Electronics Firms Adapt to New Business Environment

May 2009
By Henry S. Kenyon

Germany’s defense electronic sector supports a number of domestic and international programs. Firms are involved in systems upgrades for the nation’s fleet of Tornado attack jets, developing the avionics for the Tiger attack helicopter and network-centric systems for the Puma infantry fighting vehicle.
Domestic, national pressures drive search for new markets.

Germany’s defense electronics industry is in a state of flux. Consolidation and internationalization have changed the way companies conduct business with national and foreign customers. Local firms must band together to work with and compete against large multinational consortia for government contracts. Within this shifting landscape, the industry is poised to take advantage of these changes by expanding into new domestic and overseas markets.

With a long and distinguished history of developing pioneering electronic systems, Germany’s defense electronics industry is actively involved in military modernization efforts domestically and internationally. According to Gerhard Schempp, chairman of the defense technology section of the German Electrical and Electronic Manufacturer’s Association (ZVEI), the German defense electronics industry employs some 18,000 skilled people and is primarily composed of small and medium-sized companies. The sector develops new technologies and products for command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR) systems; system engineering and system development; embedded systems and logistics solutions. Schempp notes that after a period of downsizing and restructuring in the 1990s, the industry has grown to meet the German armed force’s (Bundeswehr’s) transformation and operational needs.

The Bundeswehr has shifted its focus from Cold War-era national defense to deployed coalition operations. Schempp says that the military’s overriding goal is to improve and sustain its operational capability. Some of the needs driving these changes include continuing multinational missions with a heavy emphasis on interoperable communications systems, ensuring extensive logistical support for overseas operations, and implementing new acquisition processes for defense systems and equipment.

Another factor affecting the defense electronics industry is the Bundeswehr’s transformation into a network-centric force. During the past decade, this change has driven the development of interfaces to connect existing systems and to enhance communications. This period has been profitable for German defense electronics firms. Schempp notes that the industry enjoyed a 7 percent annual growth rate over the last five years because of the military’s transformation. He cautions, however, that shrinking defense budgets and the effects of the global financial crisis and economic slowdown will impact the industry.

Operational pressure also has caused the German Ministry of Defense to accelerate its acquisition and development process to rush new technologies to its forces. Schempp shares that the Bundeswehr is now deployed to 11 locations around the world to support multinational missions. For the last three years, the German military has had an accelerated program that bypasses the existing acquisition process to provide troops with equipment and systems. He explains that this rapid acquisition program has an annual outlay of €1 billion with the majority of the funds going to German electronics firms.

Electronics and information technology companies are in a good position to leverage these urgent operational needs because equipment such as software-defined radios can be modified rapidly for new missions, Schempp says. One example is the need to provide transport helicopters operating in Afghanistan with systems to operate in brown-outs—small dust storms caused by the blades of an aircraft as it makes a landing. He notes that available radar sensors and software can be quickly modified and installed on German helicopters operating in the region.

Besides supporting urgent operational needs, German electronics and information technology firms are heavily committed to a range of defense programs. Two major military modernization efforts are HERKULES and SASPF. HERKULES is a complete restructuring of the nation’s military information technology infrastructure, while SASPF will implement SAP standard software and replace more than 200 customer-specific information technology solutions. SASPF is intended to optimize all aspects of information and document management across all echelons of the German military.

Companies also are involved in supporting a number of C4ISR programs such as upgrades to Germany’s CH-53 helicopters and Tornado attack aircraft, Synthetic Aperture Radar (SAR)-Lupe reconnaissance satellites and networked Puma infantry fighting vehicles. The Ministry of Defense also has defined a list of key technologies for vital core capabilities. These programs include long-endurance unmanned aerial vehicles, a future heavy transport helicopter, software-defined radios, network-enabled capabilities, service-oriented architectures, joint fire support and interoperability.

Another research and development area heavily supported by electronics and information technology firms is command, control, communications and intelligence (C3I). Major programs include a satellite communications system; FüInfosys-H, a command and control system for the German Army; FülnfoSysSK, a mission command and control system for joint and combined operations; and a nationwide network of simulators to test advanced technologies, processes and training.

German firms are heavily involved in multinational programs such as the Eurofighter Typhoon, the A-400M transport aircraft, the NH-90 and Tiger helicopters, the Medium Extended Air Defense System (MEADS) and the Artillery Systems Cooperation Activities multinational fire support operations. Germany and its defense electronics industry also play a major role in NATO’s Alliance Ground Surveillance (AGS) project. The goal of the AGS is to develop an alliance-wide core capability of airborne, wide area surveillance and reconnaissance platforms to support ground operations.

But while there is domestic and international work available for German firms, a number of challenges remain. A key issue is the relationship of defense electronics and information technology firms, which are primarily small and medium-size businesses and large multinational European consortia such as EADS. Schempp notes that smaller firms primarily work as suppliers to the systems integrators. He adds that EADS subcontracts more than 40 percent of its weapons systems work to its suppliers. But smaller firms must be competitive to participate in defense programs, he says.

One way to maintain competitiveness is for small and medium-size German firms to form alliances. In some cases, these alliances can compete against the large systems firms. Schempp explains that the Ministry of Defense encourages this competition within the industry. But the disadvantage is that alliances only have an advantage in niche areas because of financial limitations. Although the government wants competition, for developmental reasons it often awards the contracts to systems companies. “These alliances could never develop a new unmanned aerial vehicle or airplane,” Schempp observes.

The German government has revised its acquisition process as well. Schempp explains that because of smaller budgets, the Ministry of Defense now expects up-front investments from the primary suppliers of weapons system programs. Contracting firms must invest in developing prototypes to compete for programs. The result of this policy, he notes, is that only large firms can afford to develop new systems. Large firms also attempt to share the risk with their suppliers. “That quickly brings small and medium enterprises to their financial limits,” Schempp explains.

While alliances usually do not have the resources to develop a platform, Schempp admits that under some circumstances, it is possible for a business alliance to compete with larger system houses successfully. He observes that very little ongoing development of new weapons systems is occurring in Germany. The government is placing its resources into capability enhancement programs to maintain and upgrade existing platforms and systems, which allows the alliances to be competitive.

The Ministry of Defense also is creating larger programs that exceed the financial ability of all but the largest alliances. Schempp says the potential price of these developments is dependence on a few systems companies, which affects competitiveness and impacts project costs. In some program areas, system-level competitions have been eliminated, which serves to intensify competition at the subsystem and component levels.

Germany’s electronics firms also are looking at new markets such as homeland security, border protection and defending critical infrastructure. Schempp notes that the domestic security market is about the same size as the military market. Besides the domestic opportunities, German firms are working in overseas markets, such as border control programs in Romania, Saudi Arabia and the United Arab Emirates. “These are huge projects where more than 50 to 60 percent of the work is electronics and software,” he says.

Although domestic opportunities exist for homeland security applications, the opportunities remain limited because government organizations such as Germany’s Ministry of the Interior do not view military systems as applicable to border security or law enforcement. Schempp maintains that this institutional view is beginning to change. One example of the opening of these markets is the recent acquisition and installation of infrared electro-optic sensors on German police helicopters.

Exports are another key market for German firms. Schempp notes that large systems companies such as EADS drive much of this overseas business. Individual electronics companies are having difficulty keeping up. He adds that German electronics firms have begun to establish offices around the world, but they are following the systems firms. This is primarily because the large integrators are the only firms capable of winning contracts outside of Germany and Europe. He adds that German and other small and medium-size European firms need the large systems companies such as EADS, BAE Systems and Finmeccanica to win contracts and open new markets for them.

International pressures also affect the nation’s defense electronics firms. One of the challenges facing local businesses is that the German market is completely open, which allows foreign firms to compete with German companies for military and homeland security programs. But the European market is not an even playing field. Schempp explains that paragraph 296 of the European Union treaty is designed to protect a country’s defense market and industry by restricting requests for proposal to national companies. “Germany has never applied that paragraph. France is always applying that paragraph. As a consequence that affects the industry,” he says.

Schempp adds that 40 percent of Germany’s national defense spending is going to foreign companies. By comparison, he estimates that perhaps 5 percent of France’s defense budget pays for products and services by foreign firms. He notes that this uneven competition is a political issue in Germany. “We don’t want to protect our market, but want to see the same level playing field in all the countries of Europe,” he maintains.

Despite these issues, Schempp contends that the German electronics industry is well-positioned and prepared to weather these changes. He adds that the success of the industry will be determined by its ability to implement new and proven technologies in military systems and process-support solutions. Additional market opportunities exist in the area of technology transfer between the military and other state security forces for use in homeland security, border control and protecting critical infrastructures. The Bundeswehr fiscal plan for 2009 and German government research initiatives offer additional possibilities for dual-use technologies. He predicts that this favorable environment, combined with expected innovations in electronics and information technologies, could provide the industry with a compounded growth rate of approximately 5 percent in coming years.

Web Resource
German Electrical and Electronic Manufacturer’s Association (German language): www.zvei.org