Base, Bleeding Out

Back in July, DID informed its readers that India’s sanctions against Denel and disqualifications from a $2 billion artillery contract on bribery-related charges could have a major effect on the South African defense firm as a whole. In August, those sanctions came to pass, barring Denel from a contract it was likely to win and accelerating efforts already underway to radically restructure the firm.

CEO Shaun Liebenberg recently launched that shift with some frank discussion of the global defense market, and the position of small-medium players like Denel in it. At DSEI 2005 in London, UK, the outline of this new strategy is apparent. Many of the products Denel is known for will no longer define the firm. But can it find a way to stanch the bleeding and survive in a globalized market?

Denel’s Position

Mokopa Laser ATGM

The new CEO was frank about Denel not being viable under the current model. According to Liebenberg, global prime contractors succeed due to privileged relationships with their domestic customer who largely fund and promotes the development of new system platforms.

“Changes in the defence industry have forced consolidation and the forming of alliances worldwide,” he said. “Although Denel has an enviable range of products, we no longer have a captive domestic market or the scale to succeed as an independent systems integrator and exporter of such a broad range of products….”

“Our analysis of the international defence environment shows much of global defence spend is not directly accessible to independent contractors like Denel,” Liebenberg explained. “The US Department of Defense in recent years has awarded contracts almost exclusively to US and NATO companies. These companies supply most other markets, too. Developing nations like India, Brazil and Israel have strong domestic industries to serve their own customer, whilst giving intense competition to other independents.”

Rooivalk fires Mokopa

Denel’s product range drives the full scope of its ambitions home. If anything, it’s surprising that the reckoning hasn’t come sooner.

Indigenous efforts in the missile field alone include the A-Darter (intended as a Sidewinder 9X/ ASRAAM/ AA-11 Archer contemporary), Ingwe and Mokopa anti-armor missiles (think TOW2 and Hellfire/Brimstone competitors), and Umkhonto-IR ship based anti-air missile. The firm also has a full line of optronics; 3 UAV projects (including a reconnaissance UAV, a high speed stealth UAV, and a target drone); a full-fledged new-generation attack helicopter project in the Rooivalk (Eurocopter Tiger/ AH-1Z/ Mi-28 contemporary); the Umbani bomb kit (a clever kit that converts ordinary bombs to something approaching a JSOW/JASSM); world-class artillery systems in the G5, G6, and accompanying base bleed ammunition; vehicle turrets, a full line of military small arms; plus C4ISR products, licensed production of other helicopters, aircraft maintenance, and more.

Some products, like its artillery, are genuine world-beaters coping with a shrinking market for their specific product range. On the other hand, many of these expensive development projects were substitutable at home, and non-viable abroad from the get-go. Little wonder the new CEO has concluded that local defense spending clearly won’t suffice, even with some 45% of Denel’s business still deriving from the domestic market.

Worse, much of South Africa’s recent domestic spend has taken place in areas falling outside Denel’s product range, like fighter jets and naval systems. Denel’s involvement was limited to sub-contracts on the SA Navy’s corvette weapons suite, some workshare on the Gripen, Hawk and Agusta helicopter programmes, and the hope of additional workshare as part of the Airbus A400M military transport. Liebenberg clearly understands, and has stated, that some non-viable businesses would have to be made viable or exited entirely.

Denel’s New Strategy

Umbani bomb kit

Yet Liebenberg believes that his company’s capabilities are attractive to global prime contractors for partnering. Liebenberg said Denel meets the pre-requisites to act as a specialised contractor that could slot into the value chain of the global players, because it has a technology edge or low cost production capabilities in several niche areas, plus good systems integration experience.

As such, he intends to pursue a strategy that focuses Denel business on being a domestic prime contractor, whilst becoming a specialized contractor or sub-supplier to other international defense contractors.

In keeping with Denel’s new strategic direction, formally announced by CEO Shaun Liebenberg in August 2005, the Group is showcasing some of its niche defence and aerospace systems at DSEI 2005 this week in London, UK.

Denel’s advanced LCT-30 combat turret will be part of the joint Denel-EADS tender for the South African Army’s new generation infantry combat vehicle. Denel also hopes to interest more customers in its sophisticated sub-systems, like its ‘Eagle Eye’ target location binocular, Denel’s NATO certified LH-40C eyesafe laser rangefinder already in use with some European armies, the ‘Kenis’ infrared thermal imaging camera, as well as the Goshawk electro-optic stabilized airborne observation system. Denel is also supporting Zeiss Optronik of Germany with periscope equipment for a number of foreign navies.

Yet Denel hasn’t given up on all of its bigger projects. Its Umkhonto IR surface-to-air missile, selected by the South African and the Finnish navies, remains on offer now that performance testing and live firings have concluded successfully [DID: Sweden would eventually buy them too, as a partial offset for the SAAF’s new Gripen fighters]. In the artillery department, its ‘Arachnida’ electronic targeting and combat management is already in service on the UK’s light artillery guns and was exported in quantity to a Middle East customer, and Denel’s world-class artillery ammunition is currently being evaluated in the NATO environment as well as in the United States. Earlier this year, Denel announced a strategic alliance with Germany’s Nitrochemie to develop a new generation of modular propellant charges for 105mm and 155mm artillery.

It’s going to be a long road ahead for Denel, as it always is in major corporate restructurings. Jack Welch, widely considered to be the gold standard of modern-day CEOs, offered his take on the restructuring/ crisis process in a recent Wall St. Journal article that covered the aftermath of Hurricane Katrina. Yet the process is universally applicable.

In a way, however, the scale of the problem is blessing to Denel. The very overreach that has landed the firm in such trouble has also made it sufficiently important to South Africa’s defense infrastructure that allowing the firm to fail will be seen as a last resort option. Given the roster of projects it has successfully brought to fruition, it’s also clear that Denel has some very talented engineers and personnel on hand.

Strong government support, a solid share of South Africa’s production allocation for the A400M global project, and success in its alliance efforts could yet steer the South African firm back to health. Yet the international defense market is becoming a difficult place for small-mid size firms without an in-demand flagship product. Unlike Apollo 11, failure is an option.