To no one’s surprise, the business of defense often centers more on politics than on free-market principles. The reality, however, is that there is significant opportunity for governments to seek out foreign technology and for industry to enter and expand into new markets. Although far smaller than BAE Systems’ United Defense Industries acquisition, recent U.S. successes in the European market include L-3’s 2006 purchase of Advanced Systems Architectures, a UK systems engineering and software developer; Lockheed Martin’s 2005 acquisition of Insys, a UK IT firm; and General Dynamics’ 2001 purchase of Santa Barbara Sistemas, a Spanish vehicle manufacturer.

TOP VIEW  To exploit lucrative markets and ensure future growth, arms manufacturers in the United States and Europe are looking to forge  alliances, or even merge with counterparts across the Atlantic. While the potential benefit to each side is clear, serious political obstacles to transatlantic consolidation remain. Those companies that tread carefully and establish a foothold in niche industries will overcome this resistance and eventually gain much greater access to foreign markets.

BAE Systems began an acquisition process in the United States in the late 1980s, with the firm focused on increasing its U.S. capabilities while minimizing regulatory oversight and complaints from the U.S industrial base. Over several years, it was able to build critical mass in the military support services market until it became the largest engineering support provider to the U.S. Navy. With this critical momentum, BAE Systems was then able to acquire Lockheed Martin Aerospace Electronics Systems for $1.67 billion in 2000. This move proved quite the coup at the time because Lockheed’s division was involved in a number of classified high-tech military programs. The ultimate success of BAE System’s acquisition strategy in the U.S. came in March 2005, when the company acquired United Defense Industries for $4.2 billion.

Over the past decade, we have seen growth in acquisitions based on a greater need for foreign technology, integration and investment. This trend is almost certain to continue and may ultimately lead to more significant acquisitions outside of the recent successes of BAE Systems. Joint ventures, however, will likely be limited to less sensitive markets and legacy technologies, such as off-the-shelf communications equipment, noncombat vehicles and training and simulation systems. Acquirers will also target professional services such as engineering support, logistics, maintenance and IT management.
 
Restless in Washington
Three primary drivers will affect international market access in a positive way. First, transnational alliances are breaking up or are being relegated back to their constituent firms. Alenia Marconi, a 1998 defense electronics partnership between BAE Systems and Finmeccanica, dissolved in 2005. Astrium, a space-systems joint venture between BAE Systems and EADS formed in 2000, was bought by EADS in 2003. The disappearance of these alliances and others like them will spur global defense firms to further acquire and consolidate in order to reopen market access that these alliances once offered.

In the near term, most European firms will experience some opposition and will be limited to U.S. entry strategies based on alliances,partnerships and smaller tactical acquisitions.

The second driver toward increased cooperation has been growing—albeit slowly—support from the U.S. government. Despite public rhetoric to the contrary, senior officials have expressed support for greater cooperation. At a 2006 roundtable in Brussels, sponsored by the Center for Strategic and International Studies, Colonel Michael Ryan, a representative of the Defense Secretary’s Mission to the EU, said that a “needs-based approach would drive the [U.S. and European] allies to buy the best product on the transatlantic market at the best price, regardless of its point of origin.” Both the secretary’s office and pro-trade members of Congress have complained about the seemingly glacial pace of international alliance building. While most insiders at the Defense Department will not publicly demand greater cooperation, they feel frustrated that current efforts are no more than “studies of studies” with no viable and comprehensive solutions being brought to the table.

The final key driver will be the success of proper acquisition strategies. While new markets beckon to companies bent on consolidation, overtly aggressive acquisition techniques will raise red flags with regulators and defense industry executives who are likely to fight for important base markets both in the U.S. and overseas. The path to success requires a slow pace and patience with acquisitions in markets not as attractive to domestic industries. Most of the purchases of the past several years were small, and therefore did not prompt significant regulatory scrutiny. The acquisitions also tended to be vertical rather than horizontal, focusing on stable market growth. BAE Systems proved this strategy extremely successful. A long-term market commitment with an escalating acquisition strategy has put BAE Systems on even footing with other large U.S. defense firms.