Industry: The Consistent Strength of the Defense Market Continues to Provide Opportunities

The basic assumption behind multinationals corporations (MNCs) is that a weakness in one geographic region – setting aside the vicissitudes of market sectors – can be compensated by a corresponding strength of another region. The global economic crisis that began in 2009, waylaid that idea for a number of MNCs who found they weren’t either horizontally or vertically diversified enough to withstand the ensuing decrease in consumer and government spending.

However, MNCs in the defense sector have not only survived this onslaught of reduction but have, in certain instances, thrived. This can be attributed to a number of factors but, I believe, is largely due to the prevailing political winds.

Politicians, regardless of their national or ideological affiliation, are almost always guaranteed to receive a positive reaction if they stand behind their troops. In addition, citizens have been taught that the only entity standing between order and anarchy is the national security apparatus. Consequently, regardless of a nation’s economic condition, one rarely finds an absolute reduction in a country’s defense budget.

Consider, for example, the budget of the US Department of Defense (DoD). Despite spending reductions being implemented throughout the federal sector and the US Congress’ supposed hatred for increased government spending, the House of Representatives’ fiscal year (FY) 2013 Continuing Resolution (CR), as it stands, allocates more funds for the DoD than that requested by the Obama administration.

The CR will fund government operations for the rest of FY 2013 and is being supported by both political parties because it allows them to burnish their national security credentials while showing their support against tyranny and insecurity. Clearly, defense funding in the US will not pose a significant problem in the coming years.

The situation outside the US is even rosier. While the US defense budget is generally held up to be the biggest in the world, it is only so in absolute dollars. In terms of gross domestic product (GDP) percentage, it’s smaller than, to use one example, Saudi Arabia.

Subsequently, this means that, in terms of potential, the Middle East defense market is the pot of gold over the rainbow.

Before getting into the reasons for this assessment, let’s first focus on two other growing economies with fast rising defense expenditures that recently released their budgets, namely India and China.

Economic growth – while positive – has slowed and leadership in these nations has had to reprioritize its spending plans. Admittedly, the situation is slightly different in both countries as India is getting ready for elections while China just went through a leadership transition.

Regardless, leadership in both countries raised the 2012 defense budgets by healthy levels (10 percent for China and five percent for India) and has uniformly supported further increases if they are warranted. Indeed, I am pretty confident the Indian defense budget – especially for procurements – will rise higher in 2013.

The Middle East, as noted above, provides a whole host of opportunities because of the individual governments’ focus on modernizing their arsenals (timing), their massive economic resources (funds) and regional threats (need). Consequently, this region has the need for new assets and the resources to fund those procurements.

Additionally, given the focus of inter-national operability, this market provides an exponentially larger opportunity for MNCs who are able to enter one market and then parlay that sale into other regional markets.

Furthermore, MNCs in the defense space do not have to limit themselves to the military but can – and should – leverage their expertise into sales to domestic security organizations. This allows for streamlined training and better command and control between external and internal security organizations thereby assisting a nation’s defensive and offensive capabilities.

From an MNC perspective, this decreases a corporation’s reliance on a military budget and increases their visibility to the opportunities in the security sector.

Which is not to say that the sector does not have any challenges. To begin with, it’s brutally competitive and price points are constantly shifting. Companies, therefore, need to ensure their supply chains are streamlined to the barest possible extent in order to provide the margins required by the shareholders.

This is tough since the decision makers are politicians whose selections depend on a variable number of uncertain factors that can make the planning process especially difficult. Furthermore, this uncertainty is exacerbated by changes in governments that can cancel contracts.

The other challenge – and possible opportunity – is related to offsets. They are now required for a number of reasons including increasing domestic employment and promoting specific industrial sectors. While offsets can, and do, increase the overall procurement costs, countries are willing to pay for them as long as it gets them the aforementioned benefits.

The challenge for MNCs is to ensure these offsets do not change delivery schedules or product qualities. However, they also provide an opportunity to set-up high quality domestic facilities and ensure long-term customer loyalty.

The global defense sector is a growth industry that will likely sustain for the foreseeable future. While the economic crisis has brought about some new challenges, the opportunities that exist provide vertically and horizontally strong MNCs the prospect of strengthening their revenues, increasing their influence and supporting national defense in an increasingly uncertain time.