
savings in the range of approximately 15 percent, airlines
are requesting that commercial aircraft producers develop
products incorporating these advances
8
. Thus, in the last
few years, new programs, such as the Airbus A320 NEO,
the Boeing 737 MAX, the Mitsubishi Regional Jet (MRJ),
the AVIC ARJ21, the Irkut MS-21, and more recently the
Embraer ERJ product line, are planning customer deliveries
in the next several years that will incorporate these new
power plants. As of mid-December 2011, these engine
7 Aspire Aviation, “The engine battle heats up,” 10 May 2011.
8 Aviation Week and Space Technology, “Smooth Start For GTF Flight
Tests,” 22 August 2011; Aviation Week and Space Technology, “Virgin
America Launches CFM Leap On A320NEO,” 15 June 2011.
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2013E
Orders
Production
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O
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e
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producers have racked up 4,720 orders and options for
new next-generation regional and single-aisle commercial
aircraft power plants, making them among the best-selling
products in aircraft production history
9
.
Figure 2 illustrates a 30-year history and forecast for large
commercial aircraft orders and production, including a
consensus estimate for 2012 and 2013. It should be noted
that the seven-year moving average for production is
expected to reach 1,000 aircraft by 2013
10
. This is quite
an accomplishment given that only about 20 years ago,
the seven-year moving average for aircraft production was
approximately 500 aircraft per year
11
.
9 FlightGlobal, “Narrowbody engines: Makers mark the way in 2012,”
20 December 2011.
10 DTTL Global Manufacturing Industry group analysis, January 2012.
11 Ibid.
Note: The “Order” plot from 1981-1988 represent gross orders and from 1989-2013E represents net orders.
Source: DTTL Global Manufacturing Industry group analysis, January 2012; The Boeing Company data on orders and delivery, accessed on 27
January 2012, www.active.boeing.com/commercial/orders/index.cfm?content=timeperiodselection.cfm&pageid=m15523;
Airbus company data on orders and delivery, accessed on 27 January 2012, http://www.airbus.com/presscentre/corporate-information/orders-
deliveries/?contentId=%5B_TABLE%3Att_content%3B_FIELD%3Auid%5D%2C&cHash=22935adfac92fcbbd4ba4e1441d13383; DA Davidson &
Company, “Commercial Aerospace Industry Update,” 26 May 2011; The Boeing Company, news release, “Boeing Reports Strong Fourth-Quarter
Results and Provides 2012 Guidance,” 25 January 2012; QMT, “2012 to be Boeing’s year,” January 2012; Airbus, news release, “After a “year
of records,” Airbus sets its sights on continued industry leadership in 2012,” 17 January 2012; JP Morgan, “Aerospace and Defense - All About
Aerospace/Defense – 2012,” 5 January 2012; Credit Suisse, “2012 Aerospace & Defense Outlook,” 19 December 2011; Morgan Stanley, “Aerospace
& Defence Takeoff,” 21 December 2011.
Figure 2: Thirty-year history and forecast for large commercial aircraft orders and production (1981-2013E)
6
What is the future for advancements in air traffic
control (ATC), as a way to reduce aircraft fuel burn?
Global air transportation system (ATS) transformation
initiatives, including the U.S. Federal Aviation Administration’s
(FAA) NextGen program, as well as Europe’s public-
private Single European Sky ATM Research Programme
(SESAR), are expected to be implemented by 2025
12
. When
fully implemented, satellite-based navigation and the
transformational programs are expected to save an estimated
three billion gallons of fuel, four million flight hours in delays,
and 29 million metric tons of carbon emissions globally each
year
13
. With the expectation of increased demand for travel
in the next 20 years
14
, the new technology associated with
satellite positioning, navigation, and timing systems is expected
to increase fuel savings per flight by orders of magnitude,
while reducing congestion and weather-related delays.
Altogether, it is expected that the net benefit of implementing
global transformation initiatives could result in significant
financial value
15
. Specifically, the projected net present value
of global transformation programs through to 2035 is US$897
billion
16
. The estimated regional breakdown is as follows
17
:

U.S. NextGen program, US$281 billion

Europe’s SESAR program, US$266 billion

Rest of world, US$350 billion

Globally, the estimated savings accrued by different
beneficiaries include:

Airlines, 31 percent

Overall economy, 30 percent

Passengers, 34 percent

• Air navigation service providers/airports/ATC organizations, 5
percent of the total benefits

There are many challenges and risks to meeting the planned
implementation date for ATS transformation initiatives. These
include, but are not limited to, funding, technology risk,
regulatory reform, ATC procedures, technical and certification
standards, harmonization, and workforce transformation.
Given the highly complex technology involved and the
requirement for safety and reliability, successful deployment
will likely require additional effort and possibly a new
approach, such as that being proposed for the U.S. FAA
12 Eurocontrol, “10 projects that changed the face of European aviation,” 8
February 2011.
13 Deloitte United States (Deloitte Development LLP), “Transforming
the Global Air Transportation Systems – A Business Case for Program
Acceleration,” 10 May 2011.
14 Fox Business, “Airbus lifts demand forecasts on Asian growth,” 19
September 2011.
15 Deloitte United States (Deloitte Development LLP), “Transforming
the Global Air Transportation Systems – A Business Case for Program
Acceleration,” 10 May 2011.
16 Ibid.
17 Ibid.
NextGen program public-private financing initiative
18
.
There may also be significant risk that due to U.S. fiscal
constraints, implementation of the NextGen program
will be delayed, making 2025 potentially not achievable.
Furthermore, there may be some scaling of the capabilities,
which would delay the return on investment for such
programs, but could also contribute to risks of global
harmonization and interoperability with SESAR. Given
the financial condition of the airline industry, it may be
a challenge to require airlines to pay for the necessary
equipage of new technologies on board the aircraft, if the
timing or amount of return on investment is not assured.

Lastly, plans will need to be developed and implemented
to address aviation system delays attributable to the
surface environment. ATS transformation and technology
platform benefits are dependent on the successful
resolution of capacity challenges, including the insufficient
number of runways, gate shortages, and overscheduling
of flights during peak traffic periods. Avoiding the cost of
system delays, whether these are occasioned by airborne
congestion or ground-based constraints, is a key benefit
to be achieved. However, in order to achieve this, the
development and implementation of plans that address
surface-based delays will be critical.

Where is global defense spending going in 2012?
Global defense spending is expected to be flat to declining
in 2012, mostly made up of reductions in the U.S.,
United Kingdom (UK), and the rest of Europe, offset with
increases, principally in China, India, Kingdom of Saudi
Arabia, the United Arab Emirates (UAE), Japan, and Brazil.
In 2010, global defense spending, inclusive of armed
forces personnel, was estimated to be US$1.6 trillion,
with the U.S. the leader by order of magnitude, ahead
of second place China, followed by the UK, France, and
Russia
19
. Figure 3 shows the top defense spenders globally
in 2010. It should be noted that nine countries spend over
US$40 billion for defense each year.
In terms of affordability, the nominal amount spent on
defense does not necessarily equate to the importance,
requirements, or priority of defense. Countries such as
the Kingdom of Saudi Arabia spend a significant amount
of their national economy on defense because they have
national wealth created by their oil industry and security
requirements based on their location in the Middle East
and historical precedent. Israel spends a significant amount
of its national wealth on defense for good reason – their
homeland has experienced major military conflict six times
18 Ibid.
19 SIPRI, “SIPRI Yearbook 2011: Armaments, Disarmament and
International Security,” 7 June 2011.
Figure 2: Thirty-year history and forecast for large commercial aircraft orders and production (1981-2013E)
7
since their founding in 1947
20
. India, Brazil, South Korea,
and others are increasing their defense spending rapidly
due to either their wealth, creating affordability and/or
significant military threats to their national security.
Figure 4 illustrates affordability and importance of defense
by comparing military expenditures with gross domestic
product (GDP) for selected countries in 2010. As can
be seen, Kingdom of Saudi Arabia spends the highest
percentage of its GDP on military expenditures at 10.1
percent, followed by Israel at 6.4 percent, and then the
U.S., Russia, and South Korea
21
. The global average GDP
spent on defense is 2.7 percent — which is a bit over
-
stated considering the U.S. raises the average significantly
with a large portion of total expenditures
22
.
20 USA Today, “The Arab Israeli Conflict, 1947- present,” 28 August
2001.
21 SIPRI, “SIPRI Yearbook 2011: Armaments, Disarmament and
International Security,” 7 June 2011.
22 Ibid.
The U.S. Department of Defense (DOD) is now
potentially facing up to US$1 trillion in budget cuts
over the next 10 years. What could be the impact
on the skilled workforce and to the industrial base
if all the cuts were enacted?
U.S. defense budget reductions in the order of US$487
billion over 10 years have essentially been agreed to by
U.S. administration and congressional constituents
23
.
A recent challenge of the “super-committee” to agree
on deficit-reduction measures on 23 November, 2011
would, if implemented trigger the automatic “sequester”
budget reduction of an additional US$500 billion over 10
years, starting in 2013
24
. Taken altogether, that implies
a reduction in force structure, (e.g., soldiers, sailors,
airmen, etc.), as well as a reduction in investment accounts
(e.g., research and development (R&D), new program
starts, numbers of units ordered, etc.). Assuming that
23 Aerospace Industries Association, “The Real Defense Budget
Challenges Lie Ahead, “ 26 January 2012.
24 Ibid.
Japan
Germany
Canada
Brazil
Italy
Australia
China
France
India
World
UK
South Korea
Russia
U.S.
Israel
Saudi Arabia 10.1%
6.4%
4.8%
4.0%
2.7%
2.6%
2.6%
2.4%
2.3%
2.0%
1.9%
1.8%
1.6%
1.4%
1.4%
1.0%
Source: SIPRI, “SIPRI Yearbook 2011: Armaments, Disarmament and International Security,” 7 June 2011.
Figure 4: Global military expenditures by country as percentage of gross domestic product in 2010
Israel
Canada
Australia
South Korea
Brazil
Italy
India
Germany
Saudi Arabia
Japan
Russia
France
UK
China
U.S.
World
$1,611,437
$698,281
$119,400
$59,598
$59,322
$58,668
$54,527
$45,245
$45,152
$41,284
$36,972
$33,538
$27,591
$23,972
$22,788
$14,036
Source: Stockholm International Peace Research Institute (SIPRI), “SIPRI Yearbook 2011: Armaments, Disarmament and International Security,” 7 June
2011.
Figure 3: Global military expenditures by country in 2010 (US$ millions)
8
cuts will be proportional and that the entire amount is
cut, it is estimated that up to 25 percent of defense and
government contractor budgets are likely to be impacted,
all else being equal
25
. The impact on the industrial base
is likely to be significant, given that essentially one out of
four people in the defense contractor base within the U.S.
would be potentially impacted and possibly downsized
out of the workforce, should the additional US$500
billion cut take effect
26
. This could mean that the U.S.
defense industry may not be able to afford to keep certain
technology capabilities alive in the industrial base. It might
also mean that there may not be enough work to support
two or more companies in certain technologies, thus
potentially reducing competition.
Since the U.S. Congress will have until 2013 to deliberate
on the pending workforce cuts, it is expected that much
dialogue and debate will take place in the coming year
regarding the impact of the automatic budget cuts on
the U.S. industrial base. Given the immediacy of the cuts
beginning in 2013 as required in the U.S. Budget Control
Act
27
, this debate will likely bring several important
questions and challenges to the forefront. These include:
1.
What is the U.S. strategic defense posture in terms of
size of force structure? What is the U.S. capacity
to fight how many conflicts at once? What threat
environment should be anticipated?
2.
How much defense is affordable?
3.
What should the defense industrial base look like? What
sectors/capabilities need government protection?
What kind of competition is required?
4.
How should the DOD increase productivity and
efficiencies (e.g., improve and lower cost in the
weapons systems acquisition process and manage
programs better to deliver programs on time and on
budget)?
These matters are expected to be most important in
2012, as it relates to the financial performance of the
defense industry. The formulation of a renewed U.S.
defense strategy, coupled with the resulting war fighter
requirements, and ultimately the defense budget, will likely
provide the guidance necessary for defense contractors
to size their workforce appropriately, to understand what
revenues they can count on, and therefore, what their
financial performance will be in 2012.
25 Deloitte United States (Deloitte Development LLP), “The Aerospace
and Defense Industry in the U.S. — A financial and economic impact
study,” 7 March 2012.
26 Ibid.
27 U.S. Government, Budget Control Act, 1 August 2011, www.gpo.
gov/fdsys/pkg/BILLS-112s365eah/pdf/BILLS-112s365eah.pdf.
What effect will the defense budget deliberations
of the U.S. government have on the rest of the
world?
Firstly, the U.S. defense budget associated with contractor
spend is still the largest in the world, accounting for
approximately 53.9 percent of global procurement spend
28
.
Even though reductions in the DOD budget are expected
to be in the US$24 billion to US$50 billion per year range,
the budget will still be five to six times the size of its
nearest peer country
29
. These budget reductions are likely
to have two main impacts on the global market. First, non-
American A&D companies doing business with the U.S.
government will likely still continue to do business there,
albeit at a lower level of participation, all things being
equal. However, a “one size fits all” generalization would
not adequately describe the outlook for these companies
in 2012. In particular, there may be cutbacks to specific
programs that could disproportionately affect certain
European companies due to their program concentration.
Additionally, new program down-selects may occur in
2012 that could significantly strengthen a company’s U.S.
presence if they win new competitions.
Secondly, U.S. A&D companies, facing potential revenue
shortfalls from their traditional sources in the DOD, will
likely strengthen their marketing and competitive posi
-
tioning in emerging markets, particularly in India, Brazil,
South Korea, Japan, Kingdom of Saudi Arabia, and the
UAE. These countries, with their increasing wealth and
growing security concerns, are expected to increase their
purchases of sophisticated weapons systems, where U.S.
companies have competitive strengths. Thus, for European
A&D companies, there will likely be increased and intense
competition for these foreign military sales opportunities.

Finally, the more strategic impact may potentially be a
reduced capacity to address multiple and simultaneous
expeditionary military, humanitarian, or police-action
campaigns, although the DOD process for conducting
a strategic defense review may provide a clearer path
forward. However, past is prologue and should there be
a need, the U.S. government would likely ramp up its
capacity and capabilities to address defense and security
requirements in time of emergency need, as they have
done in the past, no matter what the budget is.
28 DTTL Global Manufacturing Industry group analysis, January 2012.
29 Deloitte United States (Deloitte Development LLP), “The Aerospace
and Defense Industry in the U.S. — A financial and economic impact
study,” 7 March 2012.
9
What about business jets and general aviation?
Where is the market going?
The 2011 general aviation market was expected to
rebound slightly from the devastating impact experienced
to orders, employment, and revenues that began with the
economic crisis in 2008
30
. Unfortunately, this was not the
case, as shipments for all segments of the general aviation
sector experienced continued declines through the first
three quarters of 2011
31
. Total shipments declined 9.8
percent, while total billings dropped 10.2 percent through
the first three quarters of 2011
32
. Figure 5 shows the
changes in shipments for piston, turboprop, and business
jet segments, as well as total billings for the first nine
months of 2011, compared to the same period in 2010
33
.
More of the same is expected in 2012 with only a slight
growth in orders anticipated. Several reasons may explain
the challenges the general aviation industry faces in
returning to growth. These include the number of high-
quality previously owned general aircraft available in the
market, tighter credit conditions, the smaller number of
younger people obtaining pilots licenses, and finally the
higher cost of fuel. On the bright side, China is in the
process of liberalizing its air space and expects the general
aviation industry to lead business jet aircraft growth in
the country, due to the increasing number of wealthy
individuals and burgeoning middle class. Sales to the
Middle East also are expected to follow the same pattern
and contribute to the slight increase in orders
34
.
30 GAMA, “General Aviation Airplane Shipment Report,” 7 November
2011; Aircraft Owners and Pilots Association, “GAMA: Decline in
aircraft deliveries slows, “ 7 November 2011.
31 GAMA website, accessed on 2 December 2011, www.gama.aero/
media-center/industry-facts-and-statistics/shipments-billings/.
32 Ibid.
33 Ibid.
34 Avjet Corporation, “Private Business Jets – A Global Perspective,” 1
December 2011.
Much has been reported about the A&D industry’s
need for cost efficiencies and overhead-cost
reduction. The industry continues to experience
program delays and significant cost overruns. Will
there be improvement in 2012?
Although one-time asset impairment charges to earnings
were down significantly in 2010 compared to 2009, the
U.S. Government Accountability Office (GAO) found that
on average, A&D programs were 26 percent over budget
and only 33 percent were on schedule
35
. Nevertheless,
improvements have been occurring and are expected to
continue in 2012. As companies are pressured by military,
government, and commercial customers to focus on
affordability, the need to manage costs in all phases of the
product life cycle will become increasingly important. A&D
companies will need to mitigate costs during R&D and
initial production, and then maximize profits as operations
move into full rate production and support.
Starting with the R&D process, successful companies have
implemented rigorous program and risk management
processes coupled with effective performance metrics
to manage technical risks and avoid cost overruns.
As programs enter production, successful companies
assess future market conditions, long-term operational
flexibility, and financial return on investment when
considering whether to invest in new capacity or outsource
components to strategic suppliers. As an example,
Gulfstream strategically outsourced production of their
mid-cabin business jets to a key supplier
36
. Gulfstream
traditionally operates a vertically integrated business,
but outsourcing this piece of production allowed them
to avoid making significant investments to sustain those
products.
35 GAO Report to Congressional Committees (GAO-08-467SP),
“Defense Acquisitions: Assessments of Selected Weapon Programs,”
March 2008.
36 AIN online, “Outsourcing Offshore Not a Gulfstream Goal,” 13
October 2010.
Figure 5: First nine months 2011 shipments of business and general aviation aircraft manufactured worldwide (US$ billions)
2010
2011
Change
Pistons
633
577
-8.8%
Turboprops
237
223
-5.9%
Business jets
491
427
-13.0%
Total shipments
1,361
1,227
-9.8%
Total billings (US$
billions)
$13.5
$12.1
-10.2%
Source: General Aviation Manufacturers Association (GAMA), accessed on 2 December 2011, www.gama.aero/media-center/
industry-facts-and-statistics/shipments-billings/.
10
During production, improved supplier collaboration
will help companies tend to manage and control costs.
Forecasting, planning, and scheduling maturity has been
shown to have significant impact on the ability for a
company to meet customer delivery schedule demands.
Working with suppliers to provide an accurate view of
lead times, budgets, and forecasts will improve on-time
delivery, responsiveness, and cost effectiveness. Forecasts
that include high-fidelity production lead times, work-
flow dependencies between suppliers, and accurate due
dates are critical to finding ways to reduce lead time and
mitigate potential problem areas.
Lastly, as production volumes drop and eventually cease,
successful companies monitor sustainment requirements
and continually assess the impact that the erosion in
volume and infrequent demand streams can have on
total program costs. For example, the infrequent demand
associated with sustainment requirements can cause
significant breaks in production. A break of 12 months can
increase production costs by 15 percent, for example, and
a break of 18 months can increase costs by 20 percent
37
.
In order to control costs, successful companies proactively
monitor product support profiles and potentially shift the
business model used to deliver a product and/or service to
ensure that sustainment costs for the customer are kept
low, while profits are maintained by the company
Significant attention is being paid to U.S.
Government Defense Contractor Audit Agency
(DCAA) contract compliance, with several
companies having their business systems criticized
by government auditors. What should the industry
expect in 2012?
Regulators have long held government contractors
accountable for how their money is being spent; however,
there are additional and more intense consequences for
non-compliance based on new regulations. Contractors
are already subject to numerous regulatory requirements,
contract audits, investigative oversight, certifications,
and sanctions. It is expected that continued scrutiny of
contractor business systems, a renewed focus on access to
internal audit reports, and a return of incurred cost audits.
In recent years, the U.S. government has been highly
focused on the role served by the DCAA in overseeing
compliance with requirements, such as the Defense Federal
Acquisition Regulation Supplement (DFARS). As a result,
the DCAA has taken a more aggressive and comprehensive
approach to their auditing of defense contractors
38
.
37 DTTL Global Manufacturing Industry group analysis, January 2012.
38 Deloitte United States (Deloitte & Touche Financial Advisory Services
LLP) observation, December 2011.
Further underscoring the situation, in May 2011, the
DOD issued an Interim Rule amending DFARS in an
effort to improve the effectiveness of DOD oversight
over contractor business systems
39
. The rule establishes
specific compliance requirements spanning a wide variety
of defense contractor business processes, including
accounting systems, earned value management systems,
estimating systems, materials management and accounting
systems, property management systems, and purchasing
systems. With the issuance of the Interim Rule, defense
contractors will likely experience even greater DCAA
attention. The stakes have been raised, as the Interim
Rule specifies that defense contractors may face financial
consequences for non-compliance, including withholding
of payments if “significant deficiencies” are identified
40
.
Penalties include payment withholding of 5 percent of
amounts due per system or 10 percent maximum, which
can continue until such time as the significant deficiencies
have been corrected, as determined by the government’s
contracting officer. Faced with the possibility of substantial
delays in receiving payment for services rendered,
successful defense contractors are proactively evaluating
their compliance with the new DFARS requirements to help
ensure that their business systems are not in violation
41
.
In December 2011, the GAO issued a report regarding
DCAA’s access to defense company internal audit reports
42
.
The report found that many of these internal audit reports
reviewed contained information relevant to DCAA audits,
but certain information was not provided or requested.
While acknowledging existing case law regarding access to
these confidential internal reports, the GAO recommended
that DCAA take steps to facilitate access to internal
audits and assess periodically whether other actions are
needed. The DCAA is expected to increase its efforts in
performing incurred cost audits at contractors. DCAA
management has stated it will be forming dedicated teams
to focus on performing these audits and decreasing the
current backlog of open years
43
. As these audits are being
conducted, contractors will likely experience challenges
in providing adequate documentation in support of its
transactions.
39 U.S. DOD, “Federal Register / Vol. 76, No. 96 / Wednesday, May 18,
2011 / Rules and Regulations.”
40 Ibid.
41 Deloitte United States (Deloitte & Touche Financial Advisory Services
LLP) observation, December 2011.
42 U.S. GAO, “Actions Needed to Improve DCAA’s Access to and Use of
Defense Company Internal Audit Reports,” 8 December 2011.
43 National Defense Industry Association, management presentation,
12 to 13 September 2011.
11
What is the emerging tax picture for U.S. A&D
companies?
In the past, the tax departments of A&D companies have
been viewed as cost centers that manage the company’s
tax compliance and tax financial reporting obligations. This
model may have been sufficient for U.S.-based companies
operating primarily within the United States, serving
primarily American customers. However, as companies
expand internationally and encounter new complicated
tax laws of foreign countries, in addition to the uncertain
and complicated U.S. tax laws, tax departments are being
asked to do more than what they are accustomed to
without additional resources. Furthermore, companies
may not be able to handle or coordinate their global tax
compliance obligations and may require assistance in
the U.S. and abroad. Proactive tax departments that are
well integrated with a company’s finance and operations
functions and viewed as a value driver can deliver
meaningful benefits exceeding department costs, including
lowering effective tax rates and obtaining cash tax savings
through upfront tax planning.
The U.S. tax picture for beyond 2012 is still developing.
There is a debate in Washington D.C. currently underway
on the need to reform U.S. corporate tax rules and lower
the top rate in order to make U.S. businesses more
competitive internationally. However, the prospect of
a reduced corporate tax rate comes with a significant
amount of uncertainty for taxpayers, as Congress would
likely have to make foundational changes to longstanding
deductions, credits, and incentives upon which businesses
have relied, such as the R&D tax credit, domestic
production activities deduction, completed contract rules,
and accelerated depreciation. While no action is expected
until sometime after the 2012 U.S. elections, companies
could be taking several actions to prepare for and
successfully cope with change.
What can be expected in Brazil, with increasing
levels of wealth, the pending selection of new
fighter aircraft, and growth in the civil aviation
market?
It is anticipated that the Brazilian A&D industry will
continue to thrive over the next few years, driven by GDP
and individual income growth, as well as wealth creation
particularly in the middle class. In addition, the expansion
of credit and long-term financing has been powerful
drivers of economic growth. Finally, real-dollar exchange
rates have stabilized, resulting in lower foreign exchange
credit risk. These drivers have provided a foundation
for robust economic activity and bode well for the A&D
market in Brazil.
Air travel demand has increased at impressive levels and
nearly tripled in the past decade, as more people can
afford to fly for business and leisure
44
. In commercial
airlines, revenue from domestic and international regular
flights operated by Brazilian companies has increased
from R$13.8 billion in 2003 to R$21.6 billion in 2010
45
.
In defense and security, the Brazilian Air Force budget has
increased from R$4.6 billion to R$8.02 billion, signaling
an increased priority for national defense
46
. This is one of
the most significant military investments for the Brazilian
government.
In addition to organic market expansion, Brazil’s
involvement in the 2014 International Federation of
Association Football World Cup and 2016 Olympic
games will increase travel to the country generating
additional revenue for the industry. These mega events
are likely to expand the interest in tourism, business, and
infrastructure development. The Brazilian government
plans to invest R$5.6 billion to modernize airports in
preparation for the sporting events
47
. Another important
factor driving the markets is the high-speed development
of biofuels for aviation. Thus for the next year, industry
sector activities in Brazil appear to be increasing.
How will the Canadian industry benefit from the
growth of the industry in the next years due to
increasing demand for aircrafts?
The Canadian A&D industry is composed of more than
400 companies, including a few original equipment
manufacturers (OEMs) and many tier two and tier three
suppliers
48
. It employs more than 80,000 employees,
generates revenues of approximately CND$24 billion, and
focuses primarily on the commercial aircraft sector which
represents 83 percent of the industry
49
. This situation
positions Canada to benefit from the increasing demand
arising from the global commercial sector and protects it
against defense spending reductions.
The Canadian A&D industry is benefiting from the
opportunities of the global A&D industry since more than
77 percent of its revenues are generated from sales to
44 Star Tribune, “Brazil air travel triples since 2002, stoking worries
about preparation for WCup, Olympics,” 25 January 2012.
45 National Civil Aviation Agency, “2010 Yearbook of Air
Transportation,” developed in 2011, www.stats.gov.cn/english/
statisticaldata/otherdata/brics2011/P020110412517544487450.pdf.
46 Ibid.
47 Empresas Concremat, “Building for a more competitive Brazil,”
April 2011.
48 Aerospace Industries Association of Canada (AIAC), Canada’s
Aerospace Industry Statistics, accessed on 2 January 2012.
49 AIAC, “Backgrounder Deloitte Study – Report Highlights,” 26
October 2011.
12
foreign markets
50
. The increasing demand in developing
countries such as China and India will therefore benefit
Canada. Canadian companies are likely to continue to
invest in those developing countries in order to maintain
market share and remain competitive in these markets. In
addition, industry has also focused on the development of
“green” aerospace technology to provide fuel-efficiency
relief as the price of fuel rises. As the demand for greener
aircraft increases, many Canadian A&D companies that
have invested heavily over the past few years will likely
gain financial benefits.
What impact will China have in the industry?
China is expected to continue the modernization of the
industry, with several development programs underway. In
the commercial aircraft industry, the COMAC C-919 single
aisle commercial air transport program is well under devel
-
opment, with first flight scheduled in 2014 and entry into
service in 2016
51
. COMAC forecasts 2,000 C-919 aircraft
to be produced over the next 20 years, approaching 7
percent market share of the consensus market forecast for
global production
52
. In addition, COMAC is developing the
ARJ-21 regional aircraft, which has already undergone first
flight, and is expected to be delivered to airline customers
in 2012
53
. Together, these two aircraft launch programs
represent the emergence of an industry that has struggled
over time, but now appears to be emerging as a credible
producer of commercial air transportation products. It is
expected that the Chinese commercial aircraft industry
will continue to gain attention in 2012, with continued
western supplier involvement and partnership creation, as
well as continued technology development.
In the space sector, the Chinese industry continues to
advance its space program with the development of a
space station. A plan announced by the Chinese govern
-
ment at the end of 2011 includes the launch of a space
lab and collecting samples from the moon by 2016
54
. It
also includes plans for a manned spaceship and space
freighters. The new space plan would include the design,
manufacture, and deployment of the Beidou Satellite
Navigation system, China’s version of a global positioning
systems (GPS), navigation and timing system, similar to the
U.S.-based global positioning system. Recent achievements
made by China’s aerospace industry in 2011, including a
50 Ibid.
51 Flightglobal, “C919 project at “crucial point” in detailed design –
Comac,” 25 November 2011.
52 Defenceweb, “COMAC C919 orders reach 165 aircraft,” 16
November 2011.
53 Flight Global, “Comac ARJ21-700 ready for type inspection
authorization,” 30 December 2011.
54 The New York Times, “Space Plan From China Broadens Challenge
to U.S.,” 29 December 2011.
successful docking between the Shenzhou-8 unmanned

spacecraft and the Tiangong-1 space lab module
55
.
China is also increasing its defense capitalization,
expanding its submarine fleet and developing its first
aircraft carrier, purchased from Russia
56
. It also has a fifth
generation stealth fighter, the J-20, under development,
which has captured the attention of global competitors
57
.
What is expected for India in 2012?
India is a nation on the ascent in terms of wealth creation,
spending on space, commercial air transportation, and
defense sector. First, the Indian space sector has been
experiencing growth with the launch of Chandrayaan-1,
the Indian Remote Sensing series and Indian National
Satellite system
58
. The Indian Space Research Organization
(ISRO) is experiencing success with the in-country design
and production of spacecraft. ISRO is likely to establish
new facilities and develop a host of technologies for
India’s first manned mission scheduled for 2016
59
. A new
project, the Indian Regional Navigational Satellite System,
has been developed for improving national intelligence,
surveillance, and reconnaissance capabilities with a launch
of the first satellite planned during 2012-2013. Finally, the
Chandrayaan-II mission is expected to launch in 2013, with
the objective to collect samples of lunar soil and conduct
in situ chemical and mineralogical studies
60
.
Second, regarding commercial aviation, India is one of
the fastest growing aviation markets and is expected to
be the third largest domestic market after the U.S. and
China by 2020
61
. The commercial aviation market in India
during that time is expected to grow at a compound
annual growth rate (CAGR) of 18 percent, and the market
for new passenger aircraft in India is expected to be
US$150 billion, with 1,320 new airplanes delivered over
the next 20 years
62
. Traditional mainline as well as low-
cost carriers are expected to participate in fleet renewals
55 CNN US, “Space docking marks new milestone for China’s stellar
ambitions,” 30 November 2011.
56 The Guardian, “China’s first aircraft carrier: From Russia with love,”
10 August 2011.
57 ABC News, “Chinese Stealth Fighter Could Rival U.S.’s Best: Report,”
9 May 2011.
58 Deloitte India (Deloitte Touche Tohmatsu India Private Limited),
Antrix Corporation Limited, and Confederation of Indian Industry,
“Overview of the Indian Space Sector 2010,” August 2010.
59 Flightglobal, “India’s space sector shifts to new frontiers,” 1 February
2011.
60 ISRO, website information included in Future Programme, accessed
on 18 January 2012.
61 India Brand Equity Foundation, Website information included in
Aviation, accessed in December 2011.
62 Indian Aviation, “Sky is the limit,” 18 January 2012; Boeing, “Boeing
values India Market for 1320 New Airplanes at $150 Billion Over Next
20 Years,” 6 July 2011.
13
and additions to serve growing and new markets. In
addition, the flourishing Indian private general aviation and
business jet market are expected to grow to 12 percent
of the global market, surpassing China and Japan
63
. It is
expected to reach to 2,000 units purchased by 2020, up
from 650 units delivered by August 2011 year to date
64
.
Furthermore, there is an emerging demand for helicopters
and unmanned aerial vehicles (UAV).
Finally, increased defense spending is a welcome bright
spot in India for global suppliers experiencing downturns
in their home countries. India’s 2012 Defense Procurement
Procedure will likely also define offset guidelines with
the introduction of certain standard global practices
and provision for foreign exchange risk. The indigenous
Indian defense sector continues to look for favorable
support from the Indian Ministry of Defense (MOD) in
terms of expeditious awarding of contracts, providing tax
incentives, issuing industrial licenses, increasing foreign
direct investment, and building up the indigenous defense
industrial base. Foreign defense contractors will likely need
to continue to work with these indigenous suppliers in
order to be successful in India.
What changes are expected in the industry in
France in 2012?
The French A&D industry benefits from the presence of
several large global companies, which have significant sales
to the French military, global commercial airlines, and other
commercial and government customers globally. However,
as European countries scale back their defense purchases
due to affordability reasons, French A&D companies are
finding it more difficult to rely as much on the French
government as the primary customer. Among other
areas, sales success is increasingly being pursued with the
commercial success of the Airbus product line, in particular
the A320 NEO, one of the most successful aircraft product
launches in history.
Due to the high relative value of the Euro compared to
the U.S. dollar, certain suppliers are finding it difficult to
maintain cost-competitiveness and have been pursuing
outsourcing opportunities in lower cost countries. In
addition, mid-tier aerospace suppliers may be looking for
opportunities to gain cost advantage via scale economies,
gained through industry consolidation. Activity in 2011
in the merger and acquisition (M&A) marketplace has
increased, particularly amongst the smaller supplier
community. With Airbus commercial aircraft backlogs
growing, and the anticipated rate increases taking hold,
63 Business today, “Wings of their own: Growing fortunes fuel appetite
for private jets,” 1 May 2011.
64 Aviation India, “Private aviation on boom in India,”13 August 2011.
M&A activity is expected to accelerate in 2012.
How is Germany responding to the economic
challenges facing the industry?
The German A&D industry sustained the recent global
economic crises and gained an upward momentum in
2010
65
and likely in 2011
66
. Nevertheless, the industry
outlook for 2012 is somewhat less optimistic. Given the
macroeconomic conditions, the fragile foundation for
prosperity in Europe, and the ongoing Euro crisis make
short-term developments difficult to forecast.
Public budget constraints, aggravated by the debt crisis,
are likely to continue to impact the German defense
industry. In the short term though, the 2012 public
defense budget is nominally flat at €31.7 billion, slightly
higher level than in 2011
67
. The suspension of conscription
and the downsizing of the Bundeswehr to approximately
185,000 soldiers in the midterm will lead to lower
personnel costs
68
. Expenses for maintenance, procurement
of military equipment, and defense-related research are
therefore, expected to increase. As a result, the German
commercial defense industry is not yet impacted by
discretionary spending and may see a slight increase in
procurement.
For the expected longer-term demand decrease, defense
industry companies have started restructuring programs,
striving to further boost their exports of military equipment
(by more than 50 percent in 2009 to €2.1 billion in 2010),
and accelerate their technological transformation towards
more flexible and volatile threat-responsive products and
services on the other
69
.
The impact of the flat to declining global A&D industry
will be cushioned in 2012 by the existing large backlog of
commercial aircrafts
70
. In addition, some market players
are likely to expand their product portfolio, striving to
enter new market segments, and exploring the use of A&D
technologies (e.g., carbon fiber) in other industries to gain
new end-market growth opportunities for growth. This
might also lead to increasing transnational M&A activity,
65 Handelsblatt, “Luft- und Raumfahrt im Aufwind,” 21 April 2011.
66 Deloitte Germany (Deloitte Consulting GmbH) observation, January
2012.
67 Defense News, “Germany to Boost Defense Budget by 133M Euros,”
7 September 2011.
68 The Local, “Bundeswehr begins new era as conscription ends,” 4
July 2011.
69 Frankfurter Allgemeine Politik, “50 Prozent mehr deutsche
Rüstungsexporte,” 7 December 2011
70 Airbus, “Global Market Forecast 2011-2030,” June 2011, www.
airbus.com/company/market/forecast/; Boeing, “Current Market
Outlook 2011-2030,” copyright 2011, www.boeing.com/commercial/
cmo/.
14
both from German companies investing in target markets,
as well as Asian investors investing in Western companies
in order to gain technological know-how.
In general, the German A&D industry could see some
further consolidation initiatives driven by efforts for
diversification, key system supplier platform capability,
more risk sharing, and assistance to distressed key
suppliers by OEMs.
What are the emerging trends for the Japanese
A&D industry?
The current global role of the Japanese A&D industry
is primarily as a tier-one supplier. Indeed, more than
35 percent of Boeing 787 components are made by
Japanese companies, and fully 20 Japanese companies
participate in the Airbus A380 program
71
. Although
the recent appreciated Japanese Yen has resulted in
profitability challenges for the industry, it is expected that
rate increases in these and other programs will help grow
revenues, employment, and related economic activity for
the industry in Japan for several years to come.
The industry is maturing and in selected cases is
transitioning to a full-scale platform integrator. Major
programs under development are the MRJ, a next
generation regional aircraft being produced by Mitsubishi
Aircraft Cooperation, Honda Jet by Honda, commercial
derivatives of the XC-2 by Kawasaki Heavy, and US2
by ShinMaywa. The Japanese industry has high hopes
for the commercial success of these programs because
they represent an opportunity to showcase indigenous
engineering and systems integration capabilities. They also
represent a key pathway for economic development, job
creation, and national pride.
Key success factors for the Japanese A&D industry have
been and continue to be technology and quality. However,
the industry has also realized the criticalities of voice of
customer, needs-driven engineering, and globalization to
reach the next level of performance and improve global
status. The largest impact to Japan’s A&D industry is the
transition from product- driven manufacturing companies
to global and customer needs-driven engineering
companies.
71 The Society of Japanese Aerospace Companies, “Aerospace Industry
in Japan 2010,” April 2011.
What will the budget deficit challenges in
the Mediterranean countries mean to their
contributions to the NATO organization for their
own countries defense budget impact and ability to
be a leader?
Since the end of the Cold War, military policy and
expenditure have been the subject of a constant evaluation
to ensure the ability to intervene efficiently. Furthermore,
the U.S. and North Atlantic Treaty Organization
(NATO) relationship was balanced towards greater U.S.
contribution in terms of both leading crisis situations and
military spending. The recent Arab Spring events and the
military security campaign in Libya have demonstrated the
need for Europe, particularly the UK, Italy, Germany, and
France, to take the lead
72
. European nations are becoming
more aware that security is not a zero-cost product and
that they cannot enjoy the benefits of security without also
helping to guarantee it.
As shown earlier in Figure 2 and 3 focused on global
defense spending, the UK, France, and Germany are by
far, the countries that invest most on military expenses,
with the UK at 2.3 percent of GDP compared to 1.7
percent for France, 1.8 percent for Germany, 0.9 percent
for Italy, and 0.7 percent for Spain
73
. However, considering
the combined European population and GDP and the
corresponding U.S. figures, European expenditure on
military investment is a fourth the amount spent by the
U.S, while spending on military R&D amounts to just a
sixth of the U.S. figure
74
.
With the economic challenges in Europe, particularly with
the Mediterranean countries of Spain and Italy, increases
in defense spending are not likely in the short to medium
term. According to preliminary budget projections, the
gap between U.S. and European defense spending is likely
to widen, as NATO’s 2011 spending cuts of 18 percent
in the next few years are forecasted compared to 2010
75
.
However, the term “smart defense” has been coined
to define the trend towards selective European military
spending at a time of limited available economic resources.
Smart defense involves a streamlined, more efficient model
with the adoption of a range of measures and armaments
that will enable NATO to face up to any type of threat:
From cyber war to missile defense against possible attacks
by “rogue” countries. It will seek to increase efficiency
72 The Global Policy Institute, “The Arab Spring is an Opportunity...for
Europe”, 2 September 2011; Deutsche Welle, “European divisions on
Libya hold up U.S., NATO leadership decisions,” 23 March 2011.
73 SIPRI, “SIPRI Yearbook 2011: Armaments, Disarmament and
International Security,” 7 June 2011.
74 Ibid.
75 NATO, “NATO Review 2011,” accessed on 3 January 2012, www.
nato.int/docu/review.
15
by encouraging member countries to cooperate on the
basis of interoperability and specialization. Plans are for
resources to be better allocated, no longer based on
national interests, but in the more general interests of the
alliance as a whole
76
.
What is the industry in the UK doing to address the
slowdown in defense spending?
The UK A&D industry is the third largest globally, behind
the U.S. and China, and has 520,000 direct and indirect
employees dependent on the sector
77
. Importantly, over
half of the revenues generated by UK-based firms derive
from sales made to export markets, with the U.S. DOD
being the primary export customer
78
. Thus, the industry
is important to the UK industrial base as the employer of
a highly skilled UK workforce and as an earner of foreign
revenues. As such, understanding the UK industry going
forward requires consideration of all three key revenue
generators, including UK MOD, U.S. DOD, and the
commercial aerospace sector, along with an understanding
of the UK government response.
The UK deficit reduction program has resulted in defense
procurement reforms, which have delayed contract
placements, and will reduce spending over the next three
years by approximately 8 percent in real terms. In addition,
the Currie review regarding single-source procurement
is expected to be finalized in early 2012
79
. Amongst the
expected recommendations are open book accounting
so that the UK MOD is in a better position to negotiate,
incentivizing efficiency to encourage the industry to
reduce its cost base, and a push to reduce single-source
procurement and open competition.
A similar picture to the UK is being seen, as discussed
elsewhere in this outlook. However, it could be argued that
there are still opportunities to access additional revenues
in the U.S. market via a focus on small-to medium-sized
acquisitions, as has been the case for the UK industry over
the last decade or so. The challenge now, given what is
happening in the UK market, is both securing funding
and being able to meet vendor price expectations. In
addition to the Currie report, the UK government is looking
76 NATO, Smart defense website, accessed on 7 February 2012, www.
nato.int/cps/en/natolive/78125.htm.
77 A|D|S, “Aerospace: A recipe for recession recovery,” 2011; A|D|S,
“Defence: sound investment, strategic choice,” accessed on 18
January 2012, www.engineeringcapacity.com/__data/assets/pdf_
file/0006/405168/ADS-Defence-manifesto-FINAL.pdf; The Telegraph,
“UK military spending,” accessed on 18 January 2012, www.
telegraph.co.uk/news/uknews/defence/8002911/Defence-spending-
the-worlds-biggest-armies-in-stats.html?image=2.
78 Deloitte UK observation, 14 December 2011.
79 UK MOD, “Review into single-source military equipment contracts,”
11 October 2011.
to support the industry in accessing new markets and
growing exports. This government/industry partnership
will need strong commitment on both sides as it will be
up against other countries seeking a similar export-led
recovery for their industrial base. In order to address the
above challenges and opportunities, the UK A&D industry
is preparing itself for the future by
80
:


Increasing focus on the broader security and intelligence
markets

Increasing access to customer’s preferential areas of
spend and/or customers in new geographic markets

Addressing internal costs to reflect changes in customer
requirements and reduced business activity

Focusing on operational efficiency

Looking to work more closely with the UK government
for support on exports, as recognized by the UK
government in its recent whitepaper
81


Continuing to improve internal data capture, and
leveraging this knowledge in negotiations with future
upskilled government procurement agencies

Enhancing the robustness and appropriateness of their
business portfolios through targeted acquisitions and
disposals
Where do you see M&A activity in 2012?
Global M&A activity in 2012 is likely to be driven by a
variety of factors, including the impact of the recent global
economic crisis on both corporations and private equity
firms. Specifically, investible cash, as well as borrowing
capacity will likely lead many companies to pursue M&A
activity as a vehicle for growth and to access new markets.
Many A&D companies have used their cash over the last
several years to pay down debt, buy back stock, increase
dividends, and to make elective contributions to pension
costs. At the beginning of 2011, global A&D companies
had an estimated US$49.5 billion in free cash flow, and
some used this asset to participate in the M&A market
82
.
Indeed, M&A deal value in the A&D industry in 2011
was approximately twice the level from the previous
year, driven in large part by the US$16 billion Goodrich
Corporation acquisition by United Technologies
Corporation deal announcement
83
. Additionally, the vast
80 UK MOD, ”Spending Review 2010,” covering the period to the 2014
to 2015 financial year announced on 20 October 2010.
81 UK MOD/Government, “National Security Through Technology:
Technology, Equipment, and Support for Defence and Security,”
February 2012.
82 Deloitte United States (Deloitte Development LLP), “2010 Global
Aerospace & Defense Industry Performance Wrap-up,” 12 July 2011.
83 DTTL Global Manufacturing Industry group analysis, January 2012;
Wall Street Journal, “UTC Deal Reached to Acquire Goodrich,” 22
September 2011.
16
level of capital raised by private-equity firms in previous
years should serve as a driver to deploying those funds
in 2012. Private equity investors are likely to compete for
many of the same assets as strategic buyers and in some
cases paying higher values. During 2011, multiple deals,
large and small, were announced and similar levels of M&A
activity are expected for 2012.
It is anticipated that increased activity will remain high
within commercial aerospace given the anticipated
overall increases to production levels and new program
ramp-ups. Buyers will likely continue to use M&A to
position themselves on these growing programs, as well
as increasing scale and integration capabilities to become
Figure 6: Recent energy market investments by leading A&D companies
Source: DTTL Global Manufacturing Industry group analysis, January 2012.
Figure 7: UVA data capture
Note: The quantity of data captured by UAVs has increased 50 times over the past two years, creating a market
for filtering and processing UAV sensor data.
Source: DTTL Global Manufacturing Industry group analysis, January 2012.
more relevant to the customer. Within the defense world,
the challenges of the U.S. “Super Committee” will likely
lead to a decline in certain defense programs, as the U.S.
government looks for ways to reduce the budget deficit.
This will likely have a negative impact on overall defense
industry attractiveness of certain assets. At the same time,
expect ever-increasing budget support for, and therefore,
M&A interest in, those areas which support “new
realities” technologies, such as intelligence, surveillance
reconnaissance, precision strike, cyber security, energy
security, data fusion, mission software development, and
unmanned and autonomous controlled vehicles.
0
5
10
15
MarineNuclearSolarWindFuel cellsBiofuels
13 13
10
8
5
3
Energy markets
Number of companies invested
0
300
600
900
1200
1,500
20112009
13
10
8
3
30
1,500
Year
Continuous years of video feed
17
What are the trends in talent recruitment,
development, and retention in the A&D industry?
Talent is one of the biggest challenges companies face
in the coming years, particularly the A&D industry given
its demographic composition. The often cited shortage
of engineers in the U.S. remains a challenge, but skilled
production workers are also in short supply. In the U.S.,
74 percent of manufacturers indicated that workforce
shortages or skills deficiencies in skilled production roles
represent a major challenge to productivity
84
. Cuts in
defense spending threaten to exacerbate this problem if
diversified manufacturers and smaller companies leave
thesector and skilled production workers seek employment
in other sectors.
The future of A&D industry talent is the generation
entering the workforce today. This workforce has
significantly different values and expectations than the
baby boomer workforce that makes up the majority of
A&D companies today. The industry is faced with the
challenge of attracting this new workforce and changing
some of the fundamental aspects of their culture, while
retaining the elements of the culture that have made them
successful for decades. Today’s entry-level workers value
84 Deloitte United States (Deloitte Consulting LLP) and Manufacturing
Institute, “Boiling Point: The Skills Gap in U.S. Manufacturing,” 17
October 2011.
Figure 8: U.S. defense contract spending by competition (US$ billion)
0
50
100
150
200
250
300
350
400
Competition with multiple offers
Competition with single offer
No competition
2010200920082007200620052004200320022001
Year
US$ billion
Source: David Berteau, Defense Contract Trends (Washington, D.C.: CSIS, May 2011), {page 24}.
open environments, rapid advancement, flexible work
arrangements, diverse assignments, and non-hierarchical
organizations. A&D companies have traditionally been
characterized by the opposite: Facilities are at times old,
utilitarian, and closed; access to information is tightly
controlled, advancement can be slow and measured,
hierarchies are clear and firm, and many people work a
single program for 10 to more years.
A&D companies have the opportunity to use the incoming
workforce to catalyze culture change not only to attract
the next generation, but also to address changing
trends in the industry: Increased use of fixed-price and
performance-based contracts, significantly increased
focus on affordability, and transition away from traditional
large procurement programs to new geographies and
new markets (e.g., foreign military sales, information
technology management, and cyber security). These
changes lend themselves to culture change that aligns
with the values of the future workforce. The challenge for
companies is making themselves more attractive to the
next generation, while retaining the core elements that
have made them successful: Commitment to the mission,
focus on the warfighter, and relentless pursuit of results.

18
How is the global defense industry diversifying?
The anticipated cuts in defense spending in the U.S. and
in Europe for the foreseeable future will force companies
to evolve their businesses to better suit markets outside of
their traditional customer base. As seen in Figures 6 and 7,
continuing energy concerns and a drastic increase in the
demand for UAV data capture have created new market
opportunities. In order to address these new markets,
many companies have already made investments or
acquired niche companies with the necessary capabilities
to capitalize on these opportunities.
Success in these new markets will likely require changes in
business models. As companies within the industry adapt
their business models to meet shifting demands, they will
reorient processes for interacting with customers, suppliers,
and the general marketplace. For instance, shifting from a
product-orientated business model of building ships, to a
service-oriented business model of analyzing captured data
from UAVs, requires the rationalization of manufacturing
capabilities, build-up of service operations, and customer
service delivery models.
Companies have successfully managed this transition in
the past. For example, VT Group, originally a UK defense
shipbuilding company, managed to successfully transform
its business model from a traditional shipbuilder to a major
provider of communications, defense, and education
support services by divesting 55 percent of its shipbuilding
business to BAE Systems and acquiring/integrating a
portfolio of small support service companies
85
.
85 Shipping Times, “VT and BAE Systems announce shipbuilding
merger agreement,” 25 July 2007.
Figure 9: U.S. defense spending by contract type (US$ billion)
Source: David Berteau, Defense Contract Trends (Washington, D.C.: CSIS, May 2011), {page 25}.
Will performance-based contracts become more
popular as a defense industry contracting process?
The A&D cost-reimbursable contracts that are currently
commonplace with militaries and governments are likely
to be less suitable for future commercial clients. As seen
in Figure 8, for the past 10 years, cost-reimbursable
contracts have made up a significant portion of defense
spending. In Figure 9, due to the lack of cost-type
contracts in commercial markets, and the decreased use
of these contracts by the U.S. government, companies are
becoming more adept at utilizing and managing to fixed
price (i.e., performance-based contracts).
Companies shifting from cost-type, transactional contracts
to performance-based contracts successfully define up-
front customer needs, accurate performance metrics, and
controlled risk management. In addition, the sole-source
and limited-competition contracts that military clients enjoy
are less likely to happen in the commercial marketplace.
GE, Rolls Royce, and Pratt and Whitney are leaders of
performance-based logistics services, utilizing accurate
forecast models, and proactive real-time performance
data to anticipate and prevent service interruptions, while
maintaining a consistent service level.
What are your predictions for the future of the A&D
industry?
Although it has only been 108 years since the Wright
Brothers first flight, the industry has contributed
fundamentally to the way we live, work, travel, and
communicate with the technologies created and continued
0
50
100
150
200
250
300
350
400
Cost and type
Fixed price
2010200920082007200620052004200320022001
Year
US$ billion
19
innovations developed in jet aircraft, communications
satellites, the Internet, and GPS, for example. Also,
the industry is primarily responsible for the reduction
of casualties in armed conflict due to the technology
innovations that keep warfighters out of harm’s way
with UAV, sophisticated surveillance sensors, and over
the horizon strike capability. This industry has created
the technology innovations that have contributed to the
very fabric of society — from the ability to communicate
globally around the clock from our personal digital
assistants, to safe and efficient air travel, to securing our
borders, and defending our way of life.
Past is prologue, expect game-changing technology
innovations to continue to be created within the global
A&D industry into the future. Some of the science and
technology being developed include directed energy
and high-powered microwave weapons, supersonic
missiles, long-range and high-altitude unmanned aerial
systems, satellite-based high-resolution full motion video
cameras, and extraordinary software that can trace
financial transactions of known terrorists. Interesting
technologies are being experimented that can harvest
solar power from space-based solar arrays, converted to
microwaves, or high-voltage wireless signals, to ground,
air, and sea-based distribution networks. These kinds of
innovative technologies will change the lives in society in
immeasurable ways, just like during the first century, the
industry has changed the way humans interact on a global
basis. This is indeed something to look forward to in the
near term, as well as in the future.
20
Contacts:
Tom Captain
Global A&D sector leader
Deloitte Touche Tohmatsu Limited
+1 206 716 6452
tcaptain@deloitte.com
Tim Bremer
Partner
Deloitte United States
(Deloitte & Touche USA LLP)
+1 703 251 3825
tbremer@deloitte.com
Pauline Biddle
Partner
Deloitte UK
+44 118 322 2452
pbiddle@deloitte.co.uk
Gilbert Fayol
Partner
Deloitte France
+33 1 55 61 66 97
gfayol@deloitte.fr
Nidhi Goyal
Director
Deloitte India
+91 124 679 2299
nigoyal@deloitte.com
Dan Haynes
Principal
and U.S. Consulting A&D leader
Deloitte United States
(Deloitte Consulting LLP)
+1 404 631 2155
dhaynes@deloitte.com
Michael Hessenbruch
Partner
Deloitte Germany
+49 711 16554 7311
mhessenbruch@deloitte.de
John Hung

Partner
Deloitte China
+86 21 61411828
johnhung@deloitte.com.cn
Yuichiro Kirihara
Senior Manager
Deloitte Japan
+81 3 4218 7592
ykirihara@deloitte.com
Ellen MacNeil

Partner
Deloitte United States

(Deloitte Tax LLP)
+1 202 378 5220
ellenmacneil@deloitte.com
Kevin McFarlane
Managing Director
Deloitte United States
(Deloitte & Touche Corporate Finance
LLP)
+1 213 553 1423
kemcfarlane@deloitte.com
Jose Othon Tavares de Almeida
Partner
Deloitte Brazil
+55 11 51 86 6066
joalmeida@deloitte.com
Luca Petroni
Partner
Deloitte Italy
+39 0636749217
lpetroni@deloitte.it
Martin Vezina

Partner
Deloitte Canada
+1 514 393 7139
mvezina@deloitte.ca
General (USAF retired) Charles Wald
Director and Senior Advisor
Deloitte United States
(Deloitte Services LP)
+1 571 882 7800
cwald@deloitte.com
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