PwC Aerospace & Defense 2012 Year In Review and 2013 Forecast
www.pwc.com/us/aerospaceanddefenseAerospace & defense2012 year in reviewand 2013 forecastHow are aerospaceand defense companiesperforming today?What challengesand opportunities dothey face?PwC takes a look.
Aerospace and defense year in review 1Commercial aerospace 7Defense 15Trends 20Mergers and acquisitions 31In summary 33Top 100 list 34Contents
2012 data for the largest 100 aero-space and defense (A&D) companies,by revenue, with publicly availableConsequently, several companieswere not included because theyhad not reported results by theA&D companies include those thatgenerate the majority of their revenuefrom aerospace and defense activitiesMethodologyreportable segments that derive amajority of revenue from aerospacecurrencies are translated at averageexchange rates for the years endingDecember 31, 2012 and DecemberOur report also offers PwC’s point ofOur viewpoints have been developedbased on our interactions with ourclients and other industry leaders
A&D 2012 year in review and 2013 forecast 1reported its best year ever in 2012,uptick came on the strength of asurging commercial aviation marketthat more than offset a soft defenseA&D companies reported a record-setting $695 billion in revenue andRevenue was up 4 percent comparedmargin decreased 17 basis points toresults, so these statistics slightlyunderstate the strength of commer-cial aviation earnings as a result ofthe acquisitions of Goodrich andhalf of Goodrich’s annual revenue,meaning that the year over yearstatistics do not take into accountmore than $4 billion of revenueacquired by GE Aviation at the end ofthe year, so the year over year statis-tics do not include about $3 billion oftypes of anomalies occur every year,they were particularly pronouncedCommercial aerospace companiescontinue to be optimistic aboutand steady, driving the lucrativeincreased large commercial aircraftnew record, and captured moreAerospace and defense industrydelivers a third consecutive yearSummary table (US$ billions) 2012 2011 ChangeRevenue $695 $666 4%Operating proﬁt $59.8 $58.4 2%Operating margin 8.60% 8.77% -17bpsSource: PwC analysis
PwC2Aerospace and defense industry delivers a third consecutive yearthan 2,000 large aircraft orders forthe second consecutive year andthere’s a record backlog—more thanseven years at current productionIn the wake of modest revenuedeclines reported for 2012, defenseDespite efforts by the industry andothers, sequestration went into-nies now are bracing for the conse-quences and waiting for detailsmore pressure than ever to improveproductivity, increase transparency,and respond to increasingly complexgovernment regulations and over-challenges associated with tighterschedules, and generally higherthreats, the Iranian and NorthKorean nuclear threats, andgeopolitical instability underscorethe need for increased globalsecurity and could rapidly affecthas enjoyed steady growth in defensespending and, simultaneously, thelongest up cycle in commercialwell managed the growth andachieving record results, now mustDespite efforts by the industry andothers, sequestration went into effect onMarch 1, 2013. Companies now arebracing for the consequences and waitingfor details regarding the impact onDefense companies face more pressure than everto improve productivity, increase transparency,and respond to increasingly complex governmentregulations and oversight.
A&D 2012 year in review and 2013 forecast 3Aerospace and defense industry delivers a third consecutive yearSome highlights from our analysis of 2012 resultsLargest increase in revenue (dollars) Boeing $12,963 MLargest increase in revenue (percentage) AVIC Aircraft Company 82%Largest increase in operating proﬁt (dollars) Finmeccanica $2,731 MLargest increase in proﬁt (percentage) Dyncorp 700%Highest operating margin Transdigm 41.2%Largest increase in top 100 list AVIC Aircraft Company +19 to 51Largest decrease in revenue (dollars) BAE Systems -$2,482 MLargest decrease in revenue (percentage) ThyssenKrupp Marine -27%Largest decrease in proﬁt (dollars) General Dynamics -$2,993 MLargest decrease in proﬁt (percentage) Engility -458%Largest decrease in top 100 list ThyssenKrupp -12 to 68Deleted from the 2011 listGoodrich Acquired by United TechnologiesAvio Acquired by GE AviationBarnes Group Segment reporting changeLoral Space & Communications Acquired by MacDonald DetwilerTitanium Metals Acquired by Precision CastpartsVolvo Aero Acquired by GKNIndra Security & Defense 16% decline in revenueAdded to the 2012 list#66 Engility Spun off from L-3 Communications#72 Korea Aerospace Did not make reported date cutoff in 2011#77 Cytec Engineered Materials and Umeco Business combination#80 Kratos Defense Acquisitions#92 Nabtesco Aircraft and Hydraulic Equipment#93 Wesco Aircraft Holdings#99 Sumitomo Precision ProductsSource: PwC analysis
PwC4Aerospace and defense industry delivers a third consecutive yearCompanies with operating margin > 20%#19 Precision Castparts 25.1%#46 Hindustan Aeronautics Limited 23.7%#49 Meggitt 24.5%#64 Transdigm 41.2%#69 FLIR Systems 21.65%#93 Wesco Aircraft Holdings 20.5%#97 Crane Aerospace & Electronics 22.3%Source: PwC analysisAnother year of recorddeliveries and backlog forcommercial aerospaceBoeing again was the industry’sin revenue, a 19 percent increase,on the strength of commercialthe largest revenue growth,of revenue that Boeing added in2012 would be equivalent to theincreased revenue by 15 percent,(6% when translated into US-cial aerospace companies generallyHoneywell Aerospace all reportedPrecision Castparts, Spirit, Babcock,AVIC Aircraft Company reportedthe largest revenue percentagethe largest jump on the list, advancingreported the largest revenue declinebut improved operating incomethrough a 100 basis point increase inoperating margin, the largest of anyBoeing was also the industry’s mostbillion—due to the absence of largeprogram charges recognized inThe amount of revenue that Boeingadded in 2012 would be equivalent tothe 15th largest A&D company.
A&D 2012 year in review and 2013 forecast 5Aerospace and defense industry delivers a third consecutive yearthe industry as a whole continues tobe eluded by double-digit operating-Globalizationare reporting more foreign directinvestment, with the rate moreinvestments in manufacturing, Chinastrength of its market size and capa-which has developed an aerospacetop target for R&D investments, whileChina came in seventh, presumablybecause of concerns over intellectualStates was the second most populartarget for aerospace and defense051015202530354020122011201020092008200720062005200420032002200120002421121813776369572 2 13 2 379649 106R&D ManufacturingInvestments by top 50 global A&D companies in international marketsSource: Company reports
PwC6Aerospace and defense industry delivers a third consecutive year2013 forecast and risksthird consecutive year of recordin commercial aviation more thanoffset a soft defense market andmulti-billion dollar impairmentcharges at large defense contrac-2013 performance are familiar, andsequestration is certain to have anegative impact on defense industryin the US defense market, it isgrowth is expected to slow to arate of between 4 percent and5 percent, which is approximatelythe percentage defense revenue isindustry revenue is expected to beindustry avoids the large impair-there is a risk of some impairmentsresulting from the decline in USdefense spending, the magnitudeof those charges is likely to be lessin commercial aerospace shouldapproximately offset declines in-tial for improvement in the absenceWhile there is a risk of some impairmentsresulting from the decline in US defensespending, the magnitude of those charges islikely to be less than in recent years.
A&D 2012 year in review and 2013 forecast 7In 2011, the industry set a record,than 1,000 large aircraft; in 2012,the industry beat the previous year’s-601 aircraft in 2012, the second bestin its history and close to its recordAirbus recorded 294 deliveries, lessthan half of Boeing’s tally the sameaircraft, exactly double its output of1999, its eleventh consecutive yeartime Boeing delivered more aircraft2012 was also the third best year for-tions, surpassing the 2,000 markfor the second consecutive year andpushing backlog to another record ofmore than 9,000 aircraft, or approxi-mately seven-and-a-half years atIn 2012, Boeing aircraft programscompany booked 1,124 orders for the737, the most for any Boeing modelin a single year, bringing cumulativeprogram orders above the 10,0001,000 cumulative orders for the 737program milestone, exceeding 1,000Commercial aerospace
PwC8Commercial aerospaceBoeing’s backlog is at a record $319 billion, and Airbus’ backlog is atIATA statistics 2012 2011 2010Revenue passenger miles 5.30% 5.90% 8.20%Load 79.10% 78.10% 78.40%Cargo freight ton miles -1.50% -0.70% 20.60%Load 45.20% 45.90% 53.80%Source: IATABacklog (US$ billions) 12/31/12 12/31/11 12/31/10 12/31/09Boeing $319 $293 $256 $250Airbus* $638 $679 $480 $459*At list priceAircraft backlog (units) Boeing Airbus TotalBacklog at December 31, 2011 3,771 4,437 8,208Net orders 1,203 833 2,036Deliveries 601 588 1,189Backlog at December 31, 2012 4,373 4,682 9,055Source: Boeing annual report; Airbus annual reportreported revenue passenger growthwell for the 20-year forecast ofapproximately 34,000 new planes
A&D 2012 year in review and 2013 forecast 9Commercial aerospaceOrder activity continued to bedriven in large part by the newsingle-aisle aircraft, 737MAXre-engined versions of the existingmodels, offering at least a 15 percentengines have achieved a 49 percentConsequently, a 15 percent improve-ment in one generation constitutes aSome larger orders from 2012, with approximate valueLion Air, 230 737 MAXs and 737-900ERs $22 billionNorwegian, 222 narrow-body split between Boeing and Airbus $22 billionUnited, 150 737 MAXs and -900s $15 billionPegasus, 100 A320neos not disclosedGECAS, 100 737 MAXs and -800s $7 billionAir Lease, 75 737 MAXs $7 billionTo put this in perspective, aircraft enginesof the jet era, or about 1 percentage pointannually.Consequently, a 15 percent improvement
PwC10Commercial aerospaceRegional aircraftMitsubishi reported its largestorder yet for the MRJ in 2012 fromthan doubled Mitsubishi’s backlogto 165 aircraft, pulling ahead ofBombardier, which has receivedwill formally launch its second-Among the improvements will bePratt & Whitney PW1700G and PW1900G geared turbo fan engines,complete turnabout in the regionalengine market, Pratt & Whitney,once absent from the regional jetspace, now dominates new produc-tion platforms, with engines on theBombardier C-Series and MitsubishiAviation deliveries 2011 2012Global business jet deliveries 696 672Global turboprop deliveries 526 580Global piston aircraft deliveries 898 881Source: General Aviation Manufacturers AssociationMRJ, and its recent selection forBusiness jetsBusiness jet deliveries and cyclesmore than 10% below the pre-are roughly the same as a decadefavorable for the long term, withstrong growth in the internationalmarkets, as well as improvementin the United States, driven by animproving economy and growingDuring 2012 the number ofbusiness jets in China increasedexceed 2,000, according to the
A&D 2012 year in review and 2013 forecast 11Commercial aerospaceSource: FAA and UBS estimates050,000100,000150,000200,000250,000Seasonally adjusted business jet monthly cycles00 01 02 03 04 05 06 07 08 09 10 11 12Total orders Total deliveriesSources: Actual deliveries from GAMA. Orders estimated from competitive intelligence, OEM guidance.Excludes Very Light Jet and Large corporate airliners segments.2011201020092008200720062005200420032002-1,000-800-600-400-200-02004006008001,0001,2001,4001,6001,800Industry orders and deliveries—Units, 2002–2011All graphs represent business jet data
PwC12Commercial aerospaceCommercial aerospace2013 forecastbetween 635 and 645 deliveries,a 6 percent to 7 percent increase,and Airbus is expected to achieveanother year of record deliveriesof 600 to 610 units, a 2 percent toWhile these growth rates are morein original equipment manufac-turer (OEM) deliveries in 2012, theindustry continues to establish newoutput levels create considerablestrain on an industry that arguablyhas the most complex supply chainand the one with the longest leadprevious supply chain issues whileindustry previously has faced rawmaterials shortages, late deliveries,out-of-sequence work, overtime,and rush shipments throughout thesupply chain, all of which erode the-lenges in 2013, and in the longerterm, as capacity constraints bumpand suppliers are encouraged toperform thorough supplier capacityit is unlikely that orders will main-tain the manic pace of 2011 andof 2013, Airbus booked 431 ordersand Boeing recorded 220 orders, acombined rate of 2,600 orders annu-Ryan Air ordered 175 737s, Lufthansanot expect this pace to continue or fororders to exceed 2,000 for the thirdorders to exceed the approximately1,250 deliveries predicted for 2013,pushing backlog to another new high
A&D 2012 year in review and 2013 forecast 13grown to represent about half ofleasing companies have about16 percent of the current backlog,become even more important astheir more stable business models,-tively higher grade ratings easeEconomic risks include the potentialfor slowing global growth, resultingin part from government spendingsovereign debt crisis has the poten-may be mitigated through increasesin our recent report, “Aviationas global risks are re-priced, theaircraft may intensify, and the costthe industry as a whole to be able toattract funding, but new sources ofExport Credit Agency (ECA)has become the funding source ofthe new Aircraft Sector Under-standing (ASU), which governseffect in 2013, resulting in consid-erable premium increases for thisOverall, modest growth in commer-SpaceSpace-related initiatives aremissions to the International SpaceStation (ISS) and Orbital Scienceswith the ISS under the Commercialresearch and development continuesunder the Commercial Crew Devel-SpaceX, United Launch Alliance, andSierra Nevada are among the compa-nies receiving NASA funding foron these and other space programsLong-term forecast-cial OEM aircraft is about 34,000-some observers have questionedwhether these forecasts are overlyoptimistic, they are neverthelessbased on well-founded assumptionsabout global economic growth and-erate the demand for replacementmore than 1,500 aircraft per yearand current production rates atCommercial aerospaceabout 1,200 per year, the industrycan look to future growth and alot of cushion between forecasteddemand and current production toPerhaps a key competitive advan-tage will go to the company that caneffectively raise production ratesAt the same time, new competi-tors are trying to take advantage-cial Aircraft Corporation of China(COMAC) has launched its C919more than 2,000 planes, capturingIn addition, Irkut of Russia haslaunched a narrow-body aircraft,and Bombardier is marketing itslaunch its next-generation E-Jetin 2013, but it has not announcedany plans to compete in the narrow-
PwC14Commercial aerospaceGrowth in business jetselusive and slower than wasexpected at the beginning of thestill more than 10 percent belowCompanies are reporting thatbusiness jet backlogs have beencut approximately in half since thein business jets is expected to alignwith the overall Western economicrecovery, which continues to befor aircraft remain challenged,given the lack of demand, leavingmany owners, operators, and theirbusiness jets should expect anothermedium to long term, business jetsdriven by economic growth andadapting regulations in Asia and theThe business jet rebound remainselusive and slower than was expectedat the beginning of the year.Companies are reporting that business jetbacklogs have been cut approximately in halfsince the start of the recession.
A&D 2012 year in review and 2013 forecast 15-nies reported revenue decreases ofabout 4 percent, and an increase in-tics exclude the results of Generalreported large impairment charges3 of the top 12 companies reportedrevenue increases, with Boeing up3 percent, Lockheed Martin up 1-Martin, 10 percent; BAE Systems, 2Northrop Grumman reported the bestdouble-digit operating marginsimprovements in operating marginwere reported by BAE Systems, at 100However, some investors are askingwhether the margin improvementsare sustainable or are a temporaryresult of cost reduction preceding aSequestration went into effect on--that include reduction and furloughDefenseDefense contractors brace for sequestration
PwC16Defenseof civilian staff and cutbacks in baseremains about the impact of seques-but the defense industry shouldDuring 2012, European defenseministries began responding to theconsequences of budgetary reduc-programs and reducing platform-cant uncertainty in the supplybase as companies struggle tomanage both the impact of knownreductions and the risk of uncer-to preserve capability at the sameor lower cost have burgeoned inGermany, Sweden, Norway, the UK,growing appetite for capability andcost-sharing between nations—initiatives that remain at the discus-seeks to achieve this for the Alliance,and bilateral arrangements suchencourage collaboration in a rangeof activity, from military opera-Backlog (US$ billions) 12/31/2012 12/31/2011EADS Defense $64 $73Lockheed Martin $82 $81Finmeccanica $57 $64BAE Systems $67 $58Boeing Defense, Space & Security $71 $60Thales $32 $33Northrop Grumman $41 $40General Dynamics (exc. Gulfstream) $36 $40Raytheon $36 $35L-3 $11 $10Total $497 $494Source: Company reports-lighted the importance of having thecapability to respond to unexpectedevents—the “return to contin-European capabilities able to bethe Libyan operation was relativelyand surveillance systems) thatEuropean defense companies areresponding to declines in theirtraditional markets and are simul-taneously pursuing opportunitiesin growth markets, including the-in those regions are strong competi-Exportshas led to a record backlog of $327in excess of 13,000 active caseswith more than 165 countries and$327 billion, said Vice Admiral Bill11 Bloomberg, Gopal Ratnam, “PentagonHas $327 Billion Export Backlog, SeesDrone Demand,” June 10, 2011.
A&D 2012 year in review and 2013 forecast 17DefenseUS defense export authorizationsspiked at $264 billion in 2011, themost recent year for which dataand a 394% increase compared withwas disclosed at $327 billion atmid-year 2011, is now estimated atgrowth in defense exports shouldhelp soften the impact of US defensethis period has been in Asia, dueto concerns about China’s growingmilitary power and tensions betweenNorth Korea and South Korea, andin the Middle East, due to concernsthe United States is not the onlycountries, Israel, South Korea, andRussia are all gaining from increasedUS foreign military sales (FMS) agreements and direct commercial sales authorizations2,3USD Billions050100150200250300201120102009200820072006200520042003200220012000199923815412310789675267625352554711 11 12 12 13 13 18 18 29 30 24 269Foreign military sales (FMS) agreements Direct commercial sales authorizationsOn March 7, 2013, the White Housesent its export control reformcategories on the US Munitions List(USML), with oversight responsi-bility for some categories movingfrom the State Department to thereforms, which have been supportedby industry, are designed to simplifyand streamline the export processand may lead to further increases in2 US Department of Defense, “Fiscal Year Series,” http://www.dsca.mil/programs/biz-ops/factsbook/Fiscal%20Year%20Series%20-%2030%20September%202011.pdf, Sept. 30, 2011.3 US Department of State, “Section 655 Annual Military Assistance Reports,”http://www.pmddtc.state.gov/reports/655_intro.html
PwC18DefenseDefense forecastDue to sequestration, the initialeffects of which will be felt during2013, our expectation is that defenserevenue will decline by about 5percent, based on our calculationof the defense portion of seques-tration for about seven to eightmay be mitigated, because as theindustry contracts, many of thecosts to reduce capacity and restruc-ture or terminate programs will bein margins in 2012, despite modestour estimates, the industry willbefore considering potential impair-expectations are that some compa-nies will be susceptible to impair-ment charges, similar in nature,although not necessarily magni-tude, to those reported by GeneralMarket contraction, coupled withincreasing certainty about thenature and amount of defensebudget cuts and the impact on-been toward spin-offs and divesti--tions have included the Huntington-Ingals split from Northropscheduled to complete a spin-offof spin-offs looks to be nearing itsend, to be followed by a period ofindustry is already highly concen-trated, resulting from consolidationMarket contraction, coupled with increasing certaintyabout the nature and amount of defense budget cuts and
A&D 2012 year in review and 2013 forecast 19DefenseDefense Department has opposedany further consolidation amongmajor prime contractors, but thatposition could soften, dependingwhether the major prime contractorsconsolidate further, expectations areContractors may also continueto respond to market conditionsremains on affordability, and theDefense Department now listsaffordability among its procurementfocused on improving productivity,as the industry is beginning a periodtime, there is a need to recapitalizeshift from new platforms to plat-Electronics and C4ISR, includingunmanned aerial vehicles andcybersecurity, will likely be amongMany companies are exploringcommercial applications for their-tors, and their investors, haveapproached commercial marketscautiously because of mixed experi-ences, weighted toward the nega--rience, though, is dated; defensecontractors have had ample opportu-nities in their core markets for morethe industry’s largest commercialmarkets have their roots in defenseand space technologies, such ascomputers, computer networking,forward, defense contractors areexpected to seek commercial appli-cations for their technologies, evenif it means licensing or supplyingin North Korea’s and Iran’s nuclearweapons programs, instability inthe Middle East, and other factorscould bring rapid changes in defenseDuring 2013, the European defensemarkets will likely begin to stabi-lize as defense ministries addressthe budget cuts initiated two yearsexpected until 2015, and it maybe necessary to pare some defensebudgets, still further if the Euro-zone’s austerity measures needhas announced plans to roll out aprogram will provide clarity forOEMs after some years of uncer--will likely start to manifest itself inrationalizing in-theater equipmentand logistic support and an increasein logistic movement as militarythe next few years will likely bringan acceleration of equipment refur-bishment, although the extent andits effect on the industry has yet toEuropean nations will likely continuevarious transformation programsaimed at preserving capability atlower cost and will import many ofthe ideas and concepts pioneeredin the United Kingdom a few yearsago; expectations also are for anincrease in availability contractingfor land, sea, and air platforms, plusan increasing appetite for industry-led solutions in the provision oftraining, infrastructure, and back-industry will likely take on morecomplex and broader roles, andthe United Kingdom’s AdvancedMaterials strategy may prove to be aexports will also likely continue andglobal defense industry competes inSo while the traditional, platform,and equipment-based defensemarkets in Europe remain underintense pressure, opportunities existfor industry to more broadly deliverservice-based capabilities in manythe whole of the defense supportservices market is projected to beworth an estimated £16 billion peryear by 2020, or approximately 75percent of total MoD spend withindustry; these trends will accelerate
PwC201 StrategyWhile strategy is continually evolving,-sion making is expected to acceleratedue to a rapidly changing environ-in US defense spending, companieswill likely make strategic decisionsregarding prioritization of marketsdefense spending is expected to• Lifetime affordability•• Upgrades and sustainability ofexisting platforms• Command, control, computers,communication, intelligence,surveillance and reconnaissance(C4ISR)•Many strategic decisions havebeen made in anticipation of thesechanges; many actions have beenin the form of spin-offs and dives-to shift toward industry consolida-failed merger between EADS andBAE Systems might be viewed as athe governments involved will allowmergers among any of the majorprime contractors may depend onRegardless of whether major primesTrendsEight trends to watch in A&D for 2013and beyond
A&D 2012 year in review and 2013 forecast 21TrendsIn addition, companies are expectedto have a greater focus on inter-national markets, in order to helpcompensate for the decline in USHowever, companies will increas-ingly focus on international strate-gies, which may include a morecontrol reforms proposed by the-nies will likely focus on adjacentmany organizations are expectedto approach commercial marketscautiously, they are expressinggreater interest in commercializa-2 InnovationInnovation is another area thatcompanies, innovation is the singlemost important success factor, asthan 20 executives from leadingA&D companies, who collectivelyranked innovation as the highestInnovation, therefore, is a major riskto be addressed when examiningcompliance risks, when a failure toPerhaps innovation is not under-stood as a risk because companies-cial and compliance risks, includingopportunity cost and the effective-ness of research and developmentreduced government funding forresearch and development, defensecompanies look to be making greaterinvestments in independent researchchallenge for the defense and spaceindustry is to become more commer-Commercial aerospace is enjoyingonly is demand of the end marketsstrong, but successful innovationswith dramatic improvements to-lenge lies in gaining the resources,both human and economic, to keepup with the accelerating pace ofinnovation and product develop-described it, “We have more oppor-tunities with good business casesCommercial aerospace and defensecompanies should gain greaterproductivity from research and devel-opment activities as well as prioritizepartly on viewing innovation as aabout PwC’s perspective on achievinginnovation excellence, please visitwww.pwc.com/us/gainingaltitude.
PwC22Trends3 Talent managementDemographicssenior personnel and the need to-ment levels for 2011 remained low,retirement eligibility—double-digitin most job categories—is growingby one to two percent annually andsmall decreases, as well as possibledeclines among the youngestworkers, more than 45 percent ofworkers under 35 plan to switchWith defense spending cuts on theway, expectations are for declinesfaces a challenge similar to thatfaced by companies during the post-avoid losing the next generation ofA&D talent?4A skilled work force-nology, engineering, and mathematicsthe pool of scientists and design engi-neers are particularly pronounced,with demand expected to show-more, a majority of industry jobs arein defense and security, where UScitizenship is required, furtherAccording to the Aerospace Indus-tries Association, only 44,000 of the70,000 engineers that graduate eachyear in the United States are quali-suggesting the need for strongerpartnerships between universitiesand A&D in order to identify the skillscompanies also face competition fromorganizations and other industriesis mirrored in other developedplaying an increasingly strategic roleprograms and training initiatives,designed to help retain key knowl-edge and skills, are growing intalent, and recruiting partnershipsare being developed to deliberatelymanagement are knowledge capturemanagement programs are increas-ingly critical in minimizing the effectsattention to the organizational designelements that compromise projectexecution and cross-functional collab-oration, which may be particularly4 Aviation Week, Carole Rickard Hedden,“Aviation Week Workforce Study”,Aug. 13, 2012.
A&D 2012 year in review and 2013 forecast 23TrendsEngineering talent andUS citizenshipIn Europe, for example, only about10,000 graduates from technicaluniversities choose to work withinA&D, while the industry needs at5Global/US citizenshipUS companies to focus increasinglyhave historically attracted engi-neering talent from countries such asIndia and Russia, several forces haveslowed the promise of an interna-for A&D has resulted in increasedcompetition from countries like Chinathe US government’s restrictions onthe number of H-1B visas, a special--ally, US talent is typically preferredin organizations like the US DefenseDepartment, where security clear-ance requirements rule out inter-national talent, while laws such astechnical data and knowledge with5 Aviation Week, Carole Rickard Hedden,“Aviation Week Workforce Study”,Aug. 13, 2012.-cant, making immigration reformAccording to a 2007 study by theWoodrow Wilson School of Publicand International Affairs at Princeton,two countries in particular, Indiaand China, with their vast, educated,low-wage workforces, attracted morethan 100,000 H-1B visa holders incontrols may serve to constrict thismanagement, please visit us online atwww.pwc.com/us/peopleandchange.The growth of international marketsfor A&D has resulted in increasedcompetition from countries like Chinafor skilled labor.
PwC24Trends4 Productivity andaffordabilityaffordability, including it as aAccordingly, defense contractorshave strategized to reduce costs anddefense companies with companiesin the Dow Jones Industrial Average(DJIA) on the basis of revenueper employee, using data fromcompany earnings statements andthat revenue per employee is animperfect measure and that a bettermeasure would be value added peremployee, but since that data is notavailable, we have used revenue peremployee as a reasonable surro-that defense contracts are aboutbelieve there are some valid reasonswhy defense companies have lower• Muchof defense revenue is undercost-reimbursable, or cost-• Development of leading technolo-Defense contractors arefrequently developing cutting-edge technologies, which areinherently manually intensiveand involve some degree of trial• Manydefense contracts are for singleunits or quantities measuredin the dozens or hundreds,compared with commercialenterprises that typically measure-ally intensive manufacturing andassembly and low absorption of•regulated, which can increasecompliance costs, includingcompliance with federal acqui-accounting standards (CAS), andThe industry is highly regulated,which can increase compliance costs.
A&D 2012 year in review and 2013 forecast 25TrendsDespite these inherent limitations,the industry recognizes there isroom for improvement in produc-taking action to reduce overheadcosts, including workforce reduc-tions, early retirements, and facili-We believe the following areas offer• Program management/short-ened development cycle• Supply chain management• Information technology• Knowledge managementImproving the speed and effective-ness of program development typi-cally produces the biggest gainsare the biggest factor in budgetpride in their program manage-ment abilities, the industry shouldseek continuous improvement,including unbiased, independent-more of the total value of productionis rooted in a technically complex,-ingly, any productivity improvementinitiative should address suppliers,longer accept long lead times andmarginal supplier performance aschallenge itself to get much closer tomight consider adopting leading-edgerisk management practices to regainvisibility into the supply chain thatInformation technology representsone of the biggest areas for discre-tionary spending at most companies,companies have invested millions insystems implementations but haven’tyet realized the full capabilities andproductivity enhancements that these-tions are still spending most of theirtime in legacy system maintenanceshould unlock the full capabilities offrom costly maintenance towardstrategic initiatives and competitivemanagement will likely becomea factor due to demographics, hasbeen accelerated by early retirements-nies should identify the key peopleand knowledge in their organiza-tions and capture that informationOrganizations should also create aknowledge management culture thatpromotes and rewards the effective
PwC26Trends5 Supply chainIn 2013, two major trends areCommercial aircraftproduction rate ramp-up• Previously, we discussed thecommercial aircraft productionrate ramp-up of historic propor-increase over the prior year,long term, demand is projectedto be about 1,700 aircraftannually, meaning that annualproduction rates may continue toproduction levels will likelystrain a supply chain that canbe considered to have the mostcomplex and longest lead timeDefense spending reductions•defense spending cuts will driveSome of these suppliers may besole source or produce uniquesupply chain could be left witha shortage of critical parts andlong lead times to qualify newBoth commercial aerospace anddefense contractors should reeval-uate supply chain strategy and-tive on the supply chain, please visitwww.pwc.com/us/gainingaltitude.6 GlobalizationGlobalization is driving the boommore aircraft deliveries, in unitsand value, over the next 20 yearsthan North America and Europe• Developing economies, particu-larly in the BRIC countries(Brazil, Russia, India, and China)are growing faster than devel-is becoming more knowledgebased, with businesses increas-ingly relying on the globaldeployment of human capital,a requirement for operating astrong demand for aviation,as well as resiliency for thehyper-cyclical industry, overre-that dynamic has fundamen-tally changed, as demonstratedWhile aviation demand did takean extreme downturn during the
A&D 2012 year in review and 2013 forecast 27Trendsrecession, demand reboundedfaster than the overall economyand more quickly than inprevious economic cycles,rapidly returning to pre-reces-sion levels and demonstratingthat aviation demand hasbecome much less elastic than• Consumer air travel oncewas largely a privilege of theair travel has declined, it hasbecome highly accessible to themiddle class and not readilyrelinquished, even during awill likely continue to be drivenby the growing middle class in• Aviation is viewed as a strategicindustry in emerging marketpromote aviation, airports, andthe associated infrastructure, owndirect or indirect stakes in manynational carriers, enabling them toAs a result, aviation is expected togrow about 2 percentage pointsfaster than global GDP for the fore-is creating tremendous growth andopportunity for the industry, it isalso driving challenges that require•industry and lure of high tech-nology in aerospace is attractingsuch new competitors as Comacof China, Irkut of Russia, andregional jet makers are increasingthe size and range of their jets,competing at the smaller end of• Globalization of customers andsuppliers is driving numerousindustry once was principallya domestic industry relying onbase and supply chain have-nies increasingly are operatingWhile globalization is creating tremendousgrowth and opportunity for the industry,it is also driving challenges that requirenew strategies.internationally in order to driveintimacy with customers andsuppliers, improve responsive-ness and service, satisfy offsetand industrial participationrequirements, and, in somecases, take advantage of interna-Globalization, not limited tocommercial aerospace companies,authorizations (for future deliveries)have increased more than four-foldsince 2005, from $61 billion to $264billion in 2011, as seen in the chartdestined for the Middle East andare expected to continue to focus oninternational markets and developIn a recent PwC study, aerospaceand defense companies cited thefollowing as the greatest obstacles• Safeguarding intellectualproperty• Export control compliance• Creating ethical cultures•• Managing offset and industrialparticipation requirementsto address globalization opportuni-ties and risks, please refer to A&DInsights: Accelerating global growth.
PwC28Trends7 CybersecurityGiven their role in developingcutting-edge technologies withmilitary applications, A&D compa-nies have long faced heightenedand interconnected informationevery phase of the A&D industry,companies face complex challengesto the security and integrity oftheir operations and reputation,including ongoing efforts to stealintellectual property and othersensitive business data, as wellas attempts to sabotage opera-tions and tarnish reputations byEconomic espionage.A&D remains the industrial sectormost targeted by economic espio-nage conducted by nation-states’supporting unmanned aerial vehi-cles (drones) may get particularattention from economic spiesbecause of their highly publicizeduse for intelligence gathering andIntrusions into A&D companies’-atically stolen hundreds of terabytesfrom at least 141 organizations…been created by hackers linked to aappear to have been designed tonetworks, where they are typically6• It is likely that every company inthe A&D sector has been targeted• Many US A&D companies haveCyber Security/InformationAssurance Program, underthe aegis of the Department ofDefense (DoD) and HomelandSecurity (DHS), is a forumletting A&D companies volun-tarily report cyberintrusions andletting federal authorities share• Cybertools are not the onlymeans of conducting economicof disgruntled or corruptedChung, who worked on theB-1 bomber, space shuttle, andother A&D projects for nearly 30years, was convicted in 2010 ofeconomic espionage on behalf ofin the A&D sector, with compa-nies increasingly relying on jointventures, partnerships, and manu-facturing and R&D facilities inexpanding markets—potentiallyopening new points of access forintruders—adds to the challenge of6 Mandiant, “APT1: Exposing One ofChina’s Cyber Espionage Units”,www.mandiant.com, Feb. 19, 2013.
A&D 2012 year in review and 2013 forecast 29TrendsDisruption and sabotage.companies attractive to spies alsomake them targets for cyberdisrup-tion campaigns by terrorists, rogueHacktivists, who have alreadycompanies, could conduct distrib-uted denial of service campaignspublicizing sensitive data aboutSimilarly, kinetic strikes using aparticular weapons system against arogue state or terrorist group couldlead to retaliatory cyberattacksdesigned to disable or disrupt thecomputer networks of the weapon’sUnique and evolvingregulatory environment.Because most of the largest A&Dmilitary-related projects, many oftheir processes for handling sensitiveinformation are subject to unusuallycompanies should be prepared forregulatory changes, which are in thea White House executive order (EO),“Improving Critical Infrastructure’sof a framework to reduce cyber-riskto critical infrastructure, as well asprovisions letting federal agenciesshare more threat information withcalls on the secretary of HomelandSecurity to identify “critical infra--cant military contracts—and to letthe owners of such organizationsof the details of the order will beIn addition, the Cyber Intelligence-Sharing and Protection Act hasbeen reintroduced in the Houseof Representatives, and this year’sdraft is expected to receive Whitenecessary for the complete imple-One particular concern of manycompanies is to obtain protectionfrom legal liability that could resultfrom voluntary information-sharingincluding most major A&D compa-nies, must soon develop insider threatprograms and enhance their capa-bilities to detect and prevent thesethreats, in accordance with Executiveand establishing a national policy andminimum standards for insider threatmitigation programs across federalLooking ahead.Over the next decade, the A&Dindustry will likely remain a high-priority target of threat actors dueto economic factors as well as mili--ments is to be determined, but twosmartphones, tablets, and otherdevices that can connect to theInternet are becoming ubiquitousand, with the move to a cloudcomputing paradigm, will likelydrive opportunities for theft andmanipulation of companies’ sensi-individual stakeholders can expectever greater access to companies’personal devices and from locationsNew threat factors are also likely to• Governments seeking to jump-could be tempted to sponsorcyber-intrusions and otherefforts to pilfer the intellectualproperty and know-how of• Similarly, the nature of criminalhacking may evolve, with socialnetworking tools potentiallyfacilitating a new black marketcreating powerful incentives fornewcomers to attack corporate-rity, please visit PwC’s Informationsecurity, privacy, and risk
PwC30Trends8 The regulatoryenvironmentis a key challenge facing the defenseSeveral reforms may help improvethe environment for defenseAcquisition reformAttempts to improve the currentdefense acquisition process havethat reforms have sought to placeever-increasing regulations on thehow Congress funds long-termprograms on a short-term basis, andthe manner in which the customer-•stability of requirements• Establishing realistic budgetsand funding based on theinherent risks of developingadvanced technologies• -vation in the bid and proposalprocess• Using contract structuresappropriate to risk• Promoting internationalcooperation and cost sharingThe Defense ContractAudit AgencyAudit Agency (DCAA) is to protectthe government and taxpayers fromare some considerations that couldimprove the effectiveness and• Benchmarkthe audit approach againstcommercial practices, such asthose regulations establishedunder the American Institute(AICPA) and Public CompanyAccounting Oversight Board• Establish mate-widely accepted in commercialpractice that it is impractical andcost-prohibitive to build a control• Third-party reliancestandards allow for reliance onDCAA could consider establishingstandards for third-party reliancethat promote such use where thethird party is objective and compe--Export control reformMany observers believe current exportcontrol regulations are outdated anddrive a competitive disadvantage fortechnologies that are broadly usedin commercial application are stillOn March 7, 2013, the White Housesent its proposal for export reform tobe effective in promoting US exportsand preserving key skills in the indus-
A&D 2012 year in review and 2013 forecast 3115 percent below the precedingBased on our methodology,the 2012 statistics include theannouncement that HawkerBeechcraft would be purchased bySuperior Aviation Beijing; however,the deal subsequently was aban-Overall, commercial aerospacethe defense sector did not generateeven one mega deal (above $1billion) in 2012, while 2011 broughtfour mega deals in defense, totalingIn 2012, the defense sector facedpotential US sequestration anduncertainty in defense spending,there is more certainty—or atleast less uncertainty—regardingthe future of defense budgets andthe defense industry will be ableto value companies and betterthis period begins, defense M&Ais expected to become much moredynamic and could lead to someDefense M&A is facing a “perfectbalance sheets and cash positions,and, most importantly, the neces-sity to consolidate in response toMergers and acquisitions
PwC32Mergers and acquisitionsthe attempted merger betweenEADS and BAE Systems in 2012as a harbinger of further defensedefense prime contractors willcontinue to be challenging, dueto concerns by government stake-holders, some transformative M&Atransactions are expected in defenseonce the cloud of uncertainty isLooking ahead, four trends arelikely to affect M&A activity in the• Increasing consolidation inresponse to a contracting defensemarket and cost pressuresWhile mergers among global defense primecontractors will continue to be challenging…some transformative M&A transactionsare expected in defense once the cloud ofuncertainty is lifted in the United States.•chains by big manufacturers, inboth civil and military segments,as they seek to gain bettercontrol of their large programpipelines• Continuing growth in the secu-rity, surveillance, and homelandsecurity sector• Greater investment in andcompetition from fast-growingmarkets, most notably ChinaWe believe these trends willprovide the context for growth in
A&D 2012 year in review and 2013 forecast 33companies is a barometer for the healthdisciplined management over the pastAviation has become a critical part ofcannot operate effectively withoutAviation is increasingly inelastic, andit demonstrated its resiliency duringdwarfed by sea and land freight, anincreasingly larger portion of the globalthe impact of sequestration in the Unitedis still not clear how defense budget cutsdynamic and could rapidly changemust respond to the affordability chal-for commercial aerospace is optimistic,faster than the overall economy becauseof its critical role in the global economicinfrastructure, bolstered by economicgrowth in Asia, the Middle East,Defense faces challenges, including anextended period of budget battles andanother strong year for the industry, andpossibly another record year, as avia-tion growth continues to offset a weakerIn summary