Diversification efforts localise arms manufacturing in Saudi Arabia

With the creation of a new defence holding company and clauses requiring that local manufacturing and job creation be written into new contracts with international suppliers, the Kingdom’s aerospace, defence and security sector is primed for growth.

The defence and security market in Saudi Arabia is among the most lucrative in the world, as exemplified by the more than $110bn worth of defence contracts signed during US President Donald Trump’s May 2017 visit to Riyadh. Shares in several major US defence firms soared following news of the agreements, and President Trump highlighted the boost for jobs in the US. However, the new deal also included pledges for new factories and employment prospects for people in Saudi Arabia itself.

Spending Priorities

When Saudi Arabia announced its 2018 budget, it included a commitment to increase planned military expenditure by 9.9%, to SR210bn ($56bn) compared to its original target of SR191bn ($50.9bn) for 2017. This made military spending the largest item in the budget, accounting for 23.6% of the SR889bn ($237bn) spending plan. Under the plan, military expenditure will include SR10.2bn ($2.7bn) for building advanced systems and capacities, SR3.5bn ($933m) for military education and colleges, and SR26.5bn ($7.1bn) for military medical services.

Security and regional administration spending is grouped under a separate heading in the budget. At SR101bn ($26.9bn), the 2018 security allocation is a 4.4% increase on 2017’s SR96.7bn ($25.8bn) and represents 11.4% of the budget total. The funds will be used to provide facilities, supplies, equipment, weapons and ammunition, as well as to continue work on the King Abdullah Project for Development of Security Headquarters – a five stage project that involves establishing 1296 security sites by 2020. It is expected that 551 of these security sites – representing 43% of the total – will be completed before the end of 2018. Security funding will also be used to cover other ongoing projects such as the development of two medical cities with 2500 beds, and 14 residential complexes with 10,000 homes in five regions, of which two complexes – or 14% of the total – will be handed over in 2018. In addition, the construction of two medical cities with a capacity of 2500 beds is also under way, with the projects expected to be completed by 2019.

Global Comparisons

According to “Jane’s Annual Defence Budget Report”, published by business information firm IHS, Saudi Arabia’s intended budget for 2016 was the fifth highest of any country in the world, a position the Kingdom also occupied in 2015. The Saudi budget slipped from $50.5bn in 2015 to $48.7bn to 2016, according to the report, which also showed Russia falling from fourth place in 2015, with a $51.8bn budget, to sixth, with $48.4bn. India’s expenditure increased from $46.6bn to $50.7bn in the same period, and it effectively changed places with Russia in IHS Jane’s rankings.

The US, China and the UK had the highest defence budgets in both years, with planned expenditure in 2016 of $622bn, $191.8bn and $53.8bn, respectively, according to the report.

A portion of the budget also covers ongoing costs associated with personnel. According to the most recent figures available from the International Institute of Strategic Studies (IISS), there were around 250,000 armed forces personnel in Saudi Arabia in 2015, a larger regular force than the UK, where there were 150,040 regular forces personnel in 2016. According to IISS, in Saudi Arabia there are 13,500 servicemen in the Royal Saudi Navy (RSN), 75,000 in the Royal Saudi Land Forces (RSLF) and 20,000 in the Royal Saudi Air Force (RSAF).

In addition, 16,000 men serve in the Royal Saudi Air Defence Forces and 2500 are members of the Royal Saudi Strategic Missile Forces. These five branches fall under the Ministry of Defence (MoD). The 100,000 personnel of the National Guard are administered by the Ministry of the National Guard. Crown Prince Mohammed bin Salman is minister of defence, while Prince Khalid bin Abdulaziz bin Ayyaf Al Muqrin is the minister of the National Guard.

Localisation Commitment

A central commitment made in the economic development plan, Vision 2030, unveiled in 2016, is to boost the localisation of defence industries. The plan notes that just 2% of defence spending takes place inside the country, and it sets an ambitious objective to increase the domestic share of military equipment expenditure to 50% by 2030.

The document further notes that in 2016 the entire Saudi defence industry consisted of seven companies and two research centres. Vision 2030 proposes that localising defence industries will stimulate growth across multiple sectors, create jobs and offer the potential to reduce costs.

The plan also points out that existing Saudi defence companies have tended to focus on less complex processes such as supplying spare parts, building armoured vehicles and manufacturing basic ammunition. Vision 2030 envisages the domestic manufacture of much more complex, higher-value military equipment, such as aircraft, supported by the development of an integrated national network of services and industries.

The strategy is for localisation to be achieved through partnerships with leading defence suppliers, combined with direct investment in the sector. By 2030 the aim is to have a national defence industry utilising the latest advances in technology and staffed by Saudi experts that is capable of producing equipment for both the domestic market and export.

An example of these localisation efforts was an announcement in August 2017 by British aerospace and defence company BAE Systems that it was planning on establishing a final assembly line in the Kingdom, as part of its contract to supply 22 Hawk training jets. Khaled Al Mazrou, managing director of military supplies company Rawadef Trading Establishment, told OBG, “Everything is moving in the right direction, and the government is serious about the localisation of the defence sector. The military industry is a fast-changing one worldwide.”

Defence companies currently operating in Saudi Arabia support the idea that the country offers a number of advantages for international firms considering manufacturing there, including a domestic supply of materials such as steel and aluminium, cheap fuel and a favourable tax regime. “In order to identify the potential for localisation of military factories, we should start by considering the availability of raw materials locally,” Al Marzou told OBG. “For instance, Saudi Arabia can provide continued feedstock of sand, which is commonly used for manufacturing of ammunitions, as well as aluminium and steel for armoured vehicles.”

Stakeholders have also highlighted the importance of strengthening the entire supply chain to bolster localisation. “We cannot underestimate the challenges, because you can never have truly successful localisation without a strong supply chain,” Walid Abukhaled, CEO of Northrop Grumman Middle East, told OBG. “I think what we need to do as a country is take a detailed look at the supply chain and assess how it can be built up, starting with small companies with very specific facilities, until you get companies with full system integration. I also believe mergers, acquisitions and partnerships with companies from the outside can speed that process up.”

Saudi Expertise

In May 2017 the Public Investment Fund (PIF) announced that a new national defence holding company had been created to lead this restructuring of the country’s military manufacturing capability. Saudi Arabian Military Industries (SAMI) is expected to contribute SR14bn ($3.7bn) to the country’s GDP by 2030, create over 40,000 jobs for Saudi engineers and technicians, and invest SR6bn ($1.6bn) in research and development.

The state enterprise will have four business units covering aerospace, land systems, weapons and missiles, and defence electronics. SAMI will also establish joint ventures with international original equipment manufacturers (OEMs), as well as work with existing Saudi businesses.

Yahya Al Ghoraibi, president and CEO of Alsalam Aerospace Industries, told OBG, “The newly established SAMI will play a leading and pivotal role in expanding the capabilities of the defence industry in the Kingdom. SAMI plans to fulfil its mission through a series of strategic acquisitions, the consolidation of key local assets and companies, as well as investment in new domains that will contribute to achieving its set goals in line with Vision 2030.”

The significant commitments made by US military firms during President Trump’s visit in May 2017 were clear evidence of this new strategy. At the inaugural Saudi-US CEO Forum a letter of intent totalling $6bn was signed by Lockheed Martin to assemble 150 Blackhawk helicopters in the Kingdom, creating 450 jobs for Saudis. In the same month the defence and cybersecurity firm Raytheon announced plans to establish a new Raytheon Arabia business unit to further increase local capabilities and improve employment prospects, and US-based defence contractor General Dynamics agreed to localise design, engineering, manufacturing and support of armoured vehicles, with a target of achieving a 50% localisation rate by 2030.

Following these major deals, in October 2017 SAMI announced a memorandum of understanding with Rosboronexport, Russia’s state company for the export of military products. The deal focuses on localising the manufacture of advance armament systems in the Kingdom. At the end of that month, SAMI appointed Adreas Schwer, boss of combat systems at Germany’s Rheinmetall, as its new CEO.

Military Industrial Complex

The US’s defence budget, which includes the pay and benefits of its service personnel, as well as military expenditure on arms and technology, accounted for an estimated 40% of global defence spending in 2016. The “2016 Defense Markets Report” from the US Department of Commerce’s International Trade Association (ITA) noted that US companies dominate the industry internationally, with seven firms headquartered in the US being among the top 10 players globally in terms of sales and three other US businesses in the top 20.

According to the Jane’s report, the US’s defence and aerospace sector supported 2.8m jobs between 2013 and 2015, close to 2% of the nation’s employment, of which 1.7m people were employed directly or indirectly in producing goods and services in the supply chain. Out of those 2.8m jobs, 531,000 were working in commercial aerospace and 511,000 were working for military and state firms. The ITA report also pointed out that the world’s leading defence and aerospace companies have developed complex supply chains, with 60-70% of the dollars paid to prime contractors passed on to sub-contractors. For example, Italian firm Finmeccanica alone uses no fewer than 30,000 global suppliers.

According to figures from the professional services company KPMG, while the UK has some major international companies – including BAE Systems, GKN Aerospace, Babcock International and Rolls-Royce – the country’s defence sector is highly fragmented, with 9000 firms generating employment for around 300,000 workers. KPMG also reported that defence accounts for 10% of manufacturing output in the UK. A 2016 study on the US aerospace and defence sector published by IHS indicated the industry accounted for 10% of manufacturing output and 13% of employment in manufacturing in 2015. The same report noted that the average income of defence workers was $93,000, some 44% above the national average, reflecting the highly skilled nature of the workforce. This suggests Saudi Arabia faces a significant challenge in encouraging the creation of a multitude of defence and aerospace OEMs and the smaller firms that typically supply them with components and expertise.

Chinese Model

According to analysis from the Stockholm International Peace Research Institute (SIPRI), China was the world’s biggest importer of arms at the start of the new millennium, but had fallen to fourth place behind India, Saudi Arabia and the UAE by 2016. The Chinese model may give some direction to the Kingdom’s economic planners, as the former has become capable of producing a number of complex weapons while continuing to rely on imports for items such as engines and transport aircraft. SIPRI reported that Russia has been the main supplier of arms to both China and India, while China itself has become Pakistan’s main source of defence equipment. France has also been a significant supplier of arms to China, along with Egypt, the UAE, India and the UK.

According to SIPRI, China managed to reduce its arms imports by 58% between 2007 and 2011. Its self-reliance initiatives over a decade saw the country launch two new classes of conventional submarines, the development of its own SU-27 combat aircraft and mass production of the J-10 fighter, an aircraft equivalent to the US’s F-16. China’s factories also produced assault rifles, small arms, tanks and armoured personnel carriers. In the 10 years leading up to 2011 China’s arms exports grew by 95%, and during the 2012-16 period its exports were 74% higher than during 2007-11.

Between 2012 and 2016 China was the world’s third-largest exporter of weapons, according to SIPRI, behind the US and Russia. The growth in Chinese exports from 2012 to 2016 overtook production in the UK, France and Germany, all of which had higher export figures than China during the 2007-11 period. Although the dramatic turnaround from leading arms importer to a leading exporter took place within the context of broader economic growth and an increase in manufacturing capabilities, China’s example may provide a role model for the planners of Vision 2030.

Indian Example

Another country facing similar challenges is India. SIPRI data show that India’s share of global arms imports increased from 9.7% in 2007-11 to 12.8% in 2012-16, while Saudi Arabia grew from being the world’s 11th-largest importer with 2.9% of total global imports in 2007-11 to the second largest in 2012-16, with an 8.2% share of global arms imports. India is aiming to become an arms manufacturing powerhouse and its 2011 Defence Procurement Policy (DPP) includes calls to “buy and make Indian”. The DPP programme encourages Indian private companies to form partnerships with international firms and includes minimum mandatory defence offset requirements in contracts. In 2015 the government of India granted 56 defence manufacturing licences to private businesses.

Some of the companies were already operating in the defence industry, but many others are entering the sector for the first time. Hero MotorCorp, Mahindra Defence, Anil Dhirubhai Ambani Group, also known by the name Reliance Group, and Kalyani Group have all shown an interest in the “Made in India” defence strategy.

Key Customers

An important factor that may help both Saudi Arabia and India to grow the domestic manufacture of defence equipment is their status as valued customers for some of the world’s biggest international arms companies.

The ITA reported that Saudi Arabia was the biggest market for US defence and aerospace exports in 2015, accounting for 11.4% of the total. UK Trade and Investment reports that the Middle East was the biggest market for British defence equipment in the 2007-16 period. Although specific numbers for trade with Saudi Arabia were not available, the 2015 order of 22 Hawk fast-jet trainer aircraft is an example of a major success for British defence and aerospace exporters. The Hawk’s manufacturer, BAE Systems, noted in its 2016 annual report that Saudi Arabia accounted for 21% of its global sales, equivalent in value to its home market of the UK. The company employs 83,100 people around the world, with 6200 of its staff located in Saudi Arabia. These include employees working on the Saudi British Defence Co-operation Programme, which is supporting the RSAF and RSN through to 2021. In 2017 BAE Systems was due to deliver the last four aircraft contracted under the Salam Typhoon programme.

It also noted that it is committed to supporting Vision 2030’s aims of developing thriving industries in the Kingdom, and that during 2016 it engaged in a programme of capability and knowledge transfer via the Typhoon platform. The firm is also working with its partners to boost provision of training, supply chains and IT services, including aircraft equipment and maintenance, modern electronics manufacturing, repair and maintenance, and system integration. BAE Systems also has a stake in four Saudi firms: Advanced Electronics Company (AEC); International Systems Engineering; Saudi Development and Training; and Saudi Maintenance and Supply Chain Management Company.

US Arms

SIPRI also reported that, excluding China, US firms dominated the list of the world’s top arms-producing and military services companies in 2015. First and second place were occupied by Lockheed Martin ($36.4bn) and Boeing ($28bn), respectively. BAE Systems ranked third, with global sales of $25.5bn, followed by Raytheon ($21.8bn), Northrop Grumman ($20.1bn) and General Dynamics ($19.2bn). All of these companies are also significant players in the Saudi defence sector.

According to figures from the Kingdom’s MoD, between May 2015 and June 2017 the US State Department approved potential military sales for Saudi Arabia totalling $25.5bn. These included a $11.25bn Lockheed Martin contract to supply four multi-mission combat ships, a $5.4bn Patriot missile system order shared by Lockheed Martin and Raytheon, and a $3.5bn commission for 38 Chinook cargo helicopters for Boeing in December 2016.

In August 2016 the US State Department approved a $1.15bn sales contract for General Dynamics Land Systems to supply 153 M1AI/2S tank structures for conversion into Abrams battle tanks and 20 M88 A1/A2 Heavy Equipment Recovery Combat Utility Lift Evacuation Systems and associated equipment such as machine guns and ammunition for the RSLF.

Taqnia

Spearheading the search for suitable technology partners and knowledge transfer opportunities is the Saudi Technology Development and Investment Company (TAQNIA), which is owned by the PIF. In early 2016 TAQNIA Defence and Security Technologies (DST) formed a JV with Turkish military electronics firm ASELSAN called the Saudi Arabian Defence Electronics Company (SADEC).

The Turkish and Saudi partners have an equal share in SADEC, which was formed with $6m in capital and plans to build a factory in the Kingdom to manufacture radar, electronic warfare and electro-optical equipment. “We are fortunate that we sent so many students abroad to study at the best universities over the last 10-15 years, and so we have no shortage of highly qualified staff in Saudi Arabia,” Hamad Alyousefi, CEO of TAQNIA DST, told OBG. “With ASELSAN we will train our engineers in their factories, and then we will bring them back here to work in our facility so that in two to three years’ time we will have one of the finest electronics factories in the country.” SADEC sees itself as part of a drive towards self-sufficiency in defence equipment and as having the potential to supply technology and equipment throughout the Middle East.

TAQNIA may have some valuable lessons to learn from its partner in SADEC, as ASELSAN itself is the product of a previous Turkish government initiative started in the 1960s and 1970s to produce more of its own military equipment.

Aero-Industry Leaders

Alsalam was established in 1987 under the Saudi government’s offset programme and provides maintenance, overhaul and modification services for civil, private and military aircraft. The company has since developed its services to include the assembly of military aircraft and the manufacture of F-15 components, including wings, forward fuselage, pylons and adapters.

AEC, another product of the offset programme, was founded in 1988 and has broadened its portfolio of activities beyond defence to develop solutions for energy, health care, security and ICT. Its specialties include electronics repair, logistics, engineering and development, and manufacturing.

In 2016 AEC won the Boeing Supplier of the Year Award for 2015, in recognition of its manufacturing capability. In 2015 Boeing spent some $62bn with 13,000 suppliers from around the world.

In addition, the Middle East Propulsion Company was formed in 1989 and provides maintenance, repair and overhaul (MRO) services for F-15, Tornado, Hercules and turboprop engines used on RSAF aircraft. “We started the manufacture of wings and forward fuselages for the F-15SA,” Al Ghoraibi told OBG. “The localisation of aircraft manufacturing is currently happening, but it is going to take time before it can be fully accomplished, especially for the airframe mechanical structure.” In terms of civil aircraft servicing, the country already has some competitive avantages regionally. “Saudi Arabia has an advantage over regional peers as the only service hub between India and Europe for Airbus and Boeing landing gears,” Mansour Bineid, CEO of Aircraft Accessories and Components, told OBG.

Civil Aviation

The civil aviation sector in Saudi Arabia is growing and diversifying. In late 2016 Jaan Albrecht was appointed the new CEO of Saudi Arabian Airlines, and in April 2017 he told local media the firm is planning to increase the size of its passenger fleet from 130 aircraft to 200 by 2020. In September 2017, the company launched a low-cost service called Flyadeal using eight leased Airbus A320s. This came 10 years after the low-cost carrier Flynas was launched, a firm that now operates 29 Airbus A320s serving 33 destinations.

In addition, three other airlines have applied for permission to operate in the Kingdom. According to the General Authority for Civil Aviation (GACA), Al Maha Airways, SaudiGulf Airlines and Nesma Airlines are working to meet technical and operational qualification after receiving preliminary licences. The GACA oversees economic and safety regulation, air navigation services and the operation of 27 airports across Saudi Arabia, a number of which are modernising and expanding (see Transport chapter).

Training

The localisation objectives for the defence, aerospace and security industries under Vision 2030 are driven in part by the desire to reduce the amount spent on importing finished solutions, but also by the wider need to diversify the economy away from hydrocarbons and create private sector employment opportunities for young Saudis.

As companies like Alsalam rebrand and reposition themselves to focus increasingly on manufacturing, as well as on MRO, demand is growing for employees with the matching skills necessary to work in the field. In March 2017 the Technical and Vocational Training Corporation signed a memorandum of understanding with Alsalam that will provide 500 Saudi high school graduates with training in aerospace manufacture and repair and give the company a fresh pool of qualified talent to draw on as it expands. ”Technical training will be the main focus in the lead up to 2020. The aviation industry requires around 10,000 people, with Saudi Arabian Airlines needing some 5000 of these,” Al Ghoraibi told OBG. “In the past, there was less need for technical training, but in recent years we have witnessed massive development, and new colleges are coming up to support the industry’s growth.”

Cybersecurity

Defence and security businesses are also hoping to attract some of the brightest technology graduates. Northrop Grumman, for example, hosts an annual competition called CyberArabia, which challenges students from leading universities, such as King Saud University, Princess Nourah bint Abdulrahman University and Prince Sultan University, to develop cybersecurity solutions. “To compete in the future, it is important to engage with talented young Saudis who are going to be future business leaders, and cybersecurity is a topic that is extremely important to the whole region,” Abukhaled told OBG.

A 2016 survey by consultancy firm PwC revealed that businesses in the Middle East suffer more losses due to cyberattacks on average than other regions. The firm found that 85% of firms in the Middle East had been affected by some form of cyberattack in 2015, with 18% subject to more than 5000 attacks, compared to other parts of the world where the comparable figures were 79% and 9%, respectively. The most notorious cyberattack in Saudi Arabia took place in 2012, when data on 35,000 Aramco computers was destroyed within hours by a virus known as Shamoon. Then, in November 2016 thousands of government computers were targeted by a Shamoon variant, leading to calls for better security and training from the National Cyber Security Centre.

Outlook

Saudi Arabia’s budget for 2018 shows that it is committed to equipping its armed forces with the best equipment money can buy. However, beyond the lifespan of the platforms it currently uses, the Kingdom looks set to focus increasingly on forging partnerships with suppliers prepared to help the country to create its own manufacturing base and be at the forefront of security technology.