A Better Business Model for Transnational Armaments Cooperation
The business model of transnational cooperation in armaments development and production is not working. Though founded on the promise of achieving economies of scale, especially through long production runs, the political allocation of work share tends to undermine this proposition. In its place, we propose an alternative model organized around the promise of achieving innovation in development among a small core of customers who share a compelling military-technical challenge. Because the resulting business model of transnational cooperation is a more coherent expression of how firms can ally across borders to make money and sustain profitability, it is also more likely to realize material solutions and options that show a fair return on defense ministries’ investments in these ventures.
A Long-Standing but Unworkable Business Model
A business model is “a statement of how a firm will make money and sustain its profit streams over time.” What distinguishes one company’s approach from alternatives is its particular “blueprint” of the “interdependent systems that create and sustain” its activities. Most simply for our purposes here, we would characterize a business model in four dimensions: its offerings (what one is selling), factors of production (how one is rendering the product or service), customers (to whom one is selling), and value propositions (why they’re buying, or “how do the factors render offerings that create value for customers”). Unpacking the business model of transnational armaments cooperation reveals why these programs have a poor record and suggestive of how the four dimensions could be made more coherent.
As Marc De Vore has shown, in armaments, a common model has dominated the largest transnational projects since the late 1960s. The offering has often been the most complex weapons systems, with highly integrated technical architectures. To cover the expense of these programs, the customer has tended to be an accumulation of as many defense ministries as are willing to contribute to the budget. To keep everyone happy while addressing the technical challenges, the factors of production—particularly the lengthy manufacturing runs—have been divided in advance into rigorously defined national work shares. This breadth of participation⎯”spreading the costs around”⎯it is thought would realize the value proposition of allowing lower costs through the mechanism of economies of scale in development and manufacturing.
The problem is that the model is not working. Back in 1999, a review by McKinsey & Company found that transnational projects had 30 percent higher cost overruns and 30 percent greater schedule slippages than comparable national projects. Since then, performance has not improved, and essentially every academic study of the issue has detected substantial inefficiencies.
The salient problem confounding the coherence of this business model is work share: Encouraging an increasing the number of customers was meant to discourage defections from production programs after development was complete by guaranteeing each national industry a juste retour. But parceling out work too many ways hampers management of the supply chain, through both inefficient selection of subcontractors and duplication of industrial processes. As Airbus Group CEO Tom Enders candidly observed about the problems that beset the A400M transport aircraft project,
It’s no secret that the industry would have preferred the one supplier that was known to be knowledgeable about large turboprop engines, Pratt & Whitney Canada. We conceded to a European consortium that had never worked together on that stuff. We tried to develop an engine by committee, I should say, up to a certain crisis point when this was changed. That has cost taxpayers billions. That has cost industry billions.
The full promise of scale efficiencies is difficult to achieve even in multi-national programs. It is worth noting that the actual cost curves of modern fighter aircraft, invariably produced by unitary enterprises, do not trend endlessly down by a power law. Rather, they tend to bottom out before completion of the first 200 units. The F-22 program, for example, experienced its lowest inflation-adjusted unit costs around the 115th aircraft—some three years and 64 units before production ended. These increases were not the closure costs of a line shutting down; these represented some form of organizational forgetting as experienced staff moved on to other pursuits, and newbies were trained at a price.
Few national air forces are today interested in more than 200 new fighter jets. This means that the learning efficiencies are ending just at the point where any single defense ministry should become interested in spreading production of a single aircraft across borders. Yet that very sharing, when subject to political allocation, dramatically reduces the efficiency of the supply chain, and thus increases overall cost.
A Better Model, Focused on Innovation
In response to this checkered record of transnational cooperation, we offer what we believe to be a better model, in four parts:
First, reset the proposition dimension of the business model from low cost to innovation; or, from the customers’ points of view, to expanding the set of options for solving their hardest military-technical problems. Coordinate the multinational funding of multiple, cross-border development teams pursuing new weapons concepts, not production lines.
Accordingly, reset the offering dimension of the model from production to research and development; or, again, from the customers’ points of view, to leveraging the best talent from around the world to addressing defense ministries’ shared challenges.
Third, in organizing the factors of production, concentrate on the hard organizational and regulatory work of combining synergistic engineering and design teams across borders, not on the political work of allocating production lots. Moreover, the factors dimension of this model implies the need for a more well developed scheme to manage intellectual property, allocate rights, license the manufacturing to approved production partners, and transfer the needed manufacturing know-how.
Finally, relieved of the scale motive, this new model can reset the objective of the customer dimension from “more is better” to “ few is best”. Indeed, there is some evidence that bilateral pairs are ideal.
For example, we find promising and broadly consistent with this new business model the new Anglo-French entente très cordiale most promising. At the summit at RAF Brize Norton this past January, Prime Minister Cameron and President Hollande agreed, amongst other things, on a two-year, £120 million joint feasibility study for a “future combat air system,” a £10 million contract for developing robotic submersibles for neutralizing seabed mines, and a joint investment in the British Atomic Weapons Establishment for research and testing. We equally commend for illustration the American-Israeli cooperation over missile defense that has underwritten development of the Israeli Iron Dome As Lazar Berman of the American Enterprise Institute has written, “[The] Iron Dome model—financially supporting a new system developed by an allied country after it proves itself” is a a new and clever way “to maintain American access to cutting-edge defense innovations.”
To Start Playing, Pick Your Team
What can industry do to bring this model into practice? Pick a hard military-technical problem shared by more than one ministry, and form an alliance. In the business of defense, we believe that alliances make great sense under circumstances closely resembling the typical transnational opportunity: new technologies and industrial processes buffeting customers’ buying objectives, combined with murky control over intellectual properties and asymmetric power among industrial partners. Implementing this new business model in these circumstance compels the top management of each team to select its partners primarily by capabilities, not just nationality. The fluidity of an alliance structure, without a 20th century obsession with scale, will produce a more flexible and less costly 21st century approach to modern security problems.
James Hasik is a non-resident senior fellow at the Brent Scowcroft Center on International Security, and a Williams Powers Fellow and Clements Graduate Fellow at the University of Texas at Austin. Steven Grundman is the M.A. & George Lund Fellow at the Scowcroft Center. This essay was originally presented as part of a series of talks at the British Embassy in Washington DC on “International Defence-Industrial Cooperation in the Post-Financial Crisis Era,” on September 16th, 2014.