This Pwc analysis is based on the fiscal 2012 data for the largest 100 aerospace and defense (A&D) companies, by revenue, with publicly available financial reports. Our cut-off date for publication was April 25, 2013. Consequently, several companies were not included because they had not reported results by the announced deadline.
3. Aerospace and defense year in review 1
Commercial aerospace 7
Defense 15
Trends 20
Mergers and acquisitions 31
In summary 33
Top 100 list 34
Contents
4. Our analysis is based on the fiscal
2012 data for the largest 100 aero-
space and defense (A&D) companies,
by revenue, with publicly available
financial reports. Our cut-off date
for publication was April 25, 2013.
Consequently, several companies
were not included because they
had not reported results by the
announced deadline.
A&D companies include those that
generate the majority of their revenue
from aerospace and defense activities
or, for diversified companies, those
Methodology
reportable segments that derive a
majority of revenue from aerospace
and defense activities. The results
are reported in US dollars. Foreign
currencies are translated at average
exchange rates for the years ending
December 31, 2012 and December
31, 2011, respectively.
Our report also offers PwC’s point of
view on topics affecting the industry.
Our viewpoints have been developed
based on our interactions with our
clients and other industry leaders
and analysts.
5. A&D 2012 year in review and 2013 forecast 1
The aerospace and defense industry
reported its best year ever in 2012,
in terms of revenue and profit. The
uptick came on the strength of a
surging commercial aviation market
that more than offset a soft defense
performance. For 2012, the top 100
A&D companies reported a record-
setting $695 billion in revenue and
$59.8 billion in operating profit.
Revenue was up 4 percent compared
with 2011, while operating profit
was up 2% over 2011. Operating
margin decreased 17 basis points to
8.60 percent.
We report only full fiscal year
results, so these statistics slightly
understate the strength of commer-
cial aviation earnings as a result of
the acquisitions of Goodrich and
Avio. The Goodrich deal closed at
midyear, so United Technologies
Corporation (UTC) picked up about
half of Goodrich’s annual revenue,
meaning that the year over year
statistics do not take into account
more than $4 billion of revenue
from Goodrich. Similarly, Avio was
acquired by GE Aviation at the end of
the year, so the year over year statis-
tics do not include about $3 billion of
revenue related to Avio. While these
types of anomalies occur every year,
they were particularly pronounced
in 2012.
Commercial aerospace companies
continue to be optimistic about
the future. Air traffic is robust
and steady, driving the lucrative
aftermarket business. The industry
increased large commercial aircraft
output by 18 percent in 2012 to a
new record, and captured more
Aerospace and defense industry
delivers a third consecutive year
of record revenues and profits
Summary table (US $ billions) 2012 2011 Change
Revenue $695 $666 4%
Operating profit $59.8 $58.4 2%
Operating margin 8.60% 8.77% -17bps
Source: PwC analysis
6. PwC2
Aerospace and defense industry delivers a third consecutive year
of record revenues and profits
than 2,000 large aircraft orders for
the second consecutive year and
the third time in history. As a result,
there’s a record backlog—more than
seven years at current production
rates. And the industry is anticipating
another record output in 2013.
In the wake of modest revenue
declines reported for 2012, defense
companies face an uncertain 2013.
Despite efforts by the industry and
others, sequestration went into
effect on March 1, 2013. Compa-
nies now are bracing for the conse-
quences and waiting for details
regarding the impact on specific
programs. Defense companies face
more pressure than ever to improve
productivity, increase transparency,
and respond to increasingly complex
government regulations and over-
sight. There are also significant
challenges associated with tighter
schedules, and generally higher
expectations. Persistent security
threats, the Iranian and North
Korean nuclear threats, and
geopolitical instability underscore
the need for increased global
security and could rapidly affect
defense priorities.
For more than a decade, the industry
has enjoyed steady growth in defense
spending and, simultaneously, the
longest up cycle in commercial
aviation history. The industry, having
well managed the growth and
achieving record results, now must
effectively weather the down cycle.
Despite efforts by the industry and
others, sequestration went into effect on
March 1, 2013. Companies now are
bracing for the consequences and waiting
for details regarding the impact on
specific programs.
Defense companies face more pressure than ever
to improve productivity, increase transparency,
and respond to increasingly complex government
regulations and oversight.
7. A&D 2012 year in review and 2013 forecast 3
Aerospace and defense industry delivers a third consecutive year
of record revenues and profits
Some highlights from our analysis of 2012 results
Largest increase in revenue (dollars) Boeing $12,963 M
Largest increase in revenue (percentage) AVIC Aircraft Company 82%
Largest increase in operating profit (dollars) Finmeccanica $2,731 M
Largest increase in profit (percentage) Dyncorp 700%
Highest operating margin Transdigm 41.2%
Largest increase in top 100 list AVIC Aircraft Company +19 to 51
Largest decrease in revenue (dollars) BAE Systems -$2,482 M
Largest decrease in revenue (percentage) ThyssenKrupp Marine -27%
Largest decrease in profit (dollars) General Dynamics -$2,993 M
Largest decrease in profit (percentage) Engility -458%
Largest decrease in top 100 list ThyssenKrupp -12 to 68
Deleted from the 2011 list
Goodrich Acquired by United Technologies
Avio Acquired by GE Aviation
Barnes Group Segment reporting change
Loral Space & Communications Acquired by MacDonald Detwiler
Titanium Metals Acquired by Precision Castparts
Volvo Aero Acquired by GKN
Indra Security & Defense 16% decline in revenue
Added 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 Products
Source: PwC analysis
8. PwC4
Aerospace and defense industry delivers a third consecutive year
of record revenues and profits
Companies 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 analysis
Another year of record
deliveries and backlog for
commercial aerospace
Boeing again was the industry’s
largest company, with $81.2 billion
in revenue, a 19 percent increase,
on the strength of commercial
aircraft deliveries. Boeing reported
the largest revenue growth,
$12.963 billion. In fact, the amount
of revenue that Boeing added in
2012 would be equivalent to the
15th largest A&D company. EADS
increased revenue by 15 percent,
from €49.1 billion to €56.5 billion
(6% when translated into US
dollars). Predominantly commer-
cial aerospace companies generally
reported strong revenue growth.
United Technologies, GE Aviation, and
Honeywell Aerospace all reported
growth between 5 percent and 8
percent, thanks in part to acquisitions.
Precision Castparts, Spirit, Babcock,
Triumph, and BE Aerospace, among
others, reported double-digit growth.
AVIC Aircraft Company reported
the largest revenue percentage
increase—82 percent. AVIC also made
the largest jump on the list, advancing
19 places to #51. BAE Systems
reported the largest revenue decline
but improved operating income
through a 100 basis point increase in
operating margin, the largest of any
defense contractor.
Boeing was also the industry’s most
profitable company, with $6.311
billion in operating profit, an increase
of 8 percent. Finmeccanica reported
the largest profit increase—$2.7
billion—due to the absence of large
program charges recognized in
The amount of revenue that Boeing
added in 2012 would be equivalent to
the 15th largest A&D company.
9. A&D 2012 year in review and 2013 forecast 5
Aerospace and defense industry delivers a third consecutive year
of record revenues and profits
2011. Industry operating margin
decreased 17 basis points to 8.60
percent. Despite the record results,
the industry as a whole continues to
be eluded by double-digit operating
margins. The industry’s best oper-
ating margin belongs to Transdigm,
at 41.2 percent, up slightly from
40.4 percent the previous year.
Globalization
The A&D industry is becoming
increasingly globalized. Companies
are reporting more foreign direct
investment, with the rate more
than tripling from a decade ago. For
investments in manufacturing, China
and India have been the top targets.
The United States is third, on the
strength of its market size and capa-
bilities. Fourth on the list is Mexico,
which has developed an aerospace
manufacturing niche. India was the
top target for R&D investments, while
China came in seventh, presumably
because of concerns over intellectual
property protection. The United
States was the second most popular
target for aerospace and defense
R&D investments.
0
5
10
15
20
25
30
35
40
2012201120102009200820072006200520042003200220012000
24
21
12
1813
7
7
6
3
69
5
7
2 2 1
3 2 3
7
9
6
4
9 10
6
R&D Manufacturing
Investments by top 50 global A&D companies in international markets
Source: Company reports
10. PwC6
Aerospace and defense industry delivers a third consecutive year
of record revenues and profits
2013 forecast and risks
The A&D industry has reported its
third consecutive year of record
revenue and profit, as the growth
in commercial aviation more than
offset a soft defense market and
multi-billion dollar impairment
charges at large defense contrac-
tors. The principal risks related to
2013 performance are familiar, and
sequestration is certain to have a
negative impact on defense industry
revenue and profit.
Given the significant uncertainty
in the US defense market, it is
difficult to predict what’s ahead
for 2013. Commercial aerospace
growth is expected to slow to a
rate of between 4 percent and
5 percent, which is approximately
the percentage defense revenue is
expected to decline. As a result,
industry revenue is expected to be
flat in 2013. However, operating
profit could set new records, if the
industry avoids the large impair-
ment charges of recent years. While
there is a risk of some impairments
resulting from the decline in US
defense spending, the magnitude
of those charges is likely to be less
than in recent years. The growth
in commercial aerospace should
approximately offset declines in
defense spending. Accordingly,
operating profit performance is
expected to be flat, with the poten-
tial for improvement in the absence
of large impairment charges.
While there is a risk of some impairments
resulting from the decline in US defense
spending, the magnitude of those charges is
likely to be less than in recent years.
11. A&D 2012 year in review and 2013 forecast 7
In 2011, the industry set a record,
for the first time delivering more
than 1,000 large aircraft; in 2012,
the industry beat the previous year’s
record output by 18 percent, deliv-
ering 1,189 aircraft. Boeing delivered
601 aircraft in 2012, the second best
in its history and close to its record
of 620 deliveries in 1999. In 1999,
Airbus recorded 294 deliveries, less
than half of Boeing’s tally the same
year. In 2012, Airbus delivered 588
aircraft, exactly double its output of
1999, its eleventh consecutive year
of record production. It was the first
time Boeing delivered more aircraft
than Airbus since 2002.
2012 was also the third best year for
orders. Orders exceeded expecta-
tions, surpassing the 2,000 mark
for the second consecutive year and
for only the third time in history.
The industry book-to-bill was 1.7:1,
pushing backlog to another record of
more than 9,000 aircraft, or approxi-
mately seven-and-a-half years at
current production levels.
In 2012, Boeing aircraft programs
achieved several milestones. The
company booked 1,124 orders for the
737, the most for any Boeing model
in a single year, bringing cumulative
program orders above the 10,000
mark. In addition, Boeing exceeded
1,000 cumulative orders for the 737
MAX, approximately 18 months
after launch. Those orders included
Boeing’s largest order ever: 230 737s
for Lion Air. The 777 also achieved a
program milestone, exceeding 1,000
deliveries since inception.
Commercial aerospace
12. PwC8
Commercial aerospace
Boeing’s backlog is at a record $319 billion, and Airbus’ backlog is at
$638 billion (at list price).
IATA statistics 2012 2011 2010
Revenue 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: IATA
Backlog (US $ billions) 12/31/12 12/31/11 12/31/10 12/31/09
Boeing $319 $293 $256 $250
Airbus* $638 $679 $480 $459
*At list price
Aircraft backlog (units) Boeing Airbus Total
Backlog at December 31, 2011 3,771 4,437 8,208
Net orders 1,203 833 2,036
Deliveries 601 588 1,189
Backlog at December 31, 2012 4,373 4,682 9,055
Source: Boeing annual report; Airbus annual report
For 2012, the International Air
Transportation Association (IATA)
reported revenue passenger growth
of 5.3%, a level of demand boding
well for the 20-year forecast of
approximately 34,000 new planes
at a value of $4.5 trillion.
13. A&D 2012 year in review and 2013 forecast 9
Commercial aerospace
Order activity continued to be
driven in large part by the new
single-aisle aircraft, 737MAX
and A320neo. Both offerings are
re-engined versions of the existing
models, offering at least a 15 percent
improvement in fuel efficiency.
To put this in perspective, aircraft
engines have achieved a 49 percent
fuel efficiency improvement in more
than five decades of the jet era, or
about 1 percentage point annually.
Consequently, a 15 percent improve-
ment in one generation constitutes a
significant advance in fuel efficiency.
Some larger orders from 2012, with approximate value
Lion Air, 230 737 MAXs and 737-900ERs $22 billion
Norwegian, 222 narrow-body split between Boeing and Airbus $22 billion
United, 150 737 MAXs and -900s $15 billion
Pegasus, 100 A320neos not disclosed
GECAS, 100 737 MAXs and -800s $7 billion
Air Lease, 75 737 MAXs $7 billion
To put this in perspective, aircraft engines
have achieved a 49 percent fuel efficiency
improvement in more than five decades
of the jet era, or about 1 percentage point
annually.
Consequently, a 15 percent improvement
in one generation constitutes a significant
advance in fuel efficiency.
14. PwC10
Commercial aerospace
Regional aircraft
Mitsubishi reported its largest
order yet for the MRJ in 2012 from
SkyWest, which ordered 100 firm
and 100 options of the jet. That more
than doubled Mitsubishi’s backlog
to 165 aircraft, pulling ahead of
Bombardier, which has received
148 orders for C-Series. Embraer
will formally launch its second-
generation E-Jets during 2013.
Among the improvements will be
Pratt & Whitney PW1700G and PW
1900G geared turbo fan engines,
fly-by-wire, and new wings. In a
complete turnabout in the regional
engine market, Pratt & Whitney,
once absent from the regional jet
space, now dominates new produc-
tion platforms, with engines on the
Bombardier C-Series and Mitsubishi
Aviation deliveries 2011 2012
Global business jet deliveries 696 672
Global turboprop deliveries 526 580
Global piston aircraft deliveries 898 881
Source: General Aviation Manufacturers Association
MRJ, and its recent selection for
Embraer’s second-generation E-Jets.
Business jets
Business jet deliveries and cycles
experienced a flat year and remain
more than 10% below the pre-
recession peak. Business jet cycles
are roughly the same as a decade
ago. Business jet growth looks
favorable for the long term, with
strong growth in the international
markets, as well as improvement
in the United States, driven by an
improving economy and growing
demand for replacement aircraft.
During 2012 the number of
business jets in China increased
40% to 336. Long-term estimates
exceed 2,000, according to the
Aviation Week Intelligence Network.
15. A&D 2012 year in review and 2013 forecast 11
Commercial aerospace
Source: FAA and UBS estimates
0
50,000
100,000
150,000
200,000
250,000
Seasonally adjusted business jet monthly cycles
00 01 02 03 04 05 06 07 08 09 10 11 12
Total orders Total deliveries
Sources: 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
-0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
Industry orders and deliveries—Units, 2002–2011
All graphs represent business jet data
16. PwC12
Commercial aerospace
Commercial aerospace
2013 forecast
For 2013, Boeing is forecasting
between 635 and 645 deliveries,
a 6 percent to 7 percent increase,
and Airbus is expected to achieve
another year of record deliveries
of 600 to 610 units, a 2 percent to
4 percent increase.
While these growth rates are more
modest than the 18 percent growth
in original equipment manufac-
turer (OEM) deliveries in 2012, the
industry continues to establish new
records for output. These record
output levels create considerable
strain on an industry that arguably
has the most complex supply chain
and the one with the longest lead
time. The challenge will be to avoid
previous supply chain issues while
increasing production rates. The
industry previously has faced raw
materials shortages, late deliveries,
out-of-sequence work, overtime,
and rush shipments throughout the
supply chain, all of which erode the
economic benefits of higher volume
from dropping to the bottom line.
The industry will face these chal-
lenges in 2013, and in the longer
term, as capacity constraints bump
up against record backlogs. OEMs
and suppliers are encouraged to
perform thorough supplier capacity
and readiness assessments.
While it is difficult to predict orders,
it is unlikely that orders will main-
tain the manic pace of 2011 and
2012. However, 2013 is already off
to a strong start. In the first quarter
of 2013, Airbus booked 431 orders
and Boeing recorded 220 orders, a
combined rate of 2,600 orders annu-
ally. Lion has ordered 234 A320s,
Ryan Air ordered 175 737s, Lufthansa
ordered 100 A320s, and Turkish
Airlines has ordered 82 A320s. We do
not expect this pace to continue or for
orders to exceed 2,000 for the third
straight year. But we certainly expect
orders to exceed the approximately
1,250 deliveries predicted for 2013,
pushing backlog to another new high
by the end of 2013.
17. A&D 2012 year in review and 2013 forecast 13
For the past three decades, leased
and financed aircraft have steadily
grown to represent about half of
the commercial airline fleet, and
leasing companies have about
16 percent of the current backlog,
a historic high. Aircraft lessors will
become even more important as
their more stable business models,
diversified portfolios, and compara-
tively higher grade ratings ease
their access to capital markets.
Economic risks include the potential
for slowing global growth, resulting
in part from government spending
declines. In addition, the European
sovereign debt crisis has the poten-
tial to disrupt aviation financing
markets. However, any disruption
may be mitigated through increases
in private financing. As we discussed
in our recent report, “Aviation
Finance: Fasten your Seatbelts,”
as global risks are re-priced, the
competition to obtain financing for
aircraft may intensify, and the cost
of financing may rise. We expect
the industry as a whole to be able to
attract funding, but new sources of
finance will need to be tapped.
Export Credit Agency (ECA)
financing, traditionally a backstop,
has become the funding source of
choice for many airlines. However,
the new Aircraft Sector Under-
standing (ASU), which governs
pricing of ECA financing, will go into
effect in 2013, resulting in consid-
erable premium increases for this
financing stream.
Overall, modest growth in commer-
cial aerospace is expected for 2013.
Space
Space-related initiatives are
expected to increase significantly in
2013. SpaceX will continue its cargo
missions to the International Space
Station (ISS) and Orbital Sciences
is scheduled for its first berthing
with the ISS under the Commercial
Orbital Transportation Services
(COTS) program. In addition,
research and development continues
under the Commercial Crew Devel-
opment (CCDev) program. Boeing,
SpaceX, United Launch Alliance, and
Sierra Nevada are among the compa-
nies receiving NASA funding for
CCDev. The impact of sequestration
on these and other space programs
remains to be seen.
Long-term forecast
The long-term forecast for commer-
cial OEM aircraft is about 34,000
deliveries valued at about $4.5 tril-
lion over the next 20 years. While
some observers have questioned
whether these forecasts are overly
optimistic, they are nevertheless
based on well-founded assumptions
about global economic growth and
the rate of aircraft replacement. In
fact, the significant improvements in
efficiency for new aircraft may accel-
erate the demand for replacement
aircraft. With long-term demand at
more than 1,500 aircraft per year
and current production rates at
Commercial aerospace
about 1,200 per year, the industry
can look to future growth and a
lot of cushion between forecasted
demand and current production to
absorb any softening in demand.
Perhaps a key competitive advan-
tage will go to the company that can
effectively raise production rates
fastest to shorten delivery times.
At the same time, new competi-
tors are trying to take advantage
of the growing market. Commer-
cial Aircraft Corporation of China
(COMAC) has launched its C919
aircraft. COMAC is projecting to sell
more than 2,000 planes, capturing
about 7 percent of market share.
In addition, Irkut of Russia has
launched a narrow-body aircraft,
and Bombardier is marketing its
CSeries. Embraer is expected to
launch its next-generation E-Jet
in 2013, but it has not announced
any plans to compete in the narrow-
body market.
18. PwC14
Commercial aerospace
Growth in business jets
The business jet rebound remains
elusive and slower than was
expected at the beginning of the
year. Overall cycles for 2012 were
still more than 10 percent below
the 2007 peak.
Companies are reporting that
business jet backlogs have been
cut approximately in half since the
start of the recession. The recovery
in business jets is expected to align
with the overall Western economic
recovery, which continues to be
slow. In addition, residual values
for aircraft remain challenged,
given the lack of demand, leaving
many owners, operators, and their
financiers exposed. Therefore,
business jets should expect another
year of modest improvement. In the
medium to long term, business jets
should see significant increases,
driven by economic growth and
adapting regulations in Asia and the
Middle East, particularly in China.
These longer routes favor the larger
segment of the business jet market.
The business jet rebound remains
elusive and slower than was expected
at the beginning of the year.
Companies are reporting that business jet
backlogs have been cut approximately in half
since the start of the recession.
19. A&D 2012 year in review and 2013 forecast 15
The top dozen global defense compa-
nies reported revenue decreases of
about 4 percent, and an increase in
profits of 2 percent (the profit statis-
tics exclude the results of General
Dynamics and Finmeccanica, which
reported large impairment charges
in 2012 and 2011, respectively). Only
3 of the top 12 companies reported
revenue increases, with Boeing up
3 percent, Lockheed Martin up 1
percent and Safran up 7 percent.
Revenue at Thales and L-3 was essen-
tially flat. Five of those companies
reported increased profits (Lockheed
Martin, 10 percent; BAE Systems, 2
percent; Raytheon, 6 percent; Thales,
18 percent; and Safran, 13 percent).
Northrop Grumman reported the best
operating margin, at 12.4 percent.
Four other companies reported
double-digit operating margins
(Raytheon, 12.2 percent; Safran, 10.5
percent; L-3, 10.3 percent; and UTC-
Sikorsky, 10.5 percent). Operating
margin for the group was 9.4 percent,
an improvement on 30 bps. The best
improvements in operating margin
were reported by BAE Systems, at 100
bps; Thales, at 90 bps; and Lockheed
Martin and Raytheon, at 80 bps.
However, some investors are asking
whether the margin improvements
are sustainable or are a temporary
result of cost reduction preceding a
revenue decline.
Sequestration went into effect on
March 1, 2013 and provides for $85
billion in spending cuts in FY13, half
from defense. The defense cut repre-
sents about 8 percent of the Depart-
ment of Defense’s FY13 base budget
request. The DoD is taking actions
that include reduction and furlough
Defense
Defense contractors brace for sequestration
20. PwC16
Defense
of civilian staff and cutbacks in base
support services. Much uncertainty
remains about the impact of seques-
tration on specific defense programs,
but the defense industry should
expect a proportionate reduction.
During 2012, European defense
ministries began responding to the
consequences of budgetary reduc-
tions by cutting and reprofiling
programs and reducing platform
numbers. This process is still
unfolding, and it is driving signifi-
cant uncertainty in the supply
base as companies struggle to
manage both the impact of known
reductions and the risk of uncer-
tain future reductions. Initiatives
to preserve capability at the same
or lower cost have burgeoned in
Germany, Sweden, Norway, the UK,
and elsewhere. Globally, there is a
growing appetite for capability and
cost-sharing between nations—
initiatives that remain at the discus-
sion stage. The NATO Secretary
General’s “Smart Defense” initiative
seeks to achieve this for the Alliance,
and bilateral arrangements such
as the Anglo-French Defense
and Security Cooperation Treaty
encourage collaboration in a range
of activity, from military opera-
tions to acquisition to asset sharing.
Backlog (US $ billions) 12/31/2012 12/31/2011
EADS Defense $64 $73
Lockheed Martin $82 $81
Finmeccanica $57 $64
BAE Systems $67 $58
Boeing Defense, Space & Security $71 $60
Thales $32 $33
Northrop Grumman $41 $40
General Dynamics (exc. Gulfstream) $36 $40
Raytheon $36 $35
L-3 $11 $10
Total $497 $494
Source: Company reports
NATO’s operations in Libya high-
lighted the importance of having the
capability to respond to unexpected
events—the “return to contin-
gency”—and of a strong blend of
European capabilities able to be
deployed at short notice. Though
the Libyan operation was relatively
short-lived, it highlighted significant
capability gaps (e.g., in intelligence
and surveillance systems) that
European nations will find difficult
to fill while under the current
financial pressures.
European defense companies are
responding to declines in their
traditional markets and are simul-
taneously pursuing opportunities
in growth markets, including the
Middle East, Brazil, Turkey, South-
east Asia, and India. The challenges
in those regions are strong competi-
tion and in-country barriers to entry.
Exports
The growth of defense export deals
has led to a record backlog of $327
billion at mid-year 2011. “We have
in excess of 13,000 active cases
with more than 165 countries and
institutions,” adding up to about
$327 billion, said Vice Admiral Bill
Landay at a Pentagon news briefing
ahead of the Paris Air Show.1
1 Bloomberg, Gopal Ratnam, “Pentagon
Has $327 Billion Export Backlog, Sees
Drone Demand,” June 10, 2011.
21. A&D 2012 year in review and 2013 forecast 17
Defense
US defense export authorizations
spiked at $264 billion in 2011, the
most recent year for which data
is available. It represents an $84
billion increase, 48%, from 2010,
and a 394% increase compared with
2006. The export backlog, which
was disclosed at $327 billion at
mid-year 2011, is now estimated at
around $500 billion. The significant
growth in defense exports should
help soften the impact of US defense
cuts. Much of the growth during
this period has been in Asia, due
to concerns about China’s growing
military power and tensions between
North Korea and South Korea, and
in the Middle East, due to concerns
about Iran’s military ambitions. And
the United States is not the only
country benefiting. Western European
countries, Israel, South Korea, and
Russia are all gaining from increased
defense exports.
US foreign military sales (FMS) agreements and direct commercial sales authorizations2,3
USD Billions
0
50
100
150
200
250
300
2011201020092008200720062005200420032002200120001999
238
154
123
107
89
67
52
676253525547
11 11 12 12 13 13 18 18 29 30 24 26
9
Foreign military sales (FMS) agreements Direct commercial sales authorizations
On March 7, 2013, the White House
sent its export control reform
proposals to Congress for approval.
The reforms redefine restricted
categories on the US Munitions List
(USML), with oversight responsi-
bility for some categories moving
from the State Department to the
Commerce Department. These
reforms, which have been supported
by industry, are designed to simplify
and streamline the export process
and may lead to further increases in
export authorizations.
2 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
22. PwC18
Defense
Defense forecast
Due to sequestration, the initial
effects of which will be felt during
2013, our expectation is that defense
revenue will decline by about 5
percent, based on our calculation
of the defense portion of seques-
tration for about seven to eight
months. But the impact on profits
may be mitigated, because as the
industry contracts, many of the
costs to reduce capacity and restruc-
ture or terminate programs will be
absorbed by the federal government.
The industry drove a slight increase
in margins in 2012, despite modest
declines in revenue. According to
our estimates, the industry will
likely hold operating margins flat,
before considering potential impair-
ments. As the industry contracts,
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 General
Dynamics and Finmeccanica over
the last two years.
Market contraction, coupled with
increasing certainty about the
nature and amount of defense
budget cuts and the impact on
specific programs, is also expected
to drive significant industry consoli-
dation. In recent years, the trend has
been toward spin-offs and divesti-
tures. High-profile spin-off transac-
tions have included the Huntington-
Ingals split from Northrop
Grumman, Exelis from ITT, and
Engility from L-3. In 2013, SAIC is
scheduled to complete a spin-off
to be known as Leidos. The period
of spin-offs looks to be nearing its
end, to be followed by a period of
defense consolidation. The defense
industry is already highly concen-
trated, resulting from consolidation
Market contraction, coupled with increasing certainty
about the nature and amount of defense budget cuts and
the impact on specific programs, is also expected to drive
significant industry consolidation.
23. A&D 2012 year in review and 2013 forecast 19
Defense
during the post-Cold War era. The
Defense Department has opposed
any further consolidation among
major prime contractors, but that
position could soften, depending
on market conditions. Regardless of
whether the major prime contractors
consolidate further, expectations are
for significant consolidation of the
supply base.
Contractors may also continue
to respond to market conditions
in other ways. The current focus
remains on affordability, and the
Defense Department now lists
affordability among its procurement
criteria. Contractors should stay
focused on improving productivity,
as the industry is beginning a period
of fewer new platforms. At the same
time, there is a need to recapitalize
equipment. So the focus will likely
shift from new platforms to plat-
form upgrades and sustainment.
Electronics and C4ISR, including
unmanned aerial vehicles and
cybersecurity, will likely be among
the areas of growth.
Many companies are exploring
commercial applications for their
technologies. Most defense contrac-
tors, and their investors, have
approached commercial markets
cautiously because of mixed experi-
ences, weighted toward the nega-
tive, in the past. Much of that expe-
rience, though, is dated; defense
contractors have had ample opportu-
nities in their core markets for more
than a decade. However, many of
the industry’s largest commercial
markets have their roots in defense
and space technologies, such as
computers, computer networking,
and telecommunications. Going
forward, defense contractors are
expected to seek commercial appli-
cations for their technologies, even
if it means licensing or supplying
technology to commercial entities.
The future of the defense industry is
difficult to predict, as developments
in North Korea’s and Iran’s nuclear
weapons programs, instability in
the Middle East, and other factors
could bring rapid changes in defense
priorities.
During 2013, the European defense
markets will likely begin to stabi-
lize as defense ministries address
the budget cuts initiated two years
ago. Budgetary increases are not
expected until 2015, and it may
be necessary to pare some defense
budgets, specifically procurement
budgets, still further if the Euro-
zone’s austerity measures need
to be tightened. According to the
London Times, the United Kingdom
has announced plans to roll out a
“balanced defense program” for
the first time in a generation; the
program will provide clarity for
OEMs after some years of uncer-
tainty. At the same time, acceler-
ated “transition” in Afghanistan
will likely start to manifest itself in
rationalizing in-theater equipment
and logistic support and an increase
in logistic movement as military
materiel is redeployed. As a result,
the next few years will likely bring
an acceleration of equipment refur-
bishment, although the extent and
its effect on the industry has yet to
be quantified.
European nations will likely continue
various transformation programs
aimed at preserving capability at
lower cost and will import many of
the ideas and concepts pioneered
in the United Kingdom a few years
ago; expectations also are for an
increase in availability contracting
for land, sea, and air platforms, plus
an increasing appetite for industry-
led solutions in the provision of
training, infrastructure, and back-
office shared services. Programs for
industry will likely take on more
complex and broader roles, and
the United Kingdom’s Advanced
Materials strategy may prove to be a
pioneering approach. The drive for
exports will also likely continue and
remain fiercely competitive as the
global defense industry competes in
growth markets.
So while the traditional, platform,
and equipment-based defense
markets in Europe remain under
intense pressure, opportunities exist
for industry to more broadly deliver
service-based capabilities in many
countries. In the United Kingdom,
the whole of the defense support
services market is projected to be
worth an estimated £16 billion per
year by 2020, or approximately 75
percent of total MoD spend with
industry; these trends will accelerate
in Europe. (PwC assessment based
on public domain sources, 2012.)
24. PwC20
1 Strategy
While strategy is continually evolving,
the pace of significant strategic deci-
sion making is expected to accelerate
due to a rapidly changing environ-
ment, particularly in defense. With
the advent of significant reductions
in US defense spending, companies
will likely make strategic decisions
regarding prioritization of markets
and technologies. Going forward,
defense spending is expected to
emphasize:
• Lifetime affordability
• Fewer new platforms
• Upgrades and sustainability of
existing platforms
• Command, control, computers,
communication, intelligence,
surveillance and reconnaissance
(C4ISR)
• Energy and efficiency
Many strategic decisions have
been made in anticipation of these
changes; many actions have been
in the form of spin-offs and dives-
titures. But the market is expected
to shift toward industry consolida-
tion as spending cuts take hold. The
failed merger between EADS and
BAE Systems might be viewed as a
harbinger of things to come. Whether
the governments involved will allow
mergers among any of the major
prime contractors may depend on
the extent of defense spending cuts.
Regardless of whether major primes
merge, significant consolidation of
the supply chain is expected.
Trends
Eight trends to watch in A&D for 2013
and beyond
25. A&D 2012 year in review and 2013 forecast 21
Trends
In addition, companies are expected
to have a greater focus on inter-
national markets, in order to help
compensate for the decline in US
revenues. In recent years, exports
have increased significantly.
However, companies will increas-
ingly focus on international strate-
gies, which may include a more
significant international footprint.
These efforts may be aided by export
control reforms proposed by the
White House. Additionally, compa-
nies will likely focus on adjacent
technologies and markets. While
many organizations are expected
to approach commercial markets
cautiously, they are expressing
greater interest in commercializa-
tion of their technologies.
2 Innovation
Innovation is another area that
is steadily evolving. For many
companies, innovation is the single
most important success factor, as
confirmed by a PwC survey of more
than 20 executives from leading
A&D companies, who collectively
ranked innovation as the highest
business priority.
Innovation, therefore, is a major risk
to be addressed when examining
enterprise risk. Yet many companies
do not view innovation as a top risk.
They are focused on financial and
compliance risks, when a failure to
innovate may pose the greatest risk.
Perhaps innovation is not under-
stood as a risk because companies
are more adept at measuring finan-
cial and compliance risks, including
operational risks that have financial
consequences. In comparison, it
is much more difficult to evaluate
opportunity cost and the effective-
ness of research and development
and the innovative culture. With
reduced government funding for
research and development, defense
companies look to be making greater
investments in independent research
and development (IR&D). The
challenge for the defense and space
industry is to become more commer-
cial in its approach to innovation.
Commercial aerospace is enjoying
its longest up cycle in history. Not
only is demand of the end markets
strong, but successful innovations
with dramatic improvements to
efficiency, reliability, and safety are
helping drive the boom. The chal-
lenge lies in gaining the resources,
both human and economic, to keep
up with the accelerating pace of
innovation and product develop-
ment. As one company executive
described it, “We have more oppor-
tunities with good business cases
than we can afford.”
Commercial aerospace and defense
companies should gain greater
productivity from research and devel-
opment activities as well as prioritize
investments. The solution depends
partly on viewing innovation as a
business process. To learn more
about PwC’s perspective on achieving
innovation excellence, please visit
www.pwc.com/us/gainingaltitude.
26. PwC22
Trends
3 Talent management
Demographics
The A&D sector continues to face
two significant challenges related to
talent: steady losses of experienced
senior personnel and the need to
attract skilled talent. While retire-
ment levels for 2011 remained low,
retirement eligibility—double-digit
in most job categories—is growing
by one to two percent annually and
estimated to reach 18.5 percent in
2015. And while attrition rates show
small decreases, as well as possible
declines among the youngest
workers, more than 45 percent of
workers under 35 plan to switch
employers within the next five years,
portending a significant talent drain.
With defense spending cuts on the
way, expectations are for declines
in employment levels. The industry
faces a challenge similar to that
faced by companies during the post-
Cold War era: How can businesses
avoid losing the next generation of
A&D talent?4
A skilled work force
The number of US graduates within
the critical fields of science, tech-
nology, engineering, and mathematics
(STEM) remains low. Shortages in
the pool of scientists and design engi-
neers are particularly pronounced,
with demand expected to show
continued growth in 2013. Further-
more, a majority of industry jobs are
in defense and security, where US
citizenship is required, further
limiting the pool of available talent.
According to the Aerospace Indus-
tries Association, only 44,000 of the
70,000 engineers that graduate each
year in the United States are quali-
fied to work in the aerospace sector,
suggesting the need for stronger
partnerships between universities
and A&D in order to identify the skills
required within the industry. A&D
companies also face competition from
organizations and other industries
for the available talent. This trend
is mirrored in other developed
aerospace nations.
The resulting pressure has HR
playing an increasingly strategic role
in the talent supply chain. Mentoring
programs and training initiatives,
designed to help retain key knowl-
edge and skills, are growing in
popularity. Additionally, succession
fosters early identification of top
talent, and recruiting partnerships
are being developed to deliberately
attract talent from universities.
Two other areas important to talent
management are knowledge capture
and organization design. Knowledge
management programs are increas-
ingly critical in minimizing the effects
of turnover. And firms are paying
attention to the organizational design
elements that compromise project
execution and cross-functional collab-
oration, which may be particularly
important to younger workers.
4 Aviation Week, Carole Rickard Hedden,
“Aviation Week Workforce Study”,
Aug. 13, 2012.
27. A&D 2012 year in review and 2013 forecast 23
Trends
Engineering talent and
US citizenship
The pinch is also evident abroad.
In Europe, for example, only about
10,000 graduates from technical
universities choose to work within
A&D, while the industry needs at
least 12,500 graduates every year.5
Global/US citizenship
The search for qualified talent forces
US companies to focus increasingly
overseas. And while organizations
have historically attracted engi-
neering talent from countries such as
India and Russia, several forces have
slowed the promise of an interna-
tional labor pool.
The growth of international markets
for A&D has resulted in increased
competition from countries like China
for skilled labor. Another concern is
the US government’s restrictions on
the number of H-1B visas, a special
designation letting firms hire tempo-
rary high-skilled workers. Addition-
ally, US talent is typically preferred
in organizations like the US Defense
Department, where security clear-
ance requirements rule out inter-
national talent, while laws such as
the US International Traffic In Arms
Regulations (ITAR) prevent sharing
technical data and knowledge with
foreign nationals.
5 Aviation Week, Carole Rickard Hedden,
“Aviation Week Workforce Study”,
Aug. 13, 2012.
Still, the foreign labor pool is signifi-
cant, making immigration reform
a major issue for the A&D industry.
According to a 2007 study by the
Woodrow Wilson School of Public
and International Affairs at Princeton,
two countries in particular, India
and China, with their vast, educated,
low-wage workforces, attracted more
than 100,000 H-1B visa holders in
a single year. Stricter immigration
controls may serve to constrict this
supply of talented workers.
For more information on talent
management, please visit us online at
www.pwc.com/us/peopleandchange.
The growth of international markets
for A&D has resulted in increased
competition from countries like China
for skilled labor.
28. PwC24
Trends
4 Productivity and
affordability
The Pentagon has emphasized
affordability, including it as a
criterion for procurement decisions.
Accordingly, defense contractors
have strategized to reduce costs and
improve productivity. We compared
defense companies with companies
in the Dow Jones Industrial Average
(DJIA) on the basis of revenue
per employee, using data from
company earnings statements and
company profiles. We acknowledge
that revenue per employee is an
imperfect measure and that a better
measure would be value added per
employee, but since that data is not
available, we have used revenue per
employee as a reasonable surro-
gate. In this comparison, we see
that defense contracts are about
half as productive as the DJIA. We
believe there are some valid reasons
why defense companies have lower
productivity, including:
• Limits on profitability—Much
of defense revenue is under
cost-reimbursable, or cost-
based, fixed-price contracts, with
revenues limited based on profit
limitations. Defense contractor
profitability is typically a little
more than half of the DJIA.
• Development of leading technolo-
gies—Defense contractors are
frequently developing cutting-
edge technologies, which are
inherently manually intensive
and involve some degree of trial
and error.
• Extremely low volumes—Many
defense contracts are for single
units or quantities measured
in the dozens or hundreds,
compared with commercial
enterprises that typically measure
volumes in the millions of units.
The low volumes result in manu-
ally intensive manufacturing and
assembly and low absorption of
fixed costs in a capital-intensive
industry.
• Regulation—The industry is highly
regulated, which can increase
compliance costs, including
compliance with federal acqui-
sition regulations (FAR), cost
accounting standards (CAS), and
export controls (ITAR).
The industry is highly regulated,
which can increase compliance costs.
29. A&D 2012 year in review and 2013 forecast 25
Trends
Despite these inherent limitations,
the industry recognizes there is
room for improvement in produc-
tivity. Many companies have been
taking action to reduce overhead
costs, including workforce reduc-
tions, early retirements, and facili-
ties consolidation. Direct product
costs will likely be more challenging.
We believe the following areas offer
opportunities:
• Program management/short-
ened development cycle
• Supply chain management
• Information technology
• Knowledge management
Improving the speed and effective-
ness of program development typi-
cally produces the biggest gains
in affordability. Schedule delays
are the biggest factor in budget
overruns. While contractors take
pride in their program manage-
ment abilities, the industry should
seek continuous improvement,
including unbiased, independent
assessments and benchmarking.
The defense supply chain has
become extremely complex. Typi-
cally, 50 percent to 80 percent or
more of the total value of production
is rooted in a technically complex,
multi-tier supply chain. Accord-
ingly, any productivity improvement
initiative should address suppliers,
the most significant component of
costs. Defense contractors can no
longer accept long lead times and
marginal supplier performance as
industry norms. The industry should
challenge itself to get much closer to
“just in time” delivery. The industry
might consider adopting leading-edge
risk management practices to regain
visibility into the supply chain that
has been lost through outsourcing.
Information technology represents
one of the biggest areas for discre-
tionary spending at most companies,
including defense firms. Many A&D
companies have invested millions in
systems implementations but haven’t
yet realized the full capabilities and
productivity enhancements that these
systems enable. Many IT organiza-
tions are still spending most of their
time in legacy system maintenance
and enhancements. Companies
should unlock the full capabilities of
their IT platforms, become leaner,
and migrate the IT organization away
from costly maintenance toward
strategic initiatives and competitive
advantage.
Finally, improved knowledge
management will likely become
more critical. Talent drain, already
a factor due to demographics, has
been accelerated by early retirements
and workforce reductions. Compa-
nies should identify the key people
and knowledge in their organiza-
tions and capture that information
using searchable technology tools.
Organizations should also create a
knowledge management culture that
promotes and rewards the effective
capture and use of knowledge.
30. PwC26
Trends
5 Supply chain
In 2013, two major trends are
expected to have a significant impact
on the supply chain:
Commercial aircraft
production rate ramp-up
• Previously, we discussed the
commercial aircraft production
rate ramp-up of historic propor-
tions. In 2012, the industry
delivered a record 1,189 large
commercial aircraft, an 18%
increase over the prior year,
which was also a record. In the
long term, demand is projected
to be about 1,700 aircraft
annually, meaning that annual
production rates may continue to
increase by another 40 percent.
The current and projected
production levels will likely
strain a supply chain that can
be considered to have the most
complex and longest lead time
supply chain of any industry.
Defense spending reductions
• For the defense supply chain,
the concern is that significant
defense spending cuts will drive
small suppliers out of business.
Some of these suppliers may be
sole source or produce unique
components. Accordingly, the
supply chain could be left with
a shortage of critical parts and
long lead times to qualify new
suppliers.
Both commercial aerospace and
defense contractors should reeval-
uate supply chain strategy and
evaluate supplier performance risk.
To learn more about PwC’s perspec-
tive on the supply chain, please visit
www.pwc.com/us/gainingaltitude.
6 Globalization
Globalization is driving the boom
in commercial aviation. The Asia-
Pacific region is expected to take
more aircraft deliveries, in units
and value, over the next 20 years
than North America and Europe
combined. Why?
• Developing economies, particu-
larly in the BRIC countries
(Brazil, Russia, India, and China)
are growing faster than devel-
oped economies. The economy
is becoming more knowledge
based, with businesses increas-
ingly relying on the global
deployment of human capital,
a requirement for operating a
twenty-first century business.
That new paradigm is driving
strong demand for aviation,
as well as resiliency for the
industry. Aviation once was a
hyper-cyclical industry, overre-
acting to business cycles. Now,
that dynamic has fundamen-
tally changed, as demonstrated
during the most recent recession.
While aviation demand did take
an extreme downturn during the
31. A&D 2012 year in review and 2013 forecast 27
Trends
recession, demand rebounded
faster than the overall economy
and more quickly than in
previous economic cycles,
rapidly returning to pre-reces-
sion levels and demonstrating
that aviation demand has
become much less elastic than
it used to be.
• Consumer air travel once
was largely a privilege of the
wealthy. As the relative cost of
air travel has declined, it has
become highly accessible to the
middle class and not readily
relinquished, even during a
slow economy. Aviation growth
will likely continue to be driven
by the growing middle class in
developing economies.
• Aviation is viewed as a strategic
industry in emerging market
countries. Governments, keen to
promote aviation, airports, and
the associated infrastructure, own
direct or indirect stakes in many
national carriers, enabling them to
place large orders for aircraft.
As a result, aviation is expected to
grow about 2 percentage points
faster than global GDP for the fore-
seeable future. While globalization
is creating tremendous growth and
opportunity for the industry, it is
also driving challenges that require
new strategies. Among these are:
• Competition—The growth in the
industry and lure of high tech-
nology in aerospace is attracting
such new competitors as Comac
of China, Irkut of Russia, and
Mitsubishi of Japan. In addition,
regional jet makers are increasing
the size and range of their jets,
competing at the smaller end of
the narrow-body market.
• Globalization of customers and
suppliers is driving numerous
challenges. The aerospace
industry once was principally
a domestic industry relying on
exports. But as the customer
base and supply chain have
diversified, aerospace compa-
nies increasingly are operating
While globalization is creating tremendous
growth and opportunity for the industry,
it is also driving challenges that require
new strategies.
internationally in order to drive
intimacy with customers and
suppliers, improve responsive-
ness and service, satisfy offset
and industrial participation
requirements, and, in some
cases, take advantage of interna-
tional talent or lower costs.
Globalization, not limited to
commercial aerospace companies,
is also having a significant impact
on defense. US defense export sales
authorizations (for future deliveries)
have increased more than four-fold
since 2005, from $61 billion to $264
billion in 2011, as seen in the chart
on page 17. These arms largely are
destined for the Middle East and
Asia-Pacific. Defense contractors
are expected to continue to focus on
international markets and develop
global footprints.
In a recent PwC study, aerospace
and defense companies cited the
following as the greatest obstacles
to becoming more international:
• Safeguarding intellectual
property
• Export control compliance
• Creating ethical cultures
• Managing financial risks
• Managing offset and industrial
participation requirements
For more information on strategies
to address globalization opportuni-
ties and risks, please refer to A&D
Insights: Accelerating global growth.
32. PwC28
Trends
7 Cybersecurity
Given their role in developing
cutting-edge technologies with
military applications, A&D compa-
nies have long faced heightened
security challenges. With ubiquitous
and interconnected information
technology (IT) systems driving
every phase of the A&D industry,
companies face complex challenges
to the security and integrity of
their operations and reputation,
including ongoing efforts to steal
intellectual property and other
sensitive business data, as well
as attempts to sabotage opera-
tions and tarnish reputations by
disrupting IT networks.
Economic espionage.
A&D remains the industrial sector
most targeted by economic espio-
nage conducted by nation-states’
intelligence services. Systems
supporting unmanned aerial vehi-
cles (drones) may get particular
attention from economic spies
because of their highly publicized
use for intelligence gathering and
kinetic strikes in war zones.
Intrusions into A&D companies’
IT systems have lasted for months
or years before being detected. In
February 2013, one cybersecurity
firm reported how an advanced
persistent threat (APT) has “system-
atically stolen hundreds of terabytes
from at least 141 organizations…
spanning 20 major industries.”
Two other APTs—dubbed “Shady
RAT” and “Beebus”—may have
been created by hackers linked to a
foreign government. All three APTs
appear to have been designed to
steal information from targeted IT
networks, where they are typically
introduced by infected files attached
to “spearphishing” emails.6
• It is likely that every company in
the A&D sector has been targeted
by these APTs.
• Many US A&D companies have
responded to APTs by partnering
with the federal government.
The Defense Industrial Base
Cyber Security/Information
Assurance Program, under
the aegis of the Department of
Defense (DoD) and Homeland
Security (DHS), is a forum
letting A&D companies volun-
tarily report cyberintrusions and
letting federal authorities share
detailed threat information.
• Cybertools are not the only
means of conducting economic
espionage. Exploiting the access
of disgruntled or corrupted
insiders—the “insider threat”—is
often just as dangerous: Dongfan
Chung, who worked on the
B-1 bomber, space shuttle, and
other A&D projects for nearly 30
years, was convicted in 2010 of
economic espionage on behalf of
the Chinese aviation industry.
The complex business ecosystem
in the A&D sector, with compa-
nies increasingly relying on joint
ventures, partnerships, and manu-
facturing and R&D facilities in
expanding markets—potentially
opening new points of access for
intruders—adds to the challenge of
keeping corporate IT systems secure.
6 Mandiant, “APT1: Exposing One of
China’s Cyber Espionage Units”,
www.mandiant.com, Feb. 19, 2013.
33. A&D 2012 year in review and 2013 forecast 29
Trends
Disruption and sabotage.
The same elements making A&D
companies attractive to spies also
make them targets for cyberdisrup-
tion campaigns by terrorists, rogue
states, and hacktivists.
Hacktivists, who have already
attacked financial and energy
companies, could conduct distrib-
uted denial of service campaigns
to disrupt IT networks or intrusion
attempts aimed at exfiltrating and
publicizing sensitive data about
corporations or their employees.
Similarly, kinetic strikes using a
particular weapons system against a
rogue state or terrorist group could
lead to retaliatory cyberattacks
designed to disable or disrupt the
computer networks of the weapon’s
manufacturer.
Unique and evolving
regulatory environment.
Because most of the largest A&D
companies work on classified and
military-related projects, many of
their processes for handling sensitive
information are subject to unusually
strict governmental oversight. These
companies should be prepared for
regulatory changes, which are in the
offing in three broad areas.
First, important changes stem from
a White House executive order (EO),
“Improving Critical Infrastructure’s
Cybersecurity,” published in February
2013. The order calls for the creation
of a framework to reduce cyber-risk
to critical infrastructure, as well as
provisions letting federal agencies
share more threat information with
the private sector. The EO also
calls on the secretary of Homeland
Security to identify “critical infra-
structure at greatest risk”—which
may include A&D firms with signifi-
cant military contracts—and to let
the owners of such organizations
know of that designation. Many
of the details of the order will be
released in coming months.
In addition, the Cyber Intelligence-
Sharing and Protection Act has
been reintroduced in the House
of Representatives, and this year’s
draft is expected to receive White
House support. Legislation may be
necessary for the complete imple-
mentation of the executive order.
One particular concern of many
companies is to obtain protection
from legal liability that could result
from voluntary information-sharing
with the federal government.
Finally, cleared defense contractors,
including most major A&D compa-
nies, must soon develop insider threat
programs and enhance their capa-
bilities to detect and prevent these
threats, in accordance with Executive
Order 13587, issued in October 2011
and establishing a national policy and
minimum standards for insider threat
mitigation programs across federal
departments and agencies.
Looking ahead.
Over the next decade, the A&D
industry will likely remain a high-
priority target of threat actors due
to economic factors as well as mili-
tary calculations. The challenge of
protecting corporate assets, and IT
systems in particular, will likely grow.
The ultimate nature of these develop-
ments is to be determined, but two
broad trends are likely to emerge.
Technological and cultural shifts:
smartphones, tablets, and other
devices that can connect to the
Internet are becoming ubiquitous
and, with the move to a cloud
computing paradigm, will likely
drive opportunities for theft and
manipulation of companies’ sensi-
tive data. And employees and other
individual stakeholders can expect
ever greater access to companies’
IT systems and data from their
personal devices and from locations
of their choice.
New threat factors are also likely to
emerge, reflecting shifts in global
economic activity:
• Governments seeking to jump-
start fledgling A&D companies
could be tempted to sponsor
cyber-intrusions and other
efforts to pilfer the intellectual
property and know-how of
industry leaders.
• Similarly, the nature of criminal
hacking may evolve, with social
networking tools potentially
facilitating a new black market
in stolen computer files, thus
creating powerful incentives for
newcomers to attack corporate
networks.
For more information on cybersecu-
rity, please visit PwC’s Information
security, privacy, and risk page.
34. PwC30
Trends
8 The regulatory
environment
The current regulatory environment
is a key challenge facing the defense
industry.
Several reforms may help improve
the environment for defense
companies.
Acquisition reform
Attempts to improve the current
defense acquisition process have
not succeeded. One reason could be
that reforms have sought to place
ever-increasing regulations on the
contractors. Acquisition reform
might benefit from addressing
how Congress funds long-term
programs on a short-term basis, and
the manner in which the customer
initially defines requirements and
the impact of subsequent modifica-
tions. Some observations concerning
areas ripe for reform include:
• Addressing the definition and
stability of requirements
• Establishing realistic budgets
and funding based on the
inherent risks of developing
advanced technologies
• Promoting flexibility and inno-
vation in the bid and proposal
process
• Using contract structures
appropriate to risk
• Promoting international
cooperation and cost sharing
The Defense Contract
Audit Agency
The purpose of the Defense Contract
Audit Agency (DCAA) is to protect
the government and taxpayers from
fraud and abuse. The following
are some considerations that could
improve the effectiveness and
efficiency of DCAA audits:
• Audit approach—Benchmark
the audit approach against
commercial practices, such as
those regulations established
under the American Institute
of Certified Public Accountants
(AICPA) and Public Company
Accounting Oversight Board
(PCAOB).
• Materiality—Establish mate-
riality standards. Materiality
is not defined for government
contracting exceptions. It is
widely accepted in commercial
practice that it is impractical and
cost-prohibitive to build a control
system to catch minor errors.
• Third-party reliance—The DCAA’s
resources are limited. While DCAA
standards allow for reliance on
third parties, it seldom occurs. The
DCAA could consider establishing
standards for third-party reliance
that promote such use where the
third party is objective and compe-
tent to improve the speed and effi-
ciency of the regulatory process.
Export control reform
Many observers believe current export
control regulations are outdated and
drive a competitive disadvantage for
the US defense industrial base. Many
technologies that are broadly used
in commercial application are still
subject to export control restrictions.
On March 7, 2013, the White House
sent its proposal for export reform to
Congress. Export control reform could
be effective in promoting US exports
and preserving key skills in the indus-
trial base.
35. A&D 2012 year in review and 2013 forecast 31
The total A&D deal value for the
year was $19.5 billion, about
15 percent below the preceding
10-year average of $22.9 billion.
Based on our methodology,
the 2012 statistics include the
announcement that Hawker
Beechcraft would be purchased by
Superior Aviation Beijing; however,
the deal subsequently was aban-
doned. Excluding that deal, annual
deal value was $17.7 billion, or 23
percent below the 10-year average.
Overall, commercial aerospace
M&A had a strong year. However,
the defense sector did not generate
even one mega deal (above $1
billion) in 2012, while 2011 brought
four mega deals in defense, totaling
$10.6 billion.
In 2012, the defense sector faced
potential US sequestration and
uncertainty in defense spending,
which continues into 2013. Once
there is more certainty—or at
least less uncertainty—regarding
the future of defense budgets and
the impact on specific programs,
the defense industry will be able
to value companies and better
assess M&A opportunities. When
this period begins, defense M&A
is expected to become much more
dynamic and could lead to some
historic deals.
Defense M&A is facing a “perfect
storm” of pent-up demand, strong
balance sheets and cash positions,
and, most importantly, the neces-
sity to consolidate in response to
a contracting market. We view
Mergers and acquisitions
36. PwC32
Mergers and acquisitions
the attempted merger between
EADS and BAE Systems in 2012
as a harbinger of further defense
deals. While mergers among global
defense prime contractors will
continue to be challenging, due
to concerns by government stake-
holders, some transformative M&A
transactions are expected in defense
once the cloud of uncertainty is
lifted in the United States.
Looking ahead, four trends are
likely to affect M&A activity in the
coming years:
• Increasing consolidation in
response to a contracting defense
market and cost pressures
While mergers among global defense prime
contractors will continue to be challenging…
some transformative M&A transactions
are expected in defense once the cloud of
uncertainty is lifted in the United States.
• Further re-evaluation of supply
chains by big manufacturers, in
both civil and military segments,
as they seek to gain better
control of their large program
pipelines
• Continuing growth in the secu-
rity, surveillance, and homeland
security sector
• Greater investment in and
competition from fast-growing
markets, most notably China
We believe these trends will
provide the context for growth in
deal volume and value in 2013.
37. A&D 2012 year in review and 2013 forecast 33
The performance of the top 100 A&D
companies is a barometer for the health
of the industry and reflects strong and
disciplined management over the past
decade. It also reflects the strong demand
for the industry’s products and services.
Aviation has become a critical part of
our global infrastructure. Businesses
cannot operate effectively without
global deployment of human capital.
Aviation is increasingly inelastic, and
it demonstrated its resiliency during
the recession. While air freight is still
dwarfed by sea and land freight, an
increasingly larger portion of the global
supply chain now relies on air cargo.
The outlook for defense is clouded by
the impact of sequestration in the United
States and cuts to the defense budget. It
is still not clear how defense budget cuts
will impact major defense programs.
Furthermore, the security threat is
dynamic and could rapidly change
defense priorities. The defense industry
must respond to the affordability chal-
lenge and improve productivity.
The near-term and long-term forecast
for commercial aerospace is optimistic,
with expectations for significant
growth. Aviation will continue to grow
faster than the overall economy because
of its critical role in the global economic
infrastructure, bolstered by economic
growth in Asia, the Middle East,
Eastern Europe, and Latin America.
Defense faces challenges, including an
extended period of budget battles and
uncertainty. We believe 2013 should be
another strong year for the industry, and
possibly another record year, as avia-
tion growth continues to offset a weaker
defense market.
In summary