Integrated defense
and security
solutions
Acquiring
prime contractor
capabilities
Contacts
Beirut
Dubai
London
Munich
Fadi Majdalani
Partner
+961-1-985-655
fadi.majdalani
@strategyand.pwc.com
Alessandro Borgogna
Partner
+971-4-390-0260
alessandro.borgogna
@strategyand.pwc.com
Bob Mark
Partner
+44-20-7393-3477
bob.mark
@strategyand.pwc.com
Christian Burger
Senior Partner
+49-89-54525-546
christian.burger
@strategyand.pwc.com
Berlin
Leonardo Monti
Principal
+971-4-390-0260
leonardo.monti
@strategyand.pwc.com
Diane Shaw
Principal
+44-20-7393-6420
diane.shaw
@strategyand.pwc.com
Stefan Frey
Partner
+49-89-54525-646
stefan.frey
@strategyand.pwc.com
Florham Park
Los Angeles
Randy Starr
Partner
+1-973-410-7604
randy.starr
@strategyand.pwc.com
Jono Anderson
Principal
+1-424-294-3736
jono.anderson
@strategyand.pwc.com
Dr. Hans-Joerg Kutschera
Partner
+49-89-54525-556
hans-joerg.kutschera
@strategyand.pwc.com
Dr. Jan Wille
Principal
+49-30-88705-898
jan.h.wille
@strategyand.pwc.com
DC
Joshua Harris
Principal
+1-703-682-5630
joshua.l.harris
@strategyand.pwc.com
About the authors
Christian Burger is a Munich-based senior partner
with Strategy& and is a senior member of the firm’s
operations and engineered products and services
practices. He has worked with numerous international
clients in the aerospace, defense, technology, and
healthcare industries, and focuses on strategic
transformation, organization, and governance.
Dr. Hans-Joerg Kutschera is a partner with Strategy&
based in Munich. As a senior member of the firm’s
engineered products and services practice, he focuses
on strategic transformations in supply chain, operations,
and after–sales, primarily in the aerospace, defense, and
security industry.
Diane Shaw is a principal with Strategy& based in London
and a senior member of the firm’s engineered products
and services practice. She has led numerous projects with
defense and security clients in the U.K. and Middle East,
focusing on strategy formulation and transformation, as
well as the design and execution of operating models.
Dr. Jan Wille is a principal with Strategy& based in
Berlin and a senior member of the firm’s operations
and engineered products and services practices, with a
focus on aerospace and defense. He has led numerous
projects with commercial and public-sector defense and
security clients on strategy formulation, operating model
development, and operational excellence.
Stefan Frey, a partner at Strategy&, and senior associates
Jonas Seyfferth and Andrew Suddards also contributed to
this report.
2
Strategy&
Executive summary
Governments in developed markets are scaling back on defense
spending, which is forcing defense and security companies to identify
new revenue streams. Fortunately for these companies, many
governments in emerging markets are still increasing their spending and
want to improve their defense capabilities. For defense contractors, this
represents an opportunity beyond just delivering technology and
equipment. Governments in emerging markets typically don’t have deep
expertise with complex modern weapons systems and command and
control structures. What they need are integrated, end-to-end solutions.
These are potentially very long-term and lucrative engagements for
contractors. However, to deliver integrated solutions, they will need to
develop capabilities beyond those of a traditional pure technology provider,
and they must be able to help customers develop their own capabilities
to support the project’s long-term success. Additionally, contractors need
sophisticated service delivery mechanisms in order to implement all
aspects of the integrated solution properly. Not surprisingly, these service
delivery requirements — project management, risk management, and
transformation management — all become increasingly complex the
more integrated the solution.
There are four primary ways that contractors can fill their capability
and service delivery gaps and become what we call prime contractors
for integrated solutions: (1) internal buildup, (2) acquisition,
(3) subcontracting, and (4) partnering. To be clear, not all contractors
must become prime contractors for integrated solutions to participate
in the emerging markets. Some will retain their focus on providing
technology and equipment. However, we believe that developing prime
contractor capabilities will put an organization in a more powerful position
to compete in the global environment. As a prime contractor, a company
has control over the total project, is close to the end customer, and can
decide which subcontractors are involved in the project. This creates a
value proposition that’s very difficult for competitors to imitate.
Strategy&
3
The emerging market
opportunity
The global defense and security industry is in the midst of a profound
realignment. Budget cuts by governments throughout Europe, sequestration
in the United States, the winding down of Western involvement in
Afghanistan, and the continually changing nature of warfare are leaving
many companies scrambling for new avenues of growth.
Historically, about 90 percent of the defense and security industry’s business
has come from developed markets. But from 2009 to 2013, defense
spending decreased annually by 3.3 percent in the U.K., 3.1 percent in
the U.S., and 2.7 percent in France. At the same time, other business
challenges in developed markets were becoming more acute. For
example, strict regulatory and sovereignty have limited expansion
opportunities. Companies outside the sector, such as IBM, Cisco, and
Fluor, are capturing more market share (with as much as 40 percent of
U.S. defense hardware spending now going to such commercial players).
And as threats to national security such as cyber risks evolve ever more
rapidly, OEMs need faster development cycles to respond.
OEMs need faster
development
cycles.
As a result, many defense and security companies are casting an eye toward
emerging markets, where budgets are on the upswing and where
governments are now planning to modernize their homeland security and
defense infrastructures to bring them up to par with Western counterparts.
This opportunity is particularly pronounced in the Middle East, Southeast
Asia, and Latin America. From 2009 to 2013, defense spending increased
annually by 10.8 percent in the UAE, 8.1 percent in Saudi Arabia, 7.4 percent
in China, and 1.3 percent in Brazil (see Exhibit 1, next page).
4
Strategy&
Exhibit 1
Defense spending has increased in emerging markets as it has contracted in mature markets
Development of defense spending
Maturity and compound annual growth rates 2009–13, by country1
Maturity
Growth
Indonesia
17.8%
UAE
3
10.8%
Saudi Arabia
8.1%
China
7.4%
Russia
7.1%
South Korea
1.8%
Poland
1.4%
Brazil
1.3%
Germany
0.1%
Malaysia
0.1%
India
0.1%
-0.1%
Japan
France
U.S.
U.K.
-2.7%
-3.1%
-3.3%
Maturity index2
High
Medium
Low
Average annual growth rates 2009–13 at constant 2011 prices and foreign-exchange rates.
Maturity based on military capabilities (people and information) and defense industry base (import versus export).
3
UAE growth interpolated based on 2012 (no 2013 data available).
Source: Stockholm International Peace Research Institute, Strategy& analysis
1
2
Strategy&
5
Opportunities and challenges
Not only are emerging markets experiencing growth in their defense
budgets, but the breadth and depth of their needs are in many cases
greater than in developed markets. Few of these governments have
conducted large-scale modernization programs, most are inexperienced
with modern defense and security solutions, and they often rely on
outdated command structures and strategies. They can afford
technologically complex weapons systems, but they often lack the
expertise to integrate and support such systems, and at times even use
the hardware. For example, when introducing a C4ISR (command,
control, communications, computers, intelligence, surveillance, and
reconnaissance) system, organizations struggle with managing the new
flood of data, drawing relevant conclusions, and initiating the appropriate
response. As a result, many want integrated defense and security
solutions that include everything from technology delivery to full
capability implementation.
One possible way for a defense and security company to play in this
environment is to become a prime contractor, which means providing
the equipment, ensuring the customer has all capabilities in place to
operate the new technology, coordinating all parties including
subcontractors and other stakeholders, and assuming end-to-end
responsibility for running the complete defense and security program.
Many emerging
markets
governments
want integrated
defense and
security
solutions.
The revenue potential is enormous. Integrated solution projects are usually
big, billion-dollar-plus contracts spanning multiple years, providing the
kind of long-term financing necessary for new product development.
What’s more, the lengthy engagement gives the OEM in-depth knowledge
about the customer, a chance to influence customer development in favor
of the OEM’s product portfolio, and opportunities to sell additional
technologies. For instance, a customer that wants to increase border
security with better on-the-ground monitoring devices may eventually
be persuaded to purchase unmanned aerial vehicles or helicopters to
add air support.
6
Strategy&
“A few years ago, we were selected as prime contractor for
a multiyear defense and security program in the Middle
East. A year into the project, the government official in
charge was removed due to a bribery scandal unrelated
to the project. The new official invalidated the contract
and demanded a new approach to the project, with little
concern for our investments already made in the first year.” —Country managing director, European OEM
However, these opportunities do not come without significant challenges.
Agreements in these countries can be subject to change — even after
contracts have been signed — through intervention by certain government
officials, national politics, or public opinion.
Another challenge is defining the scope of the project and requirements
for completion at the outset of the engagement. If this planning doesn’t
occur, cost and time overruns are a risk, which undercuts the customer’s
confidence. A third major challenge is coordinating the large number of
stakeholders involved in an integrated solution. Clear project governance
structures, a project management office, and well-defined roles and
responsibilities are vital. A project can quickly unravel if coordination
is lacking.
For instance, the defense community is currently looking at Brazil, where
the first tranche of a US$6 billion border surveillance system was awarded
to a local consortium of vendors. Given the multitude of involved
organizations on the purchasing side (Brazilian Ministry of Defense,
law enforcement organizations, etc.) and on the supplier side, experts
consider stakeholder complexity and limited experience with largescale high-tech security programs to be the main challenges.
Strategy&
7
Building capabilities
Based on our extensive work with companies and governments around
the globe, we believe overcoming these challenges is a matter of having
in place the right capabilities, as well as the right skills to deliver those
capabilities to customers.
The aspiring prime contractor must build up the full complement of
technical and nontechnical capabilities needed to deliver an integrated
solution to customers. Also, and no less critically, it must be able to help
customers develop their own capabilities to support the project’s longterm success. We use the “TEPIDOIL capability wheel” from the U.K.’s
Ministry of Defence to illustrate the entire set of capability needs for an
integrated solution. (TEPIDOIL is an acronym for training, equipment
and technology, personnel, information, doctrine and concepts,
organization, infrastructure, and logistics.) The more complete the
capability wheel, the further a contractor has evolved from an
equipment and technology provider to a prime contractor capable of
offering an integrated solution (see Exhibit 2, next page).
8
Start with the
doctrine and
overall strategy.
Strategy&
Exhibit 2
The TEPIDOIL capability wheel
Logistics
Training
Equipment and
technology
Infrastructure
Interoperability
Organization
Personnel
Doctrine and
concepts
Information
Note: Similar concepts
are used in other
markets — e.g. the U.S.
uses DOTMLPF, which
stands for doctrine,
organization, training,
materiel, leadership and
education, personnel,
and facilities.
Source: U.K. Ministry of
Defence, University of
Cambridge, Strategy&
analysis
Doctrine- and capability-led programs
Often, large modernization programs are driven by the right-hand side
of the wheel — technology and infrastructure — given the technological
expertise and mind-set of traditional contractors. The left-hand side,
doctrine and concepts, is often neglected or addressed only very late
in the project. This can result in the challenge of a customer receiving
state-of-the-art equipment but lacking the organizational and conceptual
capabilities to operate it.
Instead, we propose that any modernization program should start with
the doctrine and overall strategy — derived from the threat situation and
organizational capabilities — before defining which technologies should
be acquired.
Strategy&
9
“Our client wanted to actively participate in the
project to learn from us and to understand how to
run comprehensive defense programs. However,
involving their inexperienced staff in our day-to-day
project work slowed us down and made it harder to
get our work done within the agreed time.”
—Program manager, European OEM
Doctrine and concepts: Describing core processes and guiding forces in
their actions today (doctrines), as well as defining the deployment of
future capabilities (concepts). What’s the operational concept of leading
a security force in the future? How are standard operational procedures
defined? As noted above, modernization programs should be driven by
the doctrines, but in reality, given the tech mind-set of the contractors,
they are often “technology-led,” resulting in a mismatch of strategy and
deployed technology.
Equipment and technology: The systems and weapons needed to equip an
individual, group, or organization. This is the core of a capability. If the
goal is to modernize ground forces, for instance, the customer will need
technology such as infantry armor and weapons or heavy equipment
such as battle tanks.
Logistics: Planning and conducting the operational movement and
maintenance of people and equipment, including acquisition, storage,
transport, maintenance, evacuation, and disposal. For example, for the
restructuring and modernization of border security, the surveillance
systems must be transported to the right places, and then maintained
and repaired over time.
10
Strategy&
Infrastructure: The acquisition, development, management, and disposal of
buildings, structures, utilities, and facility services. For example, garages
and service workshops are necessary to provide effective maintenance for
new vehicles and vessels.
Information: Managing data, information, and knowledge across the
organization to ensure system interoperability. If maritime surveillance
systems detect an object, for example, this information must be analyzed
and then relayed to the command centers to process the data, distribute
the information, and issue orders.
Training: Practicing technical and mission-specific skills as well as
development of process knowledge. In short, people need to know
how to operate new equipment and technology.
Personnel: The recruitment and deployment of sufficient capable and
motivated personnel to fulfill the organization’s duties.
Organization: Organizational relationships of people, including military,
civilian, and contractor structures. For example, a security force might
comprise thousands of individuals with different roles, ranks, and
hierarchies. An organization needs to define who is reporting to whom.
Are there regional teams or central teams? How many people are
stationed at each post, and so on?
Strategy&
11
Building delivery skills
An aspiring prime contractor needs sophisticated service delivery
mechanisms in place in order to implement all aspects of the integrated
solution properly (see Exhibit 3). And these service delivery requirements —
project management, risk management, and transformation management
— become increasingly complex the more integrated the solution.
Exhibit 3
Requirements for providing integrated defense and security solutions
Doctrine and
concepts
Organization
Personnel
Training
Information
Customer
capability
needs
Infrastructure
Logistics
Equipment and technology
Transformation management
Service
delivery
requirements
Risk management
Service
offering
Hardware
only
12
Project management
Maintenance
and logistics
Training and
simulation
Including development
of customer organization
(e.g., strategy, operating
model, organizational
design, processes).
Source: Strategy&
analysis
1
Integrated
solution1
Strategy&
“In our first integrated solution project, we clearly
underestimated the client’s need for getting support in
restructuring their complete organization. They even
asked us to rewrite their doctrines and standard operating
procedures — something we haven’t done ourselves so far.”
—Program manager, U.S. OEM
Project management tasks are significantly broader for an integrated
solution than for a pure technology project. The project management
teams must coordinate and track activities, and report on progress across
many different stakeholders and inexperienced customers. Adding to
the complexity is the highly dynamic environment in many emerging
markets, where participants and schedules are often in flux over the course
of the project. These challenges make proactive “issue management” and
decision support crucial.
Risk management plays a critical role even before the start of the project.
Given some of the “softer” goals of integrated solution projects — such as
building up a new organization’s capabilities or formulating a new
strategy — contracts must be carefully worded to ensure that milestones
and goals are understood and the customer is willing to pay. After the
project has begun, the broad scope of the project presents significant
execution risk, and there are also various highly unpredictable external
risks (e.g., political shifts).
Risk
management
plays a
critical role.
Transformation management comes into play because integrated
solutions are so broad and deep that they often result in the large-scale
transformation of the customer’s existing organization and processes.
This transformation requires long-term investment and bears its own
significant challenge for the prime contractor. Managing such
transformations within a client requires understanding the culture
and the various formal and informal levers of change.
Strategy&
13
Filling in the gaps
Given the historical role of many OEMs as pure technology providers, most
never developed the capabilities and service delivery mechanisms necessary
for integrated defense and security solutions. In our experience, the capability
gaps are often widest in the areas of organizational development and
doctrine design, whereas service delivery mechanisms around transformation
and risk are often tailored to classic technology projects and not suitable
for the new challenges of integrated solutions. It’s critical that aspiring
prime contractors close these gaps, and we have identified several strategies
for doing so. An OEM’s decision depends in part on its starting point
and individual project requirements (see Exhibit 4).
Helv
Helv
Exhibit 4
Customer needs versus OEM proposition: Mideast security program example
Helv
Helv
Capability
Low
Medium
Doctrine and concepts
High
Gap
Organization
Personnel
Customer
need
Training
Information
Infrastructure
Prim
OEM
proposition
Ma
Logistics
Equipment and technology
Transformation management
Risk management
Project management
14
Source: Strategy&
analysis
Strategy&
Internal buildup: The organic development of missing capabilities. This
is a slow process that adds higher fixed costs to the organization; these
capabilities must be utilized to justify their expense. However, internal
buildup is a sustainable approach to adding capabilities. It’s best suited
to large-scale projects matching the OEM’s strategic business development
agenda (i.e., the OEM expects to work on other projects with similar
capability requirements).
Acquisition: Targeted acquisitions of other companies with strengths in
missing capabilities. This is more complex, requiring the identification and
acquisition of target companies, as well as effective post-merger integration.
Caveats aside, it is also a sustainable approach to building capabilities.
Subcontracting: Hiring specialized providers in areas such as IT. This is a
“quick fix,” but it is costly and introduces coordination complexity. The
bigger downside, however, is that it does not truly add capabilities;
rather, the organization simply hires them for a finite period. As a result,
subcontracting is often well suited to smaller, short-duration projects.
Partnering: Joining forces with another company with complementary
competencies, such as a systems engineering and integration service
provider, to offer all capabilities necessary for integrated solutions. Though
this approach can be put into practice more than quickly than “internal
buildup,” it demands a high level of coordination and quality control
procedures. On the positive side, each partner has an opportunity
to learn from the other during the collaboration and efficiency will
improve with joint experience over time. In many cases, partnering
can provide the best balance of risk and return (see “Capability
Buildup through Partnering,” next page).
Strategy&
15
Capability buildup through partnering
Partnering with other organizations in
the defense and security ecosystem is
an effective way to close capability gaps
for specific projects, but an OEM must
undertake it with the utmost care
(see Exhibit A).
• First, the contractor needs to
define the capabilities necessary
for the specific project, assess its
own capabilities, determine which
capabilities are missing, and identify
potential partners that can bring these
capabilities to the table.
• Next, OEMs should establish a
stringent tendering and partner
selection process. By developing,
maintaining, and fostering a partner
network, OEMs can speed this process
and also ensure interoperability of
partner systems and services.
• Rigorous contract and subcontract
management is also critical for OEMs,
as well as service providers and
advisors. This should also cover quality
assurance and monitoring, and link
payment processes to service delivery.
Implemented correctly, partnering
can cover all capability needs, reduce
uncertainty and project risks, and instill
greater customer confidence.
Exhibit A
The partner ecosystem of defense and security OEMs
Government
agencies
Armed/security
forces
Commercial
conglomerates
Civil works/
construction
contractors
Strategy and
operations advisors
Pure-play
defense and
security OEM
Other defense
OEM/product
specialists
Systems engineering
and integration
(SE&I) services
Systems engineering
and technical
assistance (SETA)
services
16
Information
systems/IT
services
Subcomponent
manufacturers
Source: Strategy&
analysis
Strategy&
Prime contractor versus
technology provider
Developing the full complement of capabilities allows a company to play
the role of prime contractor, but that doesn’t mean the company must
play this role in every case. In certain circumstances the contractor might
choose the more limited, focused role of traditional technology provider
with responsibility only for delivering and installing the technology
and/or hardware.
There are downsides to this traditional role. A contractor has no control
over key overarching program decisions, and its ability to up-sell is
generally limited to maintenance and training. Still, there are good
reasons a company with prime contractor capabilities might choose to
go this route, such as reducing risk by not taking on overall project
responsibility, lowering ramp-up costs (since no additional capabilities
must be developed), and more efficient production with standardized
products and systems. Even if a contractor chooses the pure technology
role, some other entity is likely to be taking on the role of integrator,
such as a service provider that specializes in project management of
government/infrastructure projects.
Strategy&
17
To decide which option is most appropriate in a specific situation, an
OEM must weigh several factors:
• Strategic relevance/revenue potential of project: If the market for a
specific defense solution is very small, then perfecting a set of
capabilities around that solution may not be worthwhile.
• Match of OEM capabilities with project requirements: If a contractor
must strike several partnerships to offer all necessary capabilities for
a specific project, it may decide the coordination complexity is too
expensive or risky.
• Customer background and competition: Domestic contractors are often
given preference when bidding for government contracts; this may
make acting as the prime contractor impossible, or simply too difficult
if the company is forced to work with certain domestic
subcontractors.
•Project environment and geography: The project environment can
become very complex if there are many competing stakeholders and/
or the reporting and auditing requirements are cumbersome. Another
complexity is geographic distance between the OEM home market
and the project location. This may require the construction of new
offices in remote locations, hiring expats, and long transport routes.
18
Strategy&
Conclusion
The desire by governments, particularly in the emerging markets, to
modernize their defense and security capabilities creates a growing
need for prime contractors that can offer end-to-end integrated
solutions. That’s not to say all contractors must become prime
contractors. There will still be a role for the pure technology plays,
which are less risky in the short term because they have lower fixed
costs and aren’t under pressure to utilize all TEPIDOIL capabilities. In
fact, even companies with prime contractor capabilities will sometimes
choose to play a more limited role for certain projects. The difference is
that prime contractors will have a strong and sustainable value
proposition that’s very difficult for competitors to imitate.
Strategy&
19
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