ad insights 2010

8/9/2019 Ad Insights 2010

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A&D InsightsAccelerating global growth

Industrial ProductsAerospace & Deence


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Contents

MethodologyAs part o this report, PricewaterhouseCoopers interviewed fteen Chie Executive Ofcers and other senior executivesrom aerospace and deence companies based in Canada, France, Germany, India, the Middle East, the United Kingdomand the United States. The combined sales revenue o these companies exceeded US$167 billion in 2008. The interviewstook place in person between October 2009 and February 2010. Questions ocused on the drivers and benefts oglobalisation, the challenges and risks o globalisation, investment priorities and the pace o globalisation. The results othe interviews are supported by additional proprietary research as well as analysis o publicly available inormation romBoeing, Airbus, Flight International, the Stockholm International Peace Research Institute, the Organisation or EconomicCo-operation and Development, the World Economic Forum and Thompson Financial.

Welcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 01

The need or speed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 02

The search or opportunities abroad . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 03

Newsourcesosalesgrowth

Costsavingsandtalentgains

Competitionorcompleteproductpackages

International but not yet global . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 08

CautiousaboutIPtranser Limitedbyexportcontrols

Challengedbyculturaldierences

Waryofnancialrisk

Pressuredbyosets

Successul globalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Saeguardingintellectualproperty

Beneftingromexportcontrols

Creatingethicalcultures Managingfnancialrisk

Evaluatingosets

The race is on . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Further reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

PwC aerospace and deence experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

PricewaterhouseCoopers


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Welcome 01

A&D Insights

Neil HampsonGlobal Aerospace &Deence Leader

Over recent years the subject o

globalisation, its drivers and its implications

has moved to the top o the agenda o senior

executives in most industries. Our clients

requently ask our views on how industries

are globalising and how their organisations

can beneft rom the increasing pace o

change in an increasingly complex

landscape.

Within the aerospace and deence (A&D)

industry, our clients see globalisation and itsdirect impacts as the major driver o change

in the industry, both now and in the coming

decades: the emergence o new high growth

markets, the opportunities a broader supply

chain oers and the benefts o accessing a

wider talent pool. Similarly, they recognise

that globalisation will bring new competitors

and new complexities in managing their

businesses. It is in this context that

PricewaterhouseCoopers recently

conducted its frst series o interviewswith CEOs and senior executives in the

industry. We interviewed 15 executives

rom leading companies and organisations

around the world. The objective was to

learn, frst-hand, more about the benefts

and challenges o expanding into new

international markets and the investments

and decisions companies are making to

overcome those challenges.

Globalisation is oten viewed as the rise o

new economies, but prior to the IndustrialRevolution, China and India represented hal

the worlds GDP. The clear act is that, during

the remainder o this century, the pace o

economic growth will shit decisively back to

these countries as well as those elsewhere in

Asia and the Middle East. At a undamental

level, economic growth directly benefts

A&D as increased wealth leads directly to

increased air travel by citizens and to

increased deence spending by governments.

But unlike previous decades, our

interviews have revealed that this new

wealth is redefning purchasing power as

governments and private sector companies

in emerging markets seek to participate

much more directly in the A&D industry.This provides a paradox or leading A&D

companies, the need to access new

markets and new sources o supply,

while recognising that they are creating

the competitors o tomorrow.

Our report discusses these issues

and ocuses on addressing the key

globalisation concerns highlighted

by the executiveshow to manage

increased fnancial and operational risk;

how to control intellectual property; how

to manage complexity; and how to manage

a global organisation comprised o local

cultures. This will require new management

and organisation structures, led by more

internationally experienced executives.

The next decade will bring proound

change to the A&D industry and will defne

the winners and losers or a much longer

period. Accelerating global growth will

bring real benefts to those willing totake on the challenges.


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02 The need or speed

Most industries are globalising at increasing speed. Aerospace and deenceis no exception. For most aerospace and deence companies, the customerbase, sources o production, and research and development (R&D) are alreadyinternational. Operations and the supply chain, however, remain less globalthan in other high technology industries.

The A&D executives we interviewed agree that a number o common challengesare slowing expansion into international markets. These include the ollowing:

The management o expanding oset requirements,

Increases in fnancial risk,

Dierent interpretations o business ethics across cultures, The cost and complexity o export control compliance, and

The potential loss o intellectual property (IP).

There are strategies or overcoming these challenges. Broadly speaking, ourinterviewees identifed a need to adjust leadership tactics and risk managementin response both to the risks and the overwhelmingly positive benefts oglobalisation. Programme management best practices, or example, shouldbe applied to the evaluation and delivery o osets. Another example is therameworks and controls established or compliance with US Sarbanes-Oxleylegislation, which can be re-purposed or export regulations.

The leading aerospace and deence companies o the uture will understandand overcome the barriers identifed in our interviews. They will lead in exportmarkets outside North America and the EU, where the majority o industrygrowth will occur. They will also become more efcient and gain better accessto technology and people. The end result will be global organisations thatmatch the needs o global growth markets.

Drivers Eects

Decline in political and economic barriersto trade

Growth in oreign direct investment (FDI)

Improvements in electronics/computingtechnology and telecommunications

Improvements in transportation

Creation o a globallabour orce

Globalisation o fnancial markets

Globalisation o production lowerprices, higher quality

Creation o ree trade areas/trade blocs(EU, NAFTA, ASEAN)

Evolution o global companies

Mixing and convergence o culturalvalues

Challenges to national sovereigntyin trade

Globalisation: Thegrowing interdependenceo countries worldwide,through the increasing

volume and variety ocross-border transactionsin goods and services, ointernational capital andalso through the morerapid and widespreaduse o technology.



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The search or opportunities abroad 03

PricewaterhouseCoopers interviewed executives atfteen leading aerospace and deence companies aboutglobalisation. Their businesses varied widely in size, as didtheir positions in the supply chain. All agreed about themost important actor driving globalisation in aerospaceand deencethe rapid growth o markets outside NorthAmerica and Europe.

These markets oer new customers, lower costs andaccess to talentall o which are in short supply indeveloped markets. To realise these benefts, companiesare negotiating with governments whose growing economic

power is providing increasing leverage to secure higher-value industrial osets.

New sources o sales growthAerospace and deence companies are investing in newmarkets to pursue the customers and relationships that willhelp drive sales growth over at least the next 20 years. Insome long-lived programmes, the sales generated by theoperations and sustainment o products may extend theproject lie to 40 years or more. Who would have thought20 years ago that we would be able to sell aerostructure

products to China, the Soviet Union and other countries thatwere closed markets? notes Gille Labb, President andChie Executive Ofcer, Hroux-Devtek. This has changedthe world tremendously.

Nowhere is the globalisation o the customer base morenoticeable than in the commercial aerospace industry. By2028, regions outside Europe and North America areexpected to own about hal the commercial aircrat inservice. According to Indias Civil Aviation Minister PraulPatel, within a span o fve years [India] will be breakinginto the top fve aviation markets in the world.1 Led by India

and China, the Asia-Pacifc market is projected to growmore than 70 per cent, making it the largest market in theworld or new aircrat.2

1 Aziz Hania, India to be among top 5 aviation markets: Praul Patel, Redi.com, 26 March 2010

2

Boeing, Current Market Outlook 2009 2028 and Airbus, Flying smart,thinking big: Global Market Forecast 2009 2028.

Share o global feet in operation

Source: Boeing, PricewaterhouseCoopers

23% 22%

36%

27%

21%

31%

4% 5%

6%7%

6% 4%4% 3%

0%

50%

100%

2008 2028

Africa

CIS

Latin America

Middle East

Asia Pacific

North America

Europe

Value o new aircrat deliveries 2009-2028(2008 US$ Billions)

Source: Boeing, Airbus, PricewaterhouseCoopers

Europe

North America

Asia Pacific

Middle East

Latin America

CIS

Africa

24%

19%

37%

9%

5%3%3% 736

588

1,115

272

15591 89

A&D Insights


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04


Military alliances continue to evolve and create new opportunities or NorthAmerican and European companies outside their home markets. Deenceexports rom the EU and North America have increased dramatically in recentyears to Turkey, Pakistan, Singapore, the Baltic States, the UAE, Qatar, Malaysiaand Japan. In Saudi Arabia, the growth rate o military expenditures and thegrowth rate o deence spending as a percentage o GDP are the highest inthe world.

Poland is another market with which cooperation and deence trade hasincreased. Polish military spending grew at a compound annual rate o morethan six per cent rom 2004 through 2008. This is signifcantly aster than thespending increase over the same period in the US and dramatically aster than

in the UK, France, Germany and Japan. Much o Polands spending was toreplace aging equipment delivered during Polands membership o the WarsawPact. Polands recent membership in NATO was a catalyst or new equipmentprogrammes, which have been ought over by Western suppliers. In contrast,deence spending in the traditional markets o France, Germany, Italy andJapan shrank rom 2004 through 2008.

G

rowthindefencespending

C

AGR(2004-2008)2)

Note : 1) Bubble size relates to total defence spending in 2008 USD2) In constant 2005 US$

USA

China

UK

FranceJapan

Russia

Germany

Saudi Arabia

Italy

India

South KoreaCanada

Brazil

Australia

SpainIsrael

Turkey

Netherlands

Greece

Taiwan

Poland

Colombia

Iran Singapore

Sweden

Norway

Chile

Belgium

Pakistan

Mexico

Indonesia

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

2% 4% 6% 8% 10%

Defence spending as a %GDP (2008)

For deence, globalisationis all about market access.In priority markets, thismeans how do we localiseour business and retain

key IP.

Miles Cowdry

Director, Global Corporate

Development, Rolls-Royce plc

Growth in deence spending

Source: PricewaterhouseCoopers, SIPRI


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05

A&D Insights

Cost savings and talent gainsIn 2008, the number o investments in international marketsby the top fty aerospace and deence companies reacheda ten-year high.3 The search or low-cost manuacturingremains an important motivation, but research anddevelopment investments have increased signifcantly,including the acquisition o engineering and other criticaltalent. Even according to conservative estimates, orexample, India is currently graduating about as manyengineers as the US, and China produces signifcantly

more engineering and technology PhDs than the US orIndia.4 Aerospace and deence companies cannot remaincompetitive by relying solely on the traditional sourceso talent. They must recruit the best people rom aroundthe world.

Many emerging markets contain not only talent butthe customers who will be engines o uture salesgrowth. India, or example, received the largest numbero R&D investments and the second largest number omanuacturing investments between 2000 and 2008.Unlike a decade ago, todays emerging market investmentsrarely ulfl only oset requirements. They represent large

fxed assets, investments and relationships with trustedsuppliers that cannot be abandoned without unacceptablyincreasing supply chain risk.

3 Based on the number o investments by the top fty aerospace anddeence companies according to Flight International Top 100 Rankings(2009 Edition). Includes direct organic investments and discreteaerospace joint ventures where rationale or investment was known.Excludes acquisitions.

4 Vivek Wadhwa, Gary Geref, Ben Rissing and Ryan Ong, Seeing throughPreconceptions: A Deeper Look at China and India, Issues in Scienceand Technology Online, University o Texas at Dallas, 2007.

0

2

4

6

8

10

12

14

16

18

20

22

2000 2001 2002 2003 2004 2005 2006 2007 2008

R&DManufacturing

Number o investments by Top 50 Global A&D companies ininternational markets

Source: PricewaterhouseCoopers, Flight International

Number o investments by Top 50 Global A&D companies ininternational markets (2000-2008)

Source: PricewaterhouseCoopers, Flight International

Country/Region R&D

Country/Region Manuacturing

India 7 China 13

US 6 India 11

Russia 5 Mexico 8

UK 3 US 8

W. Europe 3 Russia 6China 2 UK 3

Mexico 2 W. Europe 3

CEE 2 Middle East 3

S. Korea 2 N. Arica 3

Middle East 1 CEE 2

N. Arica 1 S. Korea 2

Other 1 Other 1

35 63


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06


Inevitably, costs rise over time in low-cost countries as a consequence oeconomic growth. Companies in many industries respond by shiting work tonew, even lower cost regions and suppliers, sometimes every ew years. Incontrast, aerospace and deence suppliers are not easily interchangeabledue to the ollowing:

Low production volumes,

A high value o invested capital per unit o output,

The large amount o intellectual capital invested in suppliers, and

The investment in certifcations or suppliers, which involve both products andprocesses.

All o these increase the level o investment. In addition, the high-profle natureo many programmes requires contractors to build strong relationships withuniversities as well as local and state governments. The ootprint o an aerospaceand deence company lasts decades rather than years.

Emeric DArcimoles, Senior Executive Vice President, International Development,Saran, explains, For us, most low-cost countries are both partners andcustomers. In order to be a globally competitive player in this market, you needto be present in low-cost countries rom a production point o view, but thesecountries could also become important customer markets. In that case, a globalpresence could also resolve oset issues.

I dont think theres a talentshortage, but I do thinkthat there are particularsocieties and economiesthat ocus on dierentareas o expertise. Ourstrategic plan is to hire thebest engineers around the

world, whether they are inMinneapolis, in Phoenix,in Puerto Rico, in Brno,India, or China.[And]I dont want to limit it toengineering talent, I use

that as an example.

Tim Mahoney

President and CEO,

Honeywell Aerospace


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07

A&D Insights

Competition or complete product packagesAs prime contractors pursue more international deals, governments andcustomers are pressing them to invest more resources directly in oreignmarkets. Executives accept that these oset requests heavily inuencecontract awards. Their companies now compete to oer a complete productpackage, which oten includes osets or similar arrangements. ClaudeLajeunesse, President, Aerospace Industries Association o Canada (AIAC),says, I think the major actor driving globalisation is still national interest. Itsclear that in many countries, i you dont build some parts o your aircrat there,they wont buy your aircrat.

North American and European governments have recently released statementssuggesting that excessive osets encourage poor procurement. The EuropeanDeence Agencys European Oset Code o Conduct notes, we want to seedeence acquisition budgets ocused on what they should be ocused on, that isequipping our Armed Forces with the military capabilities they need and not theones with the highest oset oer.

Despite these concerns, procuring governments are likely to continue usingosets and similar arrangements to create jobs and develop their economies.Osets help localise the multi-national aerospace and deence value chain,while developing the A&D capabilities o indigenous businesses, oten actingas a catalyst or aerospace and other high-technology clusters. This includes

both developed and emerging economies. In some countries, in act, osetsare required by law.

Home markets wantingindigenous capability isone o the main actorsdriving globalisation. Theprevious model o sellingproducts, whether withosets or not, is beingreplaced by governments

that want the capabilityto provide support andupgrade products

through lie.

Ian King

Chie Executive, BAE Systems


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Thus ar the fnancial crisis and ensuing global recession have not changedlong-term strategies in the aerospace and deence industry. Some companieshave delayed international investments, such as new manuacturing acilities inlow-cost regions, but executives remain committed to globalisation. MarcusBryson, Chie Executive Aerospace, GKN plc says, Long term plans haventbeen impacted as the dynamics o the global industry in say 10 years haventreally changed[However] aerospace manuacturing is generally the last intorecession and last out. In 2010 and 11, the industry will see more impact andcompanies will determine i any longer term plans need to change.

Despite the continued investment in globalisation, the aerospace and deenceindustry is less global than some other technology and knowledge based

industries according to three commonly used measures o globalisation: thedegree o import and export relative to total industry trade, the amount ooshore production, and the degree o globalisation o technology andR&D content.

Globalisation Many manuacturing industries are clearly global in nature,including aerospace

Measures Ranking

Degree o import/export relative to

total industry trade

Degree o oshore production eitherdirectly (FDI) or via supply chain

Degree o globalisation o technology/

R&D content

1. Computers

2. Basic Chemicals

3. Pharmaceuticals

4. Electronic equipment

5. Instruments

6. Electrical machinery

7. Automotive

8. Aerospace

9. Petrochemicals

10. Oil/gas exploration and refning

11. Textiles/apparel

12. Basic metals

13. Minerals/mining

14. Other transport equipment

15. Food

Source: PricewaterhouseCoopers

08 International but not yet global

I youre talking customersits a very global industry,but i youre talking aboutsuppliers, I would say itsbecoming more global. Ourown experience is that wehave customers in over100 countries but suppliers

in only over 40 countries.Also the supply chain itselhas dierent geographicalcontexts, originalequipment manuacturersand Tier 1 suppliers tendto operate on a globalbasis but Tier 3 supplierstend to concentrate on the

domestic market. As anOEM we have a presence

in over 22 countries.

Mairead Lavery

Vice President Strategy, Business

Development and Structured

Finance, Bombardier Aerospace


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09


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10


Acquisition money ows, 2007

$8.6bn

Balance $0.6bn

$8.0bn

$1.8bn

Middle East

$2.1bn

Europe

$15.5bn

North America


$1.5bn

$0.4bn

$13.1bn

North America

$11.1bn

Europe

$1.3bn

Middle East

One strong indication that aerospace and deence isinternational but not yet global is the pattern o industrymergers and acquisitions over the last ten years. Themajority o deals by volume and value have occurredin and between North America and Europe.5 In 2009,76 per cent o the deals valued above US$50 million

involved targets in North America, the UK or the Eurozone.This compares to 19 per cent o the deals with targets inAsia and Oceania. Middle East players were involved inonly a handul o deals in 2008 and 2009, none o whichhad publicly disclosed values above US$50 million, ateran active 2006 and 2007.

5 PricewaterhouseCoopers, Mission control:2009 annual and ourth-quarter review,February 2010; PricewaterhouseCoopers,

Aerospace & Deence Deals: 2008 annualreview, March 2009.


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11

A&D Insights


$0.7bn$0.1bn

$0.4bn

$0.2bn

Asia & Oceania$0.9bn

Europe

$5.6bn

North America


$2.3bn

$7.2bn

$0.7bn

$3.8bn

North America

$4.4bn

Europe

$0.5bn

Asia & Oceania

Note: In 2006 and 2007, the values include

all disclosed deals that were completed.In 2008 and 2009, the values include onlycompleted or announced deals overUS$50 million.


I the gross domestic products o China and India continueto increase aster than those o other regions, deal activityand values are also likely to continue increasing in Asiaand Oceania. From 2008 to 2009, Asia and Oceaniascombined share o worldwide deal value (aboveUS$50 million) rose rom 6 per cent to 16 per cent.


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Another measure o the progress still to be made in globalisation is thecomposition o corporate boards in the industry. PricewaterhouseCoopersexamined the executive and non-executive boards o the ten largest aerospaceand deence companies by revenue. Only 12 per cent o more than 250 boardmembers were oreign nationals. Hal the executive boards did not have asingle oreign member. Forty percent o the non-executive boards also did nothave one oreign member.

Security requirements may discourage or prohibit the involvement o oreignnationals in some aerospace and deence roles, and some executives arguethat boards do not need oreign members to have a global perspective. Still,the comparison with other industries suggests that aerospace and deence

would beneft rom more leaders with experience o working and living inmultiple countries and particularly in emerging markets.

Among the 449 board members at the top ten pharmaceutical and oil and gascompanies, or example, 27 per cent o pharmaceutical members and 15 percent o the oil and gas members were oreign. The top six oil and gas majorshave very diverse board memberships, but the remainder o the top ten arestate-owned companies. Even so, the average percentage o oreigners ishigher in oil and gas than in aerospace and deence. Dr. Maghin Tamilarasan,Associate Director, Strategic Business, QinetiQ says A key challenge is tryingto instil in senior operational management a better understanding o theglobalisation agenda and its implications.

Most o the executives interviewed or this paper believe their companieswould beneft rom increasing the pace o globalisation, but signifcant risksand challenges stand in the way. When asked to evaluate eleven challengeson a scale rom unimportant to critical, our interviewees ranked the ollowingfve challenges as most important. (The challenges o export controls andintellectual property protection tied or frst place.)

1. Weakness o intellectual property protection on new markets

1. The complexity o compliance with export controls

2. Diering interpretations o ethical requirements across dierent cultures

3. Increased fnancial risk, especially exchange rate risk4. Expanding oset requirements


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13

A&D Insights

85%

7%

8%

15%

Oil & gas boards executive and non-executive membership

Nationals

Foreign execs

Foreign non-execs

Nationals

Foreign execs

Foreign non-execs

Nationals

Foreign execs

Foreign non-execs


Note: The analysis does not include GE.



73%

14%

13%

27%

Pharmaceutical boards executive and non-executive membership

88%

6%

6%

12%

Aerospace & defence boards executive and non-executive members


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14


Cautious about IP transerExpansion into any oreign market generally increasesthe risk that protected technology and manuacturingknow-how will be transerred to partners, suppliersand customers. This is the case even in markets withestablished IP laws, courts with IP experience and areputation or eective enorcement, such as Singapore.Marcus Bryson, Chie Executive Aerospace, GKN plc,says, Investment in production overseas is necessary toachieve industry globalisation. This inevitably involves IP

transer and we are acutely aware that we are creatingour next competitor.

In emerging markets, concerns about transerring IPand relying on unpredictable protection regimes makeaerospace and deence executives even more cautious.As one interviewee explained, many original equipmentmanuacturers (OEMs) remain unwilling to transer criticalintellectual property to emerging markets. This slows theglobalisation o the aerospace and deence supply chain.

The orces o globalisation, however, are strong.Some markets that are believed to have below averageintellectual property protection are also the most attractiveor aerospace and deence investments. For example,business executives across many industries believe China,India and Poland have below average intellectual propertyprotection.6 These three markets, however, also havesome o the best overall risk profles or manuacturinginvestments based on indicators such as political stability,regulatory eectiveness, rule o law and sovereign debt.7Other countries with higher-risk but still attractiveinvestment profles, such as Turkey, Brazil and Mexico,are perceived to have even weaker IP protection.

Executives in emerging markets agree that new regulationsor better enorcement is needed. According toPricewaterhouseCoopers annual survey o global CEOs,chie executives in China and Hong Kong believe moreregulation is required. Indian CEOs, on the other hand,recognise their governments success in improving IP lawsin recent years; they advocate better enorcement o

6 World Economic Forum, The Global Competitiveness Report 2009-2010(Klaus Schwab ed.), p. 347.

7

Using econometric analysis and World Bank data, the Risk and RewardModel considers sovereign debt, political stability, regulatoryeectiveness and rule o law. See Balancing Risk & Reward: ThePricewaterhouseCoopers EM20 Index 2009 Interim Update.


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Limited by export controlsFor obvious reasons governments regulate aerospace anddeence exports namely:

National security,

Security concerns about recipient states and theirimmediate geographic neighbours, and

The potential or adverse eects on bilateral relations.

Ashok Nayak, Chairman, Hindustan Aeronautics Limited

explains There are signifcant barriers to globalisation in thedeence area, and these are likely to continue because ostrategic compulsions to hold on to critical technology,source codes and IP. The Chinese deence market, orexample, is now estimated to be the second largest in theworld (ahead o France, the UK and Russia),9 but armsembargoes prevent US and EU deence contractors romexporting to China either directly or via partner nations.

Although the barriers are higher or deence exports,export controls also create compliance risks and costs orcommercial aerospace contractors. A common example is a

commercial o-the-shel (COTS) product that is modifed ormilitary use and consequently becomes subject to militaryexport restrictions.

According to the US International Trafc in Arms Regulations(ITAR), or example, i a commercial aircrat is designed ormodifed to incorporate a piece o equipment deemed tobe restricted technology, the entire aircrat can then be

designated a deence article. When the US military adoptedthe commercial QRS-11 gyroscopic microchip or use inguided missiles, the chip became restricted by US armscontrol regulations. By 2003, many Airbus and Boeingaircrat included three o the chips in an avionics subsystem,but Boeing had to obtain a last-minute presidential waiver inorder to deliver 737s to China.10

Dual-use goods and technologies, which can be used orboth commercial and military purposes, have an extradimension o complexity because they involve civilregulations. There is a dierent set o policies, procedures,

orms and regulators or commercial products. In the caseo the QRS-11, petitions and lobbying by Airbus and Boeingeventually led the US government to re-classiy the chips ascommercial items when used in commercial avionics boxes.Accordingly the US Commerce Department now regulatesthe chips in commercial aircrat, but or other purposes theUS State Departments Directorate o Deence TradeControls (DDTC) remains the regulator.11

Another complication is the public-private partnership. InEurope some governments have proposed public-privatepartnerships (PPPs) to increase their share o major

programmes, such as the Joint Strike Fighter (JSF). Suchentities make compliance more complicated. A PPP isneither entirely government nor commercial, which canlead to conusion on the part o regulatory ofcials. Whilea European customer may believe that the entity can beclassifed as a governmental agency, the US industry andregulators will likely view it as an entirely commercial entity.

9 Military expenditure: SIPRI Yearbook 2008: Armaments, Disarmamentand International Security (Oxord University Press: Oxord, 2008),

Appendix 5A.

10 Dominic Gates, State Department goes ater Boeing, The SeattleTimes, 6 July 2005.

11 Dominic Gates, State Department goes ater Boeing, The SeattleTimes, 6 July 2005.


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17

A&D Insights

Due to the difculty o complying with both US andEuropean regulations some executives have concludedthat US export control compliance is too costly and thatUS technologies should be avoided or built around. Manysmall and mid-sized companies, both in Europe and the US,have chosen simply not to enter into the market or workthat involves US export compliance. In the EU, or example,there are contracts or satellite programmes that speciythe spacecrat must be ITAR ree. This allows the satelliteowners to shop or the lowest cost launching solutionswithout regard or ITAR restrictions. (An ITAR restrictedsatellite could not be launched on a Chinese rocket,or example.)

Despite these attempts to avoid US regulations, there is agrowing need or aerospace and deence companies thatcan comply with export controls, due in part to the ollowingcatalysts:

Penalties, increased enorcement and potential debarmentrom uture contracts, particularly by the US,

Industry consolidation, which carries the risk that acquirersmay be unaware o violations at acquired companies, and

Large multi-company and multi-national initiatives (such asthe JSF programme), which create a complex complianceenvironment.

An increasing number o European executives viewcompliance as a competitive advantage in winningbusiness rom US contractors. Companies are combiningtheir compliance experience with new control rameworksand audit methodologies. They are recruiting sta anddeveloping technology or export control managementsystems, such as secure collaboration technology. Thisincludes some mid-sized companies that are heavilydependent on the aerospace and deence supply chainand are experiencing a downow o US complianceobligations rom partners higher up in the chain. Whetherit is pursuing business that involves export controls orexperiencing a downow o obligations, a company thatproactively manages compliance will increase its chanceso delivering on budget and on time while avoidingpotentially large fnes and other costs associated withregulatory violations.


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18


0 20 40 60 80 100

Industries

thatreported

higherexternal

perpetrators

offraud

Industries

thatreported

higherinternal

perpetrators

offraud

Insurance

Financial services

Communication

Aerospace anddefence

Technology

Manufacturing

Hospitality andleisure

Chemicals

Pharmaceuticalsand life sciences

Transportation andlogistics

Engineering andconstruction

Retail andconsumer

Automotive

Energy, utilitiesand mining

Government/state-owned enterprises

Entertainmentand media

Other industries/business

Professionalservices

Global

35

25

45

39

76

80

74

74

69

70

67

67

67

36 64

64

57

57

59

53

65

73

50

55

24

20

23

23

29

30

30

31

37

41

34

33

44

External Internal Unknown

% reported frauds

% respondents representing individual industry sectors

Perpetrators o raud by industry Challenged by cultural dierences

It is a great challenge to develop consistent, global ethicalstandards that also reect the languages, mores and legalrameworks in distinct local cultures. In our interviews withaerospace and deence companies, executives wereconcerned about the various interpretations o ethicalrequirements that spring rom dierent local cultures.Compared to other industries, raud in the aerospace anddeence industry is much more likely to be committed byemployees than by persons outside the organisation. Eightyper cent o the raud reported by aerospace and deenceexecutives in 2009 was internal. This was the highestpercentage o all the industries and much higher than theglobal average o 53 per cent.12

PricewaterhouseCoopers biannual survey o globaleconomic crimes demonstrates the dierences acrosscultures in the way executives respond to employees whocommit fnancial crimes, such as the misappropriation oassets, accounting raud and bribery. These fndingscontradict common wisdom about cultural similarities. Forexample, the pattern o responses to employee raud ismore similar among UK, Russian and Indian executives thanbetween UK and US executives. (This does not appear tobe explained by dierences in the numbers and types o

reported crime.)13

From a UK and European perspective, the US approach toethics and compliance relies more heavily on rules than theEuropean model, which depends more on principles. TheUS is also currently pursuing more oreign corruption casesthan any other country; in act, since 2005 the US hasprosecuted more cases than during the prior 28 years sincethe enactment o its Foreign Corrupt Practices Act (FCPA).In 2009, corporate fnes or FCPA violations exceededUS$600 million.14

12 PricewaterhouseCoopers, Global Economic Crime Survey,November 2009.

13 PricewaterhouseCoopers, Global Economic Crime Survey, November2009. In the US and the UK similar percentages o executives reportedeconomic crimes within the previous 12 months 43 and 35 per centrespectively. In Russia the proportion was 71 per cent, and in India only18 per cent. In the types o crimes reported, the US and UK also sharedmore similarities than the UK, Russia and India.

14 For urther discussion o emerging market business strategies related toanti-corruption, see PricewaterhouseCoopers, Eyes wide open, View,Issue 12.



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19

A&D Insights

Germany, Norway and Switzerland are also consideredactive enorcers o anti-corruption measures, but in theUK, France, Belgium and many other European countriesenorcement is moderate or weak.15 This dierence maypartly explain why British executives, along with Indiansand Russians, reported ewer dismissals, as well as ewercriminal charges, reprimands and notifcations to regulators,when compared with US executives. Almost all raud casesin the US in 2008 and 2009 resulted in the dismissal othe perpetrator.

As aerospace and deence companies globalise, it will beincreasingly important that executives have the diverseexperience necessary to manage compliance with rule-

based regimes, such as the US, without losing theeectiveness o a principle-based approach. In a 2008interview about his experience ater joining Siemens tohelp it recover rom a ar-reaching bribery scandal, thecompanys general counsel explained, Healthy compliancecultures depend on a more values-based leadership wherepeople dont need to look at the rule book, where they knowintuitively what the right thing to do is.16 Much eort andinvestment will continue to go towards the development oprinciple-based cultures. One example rom the UK is theaerospace and deence trade group AeroSpace l Deence lSecurity (A|D|S),17 which has created a tool kit o best

practices or ostering an ethical corporate culture.

Executives with the proven ability to create an organisationthat demonstrates a global culture with local avour willbe much in demand as the A&D industry matures, asother industries have demonstrated this creates a morerepresentative, responsive, innovative and selmanaging organisation.

15 Transparency International, OECD Anti-Bribery Convention ProgressReport, 2009.

16 Carter Dougherty, The sheri at Siemens sees an endless battle,International Herald Tribune, 6 October 2008.

17 A|D|S is the trade body advancing UK AeroSpace, Deence and Security

industries with Farnborough International Limited as a wholly-ownedsubsidiary. A|D|S also encompasses the British Aviation Group (BAG).It is ormed rom the merger o the Association o Police and PublicSecurity Suppliers (APPSS), the Deence Manuacturers Association(DMA) and the Society o British Aerospace Companies (SBAC).

Communications is a challengebecause everything needs to betranslated appropriately. Manycultures do not question authority, andeducating employees on their individualresponsibilities is the biggest challengeto maintaining UTCs high standard oethics across a global organisation. SoPratt & Whitney spends a lot o moneyeducating and training people.

Dave Hess

President, Pratt & Whitney (a division o United

Technologies Corporation)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Dismissal Civil action/

criminal charges

Warning or

reprimand

Notify regulatory

authorities

%o

fre

portedfraudcases

Russia

UK

India

US

Response to internal raud



22/36

20


Wary o fnancial riskThe executives interviewed or this paper confrmed thatglobalisation expands fnancial risks due to transer pricing,oreign exchange, international tax regimes and sharedservices. Among these, currency risk was discussed in themost detail, possibly as a result o the recent weak USdollar and volatile exchange rates, which have placedadditional pressure on hedging strategies. Joachim Ngele,Head o Programs and Sales, Premium Aerotec, says,Exchange rate risk is one o the most important fnancial

risks o globalisation. It creates a strong incentive to go toUS dollar markets ideally in combination with low costcountry opportunities.

The principal problem or most companies is US dollarrevenue, as the global aerospace and deence market ispriced in US dollars. For companies outside the US, themajority or even all o their revenues may be in US dollarswhile the bulk o their costs are in their home currencies.Apart rom the euro, there are no other currencies thatcould potentially rival the US dollar as a standard orpayments, so the dollar standard and its associated risksare likely to continue. I the US national debt continues to

erode the strength o the US currency in the coming years,US-based operations will have a cost advantage.

Currency risk plays out over long time rames in theaerospace and deence industry because programmes lastas long as 40 years. This makes hedging more difcult.Companies generally have the tools to manage short-termcurrency risk, such as orecasting and the ability to hedgethrough fnancial instruments. Long-term contracts,however, create risks that are beyond the horizon o thecurrency markets. When fnancial instruments are availableor long-term hedging, they are oten not liquid.

As aerospace and deence companies extend their supplychains abroad, there is also an increased likelihood that

political and supply chain risks will aect fnancial risk.Changes in contract laws, taxes and oreign policies,or example, can signifcantly alter the economics o acapital-intensive programme with sovereign customers.When local suppliers are required, either because oosets or cost, companies may not have the same rangeo tools to evaluate and monitor the fnancial stability othose suppliers. In regions where capital markets andcredit reporting is still developing, simply evaluating thefnancial risk posed by suppliers can be a challenge.

All o the above actors mean that organisations need to

undertake comprehensive due diligence beore makinginvestments.


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21

A&D Insights

Pressured by osetsThe globalisation o the aerospace and deence industry ismaking the delivery o osets more challenging or OEMsand suppliers alike. In the last 20 years outsourcing rosedramatically in the aerospace and deence supply chain,and prime contractors shited costs and responsibilities tosubsystem integrators and suppliers. OEMs today expecttheir supply chains to share oset obligations.

These obligations are growing in emerging markets as the

markets increase in economic strength and gain leverage innegotiating osets. Emerging markets do not yet have therequired skills, inrastructure and IP to develop and maintainmany aerospace and deence technologies. Developingthose skills and transerring IP may not be easible,commercially acceptable or consistent with exportregulations. Dieter John, Chie Financial Ofcer, EurocopterGroup explains, Oset requirements are becoming moreand more demanding and increasingly difcult to ulfl,particularly in light o quite requently conicting strategictargets with low cost, dollarisation and emerging countryapproaches.

When localisation does occur, through direct osets orexample, supply chain risks rise. Any new operationincreases the potential or cost overruns, delays, qualityailures and programme ailure. Those risks expand whenthe operation is partially18 or wholly external and when theprogramme involves multiple government customers, suchas the JSF. When manuacturing or other operations arelocated in a oreign culture, remote rom technical expertise,or reliant on marginal inrastructure, the potential orprogramme disruption is even greater.19

Indirect osets carry their own risks. They may require

companies to support activities unrelated to the contractin which the company has little or no competency suchas social programmes. It may take considerable eortto evaluate the beneft o an indirect oset, demonstrateits value to the customer and justiy its expense tostakeholders. The risk o impropriety or its appearanceis higher with indirect osets.

18 A joint venture is one example o a partially external operation.

19 For urther discussion o managing risk in the A&D supply chain, seePricewaterhouseCoopers, How to ortiy your supply chain throughcollaborative risk management, January 2009.


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22 Successul globalisation


Sae intellectual propertyAerospace and deence companies must accept therisk o IP transer in order to enter new markets andoer direct osets, but there are a number o ways tominimise exposure. Some unctions can be moved ortranserred oshore or an acceptable level o risk, orexample, when the IP involved is not business criticalor sensitive or is otherwise long established with goodprotection (e.g. through patenting). Identiying this IPrequires a detailed understanding o which unctions are

aected and what IP is associated with those unctions.

Research and development unctions, or example, may notbe appropriate or markets in which IP laws or enorcementare weak. The strength o the worldwide IP rights or newtechnologies depends in part on the strength o the lawsand enorcement in the originating jurisdiction. The level oIP protection may be less o a concern or companies thatare moving ongoing operations with established IP rights(to a low-cost country, or example).

In either case, detail about the IP being moved or createdhelps determine i the IP can be handled saely. It is also

important to understand what would be required tosaeguard the IP, including security measures, training andpersonnel agreements. The type o corporate structure orrelationship will also aect IP protection. It is easier tomonitor and control IP in a subsidiary, or example, thanin a joint venture or external supply relationship. A jointventure, on the other hand, may provide an advantagein enorcement actions because local courts sometimeslook more avourably on local companies.

Joint ventures also raise questions or IP. Which IP is eachpartner contributing, or example, and what compensationare they receiving? Another important issue is ownership:Who will own the contributed IP and i the joint venturecreates new IP, who will own and control that? In orderto beneft rom the ability to pull IP out o a joint ventureat the end o its lie, it is obviously critical to plan or thatpossibility in advance.

The basic questions o Who will own and control the IP?and What happens to the IP at the end o the relationship?apply to many types o business structures. So too does the

question o how to maximise revenue rom IP once thestructure is up and running. Lump sum payments, orexample, have dierent tax implications than steadyroyalties based on units sold. Whichever model is chosen,subsidiary or partnering with another company, there isnever any substitute or doing detailed due diligence on yourpartners and key employees. What is their approach to IPsecurity? Do they understand the importance o IP to thebusiness? What is the process o identiying and securingprotection or new technologies? How eective are therestrictive covenants in the local employment contracts?

Because executives can do little to inuence laws andenorcement patterns, they may need to simply avoidmarkets where IP protection is lacking. The need to protectIP may also conict with government objectives (throughosets or otherwise) to develop production, innovation andservices in their local aerospace and deence sector. Whenbusinesses look careully at their IP, however, they canoten identiy compromises that balance their need or IPprotection with the needs and desires o their customers.


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23

A&D Insights

Benefting rom export controlsWhile export controls create signifcant risks or aerospaceand deence companies, many see compliance not as acost o doing business but as an opportunity to create acompetitive advantage. In Europe in particular, manyexecutives believe the ability to demonstrate compliancewith export control regulations is an important growthstrategy both or the US market and internationally.Executives expect to gain a range o benefts in return ortheir investments in compliance, rom more US business (a

license to operate) to stronger negotiating positions duringprogramme discussions and ewer unexpected compliancecosts. These benefts are sustained through sta trainingthat develops insight into licensing requirements and theskills to manage compliance. Over the long term, aneective Export Control Management System alsosupports a companys reputation.

The costs o building an Export Control ManagementSystem can be signifcant, but many executives oten do notrealise that their organisations already have many tools thatcan be applied to export controls, thus reducing the cost othe Management System. Companies that have invested in

compliance with the US Sarbanes-Oxley Act o 2002, orexample, may have many mechanisms in place that can bere-purposed. The control ramework or IP protection isanother potential resource.

To avoid a breach o export control regulations,organisations must monitor and control communication andbusiness activity within geographically and culturally diverseenvironments. Employees and partners must be able towork together worldwide and share inormation withoutbreaking regulations. Some elements o an export controlramework include the ollowing:

Management commitment (tone at the top) is regardedby many governments as the most important aspect o aneective compliance programme, requiring communicatingthe commitment, providing suitable resources andevaluating and assuring the eectiveness o theprogramme.

A compliance organisation is broadly characterised bymanagement that ensures the right personnel with theright experience are present in the appropriate locationsand have the appropriate authority and clearly defnedreporting lines.

Training is the oundation o successul compliance andrequired at all levels in the company.

Processes and procedures include export licenceapplications, documentation and recordkeeping, andscreening transactions against restricted parties lists andprohibited end users and end uses.

Physical and IT security includes the development otechnology control plans, establishing a culture osecurity, identiying oreign nationals and submittingsuitable licence applications when required.

Reviewing and auditing are government expectationsand should include integration with company qualityprocedures, reporting and eective corrective actionprocedures.

Voluntary disclosure (o violations) policy andprocesses should include senior managementcommitment to reporting, whistleblower provisions andappropriate disciplinary processes or non-compliance.

A control ramework is principally designed to inuence

behaviour. Accordingly it must incorporate and managecultural dierences. For non-US companies in principle-based cultures, adapting to the rule-based mindset o USregulators is important. Principles are the driving orcebehind a compliance culture, but executives must alsoensure they establish the systems and process that candemonstrate compliance with the letter as well as thespirit o US regulations.

The business case or compliance

Answering the ollowing questions helps to evaluate thebusiness case or investments in export control compliance.

Is compliance a undamental part o corporate strategy?

How can we create a return on the investment in compliance?

What is the result o non-compliance?

How can we create control mechanisms and are there

existing control mechanisms (e.g. or Sarbanes-Oxley) that

can be applied to export controls?

How do we create manuals, procedures and policies or

our sta?

How do we translate legislation to practical requirements?

Can we create cost reductions without compromising our

regulatory requirements?


26/36

Creating ethical culturesAs is the case with other business risks, the potentialdamage rom ethical risks is much greater when they areneglected until a crisis strikes. The best strategy ormitigating ethical risks is to establish a risk and complianceprocess that includes risk identifcation, assessment,mitigation (including prevention) and, critically, ongoingreporting and monitoring that tracks emerging andevolving risks.

Much has been written about this now traditional approachto risk management, including the Enterprise RiskManagement Integrated Framework produced by theCommittee o Sponsoring Organizations o the TreadwayCommission, known as COSO.20 As mentioned earlier,organisations like A|D|S in the UK also provide guidanceand tool kits or ethics best practices (with a specifc ocuson anti-bribery and corruption) in the aerospace anddeence sector.

The ultimate prize to be won by eectively using these toolsand rameworks is to change individual and organisationalbehaviour. This may seem obvious, but or leaders and

executives working to demonstrate compliance, systemsand processes are easier to change than behaviour. Indescribing the new anti-corruption legislation (Bribery Act),to which the UK parliament gave Royal Assent in April, thedirector o the UK Serious Fraud Ofce explained, We shallalso be looking closely at the culture within the corporate tosee how well the processes really reect what is happeningin the corporate. This is about bringing about behaviouralchange within businesses themselves and will createcorporate cultures in which no orm o corruption istolerated.21

Changing attitudes and mindsets around what is the rightthing to do in a global organisation is a complex, long-termjourney. It begins with ethical leaders and eectiveleadership (i.e. the tone at the top).22 Only by demonstratingthe right tone will ethical behaviour become embedded inthe organisation. Leaders must be seen to be committed tozero tolerance o improper behaviour. They should applysanctions and terminations consistently in response toimproper conduct by employees or third parties (agents,suppliers, distributors). It is critical to oster openness andtransparency by communicating the outcome o violationsand being consistent in the enorcement o policies.

An integrated approach helps the tone at the topspread throughout an organisation. Company values andhow they align with business objectives should be clear.The key ethical principles that drive business behaviourshould be reected in training, criteria or advancementand perormance-related reward schemes. How manyexecutives, or example, have recently positively recognisedan employee or reusing business on ethical grounds?

Emeric DArcimoles, Senior Executive Vice President,International Development, Saran, says While we also

commit to reduce the duration o the learning curve, wepreer to spend more time training local teams rather thanjust saving money, because it reduces the risk in the longterm. People oten dont realise how dierent cultures andreerences are.

Employees in dierent cultures have dierent ideas aboutwhat is the right thing to do. This is why values-basedprinciples must be the driving orce behind ethics in multi-national organisations. Rules, while important, are notexible enough to accommodate the variety o situationsand cultural contexts. The level o hospitality that is

20 The executive summary can be ound online at www.coso.org/documents/COSO_ERM_ExecutiveSummary.pd.

21

Serious Fraud Ofce, Guidance on Dealing with Overseas Corruption,July 2009.

22 PricewaterhouseCoopers Fraud Academy is currently conducting asurvey that examines tone at the top, including the actions businessleaders are taking to set the tone. Results will be orthcoming at www.pwc.raudacademy.com.

24



27/36

acceptable, or example, is heavily dependent oncircumstance. In order to make the right decision abouthow much to spend on client entertainment in each case,employees must combine global principles, such aspropriety and transparency (e.g., through a git andhospitality register), with their knowledge o what isacceptable in the local market. A rules-only approachincreases the risk that a local operation will comply withhead ofce rules without internalising the principlesbehind them.

Third-party relationships are particularly susceptible to

cultural misunderstanding. High profle cases involving theUS FCPA, or example, have shown that a contractor isliable or partners, intermediaries and representatives thatdo not meet US standards no matter where in the world thethird party operates. It is critical that ethical due diligence isundertaken to select partners, that partners are encouragedto apply your standards, and that ongoing reporting andmonitoring ensures the partner behaves in accordancewith corporate values and codes o conduct.

The UK Bribery Act makes managing third-party evenmore important. The Act is the biggest change in many

generations to UK anti-corruption law. It introduces anew crime o ailure to prevent bribery. Companiesunable to demonstrate that they have implementedadequate procedures to prevent corrupt practiceswithin their ranks orby third parties on their behalfcould be exposed to unlimited fnes as well as othercollateral consequences, such as debarment romgovernment business.23 Companies that have establishedadequate procedures, on the other hand, will have apotential shield against liability.

All o us fnd ourselves making decisionseach day to deal with these pressures.Ethical business decision making reallyenters into that every time we have tomake a decision. Various countries havedierent customs and dierent laws. ButBoeings principles or ethical conductremain the same.

Steve Goo

vice president, International Operations & Compliance,

Boeing Deence, Space & Security (BDS)

23 It is expected that the general oences will come into orce in June2010. The (Section 7) corporate oence o ailing to prevent bribery isexpected to come into orce in October 2010 ollowing issuance oguidance on Adequate Procedures by July 2010.

25

A&D Insights


28/36

Managing fnancial riskGlobalisation increases the number o political, legal andeconomic environments in which aerospace and deencecompanies operate. All o these aect fnancial risk.

Companies cultivate relationships with local authorities inorder to monitor political and legal developments, so thatthey will be warned o changes that aect their businessesand ideally have an opportunity to negotiate. Internationalfnancial partners, such as export agencies or groups o

major banks, also help deter sudden political decisionsthat may damage the proftability o a programme. (Theborrowed unds may be more expensive, but the stabilitymay be worth the cost.)

A local partner can also provide a measure o insuranceagainst political or legislative action, but evaluating partnersis more difcult abroad than at home. Especially i the localrelationship ulfls an oset requirement, companies shouldbe careul that the local partner meets both fnancial andethical standards and can deliver acceptable value ormoney (see above and below). Whatever the potentialpartners location, evaluating its fnancial reliability is a

rigorous analytical process. I the accounting and fnancialstandards o the local market are dierent enough rom thehome market, this may require an audit that includes visitsto acilities and meetings with local management.

Aerospace and deence companies that develop localpartners and operations in markets outside the US ace twoimportant structural issues that aect exposure to fnancialrisk: US dollar pricing and long project durations. Thestrategies or managing the exchange rate risk associatedwith these issues can be segmented by time horizon.

Over short periods o three or ewer years, liquid fnancialmechanisms are available or hedging currency risk. As thetime horizon extends beyond two years and up to ten,contractual mechanisms become more important. Addinga currency adjustment clause to a contract, or example, is

one customary strategy.

Over ten or more years, large-scale strategic decisions havethe greatest impact on currency risk. Two examples are theselection o a local partner and the location o a key supplychain link, such as a manuacturing acility. Other industriesdeploy assets according to portolio strategies, whichdetermine the target percentage o sales or assets orvarious regions. Oset requirements and a concentratedcustomer base limit the options or aerospace and deencecompanies, but some principles o a portolio approach arestill useul.

26



29/36

Evaluating osetsThe requirement to engage in oset activities is a commoneature o major international deence industry contracts.Osets expose aerospace and deence companies tomultiple, diverse and evolving risks.

Beore addressing the challenges o delivering an oset, acompany should determine whether or not it is capable odelivering the osets and whether it is appropriate to do so.O primary concern are ethical and reputational issues, such

as whether the osets will produce the expected beneft andwho will beneft. Value or money is also important. Is theoset the best way or the customer to achieve theexpected return? Can the contractor deliver the oset or anacceptable cost? A direct oset, or example, may not allowthe contractor to use the lowest cost suppliers. An indirectoset, such as a social programme, may be much moreefciently delivered by a non-governmental organisation.

As we discuss in more detail below, osets that involve themovement or transer o technology or know-how increasethe risk o intellectual property loss. Evaluating this riskbeore committing to an oset allows executives to

determine i the risk can be mitigated to an acceptable level.Legal and regulatory risks pose a similar question: Can thecompanys existing compliance ramework address theapplicable laws and regulations, such as the complicatedand ar-reaching US export controls, which apply to bothcivil and military technologies?

Once the company commits to oering an oset, goodmonitoring and fnancial controls are necessary. There is arisk that the osets oten do not receive the same attentionrom management as the main contract, yet each oset alsorequires detailed planning and contractual obligations to

ensure the promised beneft is delivered in the agreedtimerame. Is there, or example, a mutual agreementabout what value will be delivered and how that valuewill be validated?

Joint venture and consortia arrangements raise questionsabout whether there is appropriate sharing o responsibilityor oset commitments between the parties to thearrangement and whether there are appropriate controlsand governance in place over osets. I intermediaries areinvolved, are they being properly controlled and monitored?Aerospace and deence companies have repeatedly oundthat intermediaries provide no shield against legal andethical violations or their eects on reputation.

Osets are a cost o winning business and likely to remainso or the oreseeable uture. They do create value or

customers, but may be inefcient investments that exposecontractors to signifcant risks. More transparency wouldhelp customers create greater value or money and helpcontractors reduce their legal and reputational risks. Whendesigned and managed transparently and eectively, osetscan demonstrate a companys commitment to goodcorporate citizenship and deliver real benefts to thecommunities in which it operates.

Identiying oset risks

A&D companies need to ensure that they are managing the

potential risks associated with oset activities throughout theull lie o a programmerom the point o frst contact with

customers, through programme specifcation and contractual

arrangements, during the delivery o the commitments and

fnally to customer sign o. The ollowing questions help

executives identiy those risks:

Could our reputation and ethics be impaired?

Do the arrangements comply with relevant laws and

regulations?

Is it clear who will ultimately beneft rom the arrangements?

Do oset arrangements represent value or money or ourcustomer?

Are the osets commercially viable and what is the real

impact on our projected contract margin?

Do we and our partners have the capability and capacity to

deliver the obligations?

Are our partners operating to appropriate standards?

Will any IP leakage be acceptable?

Is it clear how the delivery o osets will be measured?

27

A&D Insights


30/36

28 The race is on

Aerospace and deence has turned a corner. Its customers and supply base arealready international. The race towards true globalisation has begun.

The speed o globalisation in aerospace and deence will always be determinedto some degree by the slow rate o change in government policy.As AshokNayak, Chairman, Hindustan Aeronautics Limited says Globalisation in thedeence area needs to be backed by a national policy. The worlds long-termdemographic and economic trends are, however, driving companies to competein emerging markets.

The winners o the race will be those with an appetite or globalisation.Globalisation may introduce new risks and more complexity into the supply

chain, but as this paper has discussed, the strategies to meet these challengesare known. Most are already in use in some orm within the aerospace anddeence industry. Others are evident in other high technology industries.

Winners will adapt, expand and execute these strategies more quickly and moreeectively than their competitors. By doing so, they will lead markets that willdrive growth over the next twenty years and beyond.



31/36

29


32/36

30 Further readingPublications rom PricewaterhouseCoopers Global Aerospace & Deence industrypractice are available to download rom www.pwc.com/aerospaceanddeence.

PricewaterhouseCoopers provides thoughtul analysis o the challenges andopportunities acing business leaders in the aerospace and deence industry.

Our thought leadership publications help inorm the strategic decisions guidingmany o the industrys leading organisations.

Mission control 2009 annual and ourth quarter review

This publication reviews 2009 dealactivity in the aerospace and deenceindustry, exploring the key driversbehind transactions. The analysis also

ocuses on deal activity by key regionand considers the uture transactionsoutlook.

How to ortiy your supply chain through collaborativerisk management

This whitepaper representsPricewaterhouseCoopers new analysison how aerospace and deencecompanies can work with their global

partners to eectively andcollaboratively manage supply chainrisks. Insight was gained throughvarious interviews with seniormanagement in the A&D industry,as well as with cross-industrythought leaders.

Creating competitive advantage: How to transormprogram management

This whitepaper sharesPricewaterhouseCoopers point oview on the aerospace and deence

industrys challenges and ourramework or program managementeectiveness. It draws on theknowledge and experience o ournetwork o A&D industry proessionals,who have extensive backgrounds ingovernment contracting, program

management, risk management, supplier management,and Lean and Six Sigma methodologies.

IFRS Industry Series: A New Flight Plan - What NewAccounting Standards will mean to the Aerospace &

Deence IndustryAerospace and deence companieshave specifc considerations to addressor a successul IFRS transition.Although planning or an IFRSimplementation may not be animmediate priority in light o the currenteconomic uncertainty, US-based A&Dcompanies would be wise to take athoughtul and measured approach toassess what IFRS will mean to them. To

help companies do this, this publication summarises some

o the complex accounting areas that are specifc to theA&D industry.


How to fortifyyour supply chainthrough collaborativerisk management*

Aerospace & Defense

Mission control

2009 Annual and fourth-quarter review

Merger and acquisition activity in the global aerospace

and defense industry

Creatingcompetitive

advantage*How to transform program management

Aerospaceand Defense

A new flight planWhat new accounting standards will meanfor the Aerospace and Defense industry

IFRS industry series


33/36

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Middle East & Africa1,400 Industrial Products professionals30 Aerospace & Defense industry professionals

Deep aerospace and deence experience

PwCs Aerospace and Deence practice is a global networko 1,200 partners and client service proessionals whoprovide industry-ocused assurance, tax, and advisoryservices to leading aerospace and deence companiesaround the world. This aerospace and deence experienceis enhanced by that o our Public Services practice, whichincludes an additional 600 partners and 9,000 proes-sionals ocused on assisting ederal, state, and localgovernments; international agencies; and healthcareentities. We help A&D companies address a ull spectrumo industry-specifc challenges across areas such asassurance, tax, operational improvement, supply chain

management, programme management eectiveness, ITeectiveness and security, compliance, export controls,and government contracting. PwCs A&D client serviceproessionals are committedboth individually and asa teamto the relentless pursuit o excellence, buildinginsights, and advancing leadership on a wide range othe most critical challenges and issues conronting A&Dorganisations. PwC is a sponsor o leading industryconerences and requently authors articles or, or isquoted in, leading industry publications.

We are proud o our relationships withAviation Weekand

Flight International, as well our participation in industryconerences and associations, such as the AerospaceIndustries Association (AIA) and American Conerence

Institute (ACI). Our involvement in these organisationsreects our commitment to addressing industry needs andurthering industry dialogue with A&D industry leaders.

Quality deal proessionals

PwCs Transaction Services practice, with more than3,800 dedicated deal proessionals worldwide, has theright industry and unctional experience to advise you onall actors that could aect a transaction, including market,fnancial accounting, tax, human resources, operating,inormation technology, and supply chain considerations.Teamed with our A&D practice, our deal proessionals can

bring a unique perspective to your transaction, addressingit rom a technical as well as industry point o view.

Local coverage, global connection

In addition to having more than 1,200 proessionals whoserve the A&D industry, our team is part o an extensiveIndustrial Products group that consists o 31,000 proes-sionals, including approximately 15,800 providing assuranceservices, 9,000 providing tax services, and 6,200 providingadvisory services. This expands our global ootprint andenables us to concentrate eorts in bringing clients a

greater depth o talent, resources, and know-how in themost eective and timely way.


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Contacts 33

Neil HampsonPartner, Global Aerospace & Deence Leader

Tel: +44 (0) 20 7804 9405Email: [email protected]

Katrine EllingsenDirector, Global Aerospace & DeenceMarketingTel: +1 (514) 205 5066Email: [email protected]

OsetsGuy HigginsDirector, Risk AssuranceTel: +44 (0) 20 7804 7383Email: [email protected]

Scott Thompson

Partner, US Aerospace & Deence LeaderTel: +1 (703) 918 1976Email: [email protected]

Export Controls

Glenn BradyPartner, Aerospace & DeenceAdvisory ServicesTel: +1 (314) 206 8118Email: [email protected]

Ron AdmiraalDirector, Assurance PIE/Export ControlTel: +31 (0) 40 224 4880Email: [email protected]

Mike FarrellDirector, Global Aerospace & DeenceComplianceTel: +31 (0) 20 568 [email protected]

Intellectual PropertyLatika SharmaPartnerTel: +44 (0) 20 7212 1574Email: [email protected]

Ethics & Compliance

Tracey GrovesDirector, Forensic ServicesTel: +44 (0) 20 7804 7131Email: [email protected]

Glenn WareManaging DirectorTel: +1 (703) 918 1555Email: [email protected]

Financial RiskShyam VenkatPartnerTel: +1 (646) 471 8296Email: [email protected]

Peter FrankDirectorTel: +1 (646) 471 2787Email: [email protected]

Acknowledgements

We would like to thank the Chie Executive Ofcers and senior executives who took the time to share their viewpoints with our team.

Contributors rom PricewaterhouseCoopers include: Neil Hampson, Katrine Ellingsen, Scott Thompson, Guy Higgins, Tracey Groves,Latika Sharma, Ron Admiraal, Ian Lambert, Robert Garretson, Shyam Venkat, Peter Frank, and Elizabeth Montgomery. In addition,Partners and Directors o PricewaterhouseCoopers Global Aerospace & Deence industry practice also conducted interviews.Thanks to Katrine Ellingsen or project management and marketing support and to Frank Moniz or design and production.

A&D Insights

AustraliaPeter DemuraTel: +61 (3) 8603 2247Email: [email protected]

Brazil

Augusto AssuncaoTel: +55 (19) 3794 5408Email: [email protected]

CanadaMario LongprTel: +1 (514) 205 5065Email: [email protected]

CanadaKatrine EllingsenTel: +1 (514) 205-5066Email: [email protected]

Central Eastern EuropeStewart BlackburnTel: +48 (0) 22 746 7143Email: [email protected]

Central Eastern EuropeAndrzej KarkoszkaTel: +48 (0) 22 746 7142Email: [email protected]

ChinaMalcolm MacDonaldTel: +86 (10) 6533 2266Email: [email protected]

France

Guillaume RochardTel: +33 (0) 1 56 57 8208Email: [email protected]

GermanyJrgen SeibertzTel: +49 69 9585 1460Email: [email protected]

IndiaDhiraj MathurTel: +91 124 3306005Email: [email protected]

ItalyCorrado TestoriTel: +39 (06) 5702 52442Email: [email protected]

Middle EastAlistair KettTel: +971 (0) 2694 6831Email: [email protected]

UKNeil HampsonTel: +44 (0) 20 7804 9405Email: [email protected]

US

Scott ThompsonTel: +1 (703) 918 1976Email: [email protected]

USJames W ThomasTel: +1 (202) 414 1370Email: [email protected]

USGina DockiewiczTel: +1 (973) 236 4648Email: [email protected]

Territory Contacts


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Visit our website at www.pwc.com/aerospaceanddeence

This publication has been prepared or general guidance on matters o interest only, and does not constitute proessional advice. You should not act upon the inormation contained in thispublication without obtaining specifc proessional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness o the inormation contained in thispublication, and, to the extent permitted by law, PricewaterhouseCoopers does not accept or assume any liability, responsibility or duty o care or any consequences o you or anyone else acting,

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