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KEY NOTE DEFENCE INDUSTRY : June 2003

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This report covers: defence equipment, sea defence, land defence, air defence, Downey Cycle, Defence Procurement Agency, Defence Logistics Organisation, Defence Budget, MOD Contractors, Ministry of Defence, Defence Agencies, Defence Support Agencies, defence projects, Strategic Defence Review, NATO Europe,

Companies covered include: BAE Systems, Thales,Rolls-Royce, GKN, Smiths Group, VT Group, Serco Group, Cobham, Alvis, Ultra Electronics,

EXECUTIVE SUMMARY

Although the Armed Forces have been in the public eye recently, the industry that sustains them is probably less well understood. In the run-up to the 2003 Iraqi Campaign, the UK defence industry responded to 170 Urgent Operational Requirements, valued at £500m, in order that the Services would be properly equipped. This seventh edition of Key Note's Market Review of The Defence Industry examines the complex world surrounding the Ministry of Defence (MoD), in which the industry operates.

A Strategic Defence Review (SDR) was undertaken after the Labour Party's victory in the 1997 General Election. Eventually published in July 1998, the SDR indicated the way ahead for the Services: from static (Army and Royal Air Force) positions in Germany to expeditionary warfare based around two new, large aircraft carriers. Following the terrorist attacks on the US on 11th September 2001, the MoD had to revise its thinking and a New Chapter to the SDR was published in July 2002. The resultant policy from these deliberations is examined in Chapter 1 of this Market Review (Defence Policy), which also looks at the MoD's planning, capabilities and requirements. Attention is given to the European military environment within which the MoD operates, and to the associated capability shortcomings.

Chapter 2 (Armed Forces) reviews the number of men and women who make up the UK's Armed Forces and the civilian personnel who support them. The problems of retention in the Services — particularly the Army — are all too apparent, with an overall shortage of 8,560 trained personnel on 1st January 2003, despite the requirement continually being lowered. The percentage of women in the Services continues to increase, as does their importance. Chapter 2 also covers the organisation of the Services and the equipment they operate.

The defence budget and its place within national expenditure is examined in Chapter 3 (Defence Expenditure). As in other Departments of State, the biennial Spending Reviews (SR) have become more important to the MoD than the annual Budget Statements. The third SR, setting Departmental Expenditure Limits (DEL) for 2003/2004 and the following 2 years, was announced in July 2002. The fourth Review is expected in July 2004. Although the Chancellor has allocated some extra money to the MoD, defence is forecast to receive a decreasing proportion of total government expenditure: 7.0 percent in 2002/2003, falling to 6.4 percent in 2005/2006.

The MoD's procurement regime is considered in Chapter 4 of this Review (MoD Procurement), with an explanation of the new acquisition cycle. The chapter concludes with a listing of 114 significant current and future equipment programmes, arranged chronologically, with details of costs and numbers where these are publicly available. The Eurofighter Typhoon programme provides a case study.

The consolidation of the European defence industry between January 1999 and April 2003 is tabulated in Chapter 5 (Defence Suppliers). The chapter continues with a survey of the companies forming the UK defence industry and the Defence Procurement Agency's (DPA) key suppliers. Thales is now established as one of the most important prime contractors in the UK, second only to BAE SYSTEMS. The chapter ends with profiles of the ten leading MoD contractors.

Chapter 6 (European Industrial Developments) takes a wider look at the European defence industry, with particular reference to NATO (North Atlantic Treaty Organisation) expenditure and European co-operation. Political aspirations continue to be hampered by declining defence budgets. BAE SYSTEMS, EADS and Thales dominate the European defence industry, and the UK's defence industrial policy is considered against this reality.

Chapter 7 (Global Defence Market) discusses the world market for defence equipment, and the UK's position within that market. Five importing countries accounted for over a third of all global trade in major conventional weapons between 1997 and 2001, and nine countries accounted for almost half this trade. The US occupies an unassailable position as the dominant exporter, with the UK claiming 13 percent of the market in 2000 and 19 percent in 2001. The UK's customer countries are identified and the importance of the Defence Export Services Organisation (DESO) is explained.

An exclusive opinion poll conducted to coincide with the publication of this Market Review is analysed in Chapter 8 (Public Opinion of the Armed Forces). Respondents were most in favour of the use of the Armed Forces for peacekeeping activities (89 percent), followed by the need for Europe to have a defence capability independent of the US (76 percent) and equality for women in the Armed Forces (69 percent). The lowest levels of agreement were recorded for compulsory National Service for men (45 percent) or women (22 percent).

TABLE OF CONTENTS

Executive Summary 1

1. Defence Policy 12

INTRODUCTION 12

Strategic Defence Review 12

A New Chapter 12

Performance and Expenditure Records 13

Policy Papers 13

POLICY CONSIDERATIONS 14

The Strategic Environment 14

Policy Priorities 14

NATO 14

European Union 15

Wider Security Interests 15

DEFENCE MISSION 16

Purpose 16

How the Mission is Achieved 16

Attitude to Personnel 16

Overall Goals 17

DEFENCE PLANNING 17

DM A: Peacetime Security 17

DM B: Security of the Overseas Territories 18

DM C: Defence Diplomacy 18

DM D: Support to Wider British Interests 19

DM E: Peace Support and Humanitarian Operations 19

DM F: Regional Conflict and Crisis 19

DM G: Regional Aggression Against NATO 19

DM H: Strategic Attack on NATO 19

CAPABILITIES AND REQUIREMENTS 20

NATO Transformation 20

Defence Capabilities Initiative 20

Prague Capability Commitment 20

EU Headline Goal 21

European Shortfalls 22

Table 1.1: EU Capability Targets — Shortfalls Remaining, December 2002 22

European Capabilities Action Plan 23

2. Armed Forces 24

INTRODUCTION 24

Number of Defence Personnel 24

Civil Servants 24

Table 2.1: Civil Service Staff in Post (number and percent), 1995-2002 24

Regular Forces 25

Table 2.2: Strength of the UK's Regular Forces (number and percent female), 1989-2003 26

Reserves 27

Regular Reserves 27

Table 2.3: Strength of the UK's Regular Reserves (number and percent female), 1st April 2002 27

Volunteer Reserves 28

Table 2.4: Composition of the UK's Volunteer Reserves, 1st April 2002 28

Table 2.5: Strength of the UK's Volunteer Reserves (number and percent female), 1st April 2002 28

Pay 2000 29

Table 2.6: Annual Basic Military Salaries (£), from 1st April 2003 30

Personnel Management 31

Civil Service Reform 31

Armed Forces Legislation 31

Armed Forces' Overarching Personnel Strategy 32

ROYAL NAVY AND ROYAL MARINES 34

Trained Strength 34

Table 2.7: Royal Navy/Royal Marines — Trained Strength (number and percent female), 1st January 2002 and 2003 34

Number of Ships/Major Units 34

Table 2.8: Royal Navy, Royal Marines and Royal Fleet Auxiliary — Number of Ships/Major Units, 1st April 1990 and 2002 35

The Fleet 36

Table 2.9: The Royal Naval Fleet, 2003 36

Base Ports 43

Devonport Flotilla 44

Faslane Flotilla 44

Portsmouth Flotilla 44

Naval Aircraft 45

Table 2.10: Number of Naval Aircraft and Their Roles, 1st April 2002 45

Naval Weapon Systems 45

Sea-Launched Missiles 45

Air-Launched Missiles 46

Torpedoes 46

Submarine-Launched Ballistic Missiles 46

Guns 46

Royal Marines — Structure and Roles 47

Royal Marines Command 47

3 Commando Brigade RM 47

Royal Naval Reserve Training Centres 48

Table 2.11: Royal Naval Reserve Training Centres, 2003 49

University Royal Naval Units 49

ARMY 50

Trained Strength 50

Table 2.12: The Army — Trained Strength (number and percent female), 1st January 2002 and 2003 50

Number of Major Units 50

Table 2.13: The Army — Number of Major Units, 1st April 1990 and 2002 51

Regular Army 52

Table 2.14: The Army — Regiments and Corps (number of regular units), 2003 52

Table 2.15: Army Divisions — Approximate Manpower and Major Equipment Holdings, 2000/2002 56

Territorial Army 56

Table 2.16: The Restructured Territorial Army — Major Units, 2002 56

Officers' Training Corps 59

Table 2.17: Officers' Training Corps — Number of Cadets by University, 2002 59

ROYAL AIR FORCE 60

Trained Strength 60

Table 2.18: The Royal Air Force — Trained Strength (number and percent female), 1st January 2002 and 2003 60

Number of Squadrons 60

Table 2.19: The Royal Air Force — Number of Squadrons, 1st April 1990 and 2002 61

Flying Squadrons and Units 62

Table 2.20: The Royal Air Force — Flying Squadrons and Units, 2003 62

Total Aircraft Strength 67

Table 2.21: The Royal Air Force — Total Aircraft Strength, 3rd May 2002 67

Air Surveillance and Control Systems 68

The UK 68

Falkland Islands 68

Regiment Squadrons and Units 69

Table 2.22: The Royal Air Force — Regiment Squadrons and Units, 2003 69

Royal Auxiliary Air Force Units 70

Table 2.23: Royal Auxiliary Air Force Units, 2003 70

University Air Squadrons 71

Table 2.24: University Air Squadrons and Air Cadet Air Experience Flights, 2003 71

JOINT ORGANISATIONS 71

Permanent Joint Headquarters 72

Joint Rapid Reaction Forces 72

Joint NBC Defence Headquarters and Regiment 72

Joint Ground-Based Air Defence 72

Joint Helicopter Command 72

Joint Force Harrier 73

Defence Academy 73

Joint Doctrine and Concepts Centre 73

Logistics 73

Equipment Capability 73

3. Defence Expenditure 74

THE UK BUDGET 74

Fiscal Planning 74

Table 3.1: The Government's 3-Year Fiscal Cycle 74

Table 3.2: The Government's Fiscal Calendar, 1998-2004 75

Government Expenditure 2002/2003 to 2005/2006 75

Table 3.3: Total Managed Expenditure by Government Department (£m), 2002/2003-2005/2006 76

Defence Remains a Priority 78

Table 3.4: Total Managed Expenditure for the Government's Main Spending Departments (£m), 2002/2003-2005/2006 78

Table 3.5: Total Managed Expenditure for the Government's Main Spending Departments ( percent), 2002/2003-2005/2006 78

THE DEFENCE BUDGET 79

MoD Expenditure Limits 79

Table 3.6: MoD Departmental Expenditure Limits in Cash Terms (£m), 2002/2003-2005/2006 79

Table 3.7: MoD Departmental Expenditure Limits on Resource Budgeting Basis (£m), 2002/2003-2005/2006 79

Table 3.8: The MoD's Total Budget on Resource Accounting Basis (£m), 2002/2003-2005/2006 80

Little Growth in Defence Spending 80

Table 3.9: Share of Planned Public Spending Increase Taken by Each Policy Area ( percent), 2002/2006 80

Table 3.10: Average Annual Growth in Departmental Expenditure Limits by Government Department ( percent), 2002/2003-2005/2006 81

Public Service Agreement 81

Aim 81

Objectives and Performance Targets 82

Responsibility for Delivery 82

THE BUDGETARY REGIME 83

MoD Planning Cycle 83

Top-Level Budget Holders 83

Central 83

Operational 83

Manpower 84

Equipment Procurement 84

Logistics Support 84

Trading Funds 84

Top-Level Budgets 85

Table 3.11: The MoD's Top-Level Budgets (£m), 2002/2003 85

Historical Expenditure on Defence Equipment 86

Sea Equipment 86

Table 3.12: Expenditure on the Production and Repair of Sea Equipment by Sector (£m), 1997/1998-2000/2001 86

Land Equipment 86

Table 3.13: Expenditure on the Production and Repair of Land Equipment by Sector (£m), 1997/1998-2000/2001 87

Air Equipment 87

Table 3.14: Expenditure on the Production and Repair of Air Equipment by Sector (£m), 1997/1998-2000/2001 88

4. MoD Procurement 89

THE PROCUREMENT REGIME 89

'Smart Acquisition' 89

The Acquisition Cycle 90

Table 4.1: The MoD's Acquisition Cycle, 2003 90

Concept 90

Assessment 91

Demonstration 91

Manufacture 91

In-Service 91

Disposal 91

Integrated Project Teams 92

Acquisition Stream 92

The Acquisition Community 93

Equipment Capability Customer 93

Table 4.2: The 'Customer' for Defence Equipment by Procurement Phase, 2003 93

ORGANISATION AND FINANCIAL CONTROL 94

Defence Procurement Agency 94

Financial Approval 95

Table 4.3: Defence Equipment Approval Categories, 2003 96

Investment Approvals Board 96

Political Approval 97

Defence Logistics Organisation 97

Defence Agencies 98

Public-Private Partnerships 98

MAJOR PROJECTS 99

Accountability 99

Current Equipment Programmes 99

Table 4.4: Current Defence Equipment Programmes by Sector, 1st May 2003 100

Eurofighter Typhoon 106

Table 4.5: Eurofighter Typhoon — UK Cost Estimates (£m), 31st March 1989-2002 106

5. Defence Suppliers 108

THE GLOBAL DEFENCE INDUSTRY 108

The Leading Suppliers 108

Table 5.1: The World's Leading Defence Suppliers by Estimated Turnover (£m), 2000/2001 108

Consolidation in Western Europe 109

Table 5.2: Consolidation in the European Defence Industry — a Chronology, January 1999-April 2003 110

THE UK DEFENCE INDUSTRY 115

Table 5.3: Companies Paid £5m or More by the MoD, 2001/2002 115

Key Suppliers to the Defence Procurement Agency 119

Table 5.4: The Defence Procurement Agency's Key Suppliers, 1st January 2003 119

The Financial Times Aerospace and Defence Sector 120

Table 5.5: Companies Listed in the Financial Times Aerospace and Defence Sector, 1st May 2003 120

Table 5.6: Selected Leading UK Defence Suppliers by Market Capitalisation (£m), 31st December 2000-2002 121

THE TOP TEN UK DEFENCE SUPPLIERS 121

Table 5.7: The Top Ten UK Defence Suppliers by Defence-Related Turnover (£m and percent), 2002 122

BAE SYSTEMS 122

Company Structure 122

Current and Future Developments 123

Commercial Aerospace 123

North America 124

Customer Solutions & Support 124

Programmes 124

International Partnerships 125

Avionics 125

HQ and Other Business 126

Financial Results 126

Thales 126

Company Structure 126

Current and Future Developments 127

Financial Results 127

Rolls-Royce 127

Company Structure 127

Current and Future Developments 128

Financial Results 128

GKN 128

Company Structure 128

Current and Future Developments 129

Financial Results 129

Smiths Group 129

Company Structure 129

Current and Future Developments 130

Financial Results 130

VT Group 130

Company Structure 130

Current and Future Developments 130

Financial Results 131

Serco Group 131

Company Structure 131

Current and Future Developments 131

Financial Results 132

Cobham 132

Company Structure 132

Financial Results 132

Alvis 133

Company Structure 133

Financial Results 133

Ultra Electronics 134

Company Structure 134

Current and Future Developments 134

Financial Results 134

6. European Industrial Developments 135

DEFENCE EXPENDITURE 135

Declining Budgets 135

Table 6.1: NATO Military Expenditure† by Region at Constant 1995 Prices ($m), 1995-2002 135

Table 6.2: NATO Members' Defence Expenditure as a percentage of Their Gross Domestic Product, 1990, 2000 and 2001 136

The 'Technology Gap' 137

Force Modernisation 137

Table 6.3: NATO Members' Expenditure on Force Modernisation as a percentage of Their Total Defence Expenditure, 1990, 2000 and 2001 138

THE EUROPEAN DEFENCE INDUSTRY 140

Smaller Supplier Base 140

Industrial Strategy 140

Table 6.4: Co-operation Initiatives in European Defence Procurement — a Chronology, 1976-2001 141

A European Equipment Market 142

UK INDUSTRIAL POLICY 143

The Defence Sector 143

Procurement Considerations 144

Research and Development 144

Wider Markets 145

7. Global Defence Market 147

THE WORLD MARKET 147

Market Size 147

The Leading Weapons Suppliers 147

Table 7.1: The World's Leading Suppliers of Major Conventional Weapons by Value of Transfers ($m and percent), 1997/2001 148

The Leading Weapons Recipients 149

Table 7.2: The World's Leading Recipients of Major Conventional Weapons by Value of Transfers ($m and percent), 1997/2001 149

UK WEAPONS EXPORTS 150

A Partial View 150

Table 7.3: Identified UK Exports of Military Equipment by Destination by Value (£000 and percent), 2001 151

Table 7.4: Selected Major Identified UK Transfers of Military Equipment by Destination, 2001 152

The Wider Picture 152

Table 7.5: UK Defence Exports by Value (£m), 1997-2001 152

Table 7.6: UK Defence Exports by Value of Contracts, Value of Deliveries and Claimed Share of World Market (£m and percent), 1988-2001 153

Customer Base 153

Table 7.7: UK Transfers of Major Conventional Weapons by Recipient by Value ($m and percent), 1997/2001 154

Defence Export Services Organisation 155

Table 7.8: The Defence Export Services Organisation — Profile of Overseas Offices, 2001/2002 156

Operating Costs 157

Table 7.9: The Defence Export Services Organisation — Operating Costs (£m), 1997/1998-2002/2003 157

8. Public Opinion of the Armed Forces 158

INTRODUCTION 158

Overview of Results 158

Table 8.1: Attitudes Towards the Armed Forces ( percent of respondents), April 2003 158

NATIONAL SERVICE FOR MEN 159

Table 8.2: Views on National Service for Men by Sex, Age, Social Grade and Region ( percent of respondents), 2003 160

NATIONAL SERVICE FOR WOMEN 161

Table 8.3: Views on National Service for Women by Sex, Age, Social Grade and Region ( percent of respondents), 2003 161

PROTECTING OVERSEAS TERRITORIES 162

Table 8.4: Views on the Armed Forces' Commitment to Protecting Overseas Territories by Sex, Age, Social Grade and Region ( percent of respondents), 2003 163

PEACE-SUPPORT ACTIVITIES 164

Table 8.5: Views on the Use of the Armed Forces for Peace-Support Activities by Sex, Age, Social Grade and Region ( percent of respondents), 2003 164

NATO ENLARGEMENT 165

Table 8.6: Views on Whether More Countries Should be Joining NATO by Sex, Age, Social Grade and Region ( percent of respondents), 2003 166

IRAQI CAMPAIGN 167

Table 8.7: Views on Whether the UK was Right to be Involved in the Iraqi Campaign by Sex, Age, Social Grade and Region ( percent of respondents), 2003 168

EUROPEAN DEFENCE CAPABILITIES 169

Table 8.8: Views on Whether Europe Should Have a Defence Capability Independent of the United States by Sex, Age, Social Grade and Region ( percent of respondents), 2003 170

DEFENCE EXPENDITURE 171

Table 8.9: Views on Whether UK Defence Expenditure Should be Increased by Sex, Age, Social Grade and Region ( percent of respondents), 2003 172

ROLE OF WOMEN 173

Table 8.10: Views on Whether Women Should Be Allowed to Have the Same Roles as Men in the Armed Forces by Sex, Age, Social Grade and Region ( percent of respondents), 2003 174

9. Glossary 176

10. Further Sources 178

Defence Agencies 178

MoD Contact Points 181

General Sources 181

Bonnier Information Sources 181

Government Publications 183

Other Sources 183

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