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Consolidation At A Crossroads: The Path To Transatlantic Cooperation"
Good morning, and thank you for the opportunity to address this distinguished audience.
The generosity of the introduction and the warmness of your welcome causes me to wonder whether you may be mistaking me for some other fellow named Coutts. I can assure you that any family connection to Coutts & Co. is at least 300 years removed … and that I am not here today to help arrange financing for the consolidation of the European aerospace and defense industry. And, if you thinking of some nautical connection, neither am I related to Roger Coutts, the world-class sailor from New Zealand. In fact, I can assure you that I do everything within my power to avoid small boats and large waves!
I would like to preface my remarks this morning with a brief story.
Some of you may be familiar with the anecdote, but it does illustrate a point that is fundamental to any discussion of industry consolidation - that we cannot always predict with accuracy where the future may lead. The story involves a poor Scottish farmer named Fleming. One day, while working in his fields, the farmer heard a young boy crying out for help and, upon investigating, found a terrified lad waist-deep in black muck that was sucking him further down as he tried to struggle free. Farmer Fleming rescued the youngster from the muddy pit and sent him on his way.
The next day, an ornate carriage pulled up to the Scotsman's modest home. An elegantly dressed nobleman stepped out and introduced himself as the father of the boy whom Farmer Fleming had saved. "I want to repay you," the nobleman said. "You saved my son's life." Farmer Fleming waved off the offer, protesting that he could not accept payment for what he did. "Well then," the nobleman said, pointing to a young boy standing in the doorway of the farmhouse, "may I at least take your son and give him a good education?" To this, the farmer agreed.
In time, Farmer Fleming's son graduated from St. Mary's Hospital Medical School in London, and went on to become known throughout the world as Sir Alexander Fleming, the discoverer of penicillin. Years later, the nobleman's son fell ill with pneumonia but was saved from certain death by the miraculous new drug, penicillin. And the nobleman's son was Sir Winston Churchill.
The point worth remembering is that we cannot always predict where seemingly random events will lead us or - more specific to our topic today - how cooperative or competitive relationships within our industry today will evolve in the future. With this caveat in mind, I would like to focus the balance of our 25 minutes together on three distinct issues:
First, how global events have dramatically influenced defense policy and the defense industry;
Second, a personal assessment of recent industry developments from my vantage point at Lockheed Martin;
And, third, issues and alternatives that government and industry must address if we are successfully to meet goals and missions in the future
Finally - despite the lesson learned from the story of the Fleming and Churchill families - I will risk a few predictions about the future course of the global defense industry. From this, I expect that you will come to understand my fundamental belief that meaningful partnerships and joint ventures remain the best way for companies to work across national boundaries.
The destruction of the Berlin Wall just a decade ago stands as an enduring cultural icon marking communism's collapse - the watershed event responsible for altering roles and missions of our nations' military, prompting incessant debate over appropriate levels of defense investment, and triggering a dramatic reshaping of the global defense industry.
This and other, more recent events have had a profound effect on our nations' military organizations and on the technologies and equipment our industry is called upon to provide. A decade of experience provides compelling proof that the decline of the Soviet Union has not made our planet an appreciably safer place. Democracies remain under attack, but a well-defined and well-understood monolithic foe has been replaced by multiple and largely ambiguous threats. This requires new doctrines, new tactics, and new tools for our warfighters.
To cite just one example of the revolution in military affairs, history tells us that for hundreds of years warfighting was premised on the belief that successful maneuvers had to be preceded by fires. Whether this preparatory barrage involved spears, rocks, arrows, bullets or artillery shells was simply a function of the era in which the battle was fought. In the future, however, unpredictable new threats and opponents may call for preliminary maneuvers by fairly small, covert and agile forces to set the stage for discrete fire and subsequent engagement by larger numbers of troops.
In short, fires preceding maneuvers becomes maneuvers preceding fires.
Recent events provide other important lessons. During the NATO action in Kosovo, we were reminded of the urgent need for interoperability among multinational forces. Let me say that this operation's success, despite communications bottlenecks and other problems presented by incompatible equipment, is testimony to the dedication of NATO's member nations and particularly the efforts of Prime Minister Tony Blair and Defense Minister Lord Robertson, who now goes on to an even more prominent position as NATO Secretary General.
Elsewhere, we are witnessing alarming growth in the number of countries possessing both weapons of mass destruction and the ability to deliver these weapons over long distances. This reminds us of the importance of ballistic missile defenses, including land-, sea- and space-based programs in which Lockheed Martin participates. We are particularly proud of our selection as the United States' industrial representative in the multinational Medium Extended Air Defense System program, or MEADS, which will give allied troops ready access to highly mobile air defense with capabilities far in excess of anything available today.
I believe that although the collapse of communism propelled us to where we are today, our future as allied nations, and as an industry, will be shaped to an even greater degree by four needs:
+The need for affordable systems;
+The need to defend against asymmetrical threats from emerging powers;
+The need for interoperability among light and lethal international forces;
+And the need to develop capabilities that ensure superiority with minimum risk of casualty.
We would do well to keep these needs foremost in mind as we continue the process of industry consolidation and embark on the first stages of transatlantic combinations.
Although I do not intend to review the history of U.S. aerospace and defense industry consolidation, I will share with you my observation that mergers and acquisitions in the U.S. generally have been market-driven transactions. Simply put, our customer market - principally the U.S. government - convinced industry that costs could be reduced by eliminating excess Cold War capacity through consolidation. The linkage between lower costs and potential improvements to corporate earnings attracted the notice of investors, with the result that industry consolidation was just as eagerly embraced by the financial markets.
The U.S. government has supported horizontal integration of the industry. Boeing, Rockwell and McDonnell Douglas joined to become the leading airframe manufacturer. Raytheon brought together elements of Hughes, Texas Instruments and E-Systems to become the largest U.S. defense electronics firm. The U.S. government has opposed what it perceives as attempts to vertically integrate the industry. Lockheed Martin and Northrop Grumman were not permitted to merge at least in part because of fears that we would stuff our platforms with our own electronics - despite the fact that we stringently adhere to merchant market and merchant supplier principles.
The U.S. government's distinct preference for horizontal integration guides ongoing consolidation at the subcontractor level, a process that has produced strong supporting players such as L-3 Communications and DRS Technologies, among many others. This process will continue as larger companies, including Lockheed Martin, refine business portfolios to focus on operations that add value for customers and create value for shareholders.
In contrast to North American consolidation, which has tended to be market-driven and horizontal, I would characterize the results of the first few years of European consolidation as leaning toward the vertical, and driven more by national interests than by market forces. As the European process progresses from mergers within borders to mergers across borders, and ultimately to linkages across oceans, we will learn the answers to several important questions.
+Will transatlantic transactions be true financial mergers, as was the case with Daimler-Benz and Chrysler, or will they be some more formal version of the numerous international partnerships the aerospace and defense industry has in place today?
+Will the transactions be shaped primarily by market forces, or by national interests?
+And, will the resulting entities be horizontally or vertically integrated?
We might look at other, closely related industries for some indication of how this process can work. Perhaps the best example I know of is one I also had the opportunity to witness first-hand while I was with General Electric, specifically the GE Aircraft Engines business. In 1969 - before I began working there - GE and Snecma of France joined in a transatlantic production agreement under which Snecma co-produced GE's CF6 commercial jet engine. Five years later, the two companies' relationship was formalized with the creation of CFM International, a 50-50 joint venture. Today CFM is the world's leading supplier of commercial aircraft engines, highly regarded for quality, reliability and customer support.
Those of us in the defense industry can, and should, take away several messages from the CFM success story. Message one is that a horizontally integrated, market driven partnership can work, serving both its customers and the shareholders of its parent organizations. Message two is my personal observation that CFM works so well because it was founded upon the concepts of mutual trust, respect and equality. The third and final message is that this sort of arrangement can work even in a business that is subject to significant government regulation and oversight.
In fact, the principal difference between CFM and partnerships in the industry's defense segment is that CFM does not penetrate the veil of national security. This suggests that resolution of security concerns may be the primary impediment to formation of multi-billion-dollar transatlantic defense partnerships.
Consolidation activity over the last 10 to 15 years in the United States and more recent activities in Europe generally have skirted security concerns. Security is not a major issue in the proposed BAe-GEC Marconi combination, which has propelled the UK to the lead in European consolidation. Nor was it a factor in Aerospatiale's acquisition of a partial stake in Dassault.
Given national security concerns, I personally am not surprised that the often-discussed European Aerospace and Defense Company thus far has failed to materialize. Although some criticize the concept as one that would encourage isolationism and promote a "Fortress Europe" mentality, I frankly believe a more accurate description of the outcome would be "weakness Europe". A strategy of procurement isolationism would in some cases deprive the European military of access to leading-edge technologies and solutions, resulting in an inevitable erosion of capabilities. I am well aware that some in Europe perceive a "Fortress America" mindset in which U.S. defense requirements are met almost exclusively by U.S. defense companies. Since my purpose today is to provide a perspective from U.S. industry, I would like to cite three points that debunk the myth of "Fortress America".
First, there is no monolithic U.S. aerospace and defense company equivalent to the EADC as it has been discussed.
Second, the U.S. Department of Defense generally compels its suppliers to compete among themselves for its business - a process that increasingly is becoming open to European competitors as well. For example, one of the businesses in Lockheed Martin's Electronics Sector currently is in competition with our friends from British Aerospace for a U.S. Air Force contract to provide penetrator warheads for conventional air-launched cruise missiles. Although the U.S. market may not be opening as rapidly as some would like, the Department of Defense is increasing its investment in promising international technologies. This points to expanding procurement opportunities in the future.
Finally, the U.S. Department of Defense has expressed its interest in maintaining competition even as the industry consolidates. The U.S. government on several occasions has exercised its prerogative to block proposed mergers when, in its view, the combined firms would have too much competitive clout.
I believe we need to shift our focus - as nations and as industry - away from "Fortress Europe" or "Fortress America" thinking, and instead seek to forge a transnational "Fortress Democracy".
As the European industry consolidates, I look for opportunities to exchange "best practices" that reflect our combined experiences on both sides of the Atlantic. I will share three observations from U.S. consolidation that might be beneficially applied by my European colleagues.
The first important lesson is that sheer size is itself neither an advantage nor a competitive discriminator in the marketplace - the very point that John Weston made in a media interview several months ago.
A second valuable lesson is that the most significant gains in competitiveness are realized only if merged companies are willing to engage in difficult actions - such as job reductions and plant closings to eliminate duplication, portfolio-shaping to focus on core competencies, and organizational changes to foster internal teamwork and present a single face to customers. In the case of the Lockheed Martin Electronics Sector, we have closed 38 percent of our plants, reduced payroll by more than $1 billion annually, divested approximately a dozen non-core businesses, and reorganized the remaining businesses into four segments that reflect our core capabilities - aerospace electronics systems, electronics platform integration, missiles and fire control, and naval electronics and surveillance systems. And, today, we are pursuing other cost-reduction initiatives aimed at achieving another $1 billion-plus in annual, steady-state savings by 2002.
A third critical lesson involves the importance of maintaining strong competition even as the number of competitors may decline due to consolidation. There are few areas in which a single contractor has become the U.S. government's sole or dominant supplier, effectively giving the military services no choice but to accept schedule extensions and cost increases as a consequence of development or production problems. From this experience, other nations should be wary of the emergence of "national champions" who may dominate either the entire market, or critical portions of the market.
I believe it is precisely to avoid the emergence of strong "national champions" in either North America or Europe that the U.S. Defense Department increasingly is opening competitions to bidders from outside the United States, is investing in international technologies that hold the promise of meeting future U.S. needs, and is actively promoting the concept of transatlantic mergers.
This brings us to what I call the consolidation crossroads. This is not the simple conjunction of two paths on crossing vectors, but rather an extraordinarily complex interchange - or a "spaghetti junction," as I believe you call it - in which the security, trade, diplomatic and industrial policies of many nations come together.
In the case of the United States, there also is a significant political element since we will have a presidential election in November 2000. The certainty of a new administration and the prospect of new appointees in departments such as Defense, State and Commerce conceivably could lead to new policy views on transatlantic consolidation within our industry.
For the moment, however, senior appointees of the current administration are publicly encouraging transatlantic mergers even as the Pentagon continues its formulation of policies and guidelines to address the very significant security and political issues inherent to such transactions. The governments of other nations have been less vocal in their views on the subject, and I frankly do believe the pace of consolidation could be accelerated if more open discussions of mutual policy issues and security concerns were to occur. Having said that, I also recognize that some nations may prefer to await the outcome of next year's U.S. presidential election before joining the discussion or debate.
In the near term, I personally do not believe that any company on either side of the Atlantic will seriously entertain a major, formal combination in the absence of explicit guidance on the terms under which such a transaction would be permitted by the interested governments. The investment of executive energy, time and money required for two companies to bring a proposed combination to the table for government review simply is too great to justify without a high degree of confidence that the transaction would win approval.
With the experience of the attempted Lockheed Martin and Northrop Grumman combination fresh in mind, I do not believe that any company will be willing to take what has been described as a "leap of faith" - jumping into uncharted waters in the hope its transaction will win government favor on both sides of the Atlantic.
I do believe that, if the U.S. government wishes to encourage transatlantic mergers, it can accelerate this process by promulgating clear, specific and unambiguous guidelines on the conditions under which such transactions would be approved. Such guidelines clearly will need to go beyond the accommodations made for GEC-Marconi's acquisition of Tracor, which essentially involved expansion of a special security agreement already in place to accommodate GEC's existing endeavors in the U.S. All of this leads me to conclude that, unless two companies are willing to serve as a real-time test case for still-evolving government policies, the first major transatlantic defense venture still may be some time off in the future.
Does this mean we should maintain the status quo in the meantime? Absolutely not!
There are ample opportunities for many of us to continue the recent, positive trend toward transatlantic partnerships, teaming and joint ventures - actions that very well might set the stage for subsequent mergers or major joint ventures in the style of CFM International. These arrangements frankly work well within the constraints of our business environment, such as declining defense investment, as a percentage of Gross Domestic Product; increasing demand for high-tech weapons and systems, which are more costly to develop and to buy; and growing recognition that the arsenals of allied nations must function together seamlessly.
Partnerships and joint ventures also offer advantages to both the companies involved and the customers they serve. Companies can team to bring together complementary strengths that enable them to jointly pursue specific opportunities for individual customers, avoiding the need for any one company to carry or to grow in-house all of the specific capabilities required to respond to discrete new business opportunities. Customers are more likely to receive optimal solutions when they are able to draw upon the relevant expertise of multiple companies from across national boundaries - without the artificial limitations of a "Fortress Europe" or "Fortress America" mindset. Finally, international partnerships and joint ventures discourage the emergence of "national champions" that can exert a monopolistic stranglehold on their nations' defense procurement process.
Lockheed Martin has significant and very positive experience with international partnerships, with more than 250 such arrangements in place throughout the world. Over 65 of these are within our Electronics Sector. These involve companies such as BAe, Marconi, Babcock and GKN Westland here in the UK, Bazan in Spain, and DaimlerChrysler of Germany and Alenia-Marconi of Italy - our partners on the international MEADS program which I mentioned earlier.
I believe our experience with these arrangements has been extremely positive because each relationship is different, with individual joint venture, teaming or partnership agreements tailored to meet specific market or programmatic requirements. In the case of the UK's 2087 sonar program, for example, Babcock is prime and we support the team with the expertise of our Ocean, Radar & Sensor Systems business. On the Royal Navy's Merlin helicopter program, our Electronic Systems company here in the UK is prime, performing all work in-country with the outstanding support of our strong partner, GKN Westland.
These relationships have been - and remain - extremely productive and mutually beneficial, providing a true "best of the best" approach to each customer requirement to which a team responds. At the same time, partnerships and joint ventures avoid many of the broad security concerns inherent to transatlantic mergers and acquisitions.
These arrangements also provide an effective and efficient means for governments and industry to deal with the growing complexity of military requirements, without demanding that each company or nation maintain a broad - and unaffordable - base of capabilities. Over time, I believe that many of the tactical partnerships in existence today will evolve into true strategic relationships, setting the stage for more formal arrangements and even outright mergers in the future.
Although U.S. securities laws and corporate policies prevent me from commenting on potential merger, acquisition or divestiture activities in which Lockheed Martin might engage, I promised to conclude with several observations and predictions and will do so now.
First, I believe that significant steps toward the first true major transatlantic merger remain some time away. Ambiguous government policies and guidelines, coupled with the inauguration of a new U.S. administration in January 2001, may make it too risky for businesses to seriously pursue a major combination in the near term.
My next prediction is that the first transatlantic merger will involve one large company, with annual revenues in excess of £10 billion, and a small- to medium-size company with sales of a few billion pounds. I do not envision governments on either side of the Atlantic permitting two very large companies to merge.
This leads to my third prediction, which is that I do not expect to see during my career the consolidation of our industry to the point that it would be dominated by just two very large global companies.
As is the case with the automobile industry, I believe we will have several very large companies in North America and several more in Europe, though each will conduct its business on a global basis.
For those who may disagree with my predictions, I will conclude with a certain promise - that Lockheed Martin will continue to form new transatlantic partnerships and joint ventures whenever it makes business sense to do so. We will do this in the belief that international partnerships achieve many of the benefits of full-fledged mergers while avoiding the most vexing issues associated with those transactions in the near term.
I thank you for the opportunity to speak with you this morning and hope that each of you has a successful and productive conference
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