Congratulations to Defense News for adding some Chinese defense contractors to its annual Top 100 list. Because these enterprises are state-owned and often part of large, diversified enterprises, the data for annual sales is difficult to obtain. The additions have caused a reshuffling of positions relative to last year’s Top 100, but the absence of Chinese enterprises had painted an incomplete picture of the structure of the global defense sector.
Some planners and analysts may scoff at the inclusion of Chinese firms, or for that matter enterprises of other countries that don’t have markets open to U.S. and European firms. But this raises the first of three lessons that can be learned from the Top 100: Pay attention to China.
The U.S. Defense Department and other defense ministries have been paying a lot of attention to China for more than a decade, and contractors have undeniably benefited from spending to counter China’s emerging defense capabilities.
The data listed in the Top 100 for eight Chinese enterprises raises a host of questions: Are these firms profitable? How much do they spend on research and development? What are management incentives and goals? How do these firms benefit from commercial enterprises that are often part of their business portfolios?
A recent McKinsey & Company study observed that the largest 100 Chinese firms in all sectors generated approximately 18 percent of sales internationally, compared to 44 percent for U.S. firms in the broad S&P 500 market index.
The same relationship may hold for China’s defense contractors. China’s major defense export customers have tended to be relatively small in number — Pakistan, Bangladesh, Thailand, Myanmar and some African states.
There are harbingers of change, however, with a Chinese firm selected in 2013 to supply Turkey with an air defense system (the deal fell through) and more recent UAV and ballistic missile sales as well as local development for Saudi Arabia. It’s likely that companies listed in the Top 100 will see more Chinese enterprises in global markets in the years to come.
The second lesson from the Defense News rankings is that it’s difficult for contractors to make significant moves on organic sales growth alone. Lockheed Martin has been the No. 1 ranked company since 2003; Boeing, Northrop Grumman, Raytheon, General Dynamics and BAE Systems have been ranked between No. 2 and No. 6.
There are two possible exceptions to this rule, however, in SpaceX and General Atomics, neither of which appear on the Top 100. There’s been a general dearth of new entrants in defense that have reached scale. Big moves in relative position have typically resulted from divestitures, or mergers and acquisitions .
For contractors that are on the list, this leads to a third lesson: The things you can’t see may kill you, or at least trip up your well-laid plans.
SpaceX is possibly an anomaly, as there are not that many billionaires with very different business models and goals targeting specific defense segments. But defense customers will continue to demand new and innovative products and services, and the number of potential competitors is far greater than those listed in the Top 100. The threats here may come from smaller firms that can rapidly scale up in new market segments — such as space, cyber or artificial intelligence — or protracted forays by large commercial technology firms into markets dominated by traditional contractors.
There are other companies not listed in the Top 100 that will play impactful roles in defense market segments. The initial public offering of Parsons raises its profile in defense. Kaman’s plan to sell its distribution business and concentrate on engineered products is another change, and the agreement between AeroVironment and Kratos announced in 2019 is another factor to weigh.
Byron Callan is a policy research expert at Capital Alpha Partners. He specializes in the defense and aerospace industries.