Canada's Evolving Position in the Aerospace Environment
The global aerospace and defence industry can be characterized as an investment intensive and high-risk industry. It has undergone significant change in the past two decades. The global industry currently consists of a limited number of OEMs, or prime manufacturers, each with its own family of products and services that address the needs of commercial, military and space systems users. Financial pressures from a restructured airline industry, and the post-cold war era with its declining defence and space budgets, set the stage for industry developments over the past two decades. Driven by increasing project costs and risks, a process of industry consolidation at the prime manufacturing level has resulted in fewer players in both the commercial and military markets. In addition to consolidation at all stages of the value chain, the new platforms that the industry has been producing are fewer in number and have shorter development periods. As a result, suppliers need to react more quickly, raise their technological capabilities and have the ability to design subsystems in-house. This need has made it all the more important for companies to secure access to, and participate in, these new platforms at an early point, as later entry is nearly impossible.
As part of the ongoing transformation of the industry, the OEMs have been refocussing their roles, leading to profound changes in industry supply chains. On the commercial side, the OEMs are striving to reduce design-development cycle times in order to bring new products to market quicker and cheaper. Traditionally, the OEMs had full vertical design and integration responsibility for all of their products. Contract purchasing of parts and component systems from suppliers was largely limited to the build-to-print elements and subsystems. More recent developments have seen the OEMs refocus on their core competencies in design, integration and assembly. Instead of producing major subsystems themselves or dealing with numerous subsystems component suppliers, they have shifted responsibility for these activities down the supply chain. In response to financial pressures, the OEMs have moved to reduce their number of suppliers and have demanded that suppliers contribute to product development costs and take a share of the associated risks. This is forcing consolidation lower down the supply chain, with a small number of very large global companies that can provide complete subsystems packages. Tier Two firms in turn are downloading subsystem design responsibilities to suppliers lower down the supply chain, rather than ordering build-to-print parts.
Canada's aerospace and defence industries have developed a strong position for themselves within this evolving global industry. While this position has developed because of particular strengths, the industry faces certain challenges as it moves forward into the future.
What Strengths Propel Canada's Aerospace and Defence Industry?
Home to Strong OEMs
Canada's original equipment manufacturers have a strong presence in international markets. Firms like Bombardier, CAE, Pratt & Whitney Canada, Bell Helicopter Textron Canada and General Dynamics Canada are recognized around the world for the products they offer. These OEMs have substantial experience in developing leading-edge products that meet the needs of international markets and in exporting to those markets. They have achieved global success despite their small home market.
One of the key factors propelling the growth of the aerospace and defence industry in the past decade has been its workforce. For example, over the 1993-2003 period, aerospace product and parts manufacturing value-added per employee was 24 percent higher than the manufacturing average.
The industry provides many Canadians with high-paying jobs. Over the past 10 years, for example, the aerospace industry has annually employed an average of 45 000 Canadians at wage levels that were 35 percent higher than the manufacturing average. The industry has one of the highest average weekly earnings levels in the Canadian manufacturing sector (Figure 3). The industry has also employed an average of 5200 R&D personnel over that time period, ranking it second behind the communications industry in R&D employment (Figure 4).
Focus on Global Markets
The Canadian aerospace and defence industry has also been propelled by its strong focus on global markets. In addition to international sales of Canadian designed and built aerospace and defence products to airlines and other final users, the Canadian industry also participates in the supply chains of the major international OEMs. For example, Canadian firms are suppliers to Boeing, Airbus, Lockheed Martin and Raytheon.
This global focus has been reflected in the industry's strong export performance, especially over the past 15 years. The industry has a high export intensity and, between 1994 and 2003, exported an average of 75 percent of industry sales (Figure 5). Over the same period, annual exports averaged $8.9 billion, and the industry had a positive average annual trade balance of $1.7 billion per year. Aerospace has consistently been one of Canada's best-performing manufacturing export sectors.
Historically, the Canadian industry has had a close relationship with the United States market. Over the past 10 years, more than 70 percent of Canada's aerospace exports have gone to the United States. For example, United States airlines have been major purchasers of Canadian regional jets. On the defence side, the Canadian industry has benefited from a wide range of defence cooperation arrangements that were put into place in the 1950s and 1960s. The Defence Production Sharing Agreement was entered into in the late 1950s in order to provide the Canadian industry with general access to United States Department of Defense procurement and to give the United States access to an integrated North American defence industrial base. Furthermore, Canada agreed that it would acquire most of its major defence requirements from the United States in order to maintain a balance of trade. The Defence Development Sharing Arrangement was signed by the United States and Canada in 1963 to complement the Defence Production Sharing Agreement by allowing Canadian firms to take on cost-shared R&D for United States Department of Defense requirements. The aim was to provide Canada with access to the latest technology in exchange for giving the United States access to a larger R&D base.
Investment in Research and Development
The aerospace and defence industry is a major performer of R&D in Canada, and the levels compare well with those in other industrial sectors. For example, the aerospace industry invested an average of $873 million annually in R&D between 1994 and 2003, representing an average of eight percent of industry sales and accounting for an average of 14 percent of all manufacturing R&D. Total cumulative R&D investment over the 10–year period totalled $8.7 billion (Figures 6, 7 and 8). In 2004, three of Canada's top 20 industrial R&D performers were aerospace and defence firms.
Specialization in Key Products and Technologies
The Canadian industry is an important player on the world stage and holds significant market share in key segments (Figure 9). Much of this success has been due to the key role that Canadian-owned firms play in the sector and to the presence of several globally connected firms with world product mandates (e.g. Pratt & Whitney Canada, Honeywell Canada). Canada has built up substantial expertise in these areas and has developed successful products that meet the needs of world markets. Growth in the Canadian industry has been driven by the capture of leading positions in these markets, which in turn forms a solid base on which to build the industry.
Supportive Government Policies
The industry's development has been backed by supportive government policies. The federal government has assisted the industry with: R&D support through Technology Partnerships Canada; industry infrastructure development; and, industry sales financing through the Regional Aircraft Credit Facility and Export Development Canada. Government has also been crucial in pursuing advances through in-house R&D activities and initiating next-generation services, such as Earth observation or satellite communication services, which were transferred to industry once demand was high enough to sustain commercial activity. The space sector has also been supported by the Space Technology Development Program, the Government-Related Initiatives Program and the Earth Observation Application Development.
Strong Technical Education
Canada's universities and colleges have internationally recognized programs to train aerospace engineers, aerospace manufacturing engineers, aviation technicians and aircraft maintenance engineers. The Canadian Aviation Maintenance Council (CAMC) has played a key role in developing curricula as well as accrediting programs for training institutions for the aerospace maintenance sector.
Solid Industry Infrastructure
The industry benefits from a solid aerospace and defence infrastructure such as university facilities, the National Research Council's Institute for Aerospace Research including the Aerospace Manufacturing Technologies Centre, the Canadian Space Agency's David Florida Laboratory, Defence Research and Development Canada and the Composites Innovation Centre. The industry also works with universities in support of the sector's R&D efforts.
High Regulatory Standards
Canada maintains high regulatory standards for its aerospace sector. Transport Canada's strong regulatory framework for aircraft certification and aircraft MRO push the Canadian industry to maintain high standards in aircraft development and maintenance.
Turbulence: Challenges Facing the Canadian Aerospace and Defence Industry
The global aerospace and defence industry is emerging from a very difficult period. As the global industry returns to a growth path, the Canadian industry faces several challenges as it tries to maintain its position in the world aerospace and defence market.
Small Domestic Market
The Canadian domestic market, both civil and military, is small and open to international competition. Total industry sales in the domestic market amount to $4 billion per year, as compared with the United States market of US 150 billion per year. This small domestic market does not provide the springboard for international sales enjoyed by other countries. In the defence and space sectors, there is not the level of R&D support that drives aerospace innovation and technology development in many other countries. It also reduces the ability of the industry to counteract the cyclical fluctuations on the civil side of the business, the side on which the Canadian industry is highly dependent.
Maturing Product and Technology Base
The Canadian industry increasingly depends on a maturing product and technology base. While some of our key niches, such as landing gear and small gas turbine engines, have maintained a strong technology and product base, the dominant position of the Canadian industry in other key niches has recently come under threat. Canada's leadership in robotics, space radar, space imaging and satellite communications is threatened as other nations realign their space strategies. The maturing product base will increase pressure to fund basic research and new product development. Without such innovation and new products, industry sales will decline, as will Canada's position in the global market.
Much of the boom in Canada's aerospace and defence sales since the early 1990s was tied to commercial aircraft production. The Canadian industry now is heavily dependent on aircraft production, which accounts for close to half of the industry output. Given the maturation of the 50-seat regional jet market, the mainstay of previous industry growth, pressures will emerge for new products and technologies to sustain the industry's performance.
The lack of a critical mass of firms with systems integration capability limits the ability to provide systems packages for new domestic and international platforms. It also has an impact further down the supply chain and reduces the opportunities for Canadian suppliers. On the other hand, systems integrators in the defence industry serve the air, naval and land markets. These have been key contributors to the Department of National Defence and continue to be a source for ongoing and future procurement requirements.
Pressures on the Supplier Base
One of the key challenges facing the Canadian industry is adapting to the changes taking place in the global supply chains for major domestic or international platforms. As the OEMs push responsibility further down the supply chain, Canadian firms must take on more design, finance and risk responsibilities. When Canadian firms participate in foreign programs, they are often expected to cover their non-recurring costs. Smaller Canadian suppliers often lack the human resource, financial and technical capacity, to participate. In addition, smaller firms lack strong market recognition and global market presence on which to build.
The industry faces quickly growing competition from traditional and emerging areas, many with strong state backing. Canada's traditional competitors, for example, the United Kingdom, Brazil, and France, are working to strengthen their human resources and technology capabilities to move up to more high-value-added activities. In the space sector, countries are focussing on the development of their domestic industries and have funding available to participate in international programs. Emerging players in eastern Europe, Russia and Asia, with a good base of aerospace skills, access to modern technology and low-cost labour, pose a challenge to the Canadian industry in labour-intensive activities.
Research and Development
While the aerospace and defence industry is one of the major performers of R&D in the Canadian economy, there is evidence that industry investment in R&D has not kept pace with the development of the sector (Figure 10). In the aerospace industry, for example, industry sales have increased substantially in the past decade, but industry investment in R&D has not increased proportionately. This has led to a major drop in R&D intensity and a focus on product development. In general, there is a need for continuous investment in basic R&D to renew the technology base for the future. The level of pre-competitive collaboration in technology development needs to be improved.
International comparisons indicate that Canadian industry is productive. For example, Canadian aerospace productivity picked up substantially in 1991 and, since that time, has generally exceeded that of Germany, Japan and the United Kingdom (Figure 11). However, Canada's long-term position is being eroded as its productivity growth is not keeping up with its competitors, lagging behind that of most of its major competitors with the exception of the United States (Figure 12).
Like aerospace industries in other countries, the Canadian industry will face shortages of skilled labour, which could hamper future growth. Increasing retirement of workers, for example, is expected to have an impact in the next few years, particularly among skilled tradespeople, an area in which replacements take longer than average to train. By 2016, only 40 percent of the current manufacturing workforce and fewer than one-third of current aircraft maintenance engineers will be on the job. It has been estimated that moderate future growth rates of up to two percent annually in manufacturing will require up to 62 000 skilled workers by 2016 (Figure 13).
In filling these skills shortages, the industry will face competition from other high technology sectors and from aerospace sectors in other countries. This will add to the difficulty of finding sufficient workers to meet the industry's future needs.
Access to Foreign Markets
Canada has been successful in selling its strengths as a skilled, competitive and productive manufacturer of aerospace, defence and space products over the years; however, the export intensity of the Canadian industry makes it particularly vulnerable to protectionist pressures. Canada's special status in the United States defence market, through mechanisms such as the Defence Production Sharing Agreement, needs revitalization. Market and technology access barriers are growing to reflect security concerns, especially in the key United States market (e.g. International Trade in Arms Regulations).
Blue Skies Ahead: Industry Opportunities
The aerospace and defence industry is also an industry ripe with opportunity for those countries and industries that position themselves to take advantage of emerging developments.
Despite recent setbacks, indicators point to a growth scenario for the aerospace industry. For example, forecasts show substantial growth over the next 20 years in the civil aircraft sector. In its Global Market Forecast 2004-2023, Airbus forecasts 5.3 percent annual growth in worldwide airline passenger traffic and 5.9 percent annual growth in freight traffic. This translates into the delivery of 17 328 new passenger and freighter aircraft over the 20-year period, valued at US$1.9 trillion. In its 2005 Current Market Outlook, Boeing also predicts major growth for the civil aircraft sector. Boeing foresees annual airline passenger traffic growth of 4.8 percent and cargo growth of 6.2 percent between 2005 and 2024. To satisfy this growth, Boeing projects demand for 25 700 new passenger and freighter aircraft over the next 20 years, valued at US$2.1 trillion. The commercial MRO sector provides another example of the growth potential of the aerospace industry. In its April 2004 forecast of the world MRO industry, AeroStrategy Management Consulting of Ann Arbor, Michigan, forecasts that the MRO market will grow at an annual rate of 5.3 percent between 2003 and 2013. It estimates that the market will grow from US$35.8 billion in 2003 to US$60 billion in 2013. This growth represents considerable opportunities for countries and companies that adopt timely and strategic approaches to the market.
Participation in Major Domestic Platforms/Projects
There will be opportunities for the Canadian industry to participate in major new domestic platforms/projects. On the military side, an increase in defence spending will provide prospects for domestic industry. In Budget 2005, the government committed to new funding of $13.0 billion over five years for the Department of National Defence. This funding adds to a defence budget that has been rising since 2001. Upcoming major defence contracts include the Hercules replacement, Medium/Heavy Lift Helicopter, Mobile Gun System, Joint Support Ship, Military Satellite Communications and Fixed Wing Search and Rescue project. Budget 2005 also included some major space initiatives, including initial funding for the SAR Constellation program (approximately $400 million over five years). The Canadian Space Agency will also examine a future hyperspectral mission.
Participation in Major International Platforms
Possibilities will also open up for Canadian firms through participation in major new international platform programs, replacement platforms, space programs and defence acquisitions. Current and upcoming civil platforms include the Boeing 787, Airbus A350, Boeing's replacement for the 737 and the Airbus update/replacement for the A320. Important international space platforms include the European-led Global Monitoring of Environment and Security system and the Aurora system, the United States-led Global Positioning System 3 and Milsatcom systems, and those platforms associated with the United States Vision For Space Exploration. On the defence side, the major upcoming platform is the Joint Strike Fighter. Canada already is a partner in the early stages of this development.
Expansion into New and Emerging Technologies and Markets
New and emerging areas (e.g. electronics, software, composite materials, etc.) and markets (security, counter-terrorism, etc.) will open up avenues for Canadian firms to participate or expand in the sector. Some of these areas are outside the traditional aerospace and defence activities. Examples would include: unmanned vehicle systems (UVS); small (personal) jet aircraft; nanotechnologies; hyperspectral technologies; diagnostics, prognostics and health management (DPHM) systems; sensors; complex networked systems; data and information management; and, software-based diagnostic and information management systems.
Market for MRO
Canada has a strong MRO capability, and the growing worldwide market for such services will present opportunities for Canadian firms. Canadian firms can look beyond their traditional market of North America to focus on emerging MRO markets such as Asia and South America. Non-labour-intensive MRO activities such as engine repair and overhaul will provide opportunities. A focus on quality, innovative repair technologies, short turnaround times and cost savings will continue to be important.
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