COMMISSION STAFF WORKING DOCUMENT On Defence Accompanying the document Communication Towards a more competitive and efficient defence and security sector
Date: 2013-07-24
Institutions: European Commission
Subjects: EU Member State, European security, common foreign and security policy, defence budget, defence expenditure, research and development













EUR-Lex - 52013SC0279 - EN











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52013SC0279

COMMISSION STAFF WORKING DOCUMENT On Defence Accompanying the document Communication Towards a more competitive and efficient defence and security sector /* SWD/2013/0279 final */









COMMISSION STAFF WORKING DOCUMENT
On Defence
Accompanying the document
Communication
Towards a more competitive and
efficient defence and security sector
Objective 
This Staff Working Document accompanies the
Communication on defence. Its objective is to provide some statistical
background for EU defence industry and market and to better illustrate some of
the points made in the Communication. 
In
particular, the Staff Working Document:
·                       
Highlights the economic importance of the
defence industry and its contribution to growth and jobs and the challenges it
is facing;
·                       
Analyses the evolution of defence spending in Europe and its consequences for the EU defence industrial base;
·                       
Presents the challenges facing the internal
market for defence;
·                       
Describes the status and progress in
consolidation in the defence industry ;
·                       
Analyses defence industrial supply chains and
the role of SMEs in the sector;
·                        
Describes new business strategies in the defence
industry in an evolving global setting. 
1.       Defence
industry strongly contributes to growth and jobs
With a
turnover of €96[1]
billion in 2012, the European defence industry brings a major contribution to
the growth of the wider economy. It provides thousands of highly skilled jobs[2], as it directly employs about 400,000 people. Moreover, driven by a
multiplier effect of between 2.2 and 2.4, it generates up to another 960,000
indirect jobs[3].
The defence
industry is a major industrial sector, generating innovation and centred on
high-end engineering and technologies. Its cutting-edge research has created
important knock-on effects in other sectors, such as electronics, space and
civil aviation. Therefore, it is a sector that is essential to retain if Europe is to remain a world-leading centre for manufacturing and innovation. Many of what have become everyday technologies in use have their
roots in the defence industry. Microwave technology, satellite navigation and
even the internet can trace their origin back to research carried out by the
defence industry.
There are also
many examples of technologies invented in the civilian sector, which were
subsequently nurtured in the military sector, and eventually found a mass-use
in the civilian economy, such as jet engine propulsion and integrated circuits.
The defence sector has three main sub-sectors: 
The aeronautics sector represents around
50% of Europe’s defence, with a turnover of €46.7 billion in 2010 (43% of this
is generated from exports), and employs around 200,000 people. The sector has
considerable experience of international collaborative projects, which involves
the sharing of total Research and Development[4]
(R&D) costs and the pooling of production orders between partner countries.
Some of these collaborative programmes have led to the formation of European
companies such as MBDA and Eurocopter. The degree of collaboration reflects the
high, and rising, costs of modern aerospace projects.
The sector has the capability to produce
world class products in most categories of aircraft and helicopters. Europe
currently builds three types of advanced fighter jets: Rafale (France),
Gripen (Sweden) & EuroFighter (Germany, Italy, Spain & UK) with a number of countries also taking part in the Joint Strike Fighter
programme of the US. These programmes are characterised by high R&D intensity
and many technology spin-offs. However, recent cuts in Member States’ R&D
investments are putting some important industrial capabilities and technologies
at risk especially in the area of future combat aircraft and attack
helicopters. Air power is an important element of national and European defence
and Europe may rapidly reach the point where it will be dependent on other
countries for critical technologies and capabilities in this respect. 
Box 1: Case study – economic
benefits of Eurofighter Typhoon[5]
Eurofighter Typhoon is Europe's largest military aircraft programme.
The programme currently supports around 100,000 jobs directly and indirectly in
over 400 European companies, many of which being highly-skilled and high wage
jobs. Many of the labour skills involved are highly transferable (e.g. to
automobile and electronics industries). The programme has contributed to
establishing world-class European companies in carbon fibre technology, sensor
fusion and advanced glass fibre cables. Technology spin-offs were also
identified, such as to civil aircraft, construction machining and mining
equipment but also the automobile industries, including Formula 1 cars in Italy
and UK. These spin-offs have been valued at €7.2 billion. 
In 2010 the land defence sector had
a turnover of around €30 billion and employed 128,700 people[6]. It has the capability for delivering and sustaining key military
capabilities in areas such as main battle tanks and armoured fighting vehicles,
as well as for sustaining and upgrading platforms. Compared to military
aeronautics, land defence is less technologically progressive and its systems
are less R&D intensive with the exception of Unmanned Ground Vehicles,
sensors, precision-guided ammunition and Chemical, Biological, Radiological and
Nuclear (CBRN) protection. The sector has developed joint ventures and
collaborative research with third parties, but not European collaborative
projects similar to the aerospace sector. 
The European land defence sector companies
are much more dependent on defence-related activities than companies in other
sectors, around 80% of their sales are defence-related[7]. Whereas some of them have
achieved notable export successes demonstrating its international
competitiveness (e.g. German Leopard tank), there are reservations about the
overall competitiveness of the sector. US firms tend to be 1.5 times larger on
average than EU companies, achieving a larger output over fewer products
(economies of scale) and are less dependent on defence. 
The naval
sector had a turnover of around €17 billion in 2010 and employed 83,200
people[8]. The sector provides full services across the entire life cycle of
a complex warship from design and construction to integration of systems and
support. European companies rank among the world top four suppliers of
warships. There are 5 main European shipyards[9] with
many other smaller producers and support services spread across the EU. A
comparison with the US underlines however that the EU naval sector has
over-capacity operating at a relatively small scale. The EU has 12 major
warship building companies versus two in the US, and US naval firms are on
average 3.4 times larger than the EU. For EU companies this means less economies
of scale and the need to spread R&D costs over small production runs. The
naval sector has only limited experience with European collaboration compared
to the aerospace sector as, until recently, pressures of R&D and unit
production costs tended to be lower than in the aerospace sector.
Besides the
three main sectors, other segments can be distinguished such as for example defence
electronics and missiles. Defence electronics is a key enabler in the land, air
and naval sectors. It plays a crucial role in modern weapon systems, and there
are a number of world class EU defence electronics firms. Nevertheless, this
paper does not expand on these sectors, mainly due the lack of substantial data
that would enable presenting them as separate entities, but also because they
are to a certain degree already an integral part of the three main sectors. 
In conclusion,
despite an overall trend towards more consolidation in the defence sector,
there is still a high level of fragmentation, in particular in the naval and
land sectors, which in turn leads to overcapacities and duplication (see
section 4). This is illustrated in the fact that platforms and systems in use
and in production in the EU are more than 3 times as many as in the USA[10].
Figure 1:
Platforms and systems in use and in production in the EU and USA, 2012
Source: CEPS
Policy Brief No 297, July 2013
2.       EU defence spending is decreasing, with a
negative outlook for the future
2.1       European defence spending has
been dramatically declining over the last decade…
Between 2005 and 2010 European defence spending has
declined by almost 10% in real terms. It is forecasted that spending between
2010 and 2013 will show a further decline of about 10%. This stands in striking
contrast to global trends. World total defence spending is expected to grow by
6.8% between 2011 and 2015 as austerity in the West will be more than offset by
accelerated defence spending in emerging markets. The US is expected to see severe cuts in defence spending by at least 10% over the period, while other
regions such as China and Russia will up to double their defence spending. In
2012 Asian defence spending overtook Europe’s defence spending for the first
time[11].
There is a risk that, by 2017, Europe will have lost 12% of its overall defence
spending since the start of the economic crisis[12].
Figure 2: Regional Defence Spending fluctuation in %,
2011-2012
Source: Military Balance 2013 data, IISS
The budget cuts are not homogeneous at a national level.
Most dramatic cuts of all are to be found amongst the smaller EU member states,
with rates above 30%. The majority of middle-sized states implemented average
cuts of 10% in their defence budgets. The situation seems to be different for
the 6 countries[13]
which are the largest spenders in overall defence, procurement and R&D,
representing 80% of total European defence and 75% of procurement spending in
2010. At one end of the spectrum, there have been sizeable cuts in defence
budgets in Germany, the UK and Spain. Between 2008 and 2011 Spain cut spending on defence equipment by more than 50%. In Sweden the core defence
spending has remained flat between 2010 and 2011, and a supplement of €4.8
billion per annum has been adopted to cover modernisation expenses. At the
other end of the spectrum, although France and Italy have been strongly
affected by the economic crisis, their spending remained largely unchanged.
Nevertheless, in the case of France this has been mainly due to standing
commitments, as the commitments for new equipment have decreased for a third
consecutive year, reaching only €6.4 billion in 2012 (€19.3 billion in 2009)[14]. 
Collaborative spending on equipment expenditure
increased from 16% (2005) to 22% (2010)[15].
Yet, this means that still a lion share of equipment expenditure is taking
place at a national level without significant coordination between Member
States thus contributing to the overcapacity, duplication and gaps in European
critical capabilities. 
Moreover, while defence budgets are declining, defence
equipment costs have been steadily increasing over time, up to 10% per year in
real terms, resulting in a doubling of weapons costs every 7.25 years[16]. As a result of these trends,
defence capabilities in most European countries have already been significantly
reduced. If this situation persists, the EU will have increasing difficulties
in providing capacities to deal with future challenges. A key factor will be
the impact of budget cuts on R&D spending which, in turn, is critical to
the development of the current and future military capabilities Europe needs.
2.2       …adversely affecting R&D
spending in the defence sector
R&D spending
in the defence sector declined by 14% between 2006 and 2010 while the overall
budgets diminished by 3.5%. This results from the fact that as R&D cuts can
be made with no short term reduction in military capability, R&D spending
is often seen as ‘discretionary’. 
France and the UK are the largest R&D spenders, both in absolute terms
and relative to overall defence spending, and represented 76% of European R&D
spending in 2010[17]. If German R&D expenditure is added, the three countries
account for the 93% of overall European R&D spending. From a global perspective the gap between European and US R&D defence
budgets increased between 2005 and 2010, the US budget(€58 billion) being 7
times larger than the European one(€8.5 billion)[18] in 2010 . 
Figure 3: R&D defence spending in EU/US, 2005-2010
Source: RAND Europe
analysis of HIS Jane's data
Moreover, the combined R&D spending of the BRIC countries (Brazil,
Russia, India and China) is continuously growing and it is projected to be more
than double than the combined R&D spending of the UK, France and Germany by
2013, whereas in 2008 it was almost equal.
Figure 4: R&D defence spending forecasts (FR, D, UK vs BRIC)
Source: RAND Europe
analysis of HIS Jane's data
Almost all
R&D in the defence sector is carried out at a national level. Only 12% of
total R&T public expenditure carried out by EU EDA participating Member
States is done on a European collaborative basis[19]. 
Box 2: Increasing defence R&D spending[20]
A significant difference to the R&D spending can be made with a
limited amount of money. If it were possible to rationalise spending on
European land forces in line with stated military ambitions and reallocate the financial
savings to R&D in the defence sector, this would contribute an additional
50% to aggregate R&D defence budget and lift it from 4.4% to 7.6% of
overall 2010 defence spending.
2.3       At the same time European
spending is dominated by personnel costs…
Between 2006
and 2010 European spending on personnel costs in the armed forces decreased by
17.5%. Cuts in personnel spending directly impacted the number of military and
civilian personnel, bringing down the overall personnel number from 2.4 million
in 2006 to just over 2 million in 2010. 
Figure 5: military and civilian
personnel numbers, 2006-2010
Source: EDA
However, this
does not change the general picture: a high share of the European defence
budget remains devoted to personnel. Almost half of the EU Member States are
spending more than 60% of their respective defence budgets on personnel. As a result
Member States spend at best 0.5% of their GDP on defence after personnel
expenses have been excluded[21].

Figure 6:
Defence expenditures of NATO member countries (% of GDP) 
Source: Slovak Atlantic
Commission, 2012
Whereas the EU
may still have 500,000 soldiers more than the US, there is a substantial
difference in terms of investment in equipment and R&D per soldier: in 2010
this amounted to €110,998 in the US versus only €26,458 in the EU[22]. In the absence of further
troop reductions, European spending per soldier is expected to follow the
downward trend of total defence spending. This development is likely to result in
smaller but progressively less capable European military forces, and will be
further exacerbated should spending priorities continue to shift away from
investment into equipment[23]. 
2.4       …whilst the increase of procurement
spending is slow to emerge
Given the reduction in defence budgets it is perhaps
surprising to note that procurement spending at the European level actually
increased by 17% between 2005 and 2010. This corresponds to an absolute
increase of over €5 billion, reaching €35.5 billion of total procurement
spending in 2010. However, this increase may be also explained by a low base,
as the growth was below one percentage point per year (from 14% in 2005 to 18%
in 2010). At the same time, the large proportion of procurement budgets,
especially in larger Member States, is contractually committed on long-term
programmes which reduce short term fluctuations. It may be noted that, at this
pace, it would take another 30 years before the combined share of procurement
and R&D would reach a level of about 40% (compared with the 41% that US defence budget has devoted to investment into equipment procurement and R&D in
2010). 
In reality, almost all Member States are considering
either delaying procurement programmes or reducing their size. Most
importantly, while the existing programmes will continue for the next 2-3 years,
few new programmes are being launched. Some medium-sized and small Member
States have decided to postpone decisions on the modernisation of key
conventional capabilities, whilst others have prioritised their modernisation
rather than tendering for a new generation of capacities[24]. This will result in the
dramatic decline of new programmes beyond 2015 which in turn will endanger the
future of European Defence Technological and Industrial Base (EDTIB). 
From a global perspective, the combined European and
North American procurement budgets are expected to decline from 64% to 45% of
2015 global procurement spending. In contrast, procurement spending in Russia is forecast to total $58 billion and to climb by 33% from 2012 to 2016.[25]
3.       Fragmentation of the European Defence
Market 
3.1 Openness and competition before the
transposition of Directive 2009/81/EC
The consequences of defence budgets
reductions are exacerbated in Europe by the fragmentation of defence markets. This
fragmentation persists at all levels – demand, supply and regulatory framework –
and has led, amongst others, to costly duplications and protectionist
procurement practices. 
According to EDA estimates, roughly 80% of
defence procurement expenditure is spent nationally, i.e. outside cooperative
projects. This does not mean that these 80% are exclusively spent for equipment
from national suppliers. However, before the entrance into force of the new
defence procurement Directive 2009/81/EC, the degree of openness to suppliers
from other Member States was relatively low. 
EU-wide publication of business opportunities
is the first criterion for market openness. From 2008 to 2010 included, more
than 1500 notices for defence contracts[26]
of a value of roughly €4 billion were published on TED (Tenders Electronic
Daily, the electronic platform of the EU’s Official Journal). On top of that,
notices for contracts of roughly €4.76 billion were published on the Electronic Bulletin Board (EBB)
of the European Defence Agency. Whereas the first category of contracts was
awarded according to the rules of Directive 2004/18/EC, the second was exempted
from EU law on the basis of Article 346 TFEU, but in principle also open to
competition from suppliers from other Member States. 
Figure 7: Contracts notified on TED and EBB
   || Values, € million 2010 Prices || Number ||   
 Publication source || 2008 || 2009 || 2010 || Total || 2008 || 2009 || 2010 || Total 
 TED || 513 || 2,626 || 885 || 4,024 || 415 || 447 || 686 || 1,548 
 EBB || 2,518 || 1,348 || 900 || 4,766 || 126 || 90 || 80 || 296 
 Total || 3,031 || 3,974 || 1,785 || 8,790 || 541 || 537 || 766 || 1,844 
Hence, in the period 2008-2010, 1,844
defence contract notices were published EU-wide. The total value of these contracts
was estimated to be €8.8 billion, which is equivalent to 3.3% of the EU’s total
defence procurement expenditure in the same period.
Figure
8: Contracts notified on TED and EBB in relation to defence procurement
expenditure
Of the €8.8 billion contract value published
on TED and the EBB, €5.8 billion was awarded to national suppliers (66%), €2.3
billion to operators established in other Member States (26%), €0.4 billion to
operators from third countries (5%). 
Figure
9: Cross-border awards of contracts published on
TED and EBB
Cross-border
contracts not published on TED or EBB
Other defence contracts have been awarded
to non-national suppliers without prior publication in TED or EBB. For the
years 2008-2010, the SIPRI Arms Transfer Database reports of 63 such
cross-border contracts with an estimated value of €3.9 billion, 32 of these contracts
with a value of €2.2 billion were awarded in competition.
The total value of EU cross-border
contracts awarded in competition was therefore €4.5 billion, which is 1.7% of
total defence expenditure in the EU or 4.3% of the total defence equipment
expenditure in the EU. 
The total value of EU cross-border
contracts – including those awarded without competition (e.g. follow-on
contracts) – was €6.2 billion, equal to 5.9% of total EU defence equipment
procurement or 2.3% of total EU defence procurement.
On top of that come contracts of a value of
€0.4 billion which were awarded to suppliers from non-EU countries.
Figure
10: Estimated value of EU cross-border defence
contracts 2008-2010
 Cross-border awards in competition || € m / % 
 Reported by TED and the EBB Estimated from SIPRI data Total || 2,260 2,200 4,460 
 Expressed as a ratio of total defence procurement Expressed as a ratio of total defence equipment procurement || 1.7% 4.3% 
 Total cross-border awards (competitive and non-competitive) Reported by TED and the EBB Estimated from SIPRI data Total ||   2,260 3,890 6,150 
 Expressed as a ratio of total defence procurement Expressed as a ratio of total defence equipment procurement || 2.3% 5.9% 
3.2 Openness and competition since the
transposition of Directive 2009/81/EC
The new Directive 2009/81/EC applies to all
defence procurement above a certain threshold and subject to Article 346 TFEU,
which allows Member States to derogate from the rules of the Directive if this
is necessary to protect their essential security interests. 
Entering into force in 2009, the Directive
had to be transposed by August 2011. However, transposition in all 27 Member
States was accomplished in March 2013 only. It is therefore still too early to
draw conclusions on the impact of the Directive on the openness of defence
markets. 
However, a first analysis of publication in
TED gives some insights in Member States application of the Directive. The
table below shows all notices published on TED by end of March 2013. It
indicates in particular an important difference in numbers of published
contract notices: up until now, a single Member State, France, has published alone 50% of all contract notices, whereas others (ES and NL) have not
published a single one. Late transposition (alone) cannot explain these
differences: Germany, which transposed late, has published a considerable
number of contracts and ranks second behind France. The table shows also other
specificities, such as the disproportion in Italy between contract notices and
contract award notices. This indicates the frequent use of negotiated procedure
without publication or the use of other procedures not foreseen in the
Directive. The high number of voluntary ex ante notices in UK and DK could point into a similar direction.
Figure 11: Number
of notices under Directive 2009/81/EC published on TED 
(21-08-2011 until
31-03-2013)
 Country || Buyer Profile || Contract Award || Voluntary ex ante Info Notice || Contract Notice || Prior Information Notice || Total 
 AT ||   || 1 ||   || 2 || 1 || 4 
 BE ||   || 2 ||   || 8 ||   || 10 
 BG ||   || 11 || 1 || 14 || 1 || 27 
 CY ||   ||   ||   || 3 || 1 || 4 
 CZ ||   || 10 ||   || 36 || 36 || 82 
 DE || 1 || 163 ||   || 235 || 7 || 406 
 DK ||   || 26 || 59 || 42 || 3 || 130 
 EE ||   ||  1 ||   ||  1 ||   || 2 
 ES || 1 ||   ||   ||   ||   || 1 
 FI ||   || 37 || 25 || 63 ||   || 125 
 FR || 1 || 132 || 44 || 515 || 3 || 695 
 HU || 1 || 23 ||   || 11 ||   || 35 
 IT || 2 || 194 || 11 || 23 || 82 || 312 
 LT ||   || 3 || 3 || 12 ||   || 18 
 LV ||   || 2 ||   || 3 ||   || 5 
 NL ||   || 6 ||   ||   ||   || 6 
 PL || 2 || 3 || 2 || 7 ||   || 14 
 RO ||   || 1 ||   || 5 ||   || 6 
 SE ||   || 4 || 1 || 17 ||   || 22 
 SI ||   ||   ||   || 1 ||   || 1 
 SK ||   || 5 || 3 || 6 || 3 || 17 
 UK ||   || 43 || 187 || 79 || 10 || 319 
 Total || 8 || 667 || 336 || 1083 || 147 || 2241 
EU-wide publication does not necessarily
lead to cross-border competition or cross-border award of contracts. The table
below shows that even in Member States with high publication rates like France and Germany, very few contracts are awarded to non-national suppliers. However, this does not
necessarily indicate a persisting “buy national” policy on the side of the
Member States. Also defence companies might be reluctant to operate outside
their home markets (in particular if this would imply to compete with
established national champions). In that case, a consistent practice of
publication by Member States can be expected to change business practice over
time, leading companies to be more active on other European markets. 
Figure 12: Number of Contracts awarded under Directive 2009/81/EC (21-08-2011
until 23-03-2013)
   || Total contracts || Awarded cross- border || Awarded nationally || % cross border 
 AT || 1 || 0 || 1 || 0 
 BE || 2 || 1 || 1 || 50 
 BG || 19 ||   || 19 || 0 
 CZ || 46 || 10 || 36 || 22 
 DE || 162 || 1 || 161 || 1 
 DK || 26 || 11 || 15 || 42 
 FI || 56 || 33 || 23 || 59 
 FR || 216 || 0 || 216 || 0 
 HU || 75 || 1 || 74 || 1 
 IT || 196 || 3 || 193 || 2 
 LT || 6 || 0 || 6 || 0 
 LV || 2 || 2 || 0 || 100 
 NL || 7 || 0 || 7 || 0 
 PL || 3 || 0 || 3 || 0 
 RO || 1 ||   || 1 || 0 
 SE || 4 || 0 || 4 || 0 
 SK || 5 || 1 || 4 || 20 
 UK || 45 || 7 || 38 || 16 
 Total || 872 || 70 || 802 || 8 
Note: For a
significant number of contracts (83) the nationality of the contractor was not
recorded. Based on the fact that the majority of contracts were awarded to
national operators, we assume that this is the case for the contractors of
which their nationality is unknown.
Figure 13: Values
of contracts in € million Directive 2009/81/EC
(21-08-2011 until 23-03-2013)
   || Total amount || Amount awarded cross-border || Amount awarded nationally || % Cross border 
 AT || 0,6 || 0,0 || 0,6 || 0 
 BE || 0,4 || 0,0 || 0,4 || 0 
 BG || 46,0 || 0,0 || 46,0 || 0 
 CZ || 20,3 || 0,0 || 20,2 || 0 
 DE || 308,6 || 0,6 || 308,0 || 0 
 DK || 40,2 || 3,4 || 36,8 || 8 
 FI || 37,6 || 16,6 || 21,0 || 44 
 FR || 129,8 || 0,0 || 129,8 || 0 
 HU || 58,9 || 0,0 || 58,9 || 0 
 IT || 277,4 || 20,5 || 256,9 || 7 
 LT || 1,4 || 0,0 || 1,4 || 0 
 LV || 1,4 || 1,4 || 0,0 || 100 
 NL || 1,6 || 0,0 || 1,6 || 0 
 PL || 4,4 || 0,0 || 4,4 || 0 
 RO || 1,7 || 0,0 || 1,7 || 0 
 SE || 1,1 || 0,0 || 1,1 || 0 
 SK || 6,4 || 3,5 || 2,9 || 55 
 UK || 839,1 || 6,9 || 832,2 || 1 
 Total || 1776,8 || 53,0 || 1723,9 || 3 
Note: For a
significant number of contract values (€ 720 million) the nationality of the
contractor was not recorded. Given the fact that the majority of contracts went
to national operators, we assume that this is the case as well for the
contractors of which the nationality is unknown. Also, for roughly one out of six
contracts the notices did not record the value of the contract.
Further monitoring and assessment over a
longer period of time are necessary to measure the impact of the Directive on
the European Defence Market. In this context, it will be important to analyse
also: 
·                        
which equipment is procured under the Directive
(the full spectrum of arms, munitions, war material, or only less sensitive and
complex equipment); 
·                        
how are the Directive’s provisions on
subcontracting applied (do SMEs get better access to non-national supply chains
and thereby to other Member States’ defence markets);
·                        
the use of the exclusions and of the negotiated
procedure without publication.
Such an assessment would be more than a statistical
exercise and goes beyond a quantitative approach. It necessitates for example a
qualitative and detailed analysis of contract award notices, but also the use
of other relevant sources, such as the specialised press.
4.       Consolidation
in the defence sector
4.1       Consolidation is taking place,
but progress is slow
The EDTIB has experienced several waves of
consolidation over the last decades. This process has led to the creation of
"primes" such as EADS and MBDA. Driven by decreasing defence spending
and increasing R&D costs, consolidation has also helped to reduce
overcapacity and duplication across Member States; has created globally
competitive companies; and has targeted R&D investments and programmes more
effectively. 
Box 3: Major
consolidation factors for the EDTIB
European
demand decline: The decreasing defence
budgets in Europe after the end of the Cold War decreased the business
opportunities in Europe and in many cases have driven companies to combine
forces and merge structures in order to benefit from economies of scale and
improve profitability.
International
competition: The increasing size and
capabilities of international competitors have been a major driver for
consolidation, especially in aerospace (Lockheed Martin and Boeing competition
for EADS) and missiles (Raytheon for MBDA). 
Technological
complexity/ R&D costs: Consolidation has
been less reluctantly met where the high technological complexity and the
consequent R&D intensity and cost were not bearable for entities below a
certain size. On the contrary, in areas of lower technological complexity EDTIB
is still highly fragmented.
Integration
of civil and defence industry: It is
observed that there is more fragmentation in areas where system providers share
a common TIB with the civil sector (ICT, C4ISTAR, defence electronics etc).
This could be explained by the increased profitability provided by the civilian
activities and the common R&D base for sector specific military and
civilian applications.
However, consolidation
has not taken place to the same extent across sectors. This is especially the
case in the naval and land sectors where fragmentation is not only observed at
regional level, but also nationally. In the land sector, industrial capabilities are concentrated in a few countries
(particularly France, Germany and UK), and the supply chains are complex. The
process of consolidation, for example in the area of armed vehicles (see figure
13), has largely taken place along national lines. Within the UK the armed vehicles sector has been reduced from 5 prime contractors to one, namely BAE
Systems.
Figure 14: Mergers and Acquisitions of the Armed Vehicles Sector in
the EU
Source:
“Anticipating restructuring in the European Defence industry”. BIPE. 2008.
Despite some national restructuring around
national champions in the UK, France, Italy and Germany, the naval sector
remains fragmented with a large number of relatively small firms and excess
capacity. The EU continues to have, for example, eleven suppliers of frigates
versus only one US supplier. 
In the aerospace sector, consolidation
efforts have led to the creation of European companies like EADS and Thales.
Joint military programmes have also resulted in new European entities such as
MBDA (missiles) and Eurocopter (helicopters). Yet, the sector continues to be
characterised by the presence of too many relatively small firms, a lack of
efficiency (in comparison to US), overcapacity and capability gaps (e.g.
strategic bombers). The average US aerospace company is
some 22 times larger than the similar top EU aerospace firms, indicating that
there are considerable opportunities for creating much larger EU aerospace
companies[27].
Overall, the defence industrial production
is concentrated in 6 European countries[28].
The defence industry in these countries accounts for 87% of European defence
production. These countries are also hosting the 20 European defence companies
that are highest ranked in the top 100 defence companies in the world. 
Figure 15: Highest ranked European defence companies in global
top-100
Source: Based
on SIPRI data. Note: an “s” in the first column denotes a subsidiary company. 
4.2       More consolidation is needed, but
there are barriers to overcome
Defence companies need a critical size in
order to be able to partially finance innovation (in particular in view of
current cuts in EU defence budgets), operate globally and develop services.
Figure 16: Importance of reaching
critical mass
Source: Roland
Berger analysis
Yet few defence companies in Europe currently have this critical size, which implies constraints regarding their
capabilities of self-financing future developments.
Figure 17: Aerospace and Defence &
Security landscape in Europe, turnover 2011, US$ billion
Source:
Companies 2011 annual report, Roland Berger analysis
From this perspective, the defence market
could evolve to a more segmented profile, distinguishing more clearly between
local and global players.
Figure 18: Potential future scenario of
the European Aerospace and Defence landscape
Source: Roland
Berger
However, in order for European defence
companies to reach a critical mass, different barriers towards further
consolidation need to be tackled:
·                        
Member States' preference to national producers over
other European suppliers. In Europe some 80% of defence contracts are still
awarded nationally[29].
·                        
Misalignment of requirements and capabilities
across Member States. 
·                        
State ownership, which is closely linked to
restrictions on Mergers and Acquisitions, equity holdings by overseas investors
and other forms of foreign investment.
·                        
Impact of the "juste retour"
principle. This refers to the rule whereby in multinational state based
armament projects instead of market mechanisms the national work share equals
the national financial investments. 
5.       Defence industrial supply chains and the
role of SMEs in the sector
5.1       The specific role of SMEs in
the defence industrial value chain and the potential for increased clustering 
The EU defence industries are characterised
by multiple supply chains. Many suppliers work in several of these supply
chains for different defence contractors on different projects.
The structure of the supply chain may
differ depending on the sector. Aerospace and electronics industries tend to
have more globalised supply chains, while the naval and land industries are
defined to a greater extent along national boundaries. This corresponds to the
differences in size and technological complexity of the programmes. 
Figure 19: Defence industrial supply
chain
Source: BIPE
On top of the supply chains are the Prime
Contractors (or ‘primes’). These are typically large companies, and in many
cases national champions, which interact with Member States defence procurement
authorities, or procuring bodies such as OCCAR and NATO agencies. These Prime Contractors
work together with lower-tier suppliers in complex supply chains to produce
specific defence products. Such a supply chain may involve many hundreds of
companies. For example, to produce the UK Warrior AFV, over 200 first tier
suppliers could be identified, whereas the German Leopard II tank combines the
efforts of about 1,500 supplying companies.
SMEs have an important role, either as
subcontractors to larger companies or as specialised product suppliers
operating in niche markets. It is estimated that the 1,320 EU defence-related
SMEs account for between 11 and 17% share of the EU's sales of defence
equipment. Whereas a number of strong clusters reinforce the concentration of
EU defence equipment production with 6 Member States hosting 87% of the total
production, these countries account for only 52% of defence-related SMEs[30]. 
Supply chains are characterised by various
emerging trends[31]:
·                        
National Ministries of Defence are increasingly
using 'partnering contracts'. This means that they prefer to contract with one
Prime Contractor who then takes full responsibility for the development and
delivery of the equipment according to some previously defined time, costs and
quality specifications.
·                        
Subcontracting activities are increasingly based
on the so-called 'risk-sharing partner' concept, whereby the development costs
of new systems or equipment is distributed across the Prime Contractor and its
partners. Under this concept, primes delegate the responsibility for
conceptualising, designing, developing and producing a new system to lower-tier
companies.
·                        
European national authorities are increasingly
open to outsourcing some of the logistical activities (i.e. transport, repair,
health) to the private sector. 
These trends are important factors in the
evolution of the relationships and interaction between larger companies and
SMEs in the supply chains. It entails a potential for increased risks and costs
to be borne by the by default financially less resilient subcontractors,
thereby reducing the competitiveness of SMEs vis-à-vis larger companies.
Besides this issue, other factors challenging the competitiveness of
defence-related SMEs are:
·                        
Information problems, i.e. difficulties in
obtaining information on future capability requirements and business opportunities
but also a lack of visibility to large companies which results in a preference
for existing suppliers or suppliers closely located to the contractor.
·                        
Access to finance, particularly in Member States
with less developed or efficient financial markets. 
·                        
Administrative burden and costs, such as for
example the costs related to IPR protection. 
Figure 20: Comparison between clustered
and non-clustered firms
Source: European
Commission, Innobarometer 2006
Networks of excellence are important
drivers of innovation in the EU defence industries. Together with clustering,
they can allow SMEs to achieve a critical mass, increase their visibility on
the EU market and their ability to compete on international markets. However,
strategies that foster the development of regional clusters tend to be driven
and funded by the regions, for which defence is not a straightforward priority.
Moreover, the current fragmented state of Europe’s defence industry limits the
potential for more cross-border networking and does not favour more
international cooperation between such clusters.
6.       New business models in an evolving global
setting
6.1       Defence industry has a
specific business model…  
The European defence industry has the
capacity to develop, produce and export a wide range of competitive military
equipment. Most of its investments in new equipment and defence R&D are
linked to important military programmes launched by Member States in the
previous decades. The reason why governments have to bear the part of R&D
costs is that the time lag between initial investment in research and
development through to in-service military capability can be up to twenty
years. Moreover, the national orders are relatively small, guided by national
specifications that limit the export potential and are subject to export
controls. Consequently, there are few incentives for private investment given
the timing and unpredictability of financial returns – thus R&D into new
technologies relies, to a large extent, on government investment.
In view of decreasing demand and the
reduced investment into defence R&D, defence industry companies have
embarked on developing new or adapting the existing business models.
6.2       Faced with lack of orders
companies are increasingly turning to third markets…
Between 2001 and 2011, industry revenues
have increased at a higher rate than European defence procurement spending and
despite decreasing global defence spending. Revenues of the top 21 publicly
traded companies operating in the defence market have increased by 58%, from
€58 billion to €91 billion (2011€)[32].
However, between 2003 and 2011, European-based revenues of major EU defence
companies fell by 10%, while the reverse occurred for the North-American share
of companies’ revenues. This suggests that industry has adopted the following
strategies to increase its resilience during the economic downturn, in
particular internationalisation and diversification.
·                        
Internationalisation
The export of European defence equipment
and services to third countries has been an important factor compensating the
reduction in new programmes in the EU. 
The following graph shows how major European
industrial players have embarked on a process of internationalising their
client base. Over half of 2011 sales for the top 15 European industry suppliers
were to non-European buyers. Defence companies are increasingly developing new
business models that allow them to work more effectively across national
borders. They make acquisitions in other non-European markets and build
partnerships with non-European producers. For example, BAE Systems established
a joint defence venture with Mahindra & Mahindra Ltd in India, and DCNS and its Brazilian partner established a joint venture (ICN) for the
construction of 4 submarines and a naval base.
Figure 21: Value of European and
non-European sales for top 15 defence suppliers
Source: RAND
Europe analysis, 2013
In 2011 the Middle East was the destination
for around one third of the European exports, accounting for €8 billion of the
total export value of €23 billion. Other main trading partners included North
America, South Asia, Southeast Asia and Africa. 
Figure 22: European defence exports by
destination, 2011
Source: European
Council data
Looking ahead, the growth of markets in the
Middle East, Asia and South America presents opportunities for European
suppliers to offset the reductions in Member State demand. 
Figure 23: Top 5 world’s arms importing
countries 2007-2012 ($ million)
Source:
SIPRI data
Figure 24: Top 6 world’s arms exporting countries
2007-2012 ($ million)
Source:
SIPRI data
However, in the near future the global
market will become increasingly competitive, with new countries being able to
offer a variety of systems and platforms. With the defence budgets at the Asia
Pacific area expected to grow at a much greater rate than in the rest of the
world[33],
the transfer of technology and the investment to the defence industries of the
region could add new companies to the list of competitors of the European
defence industry.
Box 4: Emerging
markets
Besides
the US and Russia which are already global players in the defence equipment
markets, emerging economies can increase competition and seriously affect the
exporting environment of the European defence industry. Countries such as China, Brazil, India and South Korea, combining strong economic growth, extensive and high-tech
industrial capabilities, significant security and defence concerns, and
aggressive industrial policies raise the challenge for European companies to
sustain the current market share let alone to increase the exports’ volume.
Although it is unlikely - with the exception of China - that the industry of
these countries could offer a comprehensive package of defence products, it is
certain that the growing self-sufficiency will decrease the margin of manoeuver
in traditional export markets for European military equipment (Brazil, India). Furthermore, it is very likely that in specific market segments these countries will
be increasingly presenting defence systems competitive to European ones.
·                        
Diversification 
Major industry suppliers are also
diversifying their product portfolio to balance defence products with civilian
activities in growth sectors. Civilian products represent a significant revenue
share of the EDTIB. Based on 2011 data, around 39% of sales for the top 15
European industry suppliers were based on non-defence products. The equivalent
distribution of revenues of the six major national defence industry
associations indicates that 62% of revenues were from non-defence products[34]. This suggests that the lower
tiers of the European defence supply chain engage in a more diversified set of
products than systems integrators. 
In parallel, many large companies are
increasingly profiling themselves as service providers able to present
through-life care for defence capabilities. 
6.3       ...but in a longer term this
will result in the erosion of EU defence industrial base
European defence export agreements usually
include transfers of technology and intellectual property rights and/or relocation
of production, which entails risks to the longer-term competitiveness of the
European defence industry especially if this coincides with declining R&D
investment. 
Moreover, despite efforts of EU defence
companies to adapt to a changing business environment, the continuous decrease
of national defence budgets is likely to weigh heavily on their profitability
and competitiveness. The exports of today are often the result of R&D
investments made 10 to 25 years ago. Therefore declining investment in R&D
presents a particular threat to the long term future of the European defence
sector, both in terms of its skills base and its potential to deliver new
capacities. 
Technological progress is a major goal for the industry
in order to maintain its competitiveness; it is also a key factor to achieve autonomy
in essential capabilities. EU defence companies generally devote a share of
their total sales to R&D that is well above the European manufacturing
sector: land sector (6%), naval (10%), aerospace (12%)[35]. Experts believe that in the
near future the most revolutionary technological advances for military
capabilities will come from R&D and innovation in the civil sector, which
is expected to further encourage convergence of civil and military R&D. 
Box 5: Dual
use in ICT
Dual
use, or even civil use, equipment is increasingly used in the armies worldwide.
The constantly accelerating technological progress in the field of IT/ICT for
the development of civil products and applications has made a broad variety of
solutions and technical improvements available for military use. Over the last
20 years the armed forces have increasingly acquired and used equipment,
electronic components and software, with or without modifications, originally
developed for the civil sector in order to address emerging needs in a prompt
and cost efficient way. A few years ago, USAF constructed a supercomputer
running Linux out of 1760 Playstation3 processors. Today, aircrews use tablet
PCs as electronic “flight bags” in military operations.
It is clearly important to co-ordinate and align
dual use research and new programme investment to ensure long-term viability of
key industrial capabilities. Action already taken at European level in certain
technological areas could set the model for the years to come, such as for
example in the area of Remotely Piloted Aircraft Systems.
Box 6: Remotely
Piloted Aircraft Systems
RPAS - commonly known as
drones or Unmanned Aircraft Systems (UAS) - are used in a growing number of
civil and military applications such as in agriculture, border surveillance,
infrastructure inspection, communications and broadcast services, digital
mapping etc. Beyond the manufacturers and system integrators, the RPAS industry
includes a broad supply chain providing a large range of enabling technologies
(flight control, communication, propulsion, energy, sensors, telemetry etc.).
Thus the development of RPAS technologies is creating spin-offs with
significant impact in many sectors with both civilian and military
applications.
The European Commission has long
identified the potential of this emerging technology and supported the market
by investing in research and innovation relevant for RPAS through the Framework
Programme for Research. A broad stakeholders' consultation has demonstrated the
necessity for action at EU level, setting as priorities the further development
of RPAS civil applications and the integration of the systems into the European
air space as soon as possible. The consultation has also called upon the
European Commission to support the development of a Roadmap for the safe
integration of civil RPAS into European Aviation System (RPAS Roadmap).
The Roadmap identifies the
regulatory and R&D activities necessary to achieve RPAS airspace
integration. It will also take into account the data protection and privacy
concerns associated with the civil use of RPAS in order to ensure that such use
complies with the right to privacy and the right to protection of personal
data, as guaranteed in the Charter of Fundamental Rights of the EU and in line with
other instruments forming the EU data protection framework. It will contribute
to allow the manufacturing industry to produce similar platforms for civil and
military applications, by developing harmonized civil / military safety
objectives and hybrid standards. Furthermore, it will facilitate the
coordination of future R&D activities. In order to fly across the European
airspace, military and civil RPAS require the development of similar
technologies, like for instance the capacity to detect and avoid other
aircrafts. The Roadmap initiative led by the Commission will facilitate the
establishment of the necessary synergies between civil and military projects
like those supported by the European Defence Agency.
Moreover, the defence sector has a both highly
skilled and highly specialised workforce. However, companies are starting to
experience skill shortages and this trend might aggravate in the future. For
example, studies in the naval sector highlighted difficulties in finding and
recruiting naval architects, electrical engineers, systems engineers and
mechanical engineers[36].
The recruitment problems are particularly challenging for SMEs. An important
reason why skills and competence deficits are developing relates to the fact
that a significant percentage of the workforce is expected to retire in the
coming 10 to 15 years. For example, in the manufacturing of weapons/ammunition
sector, 16.6% of all workers are older than 55, in comparison to 12.4% in
European manufacturing in general[37].
The European defence industry has to retain its key skills in order to be able
to deliver high-technology solutions in an increasingly competitive global
market. 
In conclusion, if not addressed by the Member
States the declining investment into R&D, the lack of new procurement
programmes, coupled with the risks linked to increasing internationalisation
have the potential to significantly reduce the competitiveness of the EU
defence industries in the longer term. 
[1]               ASD data
[2]               A 2011 study on the economic impact of BAE Systems on
the UK economy in 2009 estimated that, for every 10 people employed by BAE
another 19 were employed elsewhere (12 in the supply chain and 7 in the wider
economy). “The economic contribution of BAE Systems to the UK”, Oxford Economics, April 2011
[3]               “Study on the Perspectives of the European Land armament sector”, IndustriAll, October 2012. 
[4]               This document will refer to Research and Development
(R&D) and to the sub-component Research & Technology (R&T).
[5]               "The industrial and economic benefits of
Eurofighter Typhoon". Hartley. University of York. February 2008. “The
economics of defence policy: a new perspective”. Hartley. Routledge
Studies. 2011. 
[6]               "Facts and Figures", ASD. 2010
[7]               “Study on the Perspectives of the European Land armament sector”, IndustriAll, October 2012. 
[8]               "Facts and Figures", ASD. 2010 
[9]               BAE Systems (UK), DCNS (France), TKMS (Germany), Fincantieri (Italy) and Navantia (Spain).
[10]             “Armaments duplication in
Europe: A quantitative assessment”, Valerio Briani, CEPS Policy Brief, No 297,
16 July 2013.
[11]             International Institute for Strategic Studies (IISS)
[12]             Speech President Van Rompuy – “Defence in Europe – pragmatically forward”, 21 March 2013.
[13]             France, Germany, Italy, Spain, Sweden and UK
[14]             “Bilan d’activités 2012”, DGA, French MoD
[15]             "European Defense Trends 2012". CSIS, December 2012.
[16]             « A single European market for defence
equipment : organisation and collaboration ». Prof. Hartley, University of York. 
[17]             “The evolution of the European Defence Sector”, RAND, January 2013
[18]             “Defence Data 2010”, EDA
[19]             “Study on the Perspectives of the European Land armament sector”, IndustriAll, October 2012. 
[20]             “The evolution of the European Defence Sector”, RAND, January 2013
[21]             “Maintaining defence capabilities : European
share”, SAC/CEPI Policy Brief, February 2013.
[22]             “Defence Data 2010”, EDA
[23]             "European Defense Trends 2012". CSIS, December 2012
[24]             EP Study "The impact of the financial crisis on
European defence", April 2011 / “Military Balance 2013”, T&F
Informa UK Ltd. 2013
[25]             IHS Jane's Defence Weekly, 19/12/2012
[26]             Contracts for the purchase of arms, munitions and war
material, plus related services and works.
[27]             “Development of a European Defence Technological and
Industrial Base”. TNO. 2009
[28]             France, Germany, Italy, Spain, Sweden and UK.
[29]             “European defence cooperation. Sovereignty and the
capacity to act”. Advisory Council on International Affairs. January 2012. 
[30]             "The economic significance of SMEs in
defence". Europe Economics. November 2009.
[31]             “Study on the Perspectives
of the European Land armament sector”. IndustriAll,
October 2012.
[32]             CIS, 2012
[33]             IHS Jane's Defence Weekly, 20/7/2012
[34]             Rand Europe analysis of defence companies annual
reports and ASD information, 2013
[35]             “A comprehensive analysis of emerging competences
and skill needs for optimal preparation and management of change in the
European defence industry”. Eurostrategies. 2009
[36]             “A comprehensive analysis of emerging competences
and skill needs for optimal preparation and management of change in the
European defence industry”. Eurostrategies. 2009
[37]             “Study on the Perspectives of the European Land armament sector”, IndustriAll, October 2012.