Success may be only stepping stone to a bolder ambition

BY RUSSELL HOTTEN

For years, Lord Weinstock has sat in his office on the fifth floor of GEC's Mayfair headquarters plotting battle strategy for control of the UK defence industry.

His aim of creating a single UK prime contractor with the power to rival Continental and US groups has been the driving force behind many recent changes in the defence business.

Now, after 32 years in which he turned a struggling electronics firm into a respected industrial giant, Lord Weinstock perhaps has the end- game in sight.

Opinion in the City and industry now firmly believes GEC has won the battle for VSEL before it really started. But it may only be a stepping stone towards a bolder ambition.

Lord Weinstock has always dreamed of leaving an indelible mark on the defence industry by merging GEC's military interests with BAe's. Many analysts believe the pressures towards further consolidation in the defence industry makes some sort of future link-up inevitable. Lord Weinstock has held a number of talks with BAe about merging, and last year tried to encourage a joint bid for VSEL. He believes that in the new world order of declining defence budgets and growing international competition, the way forward is to create a vertically integrated UK prime contractor.

GEC's idea for BAe is the creation of an ever bigger organisation with greater buying power and a lower cost base, and increased political influence.

A handful of UK companies now compete for the bulk of work placed by the Ministry of Defence, whose procurement policy used to be to design military systems in-house and hire contractors to manage the programmes. But this approach encouraged cost over-run and a cavalier attitude among suppliers towards quality control. Now, the MoD asks contractors to tender for work at fixed cost with penalties if the job is delayed or sub-standard.

With less of the defence cake to go around, the result has been mergers, takeovers, and the collapse of many firms.

BAe is part of the European Future Large Aircraft programme, and is close to putting its missiles business in a joint venture with France's Matra, and also joining forces in military aircraft development with Sweden's Saab.

GEC has formed several alliances, most closely with Thomson-CSF and Lagardere of France. European governments are increasingly promoting Euro-projects such as Eurofighter 2000 and the tri-nation Project Horizon frigate programme.

These Darwinian times, where only the fittest survive, have been most visibly highlighted in the UK warship-building industry. Employment in UK warship-building in the three main UK yards - VSEL, Yarrow, and Vosper Thornycroft - has over the past five years fallen from 20,000 to 9,000.

The future of the three yards will depend on three up-coming contracts - for amphibious landing platform docks, the next order for Type 23 frigates and the pounds 2.5bn order for the new batch of Trafalgar submarines.

Yarrow can only bid for the Type 23 work, and GEC told the MMC committee that in the absence of the order, Yarrow would have to close in two or three years. However, GEC has guaranteed that it would keep open Yarrow to complete the forthcoming Project Horizon frigate programme, which begins in 1997 at the earliest. This implies that GEC would keep open Yarrow until 2002. But this could involve just keeping the design team and mothballing the other facilities until the time came to start the building work. Job cuts would be inevitable.

VSEL is bidding for all three contracts and has a good chance of winning the landing platform contract and the submarine order. This would provide a significant workload for VSEL well into the next decade. Yarrow stands to gain some spin-off work if VSEL wins the Trafalgar submarine deal. Vosper has a good chance of winning the Type 23 frigate contract.

With little to go round, even the Ministry of Defence believes further contraction is a matter of time. Vosper Thornycroft told the recent monopolies inquiry into the VSEL bids that the number of future contracts pointed towards work for only two yards.

The UK Government has tried to feed as many yards as possible. But, as was shown in the demise of Swan Hunter, some contractors inevitably starve. Warship-building suffers the same problem as the defence industry as a whole - with not enough work to go round, companies will eventually be thrown together or forced to close.

VSEL's top shareholders

GEC 13.98%

Gartmore 5.59%

BZW Inv Mge 5.00%

Prudential 4.32%

Mercury 4.25%

AMP Asset Mge 3.75%

Baring Brothers 3.08%

Royal Insurance 3.01%

Prolific 2.61%

Perpetual 2.51%

Merrill Lynch 2.13%