How GDLS-C can maintain its strategic positioning in the wake of the Saudi Arabia scandal

Transcription

1 How GDLS-C can maintain its strategic positioning in the wake of the Saudi Arabia scandal

2 INTRODUCTION The Issue General Dynamics Land Systems Canada (GDLS-C) recently came under scrutiny when it signed the largest export contract in Canadian history. It is slated to design and manufacture $15 billion in weaponry for the Kingdom of Saudi Arabia (KSA), a country known for its human rights abuses (Human Rights Watch, 2016). The Trudeau Government, which is provided export permits to GDLS-C, claims that it is merely following through with commitments from the previous government (Chase, 2016). That, however, has not buffered the pressure from various stakeholder groups, including concerned citizens, shareholders, and the media. In light of what has become the KSA scandal, what can GDLS-C do to ensure its long-term viability well into the future? Company Background GDLS-C is a Canadian subsidiary of General Dynamics Corporation, a major US-based defence contractor. The company s primary offering is the locally designed and manufacturer Light Armoured Vehicle (LAV) line of products (General Dynamics Land Systems Canada, 2016). Aside from its home market (Canada), GDLS-C has naturally captured friendly markets including the United States (US), United Kingdom (UK), Australia, and New Zealand (Wilson- Hodge, 2016). These Western nations are close allies of Canada, and share common history, culture, and values. Insiders have labeled the Canadian arms industry as government managed due to frequent bureaucratic intervention. Historically, this was not a significant issue because GDLS-C s activities typically flew under the radar, and their incentives were usually aligned with the government (Wilson-Hodge, 2016). However, under new pressure from the public (De Bono, 2016), the Canadian Government may begin to constrain markets that GDLS-C can legally service, putting revenue growth at risk because of how saturated friendly markets have become. To satisfy shareholder demands for growth, GDLS-C has looked beyond friendly markets to regions with high demand growth for LAV-type products, including the Middle East and North Africa (MENA), Latin America (LA), and Asia-Pacific (APAC). This has led to GDLS-C lobbying for and winning approval to export to Colombia, Peru, and most controversially, KSA. While most Canadians don t take issue with local companies selling weapons into friendly markets, they have expressed concern with less familiar jurisdictions, especially the KSA, where social and political norms are very foreign in comparison to Canada (Gollom, 2016).

3 Regulatory Background Stage in Lifecycle Regulation surrounding arms exports are tied to the Export and Import Permits Act of the 1985 Revised Statute of Canada (Government of Canada, 2016). Thus, regulatory policy is in a mature state. The government periodically makes amendments to the policy, including changes to export controls and additions of new nations to the Automatic Firearms Country Control List (AFCCL), though none of the revisions are significant policy changes (Blanchfield, 2013). Importance to the Firm and Competitors The Export and Import Permits Act, and related export legislation, are important but restrictive regulations that affect GDLS-C. Canada already requires all arms export contracts to receive approval from the Ministry of Foreign Affairs, and goes a step further to only allow weapons sales to countries outlined by the relatively narrow AFCCL. Further, because GDLS-C s parent company is based in the US, the company is required to follow US, Canadian, and the client nation s laws simultaneous (Wilson-Hodge, 2016). Meeting all criteria can be difficult, especially when significant competition comes from foreign industry that is not subject to the same legal requirements as GDLS-C. Thus, to achieve its growth targets, GDLS-C needs to expand the AFCCL while continuing to receive export contract approval and remaining in compliance. For notes on the pre-approval process, see Exhibit 1. STAKEHOLDER ANALYSIS Media The media landscape has become increasingly political and sensationalist as news organizations shift to become more like tabloids to increase viewership. Conservative media outlets have typically supported military trade (Basso, 2016), while liberal media has scandalized topics like the KSA contract (Gollom, 2016). This is notable because the media has the ability shape political discourse and public opinion, indirectly pressuring politicians to action (e.g. tightening arms export laws which could hurt GDLS-C s ability to grow). Highly organized and somewhat biased by the political landscape, the media has largely been a detractor on this issue.

4 Shareholders Shareholders invest in GDLS-C by owning shares of its parent company, General Dynamics. The US corporation is a well diversified company, with operations in defence, consumer aviation, and information systems, etc. (General Dynamics Corporation, 2016). Shareholders are interested in the success of General Dynamics, which puts pressure on GDLS-C to meet internal performance metrics like revenue and quality targets. That said, shareholders are interested in the corporation s performance holistically, so longer-term strategies are favoured over short fixes. This is reinforced by the fact that no individual entity holds disproportionate power in the parent company, and thus cannot force short-term changes. Competitors While GDLS-C holds the greatest global market share for LAV-type products, several new competitors have emerged with great success in the defence industry. These competitors include the ARTEC Boxer from Germany, Patricia AMV from Finland, and ST Kinetics Terrex from Singapore. Some competitors have even managed to displace GDLS-C in markets it previously dominated. For example, GDLS-C recently lost contracts with the US Marines and Australian Army to the Terrex and ARTEC Boxer respectively. Since all GDLS-C s competitors are foreign, they are largely unaffected by Canadian regulatory issues. However, the KSA scandal has put the limelight on GDLS-C, and may limit its ability to export to other socially and politically uncertain countries other companies wont be under such scrutiny. Government of Canada Liberal Party The most significant stakeholder is the Government of Canada, with strong emphasis on the political party currently wielding power since they are the face of the country. Major benefits to the government of Canada from increased military equipment sales to foreign governments include increased federal tax revenues which can be used to fund important services or pay down government debt. It can also promote strategic alliances and cooperation between countries, which builds up political capital and stability in politically uncertain areas like the Middle East and the South China Sea. Domestically, high-paying engineering and technical jobs are created to develop and test equipment which helps spur the economy and facilitates job creation. Most importantly, for markets where Canada already exports equipment, it s a sign of the country s good faith in seeing signed contracts all the way through.

5 Canadian Commercial Corporation (CCC) Given the Trudeau Government s intention to increase spending significantly, create new jobs, and reinforce Canada s image on the world stage, there is GDLS-C has a remarkable amount of leverage (discussed in detail in Strategy). That said, we recognize that governments are not monolithic, and some inconsistencies are evident. For example, in the case of the KSA deal, the Trudeau Government is not negotiating with KSA per se. Instead, a semi-autonomous crown corporation called the CCC (whose objective is to facilitate international trade with Canadian industry) negotiates with the KSA (Jaramillo, 2016). In effect, a crown corporation that technically works for the Canadian Government is operating counter to the government s official stance on dealing with countries with human rights abuses. GDLS-C The second most important stakeholder is GDLS-C and its employees. Export contracts can be worth billions of dollars over their lifetimes, which drives corporate revenue. The loss of these contracts would limit GDLS-C s ability to stay operational, which could lead to layoffs, plant downsizing, or total market exit. While none of these cases are positive outcomes for GDLS-C or its employees, these negative consequences could cascade into loses in economies of scale, making procurement of all equipment more expensive, both in Canada and abroad. For example, if GDLS-C stops production of LAVs in Canada, the cost for the Canadian Armed Forces to acquire LAVs elsewhere would likely increase because they are the only company that produces these types of vehicles, in large scale, in North America (Wilson-Hodge, 2016). Minor Stakeholders Other stakeholders include citizens, NGOs, political action groups, etc. While we recognize that some of these stakeholders can be passionate influencers with the ability to shape social and political discourse, the greater population doesn t find this topic to be a pressing issue. Their concerns typically have more to do with social, political, and economic issues domestically. STRATEGIC IMPLICATIONS FOR GDLS-C Managing Perceptions Canada has a sterling reputation for being a peace-brokering middle power, but risks losing this status as it appears to become more hawkish from increased arms sales. The Trudeau Government won t want to damage this reputation or risk losing its majority in the next election. GDLS-C can help mitigate this by working with the government to divert a portion of

6 the proceeds to supporting veterans and peacekeeping activities, in addition to playing up the ideas of high-skills job creation. Some citizens may oppose existing and future arms deals, citing concerns for human rights abuses and unjust military intervention into civilian matters. In this case, it s important to note that backing out of existing deals risks Canada s reputation as an honest trading partner. With respect to the KSA deal, GDLS-C doesn t have many strong arguments to make, so it s better to simply stay silent on the issue and argue for other issues that have more merit. However, the company can note security concerns in the Middle East or the South China Sea as reasons to help arm partner governments and maintain political stability in those regions. For example, GDLS-C might cite the strategic importance of oil reserves or a need to create a bulwark against an increasingly powerful China. International Expansion Alternatives Serviceable Markets A 2016 Deloitte report outlined the state of the global defence market, with nations in Exhibit 2 as the world s largest military spenders. We have further identified potential markets that GDLS-C may service in Exhibit 3, in addition to making note of existing and blacklisted nations. These countries have a combination of high growth (Exhibit 4), and strong potential demand for military equipment. It s also important to note that GDLS-C does not sell into Europe (except for the UK) because GDLS-C s sister company, General Dynamics European Land Systems, handles that market (Wilson-Hodge, 2016). 1. Latin America GDLS-C has had remarkable success expanding to LA. It successfully lobbied the Canadian Government to add both Colombia and Peru to the AFCCL, and approve export contracts with those nations (Wilson-Hodge, 2016). Moreover, given the size and budgets of LA countries, GDLS-C could operate in this region with lower levels of competition. For example, the company sells less expensive alternatives to its flagship products (like older LAV models) where many competitors do not, which prices competitors out of the market (Wilson-Hodge, 2016). However, smaller military budgets are also inherently problematic for growth Brazil was the only LA country to be included in Deloitte s list of top military spenders. Also, the region ranks poorly for human rights risks (Exhibit 5), and is plagued by internal strife stemming from drug trafficking. Subsequent media exposure may call into question whether the buying nations tend to use equipment from GDLS-C to solve non-military matters.

7 2. Asia-Pacific Among serviceable nations, those in APAC generally have better human rights records (Exhibit 3), and would be less controversial customers. Compared to Latin America and MENA, target APAC countries also have higher than average military budgets, and constitute a greater proportion of regional spending (Exhibit 6). APAC countries are also most at-risk from China s increasing military strength. Notably, South Korea (Suk-hee, 2012) and Japan (Croft, 2014) have been vocal about growing Chinese power, and have more closely aligned their policies with the West. Exporting to these countries can ensure that Canada and her allies will have their interests represented in the region. Canada may also benefit from stronger ties with allies in APAC, including technology transfer and trade deals from some of the most innovative nations in the world (Fensom, 2015). For these reasons, it may be comparatively easier for GDLS-C to lobby for export to APAC nations. However, we note that increased militarization of allies may provoke blacklist countries like Russia, China, and North Korea to themselves militarize, which would end up destabilizing the region. 3. Middle East & North Africa GDLS-C has already made inroads with a major MENA nation, KSA, and is in a favourable position to expand to other nations in the region. MENA nations also tend to be large military spenders, especially in proportion to GDP (Exhibit 7), signalling opportunity for GDLS-C to significantly grow their business. Perhaps most importantly, MENA is a high-interest region for the West because of its vast petroleum reserves, which is an important input for many allied countries. Consequently, it has also become one of the must unstable regions internationally, with numerous active conflicts including coups, uprisings, insurgencies, and the rise of ISIS (Elwazer and Almasmari, 2016). While foreign petroleum exports may run counter to Canada s economic interests, in the grand scheme it s important for Canada to help maintain stability in MENA as part of its political and military commitments with allied nations. That said, MENA countries are notorious for human rights abuses, and could put GDLS-C at risk of not receiving export approval from the Ministry of Foreign Affairs. 4. Status Quo No Further Expansion Unless Directed by the Canadian Government Given the recent KSA scandal, this option allows GDLS-C to stay out of the limelight and avoid further controversy. It also allows the company to work on handling existing large procurement contracts, and focus on other aspects of their business (e.g. spare parts, services, etc.) Additionally, waiting for the government to direct you to certain customers effectively ensures that you will always be able to have export permits signed by the Minister of Foreign Affairs. Finally, taking this option may allow management to focus on other potential activities such as selling the company. Now that GDLS-C has been approved for their large KSA deal, the

8 company may receive a favourable valuation, and the parent General Dynamics Corporation may consider selling the business unit. Removing the company from any further expansion would also ensure that it does not wade into public controversy which could deter potential buyers. However, this is also the slowest growth option because the government may not actually actively have an interest to direct GDLS-C to enter certain markets (unless it is part of broader initiatives by groups like NATO), which could lead the company to stagnate. Recommendation Overview We recommend that GDLS-C attempt to expand into APAC. This is the largest of the major markets GDLS-C has yet to capture, target customers have relatively good human rights records, and there are tangible benefits to Canada (strategically, politically, and economically) to add countries from this region to the AFCCL and approve export contracts. Consequently, this reduces the political capital needed to persuade the government to support GDLS-C s expansion into the region. APAC also inherently provides the greatest growth potential because those nations already have large military budgets which are expanding in tandem with rapid GDP growth and fear of an increasingly powerful China. Leveraging Government Relations It s critical for GDLS-C to ensure alignment with the interests of the Government of Canada, otherwise it will significantly reduce its probability of getting export permits signed. It should remain in lock-step communication with different parts of the government prior to entering a new market to gauge sentiment on whether they would support arms sales in that region. GDLS-C should also attempt to build political capital as much as possible, such as providing the Canadian Army with discounts and transferring the full value of cost advantages (i.e. less expensive equipment from economies of scale). By indicating that GDLS-C has good faith and the best interests of the government in mind will help them build a case when requesting to have APAC countries added to the AFCCL, and securing export permits. Attempting to Reduce Legislation One thing GDLS-C should actively look to do is actively lobby the government to remove the IDRDP requirement needed prior to a country being added to the AFCCL. If this regulation was removed, GDLS-C can be more agile in the countries it attempts to serve, and it helps Canada to service its interests without having to have actual formal defence relations with the buyer countries. It is beneficial for Canada to drop this legalisation, because such a formal agreement

9 takes time, although it serves almost no purpose to help vet the nations nor does it do anything for Canada s interests. While such legalisation would have made more sense when Canada was a lower-volume exporter of Arms, now that the country is breaking into the top 10 arms exporting nations (Stockholm International Peace Research Institute, 2016), it is important for GDLS-C to be in direct contact with the government to see if such restrictive regulation may be removed. They should articulate that it has not effective benefits to Canada, and that removing it and allowing defence firms to become more agile would help the industry grow. Conclusion Due to the nature of its business, GDLS-C faces immense regulatory risk. It must realise that it operates in a highly-managed industry and, in many cases, it functions as an extension of the government that helps support Canada s global interests. As such, any strategy it employs to grow its business must be in lockstep with the government. Expansion into the Asia-Pacific region asks the government to only expend a relative small amount of political capital when exports contracts need to be approved. This region is also economically important and under threat from a rapidly growing China. Thus, the government may find it in its interests to better align itself with these nations militarily, economically, politically, and strategically. However, having more countries added to the AFCCL will still be a challenge, so GDLS-C must continue to emphasise the benefits Canada gains from exporting weapons (high quality jobs, extend global influence, etc.), and why Asia-Pacific nations are particularly suited (important region, good human rights records, etc.) to be added to the list.

10 Exhibit 1: Pre-approval Process

11 Exhibit 2: Total Military Spending by Country Exhibit 3: Existing, Potential, and Blacklist Markets

12 Exhibit 4: GDP Growth by Country

13 Exhibit 5: Human Rights Risk Index

14 Exhibit 6: Potential Export Countries and Regional Military Budgets Country Budget(Billion) Region India $50.00 Asia-Pacific Japan $45.80 Asia-Pacific South Korea $36.70 Asia-Pacific Brazil $31.70 Latin-America UAE $22.80 MENA Turkey $22.60 MENA Israel $15.90 MENA Algeria $11.90 MENA Oman $9.60 MENA Region Average Budget ($ Total Regional Budget ($ Billions) Billions) Asia-Pacific $44.17 $ Latin-America $31.70 $31.70 MENA $16.56 $82.80 Exhibit 7: Military Spending (% of GDP) Note: No Data for United Arab Emirates

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16 Human Rights Watch. (2016). Saudi Arabia. [online] Available at: [Accessed 13 Dec. 2016]. Jaramillo, C. (2016). Ten facts about Canada s arms deal with Saudi Arabia. [online] OpenCanada. Available at: [Accessed 13 Dec. 2016]. Stockholm International Peace Research Institute, (2016). SIPRI Arms Industry Database SIPRI. [online] Sipri.org. Available at: [Accessed 13 Dec. 2016]. Suk-hee, H. (2012). South Korea Seeks to Balance Relations with China and the United States. [online] Council on Foreign Relations. Available at: [Accessed 13 Dec. 2016]. Wilson-Hodge, D. (2016). An Interview with Doug Wilson-Hodge, the Manager of Corporate Affairs for General Dynamics Land Systems - Canada.