Aerospace and Defense Industries Outlook_2012

7/31/2019 Aerospace and Defense Industries Outlook_2012

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February 2012

2012 Global aerospace and defenseindustry outlook:A tale of two industries


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ContentsOverview

Sector updates:

Commercial aircrat production

Air trafc control

Deense

Business jet and general aviation

County updates:

United States

Brazil

Canada

China

India

France

Germany

Japan

Mediterranean countries

United Kingdom

Trend updates:

Mergers and acquisitions

Talent

Diversiying portolio

Contracting process

Overall outlook or 2012

Contacts

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deense programs o record, as well as growth in commercial

aircrat backlogs and a capacity challenge or suppliers to meet

commercial aircrat and regional jet producers increasing

requirements.

The A&D industry is becoming more global due to

heightened competition, growing travel demands, and

security requirements in emerging markets. Globalization

provides opportunities or lower cost and or technologically

advanced product introductions, as these can be designed and

manuactured anywhere, anytime, largely due to the Internet

and digital product denition, design, and manuacturing

sotware. Globalization is also aecting product selections, in

that military and commercial customers alike are requiring that

value be oset by placing work in their countries o origin.

This tendency is likely to continue, as traditional countries arepressured to keep their jobs at home, but is balanced by the

need or companies to grow revenues and continue to reduce

labor costs. The trend in the industry toward globalization is

also marked by new market entrants, some o which receive

government nancial support that may potentially invite World

Trade Organization consideration in uture years. Expect to see

more governmental scrutiny and compliance requirements on

acquisition practices in the areas o anti-bribery, anti-money

laundering, and ethical business practices to provide a level-

playing eld o competition.

In the past, the A&D industry has experienced program

management challenges, resulting in delayed schedules andmissed budget commitments. Among other reasons, these

program management struggles could have been due to

intense competition, which would have necessitated optimist

pricing, cost, and delivery plans. A closer look at several large-

scale programs that have missed their commitments in the

last ew years reveals many root causes, including the use o

immature technologies, lack o appropriate levels o systems

engineering discipline, and a plethora o complex engineering

changes. Other causes or the overruns include inadequate

supplier business maturity, capacity, and perormance, as well

as optimistic scheduling with poor time and resources

planning or contingencies. In 2009, one-time impairment

charges amounted to an estimated US$10.5 billion, while

in 2010 this amount was signicantly reduced to an

estimated US$1.7 billion, suggesting that troublesome

programs are behind or now, and that the industry is

learning to manage programs more eciently.4 This

positive trend likely continued into 2011 and will probably

also continue into 2012.

What lies ahead in 2012 or commercial aircrat

production?

The commercial aircrat industry is likely entering a

prolonged upcycle o orders and production, as demon-

strated by recent Boeing and Airbus announcements

o plans or increased production, the rst delivery o

the B-787 Dreamliner, and the progress o new aircrat

programs underway globally5. Market orecasts o top

large commercial aircrat manuacturers describe an expec-

tation o between 26,900 and 33,500 commercial aircrat

to be produced over the next 20 years6. The diculty in

keeping commercial airlines protable, principally due to

the increasing cost o uel, is generating requirements

or more uel-ecient aircrat. This is driving demand or

derivative aircrats that are equipped with next generation

engine technology. The sales order success o the Airbus

320NEO and the Boeing 737MAX have demonstrated

that industry technology innovations can create signicant

product demand.

Advances in eciency jet-engine propulsion is one o the

most signicant technological innovations that have come

4 Deloitte United States (Deloitte Development LLP), 2010 Global

Aerospace & Deense Industry Perormance Wrap-up, 12 July 2011.

5 Aviation Week and Space Technology, Analysis: Airbus, Boeing Must

Weigh Production Increases With Care, 30 August 2011;Flightstory,

Boeing 787 Dreamliner Date or First Delivery, 26 August 2011.

6 Airbus, Global Market Forecast 2011-2030, June 2011, www.

airbus.com/company/market/orecast/; Boeing, Current Market

Outlook 2011-2030, copyright 2011, www.boeing.com/commercial/

cmo/.


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to the commercial aviation market in the last two years,

specically with the Pratt & Whitney PurePower Geared

Turboan (GTF), as well as the CFM LEAP-X jet engines7.

Because the price o jet uel continues to impact the ability

or global airlines to make a prot, the introduction o

new jet power plants, which lowers uel consumption is

an industry game changer. With a claimed uel-eciency

savings in the range o approximately 15 percent, airlines

are requesting that commercial aircrat producers developproducts incorporating these advances8. Thus, in the last

ew years, new programs, such as the Airbus A320 NEO,

the Boeing 737 MAX, the Mitsubishi Regional Jet (MRJ),

the AVIC ARJ21, the Irkut MS-21, and more recently the

Embraer ERJ product line, are planning customer deliveries

in the next several years that will incorporate these new

power plants. As o mid-December 2011, these engine

7 Aspire Aviation, The engine battle heats up, 10 May 2011.

8 Aviation Week and Space Technology, Smooth Start For GTF Flight

Tests, 22 August 2011; Aviation Week and Space Technology, Virgin

America Launches CFM Leap On A320NEO, 15 June 2011.

0

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2013E

Orders Production 7 Year Moving Avg. Production

Orders

Years

producers have racked up 4,720 orders and options or

new next-generation regional and single-aisle commercial

aircrat power plants, making them among the best-selling

products in aircrat production history9.

Figure 2 illustrates a 30-year history and orecast or large

commercial aircrat orders and production, including a

consensus estimate or 2012 and 2013. It should be noted

that the seven-year moving average or production isexpected to reach 1,000 aircrat by 201310. This is quite

an accomplishment given that only about 20 years ago,

the seven-year moving average or aircrat production was

approximately 500 aircrat per year11.

9 FlightGlobal, Narrowbody engines: Makers mark the way in 2012,

20 December 2011.

10 DTTL Global Manuacturing Industry group analysis, January 2012.

11 Ibid.

Note: The Order plot rom 1981-1988 represent gross orders and rom 1989-2013E represents net orders.

Source: DTTL Global Manuacturing Industry group analysis, January 2012; The Boeing Company data on orders and delivery, accessed on 27

January 2012, www.active.boeing.com/commercial/orders/index.cm?content=timeperiodselection.cm&pageid=m15523;

Airbus company data on orders and delivery, accessed on 27 January 2012, http://www.airbus.com/presscentre/corporate-inormation/orders-

deliveries/?contentId=%5B_TABLE%3Att_content%3B_FIELD%3Auid%5D%2C&cHash=22935adac92cbbd4ba4e1441d13383; DA Davidson &

Company, Commercial Aerospace Industry Update, 26 May 2011; The Boeing Company, news release, Boeing Reports Strong Fourth-QuarterResults and Provides 2012 Guidance, 25 January 2012; QMT, 2012 to be Boeings year, January 2012; Airbus, news release, Ater a year

o records, Airbus sets its sights on continued industry leadership in 2012, 17 January 2012; JP Morgan, Aerospace and Deense - All About

Aerospace/Deense 2012, 5 January 2012; Credit Suisse, 2012 Aerospace & Deense Outlook, 19 December 2011; Morgan Stanley, Aerospace

& Deence Takeo, 21 December 2011.

Figure 2: Thirty-year history and orecast or large commercial aircrat orders and production (1981-2013E)


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What is the uture or advancements in air trafc

control (ATC), as a way to reduce aircrat uel burn?

Global air transportation system (ATS) transormation

initiatives, including the U.S. Federal Aviation Administrations

(FAA) NextGen program, as well as Europes public-

private Single European Sky ATM Research Programme

(SESAR), are expected to be implemented by 202512. When

ully implemented, satellite-based navigation and the

transormational programs are expected to save an estimated

three billion gallons o uel, our million fight hours in delays,

and 29 million metric tons o carbon emissions globally each

year13. With the expectation o increased demand or travel

in the next 20 years14, the new technology associated with

satellite positioning, navigation, and timing systems is expected

to increase uel savings per fight by orders o magnitude,

while reducing congestion and weather-related delays.

Altogether, it is expected that the net benet o implementing

global transormation initiatives could result in signicant

nancial value15. Specically, the projected net present value

o global transormation programs through to 2035 is US$897

billion16. The estimated regional breakdown is as ollows17:

U.S. NextGen program, US$281 billion

Europes SESAR program, US$266 billion

Rest o world, US$350 billion

Globally, the estimated savings accrued by dierent

beneciaries include:

Airlines, 31 percentOverall economy, 30 percent

Passengers, 34 percent

Airnavigationserviceproviders/airports/ATCorganizations,5

percent o the total benets

There are many challenges and risks to meeting the planned

implementation date or ATS transormation initiatives. These

include, but are not limited to, unding, technology risk,

regulatory reorm, ATC procedures, technical and certication

standards, harmonization, and workorce transormation.

Given the highly complex technology involved and the

requirement or saety and reliability, successul deployment

will likely require additional eort and possibly a new

approach, such as that being proposed or the U.S. FAA

12 Eurocontrol, 10 projects that changed the ace o European aviation, 8

February 2011.

13 Deloitte United States (Deloitte Development LLP), Transorming

the Global Air Transportation Systems A Business Case or Program

Acceleration, 10 May 2011.

14 Fox Business, Airbus lits demand orecasts on Asian growth, 19

September 2011.

15 Deloitte United States (Deloitte Development LLP), Transorming

the Global Air Transportation Systems A Business Case or Program

Acceleration, 10 May 2011.

16 Ibid.

17 Ibid.

NextGen program public-private nancing initiative18.

There may also be signicant risk that due to U.S. scal

constraints, implementation o the NextGen program

will be delayed, making 2025 potentially not achievable.

Furthermore, there may be some scaling o the capabilities,

which would delay the return on investment or such

programs, but could also contribute to risks o global

harmonization and interoperability with SESAR. Given

the nancial condition o the airline industry, it may be

a challenge to require airlines to pay or the necessary

equipage o new technologies on board the aircrat, i the

timing or amount o return on investment is not assured.

Lastly, plans will need to be developed and implemented

to address aviation system delays attributable to the

surace environment. ATS transormation and technologyplatorm benets are dependent on the successul

resolution o capacity challenges, including the insucient

number o runways, gate shortages, and overscheduling

o fights during peak trac periods. Avoiding the cost o

system delays, whether these are occasioned by airborne

congestion or ground-based constraints, is a key benet

to be achieved. However, in order to achieve this, the

development and implementation o plans that address

surace-based delays will be critical.

Where is global deense spending going in 2012?

Global deense spending is expected to be fat to declining

in 2012, mostly made up o reductions in the U.S.,United Kingdom (UK), and the rest o Europe, oset with

increases, principally in China, India, Kingdom o Saudi

Arabia, the United Arab Emirates (UAE), Japan, and Brazil.

In 2010, global deense spending, inclusive o armed

orces personnel, was estimated to be US$1.6 trillion,

with the U.S. the leader by order o magnitude, ahead

o second place China, ollowed by the UK, France, and

Russia19. Figure 3 shows the top deense spenders globally

in 2010. It should be noted that nine countries spend over

US$40 billion or deense each year.

In terms o aordability, the nominal amount spent on

deense does not necessarily equate to the importance,requirements, or priority o deense. Countries such as

the Kingdom o Saudi Arabia spend a signicant amount

o their national economy on deense because they have

national wealth created by their oil industry and security

requirements based on their location in the Middle East

and historical precedent. Israel spends a signicant amount

o its national wealth on deense or good reason their

homeland has experienced major military confict six times

18 Ibid.

19 SIPRI, SIPRI Yearbook 2011: Armaments, Disarmament and

International Security, 7 June 2011.


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since their ounding in 194720. India, Brazil, South Korea,

and others are increasing their deense spending rapidly

due to either their wealth, creating aordability and/or

signicant military threats to their national security.

Figure 4 illustrates aordability and importance o deense

by comparing military expenditures with gross domestic

product (GDP) or selected countries in 2010. As can

be seen, Kingdom o Saudi Arabia spends the highest

percentage o its GDP on military expenditures at 10.1

percent, ollowed by Israel at 6.4 percent, and then the

U.S., Russia, and South Korea21. The global average GDP

spent on deense is 2.7 percent which is a bit over-

stated considering the U.S. raises the average signicantly

with a large portion o total expenditures22.

20 USA Today, The Arab Israeli Confict, 1947- present, 28 August

2001.



22 Ibid.

The U.S. Department o Deense (DOD) is now

potentially acing up to US$1 trillion in budget cuts

over the next 10 years. What could be the impact

on the skilled workorce and to the industrial base

i all the cuts were enacted?

U.S. deense budget reductions in the order o US$487

billion over 10 years have essentially been agreed to by

U.S. administration and congressional constituents23.

A recent challenge o the super-committee to agree

on decit-reduction measures on 23 November, 2011

would, i implemented trigger the automatic sequester

budget reduction o an additional US$500 billion over 10

years, starting in 201324. Taken altogether, that implies

a reduction in orce structure, (e.g., soldiers, sailors,

airmen, etc.), as well as a reduction in investment accounts

(e.g., research and development (R&D), new program

starts, numbers o units ordered, etc.). Assuming that

23 Aerospace Industries Association, The Real Deense Budget

Challenges Lie Ahead, 26 January 2012.

24 Ibid.

JapanGermany

CanadaBrazilItaly

AustraliaChina

FranceIndia

WorldUK

South KoreaRussia

U.S.Israel

Saudi Arabia 10.1%6.4%

4.8%4.0%

2.7%2.6%2.6%

2.4%2.3%

2.0%1.9%1.8%

1.6%1.4%1.4%

1.0%

Source: SIPRI, SIPRI Yearbook 2011: Armaments, Disarmament and International Security, 7 June 2011.

Figure 4: Global military expenditures by country as percentage o gross domestic product in 2010

IsraelCanada

AustraliaSouth Korea

BrazilItaly

IndiaGermany

Saudi ArabiaJapanRussiaFrance

UKChina

U.S.World $1,611,437

$698,281$119,400

$59,598$59,322$58,668$54,527$45,245$45,152$41,284$36,972$33,538$27,591$23,972$22,788

$14,036

Source: Stockholm International Peace Research Institute (SIPRI), SIPRI Yearbook 2011: Armaments, Disarmament and International Security, 7 June

2011.

Figure 3: Global military expenditures by country in 2010 (US$ millions)


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What about business jets and general aviation?

Where is the market going?

The 2011 general aviation market was expected to

rebound slightly rom the devastating impact experienced

to orders, employment, and revenues that began with the

economic crisis in 200830. Unortunately, this was not the

case, as shipments or all segments o the general aviation

sector experienced continued declines through the rst

three quarters o 201131. Total shipments declined 9.8

percent, while total billings dropped 10.2 percent through

the rst three quarters o 201132. Figure 5 shows the

changes in shipments or piston, turboprop, and business

jet segments, as well as total billings or the rst nine

months o 2011, compared to the same period in 201033.

More o the same is expected in 2012 with only a slight

growth in orders anticipated. Several reasons may explain

the challenges the general aviation industry aces in

returning to growth. These include the number o high-

quality previously owned general aircrat available in the

market, tighter credit conditions, the smaller number o

younger people obtaining pilots licenses, and nally the

higher cost o uel. On the bright side, China is in the

process o liberalizing its air space and expects the general

aviation industry to lead business jet aircrat growth in

the country, due to the increasing number o wealthy

individuals and burgeoning middle class. Sales to the

Middle East also are expected to ollow the same patternand contribute to the slight increase in orders34.

30 GAMA, General Aviation Airplane Shipment Report, 7 November

2011; Aircrat Owners and Pilots Association, GAMA: Decline in

aircrat deliveries slows, 7 November 2011.

31 GAMA website, accessed on 2 December 2011, www.gama.aero/

media-center/industry-acts-and-statistics/shipments-billings/.

32 Ibid.

33 Ibid.

34 Avjet Corporation, Private Business Jets A Global Perspective, 1

December 2011.

Much has been reported about the A&D industrys

need or cost efciencies and overhead-cost

reduction. The industry continues to experience

program delays and signifcant cost overruns. Will

there be improvement in 2012?

Although one-time asset impairment charges to earnings

were down signicantly in 2010 compared to 2009, the

U.S. Government Accountability Oce (GAO) ound that

on average, A&D programs were 26 percent over budget

and only 33 percent were on schedule35. Nevertheless,

improvements have been occurring and are expected to

continue in 2012. As companies are pressured by military,

government, and commercial customers to ocus on

aordability, the need to manage costs in all phases o the

product lie cycle will become increasingly important. A&D

companies will need to mitigate costs during R&D and

initial production, and then maximize prots as operations

move into ull rate production and support.

Starting with the R&D process, successul companies have

implemented rigorous program and risk management

processes coupled with eective perormance metrics

to manage technical risks and avoid cost overruns.

As programs enter production, successul companies

assess uture market conditions, long-term operational

fexibility, and nancial return on investment when

considering whether to invest in new capacity or outsource

components to strategic suppliers. As an example,Gulstream strategically outsourced production o their

mid-cabin business jets to a key supplier36. Gulstream

traditionally operates a vertically integrated business,

but outsourcing this piece o production allowed them

to avoid making signicant investments to sustain those

products.

35 GAO Report to Congressional Committees (GAO-08-467SP),

Deense Acquisitions: Assessments o Selected Weapon Programs,

March 2008.

36 AIN online, Outsourcing Oshore Not a Gulstream Goal, 13

October 2010.

Figure 5: First nine months 2011 shipments o business and general aviation aircrat manuactured worldwide (US$ billions)

2010 2011 Change

Pistons 633 577 -8.8%

Turboprops 237 223 -5.9%

Business jets 491 427 -13.0%

Total shipments 1,361 1,227 -9.8%

Total billings (US$

billions)

$13.5 $12.1 -10.2%

Source: General Aviation Manuacturers Association (GAMA), accessed on 2 December 2011, www.gama.aero/media-center/

industry-acts-and-statistics/shipments-billings/.


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During production, improved supplier collaboration

will help companies tend to manage and control costs.

Forecasting, planning, and scheduling maturity has been

shown to have signicant impact on the ability or a

company to meet customer delivery schedule demands.

Working with suppliers to provide an accurate view o

lead times, budgets, and orecasts will improve on-time

delivery, responsiveness, and cost eectiveness. Forecasts

that include high-delity production lead times, work-

fow dependencies between suppliers, and accurate due

dates are critical to nding ways to reduce lead time and

mitigate potential problem areas.

Lastly, as production volumes drop and eventually cease,

successul companies monitor sustainment requirements

and continually assess the impact that the erosion involume and inrequent demand streams can have on

total program costs. For example, the inrequent demand

associated with sustainment requirements can cause

signicant breaks in production. A break o 12 months can

increase production costs by 15 percent, or example, and

a break o 18 months can increase costs by 20 percent37.

In order to control costs, successul companies proactively

monitor product support proles and potentially shit the

business model used to deliver a product and/or service to

ensure that sustainment costs or the customer are kept

low, while prots are maintained by the company

Signifcant attention is being paid to U.S.Government Deense Contractor Audit Agency

(DCAA) contract compliance, with several

companies having their business systems criticized

by government auditors. What should the industry

expect in 2012?

Regulators have long held government contractors

accountable or how their money is being spent; however,

there are additional and more intense consequences or

non-compliance based on new regulations. Contractors

are already subject to numerous regulatory requirements,

contract audits, investigative oversight, certications,

and sanctions. It is expected that continued scrutiny o

contractor business systems, a renewed ocus on access to

internal audit reports, and a return o incurred cost audits.

In recent years, the U.S. government has been highly

ocused on the role served by the DCAA in overseeing

compliance with requirements, such as the Deense Federal

Acquisition Regulation Supplement (DFARS). As a result,

the DCAA has taken a more aggressive and comprehensive

approach to their auditing o deense contractors38.

37 DTTL Global Manuacturing Industry group analysis, January 2012.

38 Deloitte United States (Deloitte & Touche Financial Advisory Services

LLP) observation, December 2011.

Further underscoring the situation, in May 2011, the

DOD issued an Interim Rule amending DFARS in an

eort to improve the eectiveness o DOD oversight

over contractor business systems39. The rule establishes

specic compliance requirements spanning a wide variety

o deense contractor business processes, including

accounting systems, earned value management systems,

estimating systems, materials management and accounting

systems, property management systems, and purchasing

systems. With the issuance o the Interim Rule, deense

contractors will likely experience even greater DCAA

attention. The stakes have been raised, as the Interim

Rule species that deense contractors may ace nancial

consequences or non-compliance, including withholding

o payments i signicant deciencies are identied40.

Penalties include payment withholding o 5 percent o

amounts due per system or 10 percent maximum, which

can continue until such time as the signicant deciencies

have been corrected, as determined by the governments

contracting ocer. Faced with the possibility o substantial

delays in receiving payment or services rendered,

successul deense contractors are proactively evaluating

their compliance with the new DFARS requirements to help

ensure that their business systems are not in violation41.

In December 2011, the GAO issued a report regarding

DCAAs access to deense company internal audit reports42.

The report ound that many o these internal audit reports

reviewed contained inormation relevant to DCAA audits,but certain inormation was not provided or requested.

While acknowledging existing case law regarding access to

these condential internal reports, the GAO recommended

that DCAA take steps to acilitate access to internal

audits and assess periodically whether other actions are

needed. The DCAA is expected to increase its eorts in

perorming incurred cost audits at contractors. DCAA

management has stated it will be orming dedicated teams

to ocus on perorming these audits and decreasing the

current backlog o open years43. As these audits are being

conducted, contractors will likely experience challenges

in providing adequate documentation in support o its

transactions.

39 U.S. DOD, Federal Register / Vol. 76, No. 96 / Wednesday, May 18,

2011 / Rules and Regulations.

40 Ibid.

41 Deloitte United States (Deloitte & Touche Financial Advisory Services

LLP) observation, December 2011.

42 U.S. GAO, Actions Needed to Improve DCAAs Access to and Use o

Deense Company Internal Audit Reports, 8 December 2011.

43 National Deense Industry Association, management presentation,

12 to 13 September 2011.


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What is the emerging tax picture or U.S. A&D

companies?

In the past, the tax departments o A&D companies have

been viewed as cost centers that manage the companys

tax compliance and tax nancial reporting obligations. This

model may have been sucient or U.S.-based companies

operating primarily within the United States, serving

primarily American customers. However, as companies

expand internationally and encounter new complicated

tax laws o oreign countries, in addition to the uncertain

and complicated U.S. tax laws, tax departments are being

asked to do more than what they are accustomed to

without additional resources. Furthermore, companies

may not be able to handle or coordinate their global tax

compliance obligations and may require assistance in

the U.S. and abroad. Proactive tax departments that arewell integrated with a companys nance and operations

unctions and viewed as a value driver can deliver

meaningul benets exceeding department costs, including

lowering eective tax rates and obtaining cash tax savings

through upront tax planning.

The U.S. tax picture or beyond 2012 is still developing.

There is a debate in Washington D.C. currently underway

on the need to reorm U.S. corporate tax rules and lower

the top rate in order to make U.S. businesses more

competitive internationally. However, the prospect o

a reduced corporate tax rate comes with a signicant

amount o uncertainty or taxpayers, as Congress wouldlikely have to make oundational changes to longstanding

deductions, credits, and incentives upon which businesses

have relied, such as the R&D tax credit, domestic

production activities deduction, completed contract rules,

and accelerated depreciation. While no action is expected

until sometime ater the 2012 U.S. elections, companies

could be taking several actions to prepare or and

successully cope with change.

What can be expected in Brazil, with increasing

levels o wealth, the pending selection o new

fghter aircrat, and growth in the civil aviation

market?

It is anticipated that the Brazilian A&D industry will

continue to thrive over the next ew years, driven by GDP

and individual income growth, as well as wealth creation

particularly in the middle class. In addition, the expansion

o credit and long-term nancing has been powerul

drivers o economic growth. Finally, real-dollar exchange

rates have stabilized, resulting in lower oreign exchange

credit risk. These drivers have provided a oundation

or robust economic activity and bode well or the A&D

market in Brazil.

Air travel demand has increased at impressive levels and

nearly tripled in the past decade, as more people can

aord to fy or business and leisure44. In commercial

airlines, revenue rom domestic and international regular

fights operated by Brazilian companies has increased

rom R$13.8 billion in 2003 to R$21.6 billion in 201045.

In deense and security, the Brazilian Air Force budget has

increased rom R$4.6 billion to R$8.02 billion, signaling

an increased priority or national deense46. This is one o

the most signicant military investments or the Brazilian

government.

In addition to organic market expansion, Brazils

involvement in the 2014 International Federation o

Association Football World Cup and 2016 Olympic

games will increase travel to the country generatingadditional revenue or the industry. These mega events

are likely to expand the interest in tourism, business, and

inrastructure development. The Brazilian government

plans to invest R$5.6 billion to modernize airports in

preparation or the sporting events47. Another important

actor driving the markets is the high-speed development

o biouels or aviation. Thus or the next year, industry

sector activities in Brazil appear to be increasing.

How will the Canadian industry beneft rom the

growth o the industry in the next years due to

increasing demand or aircrats?

The Canadian A&D industry is composed o more than400 companies, including a ew original equipment

manuacturers (OEMs) and many tier two and tier three

suppliers48. It employs more than 80,000 employees,

generates revenues o approximately CND$24 billion, and

ocuses primarily on the commercial aircrat sector which

represents 83 percent o the industry49. This situation

positions Canada to benet rom the increasing demand

arising rom the global commercial sector and protects it

against deense spending reductions.

The Canadian A&D industry is beneting rom the

opportunities o the global A&D industry since more than

77 percent o its revenues are generated rom sales to

44 Star Tribune, Brazil air travel triples since 2002, stoking worries

about preparation or WCup, Olympics, 25 January 2012.

45 National Civil Aviation Agency, 2010 Yearbook o Air

Transportation, developed in 2011, www.stats.gov.cn/english/

statisticaldata/otherdata/brics2011/P020110412517544487450.pd.

46 Ibid.

47 Empresas Concremat, Build ing or a more competitive Brazil,

April 2011.

48 Aerospace Industries Association o Canada (AIAC), Canadas

Aerospace Industry Statistics, accessed on 2 January 2012.

49 AIAC, Backgrounder Deloitte Study Report Highlights, 26

October 2011.


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oreign markets50. The increasing demand in developing

countries such as China and India will thereore benet

Canada. Canadian companies are likely to continue to

invest in those developing countries in order to maintain

market share and remain competitive in these markets. In

addition, industry has also ocused on the development o

green aerospace technology to provide uel-eciency

relie as the price o uel rises. As the demand or greener

aircrat increases, many Canadian A&D companies that

have invested heavily over the past ew years will likely

gain nancial benets.

What impact will China have in the industry?

China is expected to continue the modernization o the

industry, with several development programs underway. In

the commercial aircrat industry, the COMAC C-919 singleaisle commercial air transport program is well under devel-

opment, with rst fight scheduled in 2014 and entry into

service in 201651. COMAC orecasts 2,000 C-919 aircrat

to be produced over the next 20 years, approaching 7

percent market share o the consensus market orecast or

global production52. In addition, COMAC is developing the

ARJ-21 regional aircrat, which has already undergone rst

fight, and is expected to be delivered to airline customers

in 201253. Together, these two aircrat launch programs

represent the emergence o an industry that has struggled

over time, but now appears to be emerging as a credible

producer o commercial air transportation products. It is

expected that the Chinese commercial aircrat industrywill continue to gain attention in 2012, with continued

western supplier involvement and partnership creation, as

well as continued technology development.

In the space sector, the Chinese industry continues to

advance its space program with the development o a

space station. A plan announced by the Chinese govern-

ment at the end o 2011 includes the launch o a space

lab and collecting samples rom the moon by 201654. It

also includes plans or a manned spaceship and space

reighters. The new space plan would include the design,

manuacture, and deployment o the Beidou Satellite

Navigation system, Chinas version o a global positioning

systems (GPS), navigation and timing system, similar to the

U.S.-based global positioning system. Recent achievements

made by Chinas aerospace industry in 2011, including a

50 Ibid.

51 Flightglobal, C919 project at crucial point in detailed design

Comac, 25 November 2011.

52 Deenceweb, COMAC C919 orders reach 165 aircrat, 16

November 2011.

53 Flight Global, Comac ARJ21-700 ready or type inspection

authorization, 30 December 2011.

54 The New York Times, Space Plan From China Broadens Challenge

to U.S., 29 December 2011.

successul docking between the Shenzhou-8 unmanned

spacecrat and the Tiangong-1 space lab module55.

China is also increasing its deense capitalization,

expanding its submarine feet and developing its rst

aircrat carrier, purchased rom Russia56. It also has a th

generation stealth ghter, the J-20, under development,

which has captured the attention o global competitors57.

What is expected or India in 2012?

India is a nation on the ascent in terms o wealth creation,

spending on space, commercial air transportation, and

deense sector. First, the Indian space sector has been

experiencing growth with the launch o Chandrayaan-1,

the Indian Remote Sensing series and Indian National

Satellite system58

. The Indian Space Research Organization(ISRO) is experiencing success with the in-country design

and production o spacecrat. ISRO is likely to establish

new acilities and develop a host o technologies or

Indias rst manned mission scheduled or 201659. A new

project, the Indian Regional Navigational Satellite System,

has been developed or improving national intelligence,

surveillance, and reconnaissance capabilities with a launch

o the rst satellite planned during 2012-2013. Finally, the

Chandrayaan-II mission is expected to launch in 2013, with

the objective to collect samples o lunar soil and conduct

in situ chemical and mineralogical studies60.

Second, regarding commercial aviation, India is one othe astest growing aviation markets and is expected to

be the third largest domestic market ater the U.S. and

China by 202061. The commercial aviation market in India

during that time is expected to grow at a compound

annual growth rate (CAGR) o 18 percent, and the market

or new passenger aircrat in India is expected to be

US$150 billion, with 1,320 new airplanes delivered over

the next 20 years62. Traditional mainline as well as low-

cost carriers are expected to participate in feet renewals

55 CNN US, Space docking marks new milestone or Chinas stellar

ambitions, 30 November 2011.

56 The Guard ian, Chinas rst aircrat carrier: From Russia with love,

10 August 2011.

57 ABC News, Chinese Stealth Fighter Could Rival U.S.s Best: Report,

9 May 2011.

58 Deloitte India (Deloitte Touche Tohmatsu India Private Limited),

Antrix Corporation Limited, and Conederation o Indian Industry,

Overview o the Indian Space Sector 2010, August 2010.

59 Flightglobal, Indias space sector shits to new rontiers, 1 February

2011.

60 ISRO, website inormation included in Future Programme, accessed

on 18 January 2012.

61 India Brand Equity Foundation, Website inormation included in

Aviation, accessed in December 2011.

62 Indian Aviation, Sky is the limit, 18 January 2012; Boeing, Boeing

values India Market or 1320 New Airplanes at $150 Billion Over Next

20 Years, 6 July 2011.


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both rom German companies investing in target markets,

as well as Asian investors investing in Western companies

in order to gain technological know-how.

In general, the German A&D industry could see some

urther consolidation initiatives driven by eorts or

diversication, key system supplier platorm capability,

more risk sharing, and assistance to distressed key

suppliers by OEMs.

What are the emerging trends or the Japanese

A&D industry?

The current global role o the Japanese A&D industry

is primarily as a tier-one supplier. Indeed, more than

35 percent o Boeing 787 components are made by

Japanese companies, and ully 20 Japanese companiesparticipate in the Airbus A380 program71. Although

the recent appreciated Japanese Yen has resulted in

protability challenges or the industry, it is expected that

rate increases in these and other programs will help grow

revenues, employment, and related economic activity or

the industry in Japan or several years to come.

The industry is maturing and in selected cases is

transitioning to a ull-scale platorm integrator. Major

programs under development are the MRJ, a next

generation regional aircrat being produced by Mitsubishi

Aircrat Cooperation, Honda Jet by Honda, commercial

derivatives o the XC-2 by Kawasaki Heavy, and US2by ShinMaywa. The Japanese industry has high hopes

or the commercial success o these programs because

they represent an opportunity to showcase indigenous

engineering and systems integration capabilities. They also

represent a key pathway or economic development, job

creation, and national pride.

Key success actors or the Japanese A&D industry have

been and continue to be technology and quality. However,

the industry has also realized the criticalities o voice o

customer, needs-driven engineering, and globalization to

reach the next level o perormance and improve global

status. The largest impact to Japans A&D industry is the

transition rom product- driven manuacturing companies

to global and customer needs-driven engineering

companies.

71 The Society o Japanese Aerospace Companies, Aerospace Industry

in Japan 2010, April 2011.

What will the budget defcit challenges in

the Mediterranean countries mean to their

contributions to the NATO organization or their

own countries deense budget impact and ability to

be a leader?

Since the end o the Cold War, military policy and

expenditure have been the subject o a constant evaluation

to ensure the ability to intervene eciently. Furthermore,

the U.S. and North Atlantic Treaty Organization

(NATO) relationship was balanced towards greater U.S.

contribution in terms o both leading crisis situations and

military spending. The recent Arab Spring events and the

military security campaign in Libya have demonstrated the

need or Europe, particularly the UK, Italy, Germany, and

France, to take the lead72. European nations are becoming

more aware that security is not a zero-cost product andthat they cannot enjoy the benets o security without also

helping to guarantee it.

As shown earlier in Figure 2 and 3 ocused on global

deense spending, the UK, France, and Germany are by

ar, the countries that invest most on military expenses,

with the UK at 2.3 percent o GDP compared to 1.7

percent or France, 1.8 percent or Germany, 0.9 percent

or Italy, and 0.7 percent or Spain73. However, considering

the combined European population and GDP and the

corresponding U.S. gures, European expenditure on

military investment is a ourth the amount spent by the

U.S, while spending on military R&D amounts to just asixth o the U.S. gure74.

With the economic challenges in Europe, particularly with

the Mediterranean countries o Spain and Italy, increases

in deense spending are not likely in the short to medium

term. According to preliminary budget projections, the

gap between U.S. and European deense spending is likely

to widen, as NATOs 2011 spending cuts o 18 percent

in the next ew years are orecasted compared to 201075.

However, the term smart deense has been coined

to dene the trend towards selective European military

spending at a time o limited available economic resources.

Smart deense involves a streamlined, more ecient model

with the adoption o a range o measures and armaments

that will enable NATO to ace up to any type o threat:

From cyber war to missile deense against possible attacks

by rogue countries. It will seek to increase eciency

72 The Global Policy Institute, The Arab Spring is an Opportunity...or

Europe, 2 September 2011; Deutsche Welle, European divisions on

Libya hold up U.S., NATO leadership decisions, 23 March 2011.



74 Ibid.

75 NATO, NATO Review 2011, accessed on 3 January 2012, www.

nato.int/docu/review.


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15

by encouraging member countries to cooperate on the

basis o interoperability and specialization. Plans are or

resources to be better allocated, no longer based on

national interests, but in the more general interests o the

alliance as a whole76.

What is the industry in the UK doing to address the

slowdown in deense spending?

The UK A&D industry is the third largest globally, behind

the U.S. and China, and has 520,000 direct and indirect

employees dependent on the sector77. Importantly, over

hal o the revenues generated by UK-based rms derive

rom sales made to export markets, with the U.S. DOD

being the primary export customer78. Thus, the industry

is important to the UK industrial base as the employer o

a highly skilled UK workorce and as an earner o oreignrevenues. As such, understanding the UK industry going

orward requires consideration o all three key revenue

generators, including UK MOD, U.S. DOD, and the

commercial aerospace sector, along with an understanding

o the UK government response.

The UK decit reduction program has resulted in deense

procurement reorms, which have delayed contract

placements, and will reduce spending over the next three

years by approximately 8 percent in real terms. In addition,

the Currie review regarding single-source procurement

is expected to be nalized in early 201279. Amongst the

expected recommendations are open book accountingso that the UK MOD is in a better position to negotiate,

incentivizing eciency to encourage the industry to

reduce its cost base, and a push to reduce single-source

procurement and open competition.

A similar picture to the UK is being seen, as discussed

elsewhere in this outlook. However, it could be argued that

there are still opportunities to access additional revenues

in the U.S. market via a ocus on small-to medium-sized

acquisitions, as has been the case or the UK industry over

the last decade or so. The challenge now, given what is

happening in the UK market, is both securing unding

and being able to meet vendor price expectations. In

addition to the Currie report, the UK government is looking

76 NATO, Smart deense website, accessed on 7 February 2012, www.

nato.int/cps/en/natolive/78125.htm.

77 A|D|S, Aerospace: A recipe or recession recovery, 2011; A|D|S,

Deence: sound investment, strategic choice, accessed on 18

January 2012, www.engineeringcapacity.com/__data/assets/pd_

le/0006/405168/ADS-Deence-maniesto-FINAL.pd; The Telegraph,

UK military spending, accessed on 18 January 2012, www.

telegraph.co.uk/news/uknews/deence/8002911/Deence-spending-

the-worlds-biggest-armies-in-stats.html?image=2.

78 Deloitte UK observation, 14 December 2011.

79 UK MOD, Review into single-source military equipment contracts,

11 October 2011.

to support the industry in accessing new markets and

growing exports. This government/industry partnership

will need strong commitment on both sides as it will be

up against other countries seeking a similar export-led

recovery or their industrial base. In order to address the

above challenges and opportunities, the UK A&D industry

is preparing itsel or the uture by80:

Increasing ocus on the broader security and intelligence

markets

Increasing access to customers preerential areas o

spend and/or customers in new geographic markets

Addressing internal costs to refect changes in customer

requirements and reduced business activity

Focusing on operational eciency

Looking to work more closely with the UK governmentor support on exports, as recognized by the UK

government in its recent whitepaper81

Continuing to improve internal data capture, and

leveraging this knowledge in negotiations with uture

upskilled government procurement agencies

Enhancing the robustness and appropriateness o their

business portolios through targeted acquisitions and

disposals

Where do you see M&A activity in 2012?

Global M&A activity in 2012 is likely to be driven by a

variety o actors, including the impact o the recent global

economic crisis on both corporations and private equityrms. Specically, investible cash, as well as borrowing

capacity will likely lead many companies to pursue M&A

activity as a vehicle or growth and to access new markets.

Many A&D companies have used their cash over the last

several years to pay down debt, buy back stock, increase

dividends, and to make elective contributions to pension

costs. At the beginning o 2011, global A&D companies

had an estimated US$49.5 billion in ree cash fow, and

some used this asset to participate in the M&A market82.

Indeed, M&A deal value in the A&D industry in 2011

was approximately twice the level rom the previous

year, driven in large part by the US$16 billion Goodrich

Corporation acquisition by United Technologies

Corporation deal announcement83. Additionally, the vast

80 UK MOD, Spending Review 2010, covering the period to the 2014

to 2015 nancial year announced on 20 October 2010.

81 UK MOD/Government, National Security Through Technology:

Technology, Equipment, and Support or Deence and Security,

February 2012.

82 Deloitte United States (Deloitte Development LLP), 2010 Global

Aerospace & Deense Industry Perormance Wrap-up, 12 July 2011.

83 DTTL Global Manuacturing Industry group analysis, January 2012;

Wall Street Journal, UTC Deal Reached to Acquire Goodrich, 22

September 2011.


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level o capital raised by private-equity rms in previous

years should serve as a driver to deploying those unds

in 2012. Private equity investors are likely to compete or

many o the same assets as strategic buyers and in some

cases paying higher values. During 2011, multiple deals,

large and small, were announced and similar levels o M&A

activity are expected or 2012.

It is anticipated that increased activity will remain high

within commercial aerospace given the anticipated

overall increases to production levels and new program

ramp-ups. Buyers will likely continue to use M&A to

position themselves on these growing programs, as well

as increasing scale and integration capabilities to become

Figure 6: Recent energy market investments by leading A&D companies

Source: DTTL Global Manuacturing Industry group analysis, January 2012.

Figure 7: UVA data capture

Note: The quantity o data captured by UAVs has increased 50 times over the past two years, creating a market

or ltering and processing UAV sensor data.

Source: DTTL Global Manuacturing Industry group analysis, January 2012.

more relevant to the customer. Within the deense world,

the challenges o the U.S. Super Committee will likely

lead to a decline in certain deense programs, as the U.S.

government looks or ways to reduce the budget decit.

This will likely have a negative impact on overall deense

industry attractiveness o certain assets. At the same time,

expect ever-increasing budget support or, and thereore,

M&A interest in, those areas which support new

realities technologies, such as intelligence, surveillance

reconnaissance, precision strike, cyber security, energy

security, data usion, mission sotware development, and

unmanned and autonomous controlled vehicles.

0

5

10

15

MarineNuclearSolarWindFuel cellsBiofuels

13 13

10

8

5

3

Energy markets

Numberofcompaniesinvested

0

300

600

900

1200

1,500

20112009

13

10

8

3

30

1,500

Year

Continuous

year

s

ofvideo

feed


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What are the trends in talent recruitment,

development, and retention in the A&D industry?

Talent is one o the biggest challenges companies ace

in the coming years, particularly the A&D industry given

its demographic composition. The oten cited shortage

o engineers in the U.S. remains a challenge, but skilled

production workers are also in short supply. In the U.S.,

74 percent o manuacturers indicated that workorce

shortages or skills deciencies in skilled production roles

represent a major challenge to productivity84. Cuts in

deense spending threaten to exacerbate this problem i

diversied manuacturers and smaller companies leave

thesector and skilled production workers seek employment

in other sectors.

The uture o A&D industry talent is the generationentering the workorce today. This workorce has

signicantly dierent values and expectations than the

baby boomer workorce that makes up the majority o

A&D companies today. The industry is aced with the

challenge o attracting this new workorce and changing

some o the undamental aspects o their culture, while

retaining the elements o the culture that have made them

successul or decades. Todays entry-level workers value

84 Deloitte United States (Deloitte Consulting LLP) and Manuacturing

Institute, Boiling Point: The Skills Gap in U.S. Manuacturing, 17

October 2011.

Figure 8: U.S. deense contract spending by competition (US$ billion)

0

50

100

150

200

250

300

350

400

Competition with multiple offers

Competition with single offer

No competition

2010200920082007200620052004200320022001

Year

US$

billion

Source: David Berteau, Deense Contract Trends (Washington, D.C.: CSIS, May 2011), {page 24}.

open environments, rapid advancement, fexible work

arrangements, diverse assignments, and non-hierarchical

organizations. A&D companies have traditionally been

characterized by the opposite: Facilities are at times old,

utilitarian, and closed; access to inormation is tightly

controlled, advancement can be slow and measured,

hierarchies are clear and rm, and many people work a

single program or 10 to more years.

A&D companies have the opportunity to use the incoming

workorce to catalyze culture change not only to attract

the next generation, but also to address changing

trends in the industry: Increased use o xed-price and

perormance-based contracts, signicantly increased

ocus on aordability, and transition away rom traditional

large procurement programs to new geographies andnew markets (e.g., oreign military sales, inormation

technology management, and cyber security). These

changes lend themselves to culture change that aligns

with the values o the uture workorce. The challenge or

companies is making themselves more attractive to the

next generation, while retaining the core elements that

have made them successul: Commitment to the mission,

ocus on the warghter, and relentless pursuit o results.


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How is the global deense industry diversiying?

The anticipated cuts in deense spending in the U.S. and

in Europe or the oreseeable uture will orce companies

to evolve their businesses to better suit markets outside o

their traditional customer base. As seen in Figures 6 and 7,

continuing energy concerns and a drastic increase in the

demand or UAV data capture have created new market

opportunities. In order to address these new markets,

many companies have already made investments or

acquired niche companies with the necessary capabilities

to capitalize on these opportunities.

Success in these new markets will likely require changes in

business models. As companies within the industry adapt

their business models to meet shiting demands, they will

reorient processes or interacting with customers, suppliers,and the general marketplace. For instance, shiting rom a

product-orientated business model o building ships, to a

service-oriented business model o analyzing captured data

rom UAVs, requires the rationalization o manuacturing

capabilities, build-up o service operations, and customer

service delivery models.

Companies have successully managed this transition in

the past. For example, VT Group, originally a UK deense

shipbuilding company, managed to successully transorm

its business model rom a traditional shipbuilder to a major

provider o communications, deense, and education

support services by divesting 55 percent o its shipbuildingbusiness to BAE Systems and acquiring/integrating a

portolio o small support service companies85.

85 Shipping Times, VT and BAE Systems announce shipbuilding

merger agreement, 25 July 2007.

Figure 9: U.S. deense spending by contract type (US$ billion)

Source: David Berteau, Deense Contract Trends (Washington, D.C.: CSIS, May 2011), {page 25}.

Will perormance-based contracts become more

popular as a deense industry contracting process?

The A&D cost-reimbursable contracts that are currently

commonplace with militaries and governments are likely

to be less suitable or uture commercial clients. As seen

in Figure 8, or the past 10 years, cost-reimbursable

contracts have made up a signicant portion o deense

spending. In Figure 9, due to the lack o cost-type

contracts in commercial markets, and the decreased use

o these contracts by the U.S. government, companies are

becoming more adept at utilizing and managing to xed

price (i.e., perormance-based contracts).

Companies shiting rom cost-type, transactional contracts

to perormance-based contracts successully dene up-

ront customer needs, accurate perormance metrics, andcontrolled risk management. In addition, the sole-source

and limited-competition contracts that military clients enjoy

are less likely to happen in the commercial marketplace.

GE, Rolls Royce, and Pratt and Whitney are leaders o

perormance-based logistics services, utilizing accurate

orecast models, and proactive real-time perormance

data to anticipate and prevent service interruptions, while

maintaining a consistent service level.

What are your predictions or the uture o the A&D

industry?

Although it has only been 108 years since the WrightBrothers rst fight, the industry has contributed

undamentally to the way we live, work, travel, and

communicate with the technologies created and continued

0

50

100

150

200

250

300

350

400

Cost and type

Fixed price

2010200920082007200620052004200320022001

Year

US$

billion


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innovations developed in jet aircrat, communications

satellites, the Internet, and GPS, or example. Also,

the industry is primarily responsible or the reduction

o casualties in armed confict due to the technology

innovations that keep warghters out o harms way

with UAV, sophisticated surveillance sensors, and over

the horizon strike capability. This industry has created

the technology innovations that have contributed to the

very abric o society rom the ability to communicate

globally around the clock rom our personal digital

assistants, to sae and ecient air travel, to securing our

borders, and deending our way o lie.

Past is prologue, expect game-changing technology

innovations to continue to be created within the global

A&D industry into the uture. Some o the science and

technology being developed include directed energy

and high-powered microwave weapons, supersonic

missiles, long-range and high-altitude unmanned aerial

systems, satellite-based high-resolution ull motion video

cameras, and extraordinary sotware that can trace

nancial transactions o known terrorists. Interesting

technologies are being experimented that can harvest

solar power rom space-based solar arrays, converted to

microwaves, or high-voltage wireless signals, to ground,

air, and sea-based distribution networks. These kinds o

innovative technologies will change the lives in society in

immeasurable ways, just like during the rst century, the

industry has changed the way humans interact on a global

basis. This is indeed something to look orward to in the

near term, as well as in the uture.


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Aerospace and Defense Industries Outlook_2012

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