ORLANDO, Fla. – Amid a global downturn in defense spending, the training and simulation world is booming. But in a series of interviews at this year’s I/ITSEC conference here, executives for some of the world’s largest defense firms acknowledged that the sector’s market strategy is changing.
The biggest market trend, they said, is a growing emphasis on providing services to customers. In the past decade, companies could feast on providing the technology of simulators and classroom education. Now, governments are buying less new equipment, which means industry needs to focus on upkeep and training opportunities in existing systems.
Mike Blades, an analyst with Frost & Sullivan who attended I/ITSEC, said the emphasis on providing services is a major industry trend.
“That’s the theme of the show,” he said. “There are very few programs that require new simulators, just upgrades.”
Simon Williams, a retired Royal Navy rear admiral who chairs the defense arm of Clarion Events, noted that service companies that have no role in producing education and training tools are jumping into the market for the first time.
“In the future, where the market will be is training as a service,” Williams said. “So you will have suppliers who will supply you with the technologies, but there will be an interface between the customer and the technology, which is the service company.”
“Increasingly what we’re going to see is companies — the Sercos, the Babcocks — these large global service operators will start to step into this market,” he added.
And while new companies are throwing their hats into the ring, the traditional defense industry powers are moving to adapt.
Bob Gower, Boeing Defense’s vice president for training systems and government services, said he is “aggressively” pursuing training services, which led to a recent reorganization of his team.
“We did this for a couple of reasons,” Gower told reporters. “One is where the market is, but we also see trends where some customers are buying services and upgrading systems under those services. So to me, to have a healthy business over the long term, we have to be in the services business if we want to do systems as well.
“The services portion of the business is about 10 percent of my portfolio,” Gower added. “Going forward I’d like to get to where the services is much closer to half than 10 percent, but that’s going to take me some time.”
Asked how much time, Gower said he had no set timetable, but “sooner would be better.”
Gower added that schoolhouse-type solutions, where a company owns and operates a training center on behalf of another nation, is one area of growth. The schoolhouse model essentially outsources the entire pilot training for an air force. Traditionally, militaries buy aircraft and simulators, develop courseware, train instructors and then train pilots. In this model, a company does all that and is judged on a variety of metrics, including pilots graduated.
Competitor Lockheed Martin is also pursuing that model, through what it calls “turnkey training solutions.” Jon Rambeau, vice president and general manager of Lockheed’s Training and Logistics business, said his company is focusing on “not just innovating around technology, but also applying innovative business models to help our customers manage their budgetary constraints.”
That model is “definitely something that is picking up a little bit of momentum,” Rambeau said. “When you think about the huge upfront capital investment a country needs to make to recapitalize its fleet of training aircraft, it’s a much more cost-effective model that spreads costs out over typically 20-25 years.”
That model is largely being marketed internationally. Lockheed is already doing schoolhouse work for the UK and Singapore, and expects to be on contract with Qatar in the near future. Gower added that the Middle East is particularly interested in this model of learning.
Gene Colabatistto, group president for defense with CAE, agreed that services are becoming more important. In his two-and-a-half years in his position, he said, services has grown from 33 to 48 percent of his business.
In addition to the schoolhouse model, Colabatistto said countries are learning it is easier to let companies handle upgrades and service the equipment rather than relying on military maintenance crews.
“I think the most sophisticated users realize what we’re really good at is obsolescence management,” he said. “They realize we’re really good at this because we operate 60 commercial centers. We know how to do this. So a lot of what is driving this [move to services] is the way budgets are being allocated and executed.”
Consolidation
Blades points to companies such as Engility, spun off from L-3 as a company solely focused on government services, as an example of where the market is going and evidence of enough services requirements to merit a spin-off.
At the same time, Anthony Smeraglinolo, Engility president and CEO, warned in a keynote address at the show that there is an oversaturation in the services market and a correction may be coming.
“It is still a great market, but there are too many of us addressing it,” he said. “When there is more capacity than demand, something needs to give, and I think we have begun to see that in terms of industry consolidation.”
Smeraglinolo has put that into effect, acquiring two government services firms in Dynamics Research Corp. and TASC over the past 12 months to grow Engility’s marketshare.
“I firmly believe consolidation is a fundamentally good thing for both industry and our government partners,” he said. “Mergers and acquisitions result in increased scale, which enables fixed infrastructure costs to be spread across the larger base.”
Smeraglinolo’s speech set off different reactions among industry attendees at the show.
Some, such as Blades, agreed there will be more merger and acquisition (M&A) activity in the sector in the near future, noting that “some companies just might not make it.”
CAE’s Colabatistto, however, warned acquisitions may be limited, the result of a small pool of companies that would make sense for a larger firms to acquire.
Many of the firms doing interesting things in the simulation and training world that larger companies could acquire are categorized as small businesses under US government regulations, he said, reliant on the ability to compete for small business set-aside contracts. If those companies are claimed by larger firms, those small-business contracts go away.
“So we look at those companies and it’s very hard to find which ones you would actually acquire,” Colabatistto said.
“I think there will continue to be acquisitions,” he said. “But to make a large play in the market is difficult with budget uncertainty and then in the smaller companies, the way they are classified makes it very risky.”
Even if chunks of the sector are gobbled up in acquisitions, Williams said, the training and simulation market is at a point where new ideas are constantly leading to new companies popping up.
“Yes, there will be consolidation, but equally, in a highly innovative market, you will always have the disruptive technology and the small entrepreneurial companies that will be starting up to fulfill a need that the major corporation doesn’t foresee because they [the small companies] have the agility to do so,” he said.
“So I think we will always have a number of smaller players, and they will be subject to M&A activity as time goes on,” he added. “It will almost be self-refreshing.” ■
Email: amehta@defensenews.com.
