CEPA STRATCOM PROGRAM
CEPA
11 September 2014

Looking Farther Than One Contract: Perspectives for a U.S.-Polish Defense Industrial Partnership

Marcin Terlikowski, Analyst and Head of the European Security and Defense Economics project at the Polish Institute for International Affairs (PISM), offers a Polish view of defense industrial cooperation with the United States. As Poland looks to make the most of its big-budget military modernization program, national leaders are considering ways to deepen U.S. ties while simultaneously benefiting the domestic economy. If done correctly, Terlikowski contends, cooperation with U.S. industry would help all sides and ultimately lay the groundwork for an integrated transatlantic defense market.
Introduction
 
Amidst the Russian-Ukrainian conflict, Poland and America are renewing their partnership. Not only do they talk to each other more often, and on a much higher political level than they used to, but they are also moving bilateral military cooperation into an entirely new dimension. U.S. soldiers are already often guests in Poland, training together with their Polish counterparts to sustain the highest level of interoperability, as born in the deserts of Afghanistan. In the coming months, it is likely that American military equipment will be prepositioned in Poland to assure a swift NATO response if another crisis erupts in Central and Eastern Europe and threatens allies directly. And, as Poland is seeking to invest billions of dollars in its military, chances are that Polish-American defense industrial cooperation will finally become a reality.
 
Making it happen, though, is a big challenge. For Poland, the issue of defense industrial cooperation is particularly complex and sensitive, mostly because of the inefficiencies of Poland’s defense sector and European armaments policies, in which the country will become increasingly entangled. Consequently, successful cooperation would require—from both Warsaw and Washington—acknowledging the other partner’s legitimate defense economic interests, mapping out technological barriers and opportunities, and committing to a long-term partnership.
 
One of a Kind: Poland on the Global Armaments Market
 
Poland’s position as a manufacturer of arms is special, even though Polish defense companies do not come close to global business leaders like Boeing, Lockheed Martin, BAE Systems, Raytheon or Airbus Group. At the same time, one cannot easily neglect them: they have traditionally provided the vast portion of the Polish armed forces’ equipment (tanks, howitzers, armored vehicles, radar systems, firearms, ships), developed some competitive niche technologies (military electronics, unmanned aerial vehicles [UAVs]) and played a special role in the national concept of security.
 
But Polish arms companies have largely remained focused on the domestic market; they have stayed to the side of the European processes of industrial consolidation, skipped common procurement projects within Europe and looked with suspicion on any form of international cooperation. In fact, there are only a few cases of Polish companies winning export contracts, for either final systems, like tanks, or components, like radios. This, however, is about to change.
 
What will determine the future of the Polish defense sector is the national armed forces modernization program. Amounting to approximately $40 billion, it is meant to replace legacy military equipment by the year 2022 with state-of-the art systems like modern air and missile defense, transport and attack helicopters and submarines. As Poland has decided to develop these new capabilities in partnership with foreign contractors, opening its home defense sector for international cooperation will follow. And the sheer size of the modernization effort itself makes the level of possible collaborative endeavors unprecedented in Poland’s history. For better or worse, this process will change the structure of the Polish arms industry.
 
There is another driver of change in Poland’s defense sector: European policies. Top EU defense producers (the UK, France, Germany, Italy, Spain and Sweden) have developed Europe-focused armaments policies. These take the form of joint intergovernmental armaments projects (like the Eurofighter Typhoon or Airbus A400M transport aircraft), which support industrial consolidation. This is why Airbus Group was born more than decade ago. Today, these efforts propel collaborative research and technology (now done mainly within the European Defence Agency) and the deregulation of the arms market (through the European Commission, which enforces strict implementation of the 2009 regulations making virtually all arms procurement procedures open for free competition). Geographical proximity and participation in the well-established EU common market makes it a necessity for Poland to find its place and role within these very special armaments policies.
 
In combination, these drivers present Poland with a binary choice: grow or perish. Either Poland uses its armed forces modernization program to form effective partnerships with foreign contractors, finds its role within the broader European armaments policy and—eventually—boosts its defense technological and industrial base to a new level, or its defense technological and industrial base will perish. To avoid the latter scenario, cooperation with foreign contractors must be tailored to Polish needs and real capabilities.
 
About Burden- and Risk-sharing: International Defense Industrial Cooperation
 
Arms are unlike any other goods. A government is unable to just buy a weapon system off the shelf, with the exception perhaps of firearms and body armor. Huge development and production costs prevent companies from keeping backlogs of equipment. As such, whenever a country considers a new contract, production must be started anew. And here policy comes into play. If the client has any national defense industrial plants, it usually wants at least a part of the production to be located at home. The first motivation is to re-invest national defense spending back into the domestic economy. A second imperative is the security of supply. This assures the greatest possible control over the production, deliveries and future maintenance or upgrades of a product. Of course, for a contractor such expectations of the client (often formalized as counter-trade agreements or, in other words, offsets) are a challenge. But the weapons market is driven strictly by demand, so cooperation between the contractor and client is the name of the game.
 
Licensed production is regarded as the least complicated form of international defense cooperation. In this case, the client does not buy a product outright, but acquires the rights (together with know-how and often also manufacturing equipment) to produce a given quantity of a weapon system in its home industrial plants. Licensed production generates limited economic gains for the local economy: it creates some jobs, but rarely do these arrangements allow for the re-export of equipment or modifications to the weapon by local subcontractors. Nevertheless, security of supply is fulfilled: arms do not have to be shipped from overseas and—usually—can be maintained at home. In addition, there is relatively little risk for the client, as it is not responsible for the project in its entirety; for instance, the client doesn’t have to bother about how to market the product through its life cycle.
 
A more complex form of international defense cooperation is a joint venture (JV). This can take the form of a separate company or a less formalized alliance of two (sometimes more) firms representing the contractor and the client. What is special about JVs is that they are established for the purpose of a single contract. While the JV formally acts as prime contractor, which delivers the final product, the burden sharing (and consequently the risk) is split between the foreign contractor and the domestic partner(s) more evenly than in licensed production. JVs allow some degree of technology transfer and industrial partnership, and thereby can generate more economic benefits for the client (like opening a supply chain for local subcontractors). Much depends on the agreement between the cooperating companies. A JV can last decades and not only deliver the contracted product but also successfully maintain and modernize it. It can also disappear after the completion of a task, when cooperating companies turn to other contracts or partners.
 
The most complex form of cooperation in the arms industry is an intergovernmental investment project, in which at least two governments agree to jointly develop a weapon system. There are a couple of particularities to this model. Unlike licensed production or JVs, there is no customer-client relationship. Rather, the partners are equal. Further, the product is meant to be used by the armed forces of all participating governments. The developed technology is not transferred, but belongs—right from the outset—to the partners. Finally, the partners make sure that the labor is divided in such a way that the money they put into the project eventually comes back to their national economies. Risk and responsibility for managing the project are also evenly split. This is all achieved by establishing a new company with governments or their industrial agents as shareholders. The company created for this task allows for the centralization of project management and, thereby, more efficiency, transparency and control over the process of developing and producing a given weapon system. Usually, the company lasts through the life cycle of the product and even deals with the decommissioning of a weapon system when it becomes obsolete.
 
Poland and America as Defense Industrial Partners?
 
To date, the record of defense industrial cooperation between Poland and the United States has been mixed. Take, for example, Poland’s purchase of U.S. F-16 fighter aircraft in the 2000s. It left many in Poland with a sense of disappointment. The economic offsets from the purchase were short-lived, while the life-cycle costs were long and greater than initially expected. As a result, the purchase colors domestic perceptions of large-scale defense deals with the United States. Nevertheless, the United States can become an important defense industrial partner for Poland, if it wishes. For its part, Poland could benefit greatly from partnership with American defense contractors, if it sets its defense industrial policy goals correctly, communicates them openly and pursues them with consistency. For this reason, choosing the right form of cooperation and the right strategic goals is absolutely crucial for this success.
 
Needless to say, Polish leaders are not interested in another off-the-shelf purchase. Neither are they eager to accept licensed production or short-lived joint ventures. Poland’s ambition ought to be something more than just assembly of a weapon system using manufacturing equipment brought from overseas and with no real technology transfer. Instead, Poland should aim for a genuine and long-term partnership in which U.S. defense contractors take the best Polish businesses on board and help them develop excellence in particular niches. In other words, Polish-U.S. defense industrial cooperation should be project-based and strategically driven.
 
What does that mean? For starters, the offer of American contractors should be adjusted to particular Polish needs and manufacturing capabilities. Next, parts of the development/production process in which Polish businesses could contribute with their own components should be identified. Partners ought to build a robust corporate structure to run a project and assure both proper access for Polish partners to decision-making and sound risk-sharing. Further, sustainable supply chains would have to be built, relying on Polish subcontractors. And last but not least, the life cycle of the product should be designed in a way that it can be competitive on the global market. As ambitious as it sounds, this is a doable plan and it could bring benefits to both partners.
 
The stakes for Poland are obvious: technology transfer, growth of its domestic defense industrial base, spillover effects to civilian branches of the economy and, of course, new capabilities for its armed forces. But there is even more behind the build-out of a successful Polish arms industry. A strong defense industrial and technological base would allow Warsaw not only to accept European armaments policies, as has been the case for many years, but to actually shape them in cooperation with top EU arms producers. It is as simple as that: the more assets a country has when it negotiates future armaments programs, defense consolidation or new arms market regulations, the more its interests will be reflected in final European-level decisions. Finally, there is a hidden security gain to this approach: if Poland advances to the position of sole supplier of components that are unique and crucial for the supply chain of a weapon system, especially one that is in widespread use across the transatlantic community, its overall security stance will be reinforced.
 
Conversely, U.S. cooperation with Poland is likewise beneficial. Not only can the United States expand in the growing Polish defense sphere, but it could also anchor itself more firmly in a very competitive and otherwise closed European armaments market. The future of the global defense industry is consolidation. Transatlantic industrial cooperation—considered unrealistic and not feasible for decades—will gradually become a must. If the United States and Europe do not work together, then Russia, China or third-tier arms manufacturers like Brazil, the Republic of South Africa or the Republic of Korea would win new contracts, especially in the defense markets of Asia or Africa. Consequently, U.S. investments in Poland could become one of the first steps in building a transatlantic defense market, particularly if linked to opening the American market for European defense products. That would ultimately be good for both Europe and America.
 
Conclusions
 
Final decisions about the choice of contractors to deliver new capabilities for the Polish armed forces are yet to be made. For sure, the United States will not win all of the contracts; some European products seem to be better tailored to Polish needs—for example, small conventional submarines, which America simply does not produce. But even two or three contracts won by U.S. prime contractors would be more than enough to start a genuine defense industrial partnership. That partnership should build on the elements proposed above, of which creating a strategic vision of cooperation is the most important. When considering engagement on the Polish arms market, the United States should look beyond one single contract and pursue a sustainable defense industrial and security partnership with a trusted ally, located in the region where the ghosts of the Cold War have just reappeared.