22 April 2020, NIICE Commentary 4203
Madhulika Baniwal
The world is witnessing a global health crisis that is inducing human suffering and jolting every sector of a country causing human economic and social crisis. The COVID-19 pandemic is attacking all industries at their core. One such industry is the Defence Industry.
While it is still early to meticulously conclude whether the armed sector will remain unaffected by the pandemic or fluctuate, it is of paramount significance that the defence companies diagnose what the major impact points are, and further assess alterations in their business development plans and supply chains.
For the defence ministry, the implications of COVID-19 will be most prominent in budgetary terms, though the economic and fiscal consequences of COVID-19 will be reflected in years following 2020, when the expenditure on the crisis will be reflected in government spending policy. As happened during the 2007–08 Global Financial Crisis, the global GDP did not contract until 2009 and the hefty diminution in defence did not occur until 2012 and 2013. In 2011, global defence spending touched USD 1.55 trillion (USD rate of 2015). It took five years for the spending to recover back to this level, reaching USD 1.56 trillion in 2016 (USD Rate of 2015).
Followed by fiscal predicament, other severe impacts will be felt on production, manufacturing and supply chains. Defence manufacturing companies situated in countries badly hit by COVID-19 along with those that are dependent on supply chains located in affected countries are the immediate victims of the pandemic. A case in point is Fincantieri of Italy, which has suspended its ship building operations for the time being. With COVID-19 cases on peak in Western Europe, several other defense firms have suspended their operations, such as Navantia and Indra in Spain, which are being affected by partial or complete shutdowns or regulated functioning, thus affecting production queues and deliveries. Likewise, the delivery of the first batch of four Rafale multirole fighter aircraft from France to the Indian Air Force (IAF) is delayed by three months. Similarly, the training course of Indian pilots in France has been negatively impacted.
Another setback being faced is by the production for supply chain and resourcing patterns of the Defense Technology Industry Base (DTIB), as production with branched-out supply chains are more likely to endure supply side constraints. Moreover, defense firms with technological advancements and automated plants may be less affected by the practice of social distancing. Similarly, those companies that still follow just-in-time production probably have a greater level of inventory, and thus could be able to handle the supply side shocks for a longer duration.
Business development in defense will also suffer as it is identified with lengthy negotiation periods, protracted engagements, government-to government (G2G) linkages, extensive testing and evaluation, and across the table meetings. Many high-stake procurement projects are discussed and finalized during defense shows such as EUROSATORY 2020 that was scheduled for June in Paris, now remains an uncertain event – thereby the boulevards for business development are reduced. Even though meetings and discussions are still happening over teleconferencing, the final call for high-stake procurements are unlikely to be made online. Besides, it is also not safe to discuss matters of security and defence over online platforms because of the possible breach of privacy. Thus, the pandemic has halted business development in this industry.
Military exercises, which are a great opportunity to attract operators and decision-makers of prospective buyer nations, have also been deferred until the situation eases. A cessation in military exercises has resulted in reduced interaction and informal testing of equipments, thereby, compromising on an exercise’s latent business development potential. Needless to say, military exercises are an important part of a nation’s Foreign policy, and their deference may create a diplomatic bottleneck in some bilateral relations.
Another major concern hovers around the government’s step of de-prioritizing defense spending and procurement. Countries with major defense expenditure allocate around 2 percent of their GDP solely to defense. By that figure, countries overwhelmed by the pandemic will have to upsurge their investment on social security and healthcare spending. This shifting of funds will eventually be met by channeling funds from other higher-value budget components – defense included.
Another major challenge faced by defense companies relates to maintaining all assembly lines and an active workforce during the time of reduced sales. Currently, companies are battling with dilemmas over critical questions, like whether to retain the workforce level or cut it short it by losing capable man power and whether the payment to vendors be deferred. Similarly, whose help should the loss-stricken enterprises seek and should the R&D budget be utilised for paying salaries at the danger of compromising on technological edge. They are also puzzled with what should be done with suspended production sites and how they can preserve the shareholder confidence. Answering these questions in such distressing and confusing times can be a tricky task, especially for defence businesses.
Lastly, the impact of pandemic on defence industry clearly visible through the declining of stock prices. Since 10 February 2020, Lockheed Martin’s stock price has fallen by approximately 28 percent, Leonardo’s by 55 percent, Thales’ by 33 percent, and Fincantieri’s by 32 percent. Shares of some defense companies are currently trading at their lowest prices from the past five years.
Considering that the defense contracts are highly valued contracts, a potential loss of business due to a COVID-19 can result in companies losing out on anticipated sales worth hundreds of millions of dollars. The setbacks might be temporary, due to suppressed demands and the defense sector might rise once the pandemic is controlled. However, if the discovery of the vaccine or cure takes longer than expected, defense spending might be de-prioritized and the supply side pressures will cause defense companies to face tough decisions. In this regard, it is also crucial to understand that unless a vaccine or cure is developed and administered, the potential resurgences of COVID-19 cannot be ruled out.
Uncertainty in the contemporary world must be accepted as a norm and the defense industry must explore multiple coping mechanisms. Strategy should not just be focused on growth but must include scenario-based resource planning and material substitution. Manufacturing principles advocating on maximising efficiency and reducing costs through maintaining minimal inventory might matter no more during the time of crisis. Technological interventions to boost automation levels and the use of unmanned arrangements can curtail downtime during consternation. Coincidentally, many defense companies have strong capabilities in these two sectors. Thereby following Benjamin Disraeli’s quote of “preparing for the worst, but hoping for the best”, seems to be a positive paradigm for defense companies during these uncertain times.
