The struggle to replace the US’s 1950s KC-135 tankers is one of the longest running sagas in defence procurement. Aerospace giant Boeing originally won the contract in 2003 but its bid was thrown out when criminal charges were brought against an air force official accused of colluding with the company on the deal. She was jailed and Boeing’s CEO and CFO resigned.

Five years later, a joint venture between Northrop Grumman and EADS, the parent company of Airbus, won the reopened competition with a rival offer. Boeing appealed to the Federal Government Accountability Office, complaining that the terms of offer were biased in favour of its European competitor. The Pentagon went back to the drawing board but, Northrop, having had enough, pulled out in March this year leaving the $35bn spoils to Boeing. That looked to be the end of it, but in April EADS announced it would tender a new offer without the assistance of its US partner, and the US Department of Defense (DoD) extended the bidding period by two months.

The Pentagon now claims that the contract will start on 12 November but that is looking increasingly unlikely as final bids will not be placed until July. The story is just a particularly tortuous example of the process behind the awarding of defence contracts, but Lieutenant General Ken Pennie (retired) argues that insider knowledge and understanding of processes is vital for any company hoping to win government bids.

Pennie served as commander of the Canadian Air Force, having previously worked as director general of strategic planning at the Department of National Defence. As a result, he is familiar with the twisted passageways that eventually lead to contracts being awarded. Boeing has a significant lobbying presence inside the beltway to support its commercial activities, but, Pennie says, that does not necessarily give it an outright advantage. "It can work in many different ways so it depends. I know that’s not very racy but it’s the reality. Success relies on a range of factors."

“The struggle to replace the US’s 1950s KC-135 tankers is one of the longest running sagas in defence procurement.”

Local knowledge and contacts are useful but foreign companies can bring in experts and Pennie himself now works as a consultant, guiding companies hoping to supply the Canadian military. There is evidence to show that Northrop and EADS had been outspending Boeing in terms of political contributions for a number of years.

EADS’s ongoing problems come from another source. At first glance, the dispute over the programme, known as KC-X, appears to be about specifications. Boeing’s aircraft, based on the 767 airliner, was smaller and less expensive.

The Northrop Grumman-EADS proposal, based on the Airbus A330, was larger and, its makers argued, more capable. But under the surface a witches’ brew of special interests was bubbling up.

Foreign invasion

As a European company allegedly boosted by favourable tax and investment conditions at home, EADS has been cast as a spoilt foreign usurper in the KC-X story. Everyone from the Wall Street Journal and the Economist to the AFL-CIO trade union has thrown in their two cents as to whether opting for Boeing would represent patriotism or protectionism.

The picture is further complicated by Alabama representatives keen to point out that the Airbus planes would actually be assembled in their state. Their counterparts from Washington claim this is unimportant in the bigger picture. However much the European company spends on lobbying, it is unable to shake off the perception that awarding it the contract would be against the wider US interest.

While the stakes are particularly high in the District of Columbia, Pennie argues that defence procurement is as complicated in any major capital. "The process in each country is unique and requires deep understanding," he says. "The UK, US, Canada and Australia all have their own challenges and bureaucratic environments that have to be dealt with."

“Insider knowledge and understanding of processes is vital for any company hoping to win government bids.”

In Canada, for example, there are three major government departments involved in setting the procurement agenda. First the military wing of the Department of National Defence (DND) develops its requirement, which must be clearly nested in the current government defence policy. Then the administrative side of the department has to organise a formal acquisition project management office. The acquisition process and ultimate contract will be handled by Public Works and Government Services Canada, which in turn must meet the conditions of the national industry strategy as laid down by Industry Canada, the government department responsible for economic development. "Clearly DND have the primary authority to decide what the military requirement is," Pennie explains, "but how it gets delivered can get very complex."

In their 2009 annual reports, Boeing and EADS cite defence work as offsetting softer commercial demand and a programme like KC-X is particularly appealing as it builds on existing jet liners.

The projected $35bn value would represent a significant order to either company but the extensive development cycles of the project and uncertainties involved in the bidding process are major disadvantages.

The programme has dragged on so long that it faces colliding with the next defence procurement cycle and while the defence market remained robust last year, there are signs of trouble on the horizon. Major spenders like the US and the UK look set to re-evaluate their priorities in the coming years and rein in spending growth.

A UK MoD green paper, designed to outline the terms of an upcoming strategic review, raised questions about the resources the country will realistically be able to commit to military activities in coming years.

More concretely, the American Quadrennial Defense Review (QDR), published by the DoD earlier this year talked of "trade offs" that would be necessary in the future. The authors argued that the country should abandon the "quixotic pursuit of high-tech perfection", adding, "we cannot afford everything we might desire". Secretary Robert Gates foreshadowed these conclusions in a 2008 speech when he described the military’s weapons platforms becoming "ever more baroque" and too expensive to field in effective numbers.

“The use of UAVs has become increasingly important: we’re seeing that in Iraq and Afghanistan.”

Congress’s decision to put the F-22 Raptor on ice earlier this year made it clear that the government was not just making empty threats. The QDR also noted the intention to draw down the number of fourth generation fighters, reducing the scope for service and maintenance contracts. The risk for manufacturers is getting caught between two weak cycles in the military and commercial sectors.

Pennie believes that companies balanced between the two fields will fare best. "The indications seem to be that by 2011 commercial orders will be picking up," he says, "but there’s always a lag between orders so this year will be pretty tough as the effects of the 08/09 recession continue to be felt. During a downturn, defence spending stays about the same, so if you’re a firm that does business in both defence and commercial, you’d be struggling in the latter but making do in the former."

In the longer term, he acknowledges that there will be greater challenges as the relative importance of the US market declines. Of the high-growth economies, Russia, which faces its own spending problems, and China are largely closed to corporations in Nato member states. India and Brazil, however, might offer greater opportunities. Both are keen on the F-35 Lightning, the fruit of the joint strike fighter (JSF) programme, but Pennie also sees opportunities for sales of older platforms.

"If a country can’t really afford, or doesn’t really need, the capabilities of the fifth generation, then earlier systems might be absolutely fine," he says. "Each nation has to make its own cost-effective choices."

Emerging markets

The Indian medium multirole combat aircraft (MMRCA) programme seeks to procure 126 fighters and is expected to be worth $10bn. It has attracted interest from major jet builders including Lockheed Martin, Mikoyan, Dassault, Saab, Boeing and Eurofighter. While all are tendering fourth-generation aircraft, Lockheed Martin has held out the prospect of an upgrade to F-35s down the line. But as is often the case with Indian bureaucracy, the government allowed the bids to lapse as testing over-ran and the vendors must now resubmit their offers and the process may now drag on another year.

Brazil has also been running a $2.2bn competition for 36 aircraft. Lockheed Martin determined the country to be an unsuitable export destination for the Lightning and the field has been narrowed to Dassault’s Rafael, Saab’s Gripen and Boeing’s F/A-18. The deal was due to be announced in April but a legal challenge has been filed amid claims that President Luiz Inácio Lula da Silva has shown preference for the French bid. Any award is now likely to be similarly delayed by a year.

“Improving commercial conditions should ease the pressure on military contracts for some manufacturers.”

Although China might not be accessible as a market for Western aerospace companies’ defence products, if it presses ahead with its own fifth-generation aircraft – the J-XX – other air forces could face pressure to modernise more quickly. An Australian defence white paper has already suggested that it will seek enhanced capabilities in response to a perceived shifting of power in the Asia-Pacific region. Pennie stresses that the ongoing modernisation of the Chinese military poses real potential concerns and states with interests in Asia will need to pay closer attention in the future.

In the shorter term, the entry of the first F-35s into service – now expected in 2015-16 – should help militaries control their costs. The Lightning is a more utilitarian aircraft than the F-22 Raptor and while it is projected to outstrip all earlier fighters, it has a considerably lower unit cost. Throughout the life of the programme there has been an emphasis on cost containment, in response to the spiralling price of new systems.

Despite Congress’s implicit decision to plump for the F-35, Pennie believes that the older, more advanced platform might find it still has a role to play. He makes the comparison with the F-15 and F-16. With the introduction of the Falcon, it was widely assumed that the Eagle would only be produced in limited numbers but as the unit costs of F-15s came down, it evolved and continued to find a market. If the threat picture were to change and the costs of the F-35 continue to rise, the same could happen to the F-22, he suggests.

While the F-35 represents a small step towards lower costs, the increased use of unmanned aerial vehicles (UAVs) is a more radical shift. The Obama administration has authorised the use of Predator drones for significantly greater numbers of missions and the 174th Fighter Wing, based in Syracuse, NY, is on course to be the first wing consisting entirely of unmanned aircraft.

"The use of UAVs has become increasingly important: we’re seeing that in Iraq and Afghanistan," Pennie says. "They have a lot of advantages, particularly when they can stay aloft for long periods of time and provide persistent surveillance of specific areas."

Drones are principally used in surveillance and ground attack missions but Pennie believes "we’re limited only by our imagination" when considering new roles.

The shift to using UAVs presents governments with a great opportunity – the unit cost is a fraction of that of a jet fighter – but poses a challenge to manufacturers. The Predator, and its offspring the Reaper, are not produced by Northrop Grumman, Boeing or Lockheed Martin but by General Atomics Aeronautical Systems (GA-ASI), a relatively new entrant to the market.

“Companies will need to devote resources to servicing new markets such as South America and east Asia.”

The barriers to entry for the development of a UAV are considerably lower than those for a traditional aircraft. "Almost everybody is trying to get into the business," Pennie says, "but to what extent there will be a robust industry remains to be seen. It’s a very dynamic field at present and most of the major players are looking at it very hard. It could show significant growth potential."

The challenge for larger manufacturers is to develop the software component of the system that connects the drone to operators on the ground. "Certainly larger firms have the ability to do this, but some of the smaller ones are more nimble and react more quickly. It’s a competitive environment where whoever can bring the most value to the table has the best chance of winning."

As the technology matures, the market will be harder to enter and costs will go up as platforms become more sophisticated. Firms that act quickly could potentially seize the initiative and secure their position. The authors of the QDR note, "the increasing precision, persistence, and autonomy of unmanned systems hold great promise," and outline a plan for increasing the number of units available to commanders. It seems almost certain that as long as Nato forces are engaged against insurgents, UAVs will play a key role and represent an important market.

The outlook for aerospace firms is mixed. Improving commercial conditions should ease the pressure on military contracts for some manufacturers but the downward forces on defence spending could pose significant difficulties for others. Companies will need to devote resources to servicing new markets such as South America and east Asia and adapt to new technological possibilities. The overall picture is likely to be one of an increased range of opportunities but more intense competition for large deals.

This article was first published in our sister publication Defence & Security Systems International.