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Going Global: US Firms Grow Foreign Connections as Domestic Spending Stalls

Jun. 22, 2013 - 03:45AM   |  
2013 Paris Air Show
Golden Anniversary: Crowds gather at the 50th edition of the Paris Air Show in Le Bourget, France, where defense executives laid the groundwork for international connections. (Colin Kelly / Staff)
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PARIS — At the 2012 Farnborough International Airshow, the talk revolved around how the sequester was going to eviscerate US defense companies. In 2013, the Paris Air Show was all about how those companies are going to make up for the cuts with business overseas. And company representatives had busier schedules than they had seen in years.

That doesn’t mean doing international business is easy. Companies face the complexities of regional differences, US export restrictions and ever-more complex offset demands.

“The faint of heart shouldn’t be involved in this process,” said Raytheon CEO Bill Swanson.

The show itself offered few developments and even fewer headlines. Most US companies, minding the cost of hauling people and equipment across the Atlantic, had a smaller footprint than in years past. Boeing had a single press conference associated with its defense business. Lockheed Martin had only three.

But cloistered away in company chalets, defense executives were busier than they’ve been in years, laying the groundwork for a barrage of international deals they expect will bolster bottom lines under pressure from US defense cuts.

“Companies both large and small are in a panic over US spending, so they’re looking at international business,” said Bruce Lemkin, former US deputy undersecretary of the Air Force for international affairs. “Can they make up the difference? I have no idea. Should you try? Of course. Can you make up part of it? Sure.”

For companies like Raytheon and Boeing, recent efforts to grow international business have paid off in the form of packed meeting schedules.

“We’re turning away meetings right now,” said Jeff Kohler, vice president for business development at Boeing Military Aircraft. “This is much busier than I remember two years ago.”

But making that international business happen carries with it certain complications, not least of which is managing an increasingly complicated supply chain and manufacturing base. Nearly every defense company says it will increase its percentage of international revenue by large percentages, but it’s not that easy.

“Each barrier to me, every 5 percent, is like going through the sound barrier, so we’ve got to be prepared for it, and wishing and hoping is not a good strategy,” Swanson said.

One of those barriers, managing offset obligations, has been tripping up some companies. Offsets are clauses added to contracts that require a vendor to invest locally, whether it be local manufacturing, technology transfer or business development.

In the past, unfulfilled offset obligations could be satisfied through payment of a penalty clause, and in many cases companies just factored the cost of the penalty into their budget calculation. But countries have moved away from that model, writing offset clauses that cannot be as easily satisfied and whose penalties are far worse.

Executives from several top defense contractors have complained that countries’ demands are becoming unreasonable, and industry sources said that for several companies, the obligations, which frequently accumulate from contract to contract, might be too great to make future deals worthwhile.

“The customer is getting smarter and the US defense community is waking up to the fact that the customer is getting smarter,” said Grant Rogan, founder of the Blenheim Capital Group and an expert on offsets. “There’s been a change of focus at the corporate level, without exception. There’s been an awareness about corporate liability from a balance sheet perspective. There’s been a focus on reputation which, in my mind, is more important than finances.”

With international business becoming a larger part of US contractors’ plans, handling those offset challenges is becoming a necessity.

“If you don’t know how to do offset business, you better stay out of the international business,” Swanson said. “What’s really changing dynamically is that nobody wants you to buy olive oil or olives or grape leaves, or pottery or petroleum. What they’re asking to do now is set up businesses. And oh, by the way, what you are now, is you’re no longer a supplier, you’re no longer a vendor, you’re a partner. And you better be willing to be there for some time and commit resources.”

Raytheon, which will grow its international revenue to 30 percent of its business in the near future, has been investing in the kinds of local presence that can allow for expansion, Swanson said.

“If your company goes, in the last five years six years, from 18 percent to 25 percent, that just doesn’t happen because the CEO says, ‘I want to be at 25 percent,’ ” he said. “You’ve got to put plans in place and strategies in place and structures in place and people in place to go do that. And for us to hit 30, we’re going to go make decisions now, this summer, this fall, to get ourselves ready for 30.”

Boeing, which hit 27 percent international revenue in 2012, also views the offset obligation as one of local partnership, although that view has developed over time.

“In the past we did, but I know others still do, say ‘OK, I’ve got a $1 billion offset commitment,’ Kohler said. “They go in, $1 billion, and I’m gone.”

“It’s evolved a lot,” said Chris Raymond, vice president of business development and strategy for Boeing Defense, Space & Security. “Just indicative of the mindset, everybody used to call it offsets. We changed the name of our group internally to international strategic partnerships. I don’t like the term offsets anymore, I think it implies the way it used to be. So our headset on that is that they’re partnerships.”

Beyond the offset challenges, US companies have faced a complicated export control system that has at times been criticized for being overly difficult. That’s beginning to change as the system is reformed and military item control lists become more definitive.

“I think the restrictions, I wouldn’t say they’re getting better but they’re getting clearer,” said Kohler, who previously served as the director of the Defense Security Cooperation Agency in the Office of the Secretary of Defense. “We’ve had better policy on electronic warfare, on [electronically scanned] radars. It goes back to [former Defense Secretary Robert] Gates and higher walls around fewer things.”

Although countries have complained about not being able to get products from the US, those complaints haven’t always been well founded, Lemkin said.

“Most of the countries that were complaining were talking about products that we weren’t going to sell them anyway,” he said.

But in other cases, products widely available internationally have been restricted. “If they don’t get it from us, they’ll get it from somebody else,” Lemkin said.

And administration officials, recognizing the challenges for industry, are making an effort to help.

“We are seeing changes, we are seeing changes in the attitude, we are seeing changes in cooperation,” Swanson said. “The degree varies in each of those categories, but clearly the senior leadership really gets it.

“It doesn’t change like a light switch going on and off, it’s more like a dimmer.”

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