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BAE Systems’ Salam Deal Hints at the Importance of Defence Industrial Partnerships with Emerging Powers

Commentary, 25 February 2014
Defence Management, UK Defence, Europe, Middle East and North Africa
After protracted negotiations, UK defence giant BAE Systems and Saudi Arabia have agreed on the pricing for 72 Eurofighter Typhoon combat jets. The deal highlights the crucial relevance of and challenges to defence-industrial partnerships between Western countries and emerging powers around the world.

After protracted negotiations, UK defence giant BAE Systems and Saudi Arabia have agreed on the pricing for 72 Eurofighter Typhoon combat jets.  The deal highlights the crucial relevance of and challenges to defence-industrial partnerships between Western countries and emerging powers around the world.

Saudi Typhoon Courtesy BAE SYSTEMS

The commercial agreement between BAE Systems and the Saudi government on 19 February for the delivery of seventy-two Typhoon military jets successfully concludes years of negotiations at both the corporate and government level. This was a project that was almost abandoned. The original price tag of £4.5bn agreed in 2007 was deemed too low by BAE Systems to make the contract commercially sound due to escalating programme costs, which would in turn substantially increase the company’s commercial risk portfolio. According to BAE Systems estimates, further delays in the negotiations would have reduced the company’s earnings per share by around 15 per cent.

With a cash payment due early this year for the more than thirty jets already handed over, this agreement is therefore much valued by BAE Systems’ board and investors alike, who saw the company’s shares rising by almost 3 per cent on the day of the deal’s announcement. The deal may also help with BAE Systems' bid to sell the Typhoon to the Kingdom of Bahrain. This is arguably good news for a company that is Britain’s largest defence contractor and manufacturing employer, as it seeks to cope with falling defence equipment budgets in its traditional Western home markets – particularly in the US.

Sustaining Core Defence Industrial Capabilities

Beyond its commercial dimension, the deal also has significant strategic implications for the sustainment of core defence industrial capabilities in the UK and more widely in Europe.

BAE Systems’ Warton factory in Lancashire, employing around 5,000 staff, houses a significant share of Europe’s engineering skills for fighter aircraft. Although the plant in Warton continues to build aircraft for Britain’s Ministry of Defence, this deal is due to end in 2019. The Salam deal, particularly when followed by additional Typhoon export contracts, will prove highly valuable in securing a long-term military aircraft production perspective for Warton, thereby also safeguarding the engineering skills for the British and European defence industrial base.

These skills are crucial for industry to deliver high-quality, cutting-edge defence products and services. Early findings of research currently conducted by RUSI’s Defence, Industries and Society Programme (DISP) suggest that these skills, once lost from the defence industrial base, do not just reside in a different sector of the economy to become re-accessible to the defence industry at a later point. Instead a significant share may likely vanish entirely only to be rebuilt with substantial financial resources over a long time period.

Given US technology transfer restrictions and potential risks to operational autonomy in case of conflicting strategic interests, a general reliance on the US military aircraft industry does not appear as a viable option. Export contracts like the Salam deal must therefore be considered as an important foundation for the defence industrial skills base.

International Defence Industrial Co-Operation

The agreement highlights the crucial relevance of defence-industrial partnerships between Western countries and emerging powers around the world as well as the challenges they present for both governments and industry.

For Western governments, they are an opportunity to keep their own defence acquisition programmes at acceptable unit-costs and to strategically advance their overall bilateral relations with the emerging power through the minutiae of defence industrial contracts as part of their broader foreign and security policy. For the latter, access to high-quality, cutting-edge equipment and its through-life support service including training is an obvious reason to engage in defence industrial co-operation with Western states. More fundamentally though, these countries also seek to build strategic relationships with Western states as part of their overall defence posture.

Furthermore, emerging powers seek to build up their own defence industrial base in the mid- to long-term. Accordingly, international military sales today not only encompass the export of equipment and its through life support services but often involve the transfer of technology to and build up of production capacities in the customer state.

Hereto, joint-ventures between international and domestic defence businesses are regularly created, which allow Western companies easier access to the emerging markets while at the same time ensuring that industrial expertise can be acquired by the importing state, which often holds direct ownership in domestic defence businesses.

Governing Defence-Industrial Partnerships

The multitude of stakeholders involved in international defence industrial co-operation sheds light on the high complexity of successfully establishing and effectively managing such bilateral relationships. Their often diverging rationales emerging from different cultural and organisational backgrounds make this an inherently dynamic, non-linear and risk-intensive endeavour.

The UK’s failure in December 2013 to seal a multi-billion pound deal to sell sixty Typhoon jet fighters to the United Arab Emirates (UAE) serves as a reminder of these challenges. Accordingly, a strong governance and a close steering of operational activities is needed to make defence industrial partnerships among Western states, emerging powers, industry and investors work. The generation of trust among these stakeholders, with often diverging rationales emerging from different cultural and organisational backgrounds, and an efficient day-to-day management of corporate joint-ventures are essential elements in this regard.

In order to successfully master these tasks, Western governments require significant ex­pertise – cultural, technological, organisational, operational, financial, etc. – a self-reflective acknowledgement of the complexities of bid-management, as well as a well-estab­lished network of inter-personnel relationships in the government, corporate and investor domains to rely upon throughout the process of establishing and delivering defence industrial partnerships.

The delivery of the Saudi Arabian deal hints at the importance of these factors to business and governments alike.

Author

Henrik Heidenkamp
Associate Fellow
Henrik is a RUSI Associate Fellow supporting RUSI’s research into the public-private... read more

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