Foreign Involvement in the Defence Supply Chain Contents

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The impact of COVID-19 on the Defence Supply Chain

The impact on finances

56.Part of our motivation to launch this inquiry was to ensure that the financial consequences of the COVID-19 pandemic did not result in increased vulnerability of companies with the UK defence supply chain. Our inquiry launch came after comments by the European Commissioner for Competition, Margrethe Vestager, who warned that the pandemic had made companies vulnerable to foreign bids and suggested that European countries should buy stakes in companies to stave off the threat of Chinese takeovers.94 This comment was matched by some of the evidence we received, which linked the financial consequences of COVID-19 to an increased risk of foreign involvement in defence industries. Airbus, for example, made the case that a failure to support the UK supply chain would leave innovative companies supplying defence programmes at greater risk of foreign takeover.95 Mandy Ridyard, Finance Director of Produmax, told us that companies working in aerospace and defence are “bound to be at risk, from either disappearing or being taken over”.96

57.Paul Everitt and Andrew Kinniburgh told us that the defence industry has remained relatively resilient throughout the pandemic, and that a number of companies in related sectors have expressed their interest in developing their work in defence.97 ADS Group also said that the UK’s defence and security industries remained broadly resilient during the early stages of the COVID-19 pandemic.98 However, the MOD noted that the COVID-19 pandemic created financial challenges across the defence and security sectors, and that liquidity and cash flow concerns continue, particularly for firms with exposure to the civilian aerospace sector or relatively high debt. The MOD reported that many defence and aerospace companies have had to introduce cash conserving strategies, for example suspending dividends, reducing executive pay and pension contributions and arranging additional credit facilities.99 ADS Group stated that small and medium-sized enterprises continued to face severe challenges with significant impacts on adjacent industries such as civil aerospace.100

58.Airbus’ evidence also emphasised the impact on commercial aerospace, arguing that it was essential that the UK Government supports businesses operating in commercial aerospace through the crisis to ensure that they are able to continue delivering vital products and services to defence and to prime contractors.101 We heard about the impact of COVID-19 on civil aerospace during a panel with small and medium sized enterprises. Jayne Moorby, Marketing Manager of Oxley, alongside Mandy Ridyard, explained that their companies do a combination of defence and aerospace work and that aerospace has been heavily impacted with the cancellation of orders, delays and greater price pressures. Both witnesses described pressure on cash reserves and the restructuring that they had been forced to engage in, with Mandy Ridyard explaining that her business was 30% down against planned business.102

59.The defence industry in the UK has remained broadly resilient in the face of financial pressures resulting from the COVID-19 pandemic. Unfortunately, the same cannot be said for all businesses within the defence supply chain, particularly those that also operate in commercial aerospace and are small and medium sized enterprises. The financial vulnerability of such businesses could increase the risk of hostile foreign involvement in the defence supply chain.

Assessing Ministry of Defence support to industry

60.In response to the financial impact of the COVID-19 pandemic the MOD said that it had undertaken targeted financial relief measures to support cash flow, maintain service delivery and retain staff within the defence supply chain. This included forward ordering, prepayment, interim payments and payment on order rather than receipt, accompanied by strong guidance around the MOD’s expectation that suppliers continue to pay employees and flow down funding to their supply chains. The MOD stated that it had also made interim payments to prime contractors when required, meaning that primes received some payment early and in advance of delivery of services or products to the MOD, and that primes had actively supported their supply chain in a similar way, responding to requests for financial and other assistance, which had ensured continuing cash flow through supply chains.103

61.Some of the evidence we received was critical of the level of support provided by Government. William Hynett, Chief Executive of Britten-Norman, told us that “the amount of support that we have had from Government to date has been pretty limited”.104 Regarding the MOD’s pre-payment plans, forward ordering, interim payments and payments on order, three SME witnesses said that they had benefited from none, with William Hynett commenting that “They have not been communicated to me at all”.105 Mandy Ridyard said that “most of the primes” do not seem to ensure that interim payments flowed down the supply chain.106 Responding to this criticism, the Minister for Defence Procurement said that he was sorry if it was the case that some small and medium sized enterprises did not know about the support but that he was aware of “a lot” of examples where companies were very pleased.107

62.The support provided in the UK, particularly support for commercial aerospace, has also been compared negatively with that provided in other countries. Francis Tusa told the Committee earlier in the year that France had set up a committee “to look at the complete defence supply chain of SMEs across the piece”, which he explained “were in danger of going broke and also being bought out.”108 He called for the MOD to consider doing the same, later adding:

“Looking at the approach with Covid effects, France very quickly set up an inter-ministerial team to look at the supply chain with industry for defence and aerospace, to highlight which companies were at risk of collapse, especially if they had key roles in the defence supply chain, and, if so, what could be done to rescue them.”109

63.Responding to this comparison, the Minister for Defence Procurement argued that the work on defence supply chain resilience had started before COVID-19 and that the MOD had had ongoing dialogue with industry via the Defence Supplier Forum.110 Lieutenant General Jim Hockenhull, Chief of Defence Intelligence, also highlighted work conducted in 2016 through the “Defending Defence” programme which focused, in part, on supply chains.111

64.Michael Formosa told us that France and Germany proactively supported their civil aerospace industries:

“Not only have their defence and interior ministries sped up acquisition, but, in the case of France, I believe it was about €15 billion in bail-out, which took the form of loan forgiveness and financing. About half of that went to Air France, but the balance was aimed at the OEMs like Safran, Airbus and Thales, where the Government invested in a fund with the proviso that the OEMs would follow suit and specifically help small businesses in the supply chain and invest in greener tech. The Germans did something similar with about a €10 billion bail-out. Their five-year plan for military procurement was pulled forward. A lot of 2024–25 money was pulled back into 2021–22.”112

65.When asked whether the UK had done enough to support civil aerospace, the Minister for Defence Procurement argued that it had, stating that there had been about £9 billion of COVID-19 corporate finance support, loan guarantees, export credits through the furlough scheme and business interruption loans.113

66.The Ministry of Defence and wider Government have provided substantial support to businesses in the defence supply chain. Unfortunately, we heard that this support has not always reached its intended beneficiaries or had the intended consequences. The Ministry of Defence should improve its communication strategy with small and medium sized enterprises to ensure that they are aware of the support that they are eligible for at this difficult time.

67.The commercial aerospace industry remains financially fragile. The Ministry of Defence should already be aware of the close links between this industry and the defence supply chain and should consider what more it can do to support businesses which operate here, particularly small and medium sized enterprises.

The impact on global supply chains

68.COVID-19 heavily disrupted global supply chains as countries introduced measures which included the disruption of manufacturing and restriction of exports and imports. The pandemic also resulted in workforce reductions and travel bans.114 The MOD’s evidence recognised the impact this could have on the defence supply chain as the defence and security sectors are heavily reliant on global supply chains for raw materials and components.115

69.UK defence companies therefore have significant global supply chains and, according to material provided to the MOD by the Security and Resilience Industry Supplier Community, some companies are reviewing their supply chains and seeking domestic alternatives for supply, potentially resulting in shortened supply chains and improved transparency. The MOD also noted that the international trend appears to be movement towards increasingly local supply chains, accompanied by the risk of protectionism, motivated by security, surety of supply and economic stimulus. The impact of such measures, the MOD explained, is likely to be exacerbated by pandemic-induced changes to many bilateral and multilateral relationships, including those relating to trade.116

Efforts to reform the supply chain

70.The Minister for Defence Procurement told us that the MOD has “broadened the intensity of the screening” of its suppliers and has had a “very active dialogue” through the Defence Supplier Forum and other forums.117 Despite some efforts to explore alternative and shortened supply chains, the Minister for Defence Procurement explained that it would be difficult to source entirely from the UK as:

“ … that will rack up enormous costs, and our ability to provide all the capabilities that we wished to would be compromised by spending money perhaps unnecessarily on getting something from a particular source.”118

71.He concluded that there was a balance to be struck and that the MOD were conscious of the need to strike a balance, particularly with regards to materials such as rare earths.119 Air Marshal Knighton explained that about a third of the world’s reserves of rare earth elements were in China, as well as two thirds of the production capability, but that only about 5% of rare earth imports from China were relevant to defence.120

72.The COVID-19 pandemic impacted the supply chains of defence businesses as well as their finances. Global supply chains for defence represent a vulnerability, especially when these supply chains include materials from countries not closely aligned with the UK. The Ministry of Defence should set out how it is proactively supporting efforts from defence businesses to seek domestic alternatives for supply and to shorten supply chains.