Defense companies must be able to rely on large orders being long-term

After years of declining defense spending in many Western countries, the war in Ukraine has led to a huge increase since 2022.

Although NATO member states are not directly involved in the conflict, their support for Kyiv has led to an increase in the production of weapons and other military equipment.

And longer-term concerns about Russia have led NATO countries to further increase their own weapons stockpiles.

For defence companies such as Britain’s BAE Systems, this has meant a rise in revenue over the past three years. This month, the company announced that its revenue in the last six months had risen to £13.4 billion. 13% higher than in the same period in 2023.

The order book now stands at £74.1 billion, the highest level ever. “We will continue to invest in new technologies, equipment and our people so that we can meet our record order book and help our government customers stay ahead in an uncertain world,” said BAE CEO Charles Woodburn.

But how easy was it for Western arms companies to increase their production? And how long will the boom in demand last?

In order to boost arms production, the main aim since 2022 has been to increase the production of existing factories. But that is not quite as easy as it sounds.

Many sites had only been running properly for years or had not been running properly at all, so expanding production was neither quick nor easy.

Andrew Kinniburgh, director general of Make UK Defence, one of the industry associations, gives me an example.

“If you look at the Nlaw (a shoulder-launched anti-tank missile system) designed by Saab and built by Thales in Belfast, you saw that they had no new orders there for many years and the production line was basically idle.”

Then Thales got a contract worth £223 million from the UK Ministry of Defence (MoD) to manufacture thousands more in Belfast over the next four years. Going from being ‘mothballed’ to fulfilling an order of this magnitude is quite a challenge.

The plant recently received a contract worth £176 million from the Ministry of Defence for a separate weapon, the Thales lightweight multi-role missiles.

“I am incredibly proud of our workforce in Belfast, who have risen to this challenge with great commitment,” says Alex Cresswell, CEO of Thales in the UK. “This includes new shift models and the introduction of processes to maximise working time.”

“From just before the invasion of Ukraine until this year, just over two years ago, the factory’s production has doubled. It has doubled and is now higher than ever before at this factory. And in the next few years it will double again.”

Since the end of the Cold War, most Western armed forces have not been prepared for the possibility of a major conflict. They only use ammunition during training and weapons stocks are very low.

A significant portion of the stocks have been transferred to Ukraine and now need to be replaced. And future stocks will need to be much larger.

According to Kinniburg, Western governments must help arms companies invest significantly in new production facilities and storage space for weapons.

Building more weapons and increasing ammunition stockpiles is very costly, but NATO countries will find the money to do it. As the International Institute for Strategic Studies recently reported, “Overall, NATO’s total spending will increase by 11% in 2024, compared to 3% in 2023.”

Growth was even stronger among European NATO members, “who increased their joint military spending by 19 percent in real terms by 2024,” the study says.

In the UK, the new Labour Prime Minister Kier Starmer reaffirmed the Commitment to increase defence spending from 2% to 2.5% of GDP.

This is happening while Russia is significantly increasing its arms production and imports from North Korea and Iran. Although China denies supplying weapons to Russia, it supplies Moscow with “Dual-use article” – those with both commercial and military applications.

Stuart Dee, head of defence and security research at think tank Rand Europe, says NATO member states’ increased military spending is unlikely to be a temporary phenomenon. “Now that the conflict in Ukraine has been going on for over two years, it is increasingly unlikely that it will be short-lived.

“In addition, the security situation that emerges from the Ukraine conflict, whenever that may be, is becoming increasingly uncertain, and security challenges loom around the world. We are likely to see a continuation of the general increase in defense spending as states around the globe move away from a relatively benign phase.”

But arms manufacturers seem unconvinced, having been unpopular for decades. According to Dee, this means that Western governments are trying to convince them that they are popular again and will remain so.

“Governments are trying to give assurances that this is a long-term supply agreement,” he says. “That it is not just a matter of two seconds and then you have to deal with another 30 years of decline.”

Governments are trying to spread this message. Dr. Cynthia Cook is a senior fellow in the International Security Programme and director of the Defense Industry Initiatives Group at the Center for Strategic and International Studies in Washington.

She says one way for governments to do this is to place long-term contracts now. “The challenge for defense companies is not just how long the war in Ukraine will last and whether investments will be worthwhile, but also who will pay for it.”

“Governments can send a signal by signing long-term, multi-year contracts that signal to industry that they will get the money back from these investments.”

But that is not the only problem facing defense companies. New investments and capacity drive up costs, and the next time the government calls for ammunition, the company that has not invested in increased production may well be able to undercut the company that has invested. It is difficult to know which way to go.

Then there’s the problem of recruitment. People are afraid to get into an industry that was ignored and run down until the war in Ukraine broke out. People aren’t exactly lining up to get into an industry and dedicate their lives to it when it’s been in the doldrums for so long.

Nevertheless, defense companies such as Lockheed Martin and General Dynamics in the USA, Rheinmetall in Germany, Saab in Sweden and BAE Systems in the UK continue to experience a boom in orders. This is also reflected in their rising share prices.

The FTSE All-Share Defense and Aerospace Index has increased by more than half last year.

And then, of course, there are the lessons that can be learned from the war in Ukraine. Experts from the armed forces and their suppliers from all over the world are studying the data from the battlefield.

Military drone manufacturers seem to be the first big winners in this analysis. It is a new technology that is cheap and easy to use and will have a decisive impact on the future of warfare. Small and medium-sized companies are making a name for themselves in this sector.

This in turn means more money needs to be invested in drone defence. No country can afford to shoot down £500 drones with missiles that cost hundreds of thousands of pounds and take months to replace.

War is good for business, but it is also usually good for developing new technologies and weapons, and for developing a response to those new weapons.

Ukraine is merely accelerating this process, albeit at an enormous cost in human lives and misery.