What are the implications for Australia’s defence industry of the impending re-organisation of Defence and the DMO? To frame an answer to that question you need some sense of how Defence, as a customer, currently shapes the industry itself and the market more generally. I’ve discussed some of this in previous Blog posts; the diagram below shows how I believe a number of external forces shape Australia’s defence industry and I’ll explore these forces, and the potential implications of some of the changes in the department, further down the page.
Fundamentally, the industry is shaped by four forces: Defence’s need for high technology; its culture of risk aversion; the relatively small size of Australia’s domestic defence market; and the monopsonistic and monolithic nature of the defence customer. These last two factors in combination, especially when compounded by other factors such as the Customer-Active Paradigm, make the Australian defence market unique.
Defence tries to use technology to compensate for the small size of the ADF: it explicitly seeks equipment which provides it with a capability edge and is generally not available to Australia’s regional neighbours.
Will this change with the reorganisation of Defence and the DMO? Not at all: the drivers of the ADF’s technology demand will remain exactly the same.
However, technology, and the complexity that goes with it, has a price: Defence has suffered many disappointments and much criticism in the past over equipment acquisition projects which have run late or exceeded their budgets. This has made Defence extremely risk-averse and therefore more inclined to buy low-risk products off the shelf, and therefore usually from overseas, rather than take the risk of developing new equipment in-country.
This inclination is reinforced by Australia’s strong alliances with both the USA and the UK and the resulting privileged access it receives to their intelligence, technology and equipment. To some extent also a preference for US equipment, for example, reflects a genuine need for interoperability with Australia’s major ally as well as a need to ensure the health of the alliance. Arguably, a major factor in choosing foreign-manufactured equipment in preference to locally manufactured is often the existence of a logistics supply chain and large organisation to which the ADF can turn in time of war or if it encounters technical problems with its equipment.
Arguably also, the case for an overseas purchase isn’t always tested with appropriate rigour, creating the impression of a ‘lazy default’ which favours imported, off the shelf equipment and tilts the playing field against local industry players seeking to develop new equipment in Australia, or even to play some sort of role in the industrial supply chain.
Will this change? That ‘lazy default’ is a very subjective judgment but is based often on a lack of transparency, and therefore of any contestable logic, in the Defence and government decision-making processes. As long as a Prime Minister or Minister for Defence feels he or she has the right and a reason to make a ‘Captain’s call’, sound process will be at the mercy of political forces, regardless of the capability in question. A community-wide perception that Australian industry is incapable of doing an efficient, economical job simply makes it easier to argue a case for cutting local firms out of the action.
What about a more considered capability development and acquisition process? A couple of ‘IFs’ here - IF 1) a national debate on industry policy gets under way, embracing defence industry policy also and considering operational capability along with economic and industrial base factors, then there’s a chance that risk-aversion might be mitigated somewhat by a wider debate on the benefits of engaging Australia’s defence industry. And IF 2) the reorganization provides an opportunity for local industry and R&D capabilities to engage better with the end-user and show their worth without being filtered through a separate and disinterested DMO, then again the prospects may be good. In recent weeks it would appear that a sector-wide policy for Australia’s naval shipbuilders and repairers is under active consideration: this may address partially the two ‘IFs’ above. And if this proves to be more than a political expedient and delivers real benefits to the Navy as well as industry it would be nice to think such a policy could be applied more widely across the defence sector.
This all highlights the fact that the Defence market in any nation is a monopsony: the only customer for defence equipment and services is the Government which, through the way it spends its acquisition and research budgets, exercises complete control over the size of the market, its behaviour and the barriers to entry faced by industry players. This won’t change.
Furthermore, Defence is a monolithic customer: if a market exists in Australia for, say, 100 jet fighters capable of carrying out a particular task, aircraft manufacturers will not compete to win a 20 or 30 or 60 per cent market share – Defence will typically buy 100 identical aircraft from a single manufacturer under a single prime contract, though possibly in successive phases or ‘tranches’. Market share becomes a binary value – one hundred per cent, or zero. This has important implications for manufacturers, especially as Defence may not replace these aircraft for 30 years or more – the market is characterised by significant peaks and troughs in demand with significant technology growth between them.
Again, this won’t change.
The relatively small size of Australia’s defence market means that demand is frequently small so local manufacturers may not achieve economies of scale when developing new products for the ADF and therefore may not be able to compete on price with foreign manufacturers whose larger domestic markets (and possibly other export sales) have helped make their equipment cheaper and have spawned a robust engineering and logistics capability to support it.
This won’t change: Australian defence spending isn’t likely to grow unexpectedly so the accessible market for Australian defence companies can only grow if Defence spends more of its money on local acquisition, or if Australian firms make significant inroads into export markets and global supply chains – something which Defence has helped with in the past and could usefully do again.
Because of the shaping effects on it Australia’s defence industry has been only intermittently successful in developing sustainable R&D, design, systems integration and manufacturing capabilities along with the management and marketing skills that are required to innovate successfully and compete credibly in the market place. For all these reasons barely 40% of Defence’s equipment acquisition budget finds its way to Australian companies, either directly or indirectly (via overseas pries dealing with local suppliers and sub-contractors). Graeme Dunk’s excellent analyses of DMO capital equipment spending patterns on behalf of ABDIU suggest that even 40% may be hard to sustain into the future unless something changes.
A cursory sensitivity analysis suggests that the greatest beneficial change in Australian industry’s prospects would come from tackling the two things that could change: market size and the risk-aversion of the Defence customer. The former can only change if Australian firms gain better access to export markets and global supply chains, and Defence has a vital enabling role to play in this. To change the latter, industry needs to shoulder the burden of proof, and do so convincingly, in order to attract more of Defence’s attention and then, hopefully, money.