Restructuring the UK defence industry: Market pressures and management initiatives

Restructuring the UK Defence Industry: Market Pressures and Management Initiatives Paul Bishop and Tim Williams

T

HE UK DEFENCE INDUSTRY has traditionally operated in an environment vastly different from the civilian marketplace.’ Until the mid 198Os, most contracts were awarded by the state on a non-competitive basis and priced according to actual cost plus a profit markup. Thus, companies faced few pressures to curtail costs with the state prepared to absorb costs in excess of those forecast when a contract was awarded. Firms maintained their position in the industry primarily through developing a lead in the production of specialized, high-quality products. Competitive advantage was largely based upon product differentiation rather than cost leadership and senior management was dominated by technical specialists rather than individuals with commercial business skills. The peculiar nature of the defence market fostered a distinctive culture characterized by a close, often ‘cosy’, relationship amongst management, the military and the state. The major contractors within this ‘military-industrial complex’ could rely upon a steady flow of defence contracts and were effectively protected from international competition.’ Indeed, by the end of the 1970s many leading defence firms were state-owned, and the development of the industry was largely determined by political decisions rather than the dictates of the market. The relatively stable nature of the UK defence market was shattered in the 1980s as a result of a series of dramatic changes in the domestic and international defence environment which are documented in Table 1 .3 The first sign of change was a major programme of privatization in the early 1980s arising from the application of ‘Thatcherism’ to the industry. This was followed by the widespread introduction of com-

petitive tendering and fixed-price contracts. These changes radically changed the basis on which the industry operated, with firms having to pay much greater attention to costs and competitive pressures than had hitherto been the case. The process of change was intensified by cuts in real defence spending following a reappraisal of the UK’s international role with the ‘ending’ of the Cold War (Figure 1). As a consequence of these massive changes in the defence market, the performance of many defence firms was seriously compromised. Indeed, the share price of leading defence contractors halved in comparison to the FT All-Share Index during the period Long Range Planning,

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Traditional

market conditions

Direct contract negotiation with individual contractors Cost-plus pricing Stable or rising real defence spending Dominance of product differentiation strategies Project-based collaboration High level of state involvement/ownership Cold War (permanent threat of hostilities)

1981-1991.4 British Aerospace reported a record loss and other major contractors such as Dowty succumbed to foreign takeover.5 In response to these problems many companies were forced to reappraise their corporate strategy in an attempt to turnaround declining performance.’ Some companies decided to move into civilian markets, whilst others sought to consolidate in existing market niches or expand operations in overseas defence markets.7 Substantial restructuring of production occurred as a consequence of a series of mergers, takeovers and increasing international collaboration. The net effect of these changes is that many market segments are now dominated by only one or two major producers.’ For many contractors the development of new corporate strategies appears to have been associated with significant changes in management structure and personnel. British Aerospace, for example, has undergone several changes in its top management as it has searched for an appropriate response to declining performance and loss of markets.g The importance of such managerial changes at a time of crisis is well documented in the wider management literature. Indeed, some studies suggest that management change is frequently a prerequisite for successful

New market conditions Competitive tendering Fixed-price contracts Falling real defence spending Change to strategies of cost leadership Strategic international alliances/mergers Privatization and reliance on market forces Post Cold War (reduction in perceived threat of war)

turnaround. A study by Slatter, for example, concluded that almost 90% of a sample of companies which had experienced successful turnarounds had undergone substantial changes in top management.” Similar conclusions have been reported in other studies including those of Grinyer et al., Chan and Schendel, Patten and Riggs.” However, Arogyaswamy ef al. are more sceptical arguing that the evidence from large sample studies as to the effectiveness of management change is inconclusive.” They suggest that such change may be disruptive to the operations of a firm and is only likely to be successful if management has been stigmatized by failure, or when significant strategic reorientation is required. It has also been suggested that management change may be associated with particular types of strategic response. Whittington, for example, argues that in times of recession, management change is associated with a strategy of rationalizing focus, which combines cutting costs with focusing upon core market segments.13 In the case of the defence industry the qualitative nature and quantitative scale of the changes which have occurred would seem to make management change a likely response to crisis. It is clear that the defence market has traditionally exhibited a specific culture deriving from the unique features of the military-industrial complex.‘4 The skills required to operate in this market have been quite different from the commercial and marketing skills typically necessary in civilian markets. Managers steeped in the culture of the defence market may, hence, find it difficult to adapt to the new market conditions. Such a view accords with the approach of theorists such as Child and Smith who argue that long-established organizational practices and beliefs may be a significant impediment to strategic innovation.15 Management change in the defence sector may, hence, be viewed as a vehicle for the adoption of a new strategic recipe required to operate successfully in a more competitive market environment. Moreover, the sheer scale of the change facing many companies may require different management structures and executives with experience of managing change rather than the traditionally stable conditions of the defence market.

Restructuring the UK Defence Industry: Market Pressures and Management Initiatives

Although there are many specific examples of management change in the defence industry, there has been little systematic study of the extent and impact of such change. This article attempts to fill this gap through an analysis of data derived from a survey of defence firms in south-west England. This region is of particular relevance as it is the most heavily defence dependent of all UK regions and is the location for many leading contractors. The article begins by presenting evidence concerning the importance attached to managerial changes by the sample companies. The relationship of factors such as company size and defence dependency to management change is also then discussed. This is followed by an analysis of the interaction between managerial change and strategic change. Finally, the impact of management change on company performance is assessed and the wider implications of the case study are evaluated.

Company Characteristics Management Change

and

In Summer 1995 a postal survey was conducted of all defence contractors and sub-contractors which could be identified in south-west England. The sample firms were identified from various business directories and local authority listings. Firms purely supplying services were excluded from the survey and consequently a total of 527 questionnaires were distributed. After deleting firms which had gone out of business, moved from the area or whose replies were unusable, 175 questionnaires were available for analysis. It should, however, be noted that not all respondents replied to every question and hence the subsequent analysis is often based upon a smaller number of responses. One problem involved in assessing the importance of managerial change as a strategic response to the restructuring of the defence market is defining the concept of ‘management change’. Previous studies have adopted a variety of approaches. Whittington and Chan, for example, concentrate upon the replacement of the Chief Executive.” However, whilst such a change is clearly of major importance, significant management changes and re-organization can obviously occur without change at the very top of the hierarchy. Other authors have hence taken a wider view. Schendel et al., for example, define change in terms of ‘general management changes’ which encompasses changes in general managers including chief executive officers.” In terms of the present study a further complication is that interest is not centred upon management change per se, but on change related to specific environmental changes in the defence market. Obviously managers may leave a firm for a variety of reasons, and without detailed knowl-

edge of individual cases it would be difficult to attribute particular changes to defence related factors. Given the above issues, and the desire to define a variable appropriate for statistical analysis, the approach adopted in the present study involved allowing managers to define management change. Thus, respondents were asked to indicate the importance of management change in their establishment as a direct response to changes in the defence market. Whilst this inevitably introduces a degree of subjectivity into the exercise, it avoids the pitfalls of restricting management change to turnover in particular jobs and specifically relates such change to the defence environment. In effect, therefore, the survey defined management change in terms of managers perceptions concerning the importance of general management changes as a strategic response to developments in the defence market. Table 2 presents the basic data concerning the importance of management change to company strategy. The results reveal that almost a quarter of companies ranked managerial change as being very important and a further third indicated that it was of some importance. However, 46% of respondents ranked it as unimportant. These results suggest that although management change has been of some importance to many companies, a significant number of sample companies have made no radical change to their original management structure as a direct response to changes in the defence sector. The presence or absence of management change in a company could plausibly be related to a number of factors which were measurable from the survey data. First, the degree of defence dependency of a company. Examination of this characteristic was motivated by the fact that companies which are highly dependent upon defence are likely to have been under the greatest pressure to change strategic direction and thereby exhibit a greater propensity to undertake top management change. A second potentially important variable is ownership status. Independent firms, often directly owned by managers may undertake less management change than companies which are branches of major concerns and may face pressure from both shareholders and central management. A third factor is company size. It is possible that large companies, with complex managerial structures built up over

Very important Important Not important Missing observations

No.

Percentage

38 49 75 13

23.5 30.2 46.3 -

Long Range Planning Vol. 30

February 1997

(

High defence dependency Medium-size firms Large-size firms

Significance

Estimated likelihood

0.0089 0.0477 0.0005

3.06 2.62 6.75

24

years in the defence market, may need to re-organize and eliminate managerial tiers. Moreover, such companies may have the resources to head hunt particular individuals. However, small companies may have less room for manoeuvre and simply not have the resources to access the market for new highly paid professional managers. A final factor is contractor status, namely whether a company is a direct Ministry of Defence contractor or simply a sub-contractor. The cultural barriers to change are likely to be much greater for managers directly involved with the Ministry of Defence and, thus, their need for management change may be greater. The relationship between company characteristics and management change was tested by logit analysis. This involves estimating the probability of management change as a function of the four factors discussed above. Management change was defined as either ‘present’ if it was very important or important to a company or, ‘absent’ if it was regarded as not important. The analysis proceeds by including all possible characteristics and successively deleting statistically insignificant variables using a likelihood ratio test. The various company characteristics were defined as categorical variables. The categories of the significant variables are outlined in the subsequent discussion. The logit analysis revealed that neither ownership status nor contractor status were significantly related to management change. However, as can be seen from Table 3, both defence dependency and company size were significant at the 5% critical level. The importance of the variables can best be assessed by calculating the estimated likelihoods. As far as defence dependency is concerned, the estimated likelihood is 3.06. This implies that companies with over 10% of their sales accounted for by defence (high defence dependency) are three times more likely to have undertaken management change than companies with low defence dependency. This seems to confirm the view that changes in the defence market have been a major factor motivating managerial change. The estimated likelihoods for company size imply that medium-sized firms (11-100 employees) are 2.6 times more likely to have been engaged in management change than smaller firms (l-10 employees) and large firms (over 100 employees) are 6.75 times Restructuring

the UK Defence Industry: Market Pressures

\ more likely. This indicates that company size has a considerable impact upon the probability of management change possibly reflecting the pressures on performance arising from shareholders and the capital market. The lack of importance of ownership status to managerial change is perhaps surprising given the arguments outlined above. It is, however, possible that the extent of change in the defence market has been such that even small independent companies have been forced to engage in considerable management change. Alternatively, the results may simply reflect the rather crude measure of ownership status employed in the analysis. It is plausible that a more sophisticated measure which identified several types of firm may have yielded different results. The insignificance of contractor status suggests that the pressures for change have been felt equally by direct contractors and sub-contractors. This could reflect that fact that the survey was undertaken several years after the changes in the defence market began to gather pace and, thus, the process of change has permeated the entire market.

Management Strategy

Change and Company

One interesting question concerns the extent to which management change is associated with particular corporate strategies. It might be thought, for example, that companies pursuing civilian diversification would be more likely to need to overhaul their management than companies which are moving into related defence markets. The questionnaire survey provided some insight into this question with regard to six strategy options-labour reduction, merger/ takeover, movement into defence export markets, civilian diversification, movement into new domestic defence markets and rationalization of defence product lines. Table 4 tabulates the presence or absence of a strategy element against the importance attached to management change. A simple Pearson x2 test of association rejects the assumption of independence between management change and all six strategy elements at the 5% significance level. Thus, the evidence suggests that a relationship exists between managerial change and all of the identified strategies. The conclusion to be drawn is that management change is associated with strategic change per se, rather than being identified with particular strategies. The relative importance of managerial change to the various strategy elements can be appreciated more clearly from Table 5. It can be seen that management change was most important in the case of mergers, defence rationalization, exports and labour reduction. Clearly, in the case of mergers,

and Management

Initiatives

Importance

of management

change (No. of firms)

Strategy

Very important

Important

Not important

Statistics*

Labour reduction No Yes

8 29

17 32

32 17

Pearson: 38.806 Significance: 0.00

Merger No Yes

18 18

26 21

73 2

Pearson: 40.576 Significance: 0.00

Exports No Yes

11

27

29 19

50 23

Pearson: 16.318 Significance: 0.0003

Civilian diversification No Yes

5 32

6 42

27 48

Pearson: 11.710 Significance: 0.003

Defence diversification No Yes

5 32

12 35

36 39

Pearson: 15.088 Significance: 0.005

Defence rationalization No Yes

17 16

32 16

69 6

Pearson: 23.416 Significance: 0.000

*This is the Pearson x2 with 2 degrees of freedom in all cases; the hypothesis of independence between management corporate strategy element can be rejected if the significance

change is almost inevitable, whilst movement into new export markets is likely to require managers with experience of operating in overseas markets. The relative importance of management change to the strategies of rationalization and labour reduction could suggest that existing management may be unwilling to engage in such ‘pulling back’ strategies. Indeed, the very need for such strategies may be regarded as a sign of managerial failure. Thus, companies may require a new management team to take the hard decisions necessary for the implementation of such strategies. This accords with the results of Whittington’s study, which concludes that firms involved in rationalization are more likely to change

management

Percentage Strategy

of firms stating management Very important

Labour reduction Merger Exports Civilian diversification Defence diversification Defence rationalization

37 46 39 26 30 42

change is: Not important 22 5 33 39 36 16

change and a

level is (0.05.

their chief executive than companies involved in other strategies. Surprisingly, the smallest proportion of firms indicating that managerial change was very important and the largest proportion saying it was insignificant arose in the case of civilian diversification. This could reflect a number of factors. First, it is possible that some companies are moving into civilian markets which are strongly related to their traditional defence markets. Thus, managers may be able to make use of existing managerial and technical expertise. Alternatively, companies could be adopting a gradualist approach to civilian diversification involving on-thejob learning of new business skills. Hence there is less need to acquire these skills externally. In addition, it may be that some companies are simply paying lip service to civilian diversification and are not as committed to the strategy as they indicated in their responses.

Management Performance

Change and

The impact of management change upon company performance is difficult to evaluate as no information regarding company profits was gathered in the survey. However, establishments did provide details Long Range Planning Vol. 30

February 1997

Expected impact of competitive Management

change

Positive

tendering

Neutral

Negative

Total

important

9

Important Not important

7 14

15 26 43

14 15 17

38 48 74

Total

30

84

46

160

Very

Pearson: 4.46. Significance: 0.347. Likelihood ratio: 9.80. Significance: 0.336. Degrees of freedom: 4.

concerning their view of the future impact of increased competitive tendering and changes in defence expenditure upon their business. It is plausible that companies which have adopted successful strategies will view the future with greater optimism than those which are continuing to face major problems. A test for the existence of a relationship between managerial change and future expectations may hence provide some tentative evidence of the impact of managerial changes on performance. Table 6 tabulates company expectations concerning the future impact of competitive tendering against the importance of management change. Both Pearson and likelihood ratio tests fail to reject the hypotheses that there is no relationship between the two variables as significance levels are well in excess of the 5% level. Thus, management change appears to have had no impact on company expectations concerning the impact of competitive tendering. This is perhaps surprising as it might be thought that management change might have been associated with the introduction of managers better equipped to operate in competitive market conditions. The results suggest that existing management has adapted equally as well (or badly) as new management teams to the new market conditions. Table 7 presents data on the relationship between

management change and company expectations concerning the future impact of changes in defence expenditure. The relationship is marginally insignificant at the 5% level using the Pearson x2 statistic. However, the relationship is significant using the alternative likelihood ratio statistic. Thus, the results are somewhat inconclusive and further studies are clearly necessary to establish the presence or absence of any significant relationship. Whilst the statistical results are ambiguous, an examination of the first row of Table 6 is interesting. It is clear that companies which regard management change as very important tend to view the future positively or negatively. Indeed, only four companies (10%) were neutral with regard to their view of the future. This suggests that major managerial change may have an important qualitative effect upon a company which significantly improves or weakens performance, rather than merely changing performance in a marginal manner. Following the general argument of Child and Smith, it could be argued that this reflects the view that new management offers a new ‘strategic recipe’ which implies a significant discontinuity in the structure and hence performance of a firm.18 This is particularly likely to be pertinent in the defence industry as existing recipes are likely to have been outmoded by the new market conditions

View of future impact of defence on company business Management

change

Very important important Not important Total

Positive

Neutral

Negative

Total

12 7 13 32

4 12 24 40

22 30 36 88

38 49 73 160

Pearson: 9.36. Significance: 0.053. Likelihood ratio: 9.80. Significance: 0.044. Degrees of freedom: 4.

Restructuring

the UK Defence Industry: Market Pressures and Management

Initiatives

and there have been new strategies.

significant

pressures

to adopt

Conclusion Although the UK defence industry has undergone major changes in recent years there has been little systematic study of the extent of managerial and strategic change. This article has sought to provide a detailed examination of some of the issues involved through an analysis of data derived from a survey conducted in the most defence-dependent region of the UK. It should, however, be noted that the evidence is limited to a study of defence industrial firms in one region at one point in time. A generalization of the results would require further studies of other regions and an examination of the process of management and strategic change over time. In addition, it would be interesting to examine similar issues within the context of firms which provide services rather than industrial products for defence purposes. The evidence presented in this article suggests that changes in the defence market have prompted substantial management change and re-organization. Indeed, highly defence-dependent firms in the sample were three times more likely to have undertaken significant management change than firms with low levels of defence dependency. In addition, it is clear that firms with over 100 employees have been more extensively involved in management change than their smaller counterparts. Moreover, management change has been strongly associated with strategic change. Indeed, all six strategic options covered by the survey were statistically related to management change. Thus, although some strategies appear to be more strongly associated with management change than others, the general conclusion is that management change is associated with strategic change per se rather than particular types of strategy. This may of course reflect the peculiar nature of the traditional defence market and the overwhelming need for cultural change in many specialized defence companies. However, it also accords with the more general view that management change is of particular importance at times of crisis, and for companies engaging in turnaround strategies. Given the unique nature of the defence market, it is difficult to assess the relevance of the findings of the study for other industries. Nevertheless, it appears clear that when the conditions prevailing in a market are highly specialized this is likely to result in the development of a set of managers with specific skills which are difficult to transfer to more ‘standard’ markets. This suggests that the need for management

change may be related to the extent of the change in skills required to move in a new strategic direction. A crucial element in any programme of strategic change should hence be an assessment of the management skills required to implement the new strategy and whether these can be acquired by retraining or necessitate the introduction of new personnel. In addition, the importance of managerial change to large companies suggests that pressure for change may often arise as a consequence of shareholder reactions to declining performance. Managers may be stigmatized by failure and a new regime instituted to restore the lack of confidence in the company. Management change may hence not always be a conscious internal strategic change but may be forced on a firm by conditions in the capital market. This issue, which is also discussed by Arogyaswamy et al., is clearly worthy of further research. The effect of management change on company performance is clearly inconclusive but the evidence tentatively suggests that management change is no panacea for improved performance. It is unwise to see management change as a ‘cure for all ills’, for whilst such change may have a dramatic effect upon a company the effect may be negative rather than positive. This suggests that management change needs to be as carefully planned as any other change affecting a company and to institute such change as a quick response to shareholder pressure may not achieve the desired improvement in performance. Moreover, the results of the study lend some support to Arogyaswamy et al.‘s note of caution concerning the assumption that management change is vital to successful turnaround. Indeed, a sobering thought is that over half of the sample companies in which management change was regarded as very important viewed the future prospects for their company with some pessimism. Finally, it is perhaps worthwhile summarizing the most important managerial implications of the evidence presented in this article: Significant management change may have a qualitative effect on a company which results in a major improvement or weakening of performance, rather than merely changing performance in a marginal manner. Management change appears to be associated with strategic change per se rather than a particular type of strategic change. Strategic diversification ation of the managerial in a new market.

requires a full appreciskills necessary to operate

Management change should be examined as a key element within the process of strategic planning.

Long Range Planning Vol. 30

February 1997

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Restructuring

the UK Defence Industry: Market Pressures and Management

Initiatives