House of Commons - Defence

Select Committee on Defence Second Report

THE CHALLENGES FOR THE NEW HDES

Overview

17. For the UK economy, defence exports have been a success story in recent years— across all ranges of goods the UK secures about 5% of the world export market, but in defence products we have a 23% share.[50] In the long term there is a real likelihood that our export performance will suffer as declining research budgets, particularly compared with other competing countries, mean that we cannot continue 'consuming our technological inheritance', even if those budgets were used ever more efficiently.[51] The Committee will be examining the state of defence research in a separate inquiry. There are also, however, some significant near-term challenges (described below), which Mr Edwards may be more readily able to influence. They will not make his job an easy one.

The need for new markets

18. The UK is the second largest defence exporting country, capturing 23% of global new export orders, behind the United States with 42% (Figure 3). While performance of the three other principal exporting nations—the US, France and Russia—has varied over the last few years, UK defence exports have risen in each of the last three years (Figure 4). The most important market area for the UK is the Middle East, which was the recipient of 62% of the UK's defence orders secured in 1997 (Figure 5). Indeed, over the last 10 years or more, the UK's share of the global market has been principally driven by our performance in the Middle East, with the bulk of exports to the region accounted for the the Al Yamamah contracts. In the last two years, the UK has won more of the Middle East market than has the US.[52] The Far East is our second most important market accounting for a further 18% of our exports. The UK's three government-to-government sales agreements lie in the Middle and Far East—Kuwait, Saudi Arabia and Malaysia. UK defence export orders from Latin America and Africa, on the other hand, have been much less significant—$100 million in 1997, or about 1% of the UK defence export total.

19. On the face of it, countries looking to buy their defence equipment from abroad could be expected to buy American. Purchasing from the US would offer the prospect of political and military links with the world's remaining superpower, and equipment prices that can be kept down by high-volume US production runs. In many ways it may be thought surprising that the US does not secure an even bigger share of the world market than it does. One needs only to bear in mind the recent competitiveness of international markets (following reductions in US domestic orders and industry rationalisations) which have made US firms very competitive abroad. And yet the US is matched, and even out-performed, by the UK in the Middle East. We raised this with Mr Edwards. He told us that price, political ties with the UK and logistic and training support all played a part in the UK doing well in particular markets, but that a major overriding driver has been the desire in certain countries not to put all of their eggs in one [US] basket, and when they have looked around for another 'basket' they have looked favourably upon the UK.[53]

20. However, the Asian financial crisis and reduced oil price have now had an impact on UK defence export prospects. The MoD considered that the defence modernisation plans of Malaysia, Thailand and Indonesia were those principally affected by the financial crisis, and that it expected them to delay by at least two to three years some of their major planned acquisitions. Several Middle Eastern countries have recently curtailed their procurement plans because of the fall in oil prices over the last year. And the South American market, though small, has also been affected.[54]

21. Our witnesses were nevertheless upbeat about future prospects. Mr Edwards and his colleagues considered that the important existing markets in the Middle East and Far East would continue, though at a lower level, because the countries involved still perceived threats and would continue to give priority to, and find funds for, defence requirements.[55] Many of these countries do not have indigenous defence industries, and their military capabilities can only be upgraded for so long before equipment is replaced. Over the next five years, the MoD told us, perhaps 10% of previous export levels would be lost.[56] In the Philippines, the economy had not been as hard hit as some others. New potential markets were developing in Australia, South Korea, Canada and South Africa,[57] and when the three new NATO members (Poland, Hungary and Czech Republic) are in a position to meet their significant new equipment requirements the UK will be competing for the orders, along with US and other European firms.[58]

22. The defence export market is clearly in for a rocky ride in the next few years, but the MoD's assessment of the UK's prospects is upbeat. We endorse the MoD's approach of retaining close links with our traditional customers when their defence budgets may be under pressure (showing that we are not merely 'fair weather friends'),[59] while working hard to generate new markets and resurrect old ones.

The consequences of rationalisation and collaboration

23. In our inquiry last year on aspects of defence procurement and industrial policy[60] we reported moves underway to rationalise the defence industry, including trans-national mergers which were then beginning to materialise. This raises important issues for DESO, which is charged with facilitating UK defence exports. Mr Edwards told us that—

The guiding principle has been: let's look at the activity which is going to result in this country [from a particular export]—jobs, technology, whatever it is ... how good is it for United Kingdom plc? After that we look at the ownership of the company or where the control is, and that seems fairly useful for doing the initial cut, discriminating between the various competitions that we could support. That means we [could] end up supporting French-owned or American-owned or Canadian-owned companies in this country in their efforts. The next dilemma is if you are dealing with an Anglo-French joint venture versus a Canadian-owned company in this country, for instance, you look at where the activity is and if the Anglo-French joint venture is going to have all of its activity in France and the Canadian-owned company is going to have all of its activity in the UK, then we will support the Canadian one. So we have been using this rule of first of all [looking at] the activity, and then at ownership to help ... but it is going to get more complicated.[61]

24. Such complicated cases include, for example, providing marketing support for Swedish Saab aircraft because they are 35% owned by British Aerospace.[62] Similar difficulties arise with collaborative projects. With Eurofighter the collaborative manufacturers have decided which of them will take the lead in each market, and then DESO will come alongside to lend support where appropriate.[63] British Aerospace, and thus DESO, are earmarked to support the marketing of Eurofighter-Typhoon in Australia, Bahrain, Canada, Kuwait, Malaysia, Saudi Arabia, and the UAE.[64] But as firms in the Eurofighter consortia rationalise and merge, working out such arrangements is bound to become more difficult.[65]

25. We recognise that in marketing particular products, establishing the UK's interests is not a precise science, and that defence industry rationalisation is going to make it far more difficult in future. Being able to do so, however, goes to the heart of DESO's raison d'être and the organisation must be able to demonstrate clearly that its marketing works to the benefit of this country. Collaborative programmes, by their nature, can serve to dilute the potential benefits of exports that may be available for any one country. In these circumstances we expect Ministers and DESO to do all they can to persuade DESO's counterparts in other collaborative countries to shoulder a fair share of the export marketing effort.

DESO's resources

26. A key DESO target is to support UK companies to achieve annual defence export orders of at least £5 billion a year over five years, measured on a three-year rolling average. For the three years to 1997 export orders averaged £5.2 billion a year.[66] However, as the global market constricts further, a goal expressed in terms of market share may be adopted instead, with DESO being set the target of helping the UK retain its second place after the USA with at least 20% of the market.[67] Over the period 1994-1997, the value of exports per DESO employee improved by 30%.[68] DESO has a target of improving this ratio by 3% a year over the next five years. While the MoD as a whole has an efficiency target of 3%, DESO's target is rather different in that a critical element in the ratio is the volume of UK export orders over which it has only limited influence—thus far the 'efficiency' gains appear primarily to have arisen from expanding UK defence exports. This target is likely to become more challenging to achieve, however, as the global export market contracts further.

27. Of more concern to this Committee, however, are the resource assumptions built into DESO's plans, and in particular the cut of over 100 staff over the four years to April 2002—a fall of 16%. The new HDES said that this was in part based on assumptions about the winding up of the Kuwait project office in another two to three years unless there are new orders[69]—there are no current plans for any new project offices.[70] Mr Edwards, who has inherited the previously planned DESO staff reductions, summed up his own concerns about resources—

[The staff figures] worry me as well, because if we are being this successful and if we are bringing in receipts far in excess of our costs, 'why do we not do more' is the question I would ask, 'instead of less of it?' ... Certain assumptions have been made that there will be less work to be done, and therefore fewer people needed in the project offices. I understand that these drops are mainly due to the project offices which have about half of our people. So those assumptions, I think, need to be questioned going forward, and if we are successful in selling more things in Kuwait that project office will not drop in size. [For] the remainder, if you like the core of DESO, ... we are building in assumptions that we will improve productivity [by] 3 per cent a year ... So I think what you have put your finger on is that if we are as successful as apparently we are, why have we planned to get smaller? I think we have to question those numbers in the future, based upon whether we want to maintain the size of the project offices, and maybe add another project office if we are successful in another country, and not arbitrarily allow our capability to go down. On [staff for] licensing [work], that is so sensitive that I will make the commitment to keep an eye on making sure that we have the appropriate resources to make sure that not only do we handle them efficiently, but handle them responsibly as well.[71]

28. The global defence export market involves some fiercely-fought competitions, and the US in particular push their products very hard. If opportunities present themselves for expanding the UK's market share, the resources needed by DESO should be reassessed by the MoD. By the same token, if a shrinking world market for defence-related goods renders government support for exports disproportionate to the potential benefits, we would again expect DESO's resources to be re-examined. Any significant changes proposed should be notified to the Committee. That said, Mr Edwards' determination to fight his corner over resources for DESO, and his commitment to provide sufficient resources to discharge responsibly DESO's export licensing role (especially in view of the need for improved parliamentary scrutiny of defence exports, the case for which we reaffirm), is entirely appropriate.

Meeting the challenges

29. These challenges we have set out above are significant. In selecting Mr Edwards as the person to meet these challenges, the MoD has secured someone with some 35 years' experience in the defence and aerospace industry.[72] Significantly, these include 16 years with firms in the US[73] which has dominated the market. He told us that he hoped to address the opportunities there were to employ more effectively the marketing approaches used in the US, in particular customer support.[74] We endorse his appointment, and look forward to seeing evidence of the success of his stewardship of the Defence Exports Services Organisation.

50 Ev p 24 Back

51 Q 6 Back

52 In 1997 the UK won US$5.5 billion of orders in the Middle East compared with US$4.0 billion by the US Back

53 Q 64 Back

54 Ev p 29 Back

55 Q 67 Back

56 QQ 69, 70; and Ev p 32 Back

57 QQ 69, 70 Back

58 Q 70 Back

59 Ev p 29 Back

60 HC 675 Back

61 Q 75 Back