PRIVATIZATION IN NACC COUNTRIES Defence Industry Experiences and Policies and Related Experiences in Other Fields COLLOQUIUM 1994 ********* COLLOQUE 1994 PRIVATISATION DANS LES PAYS DU CCNA Experiences et politiques des industries de defense et experiences comparables dans d'autres secteurs Colloquium 29-30 June, 1 July 1994 Brussels --------------------------------------------------------- PRIVATIZING DEFENCE INDUSTRIES: A SHIPPING SECTOR CASE Fredrik Behrens When western governments sold off their shipyards in the 1980s, they went into a thriving private sector that could help them diversify by absorbing new products and creating new markets. Even so, the exercise wasn't painless. The yards had to break up to survive, and many of them have only recently become competitive. Russia's shipyards are walking a higher tightrope with no safety net, says Fredrik Behrens. Either the Russian state or foreign investment will have to provide one. Fredrik Behrens is the Executive Vice-President in charge of International Developments of the Norwegian company, Kvaerner Rosenberg a.s. The shipyards and their related construction industry play an important role in employment and have a strategic role as an element of the defence industry. This is why many shipyards in western Europe were nationalised and "protected" when shipbuilding in the 1970s experienced a dramatic fall after a rapid rise. Japan and South Korea's present dominant position in shipbuilding is primarily due to this double change in the market and national "protection" of West-European yards. Only lately have some European yards again become competitive. In Norway, increased investment in offshore oil and gas activities lessened the impact on employment from reduced shipbuilding. In the UK and continental Europe the impact on employment and the costs to society were dramatic. A Brief History of a Selection of Companies ------------------------------------------- Kvaerner Govan shipyard, Glasgow, UK The yard was founded in 1854, and nationalised in the 1970s as part of British Shipbuilders. It was privatised in 1988, becoming part of Kvaerner, and became successful and profitable in 1994. The privatisation process reduced the number of employees from 2,200 to 1,500. Investments were made in modern hull construction technology as a part of the privatisation agreement with British Shipbuilders. The yard was and is a merchant shipyard, with limited military experience. Today the yard operates in close co-operation with other Kvaerner shipyards. Joint orders on ships series, exchange of personnel and co-operation in productivity measures and supply are important elements of its success. Changing labour relations was a difficult task, which only ended successfully after some turmoil. Absenteeism was reduced from 22% in 1989 to 5% in 1993. Kvaerner Govan recently won the contract for a new British helicopter carrier through its business relationship with the VSEL (Vickers), which at a time was also a part of British Shipbuilders. After privatisation, it continued as a military specialist, particularly on submarines. VSEL closed their shipyards recently as a private company, when it was made clear that carrying on as a military shipyard was not commercially attractive. The present collaboration is seen to have a future in cases where the merchant yards maintain their competitiveness and by this give added value for money for the part of the military orders where merchant shipbuilding standards and procedures can be used, and the defence specialists develop and exploit their speciality on the elements of the order where such knowledge is of greatest importance. Kvaerner Govan are seeing increased subcontracting on steelworks and specialist work on the control area in addition to the traditional subcontracting of insulation, ventilation, carpenters and electrical installation which they share with the local construction projects. They also used to subcontract painting, but have built a department themselves to operate their painting facilities in close co-operation with their modern production line. There is a rather poor infrastructure in terms of unit subcontracting in Glasgow and the company is raising discussions with their regular subcontractors about their willingness to take the peaks and valleys. Swan Hunter shipyard, Tyneside, UK ---------------------------------- Founded 1842 - Nationalised 1977 - Privatised 1986 (management buy-out) - crises since 1993 At the time of losing the helicopter carrier to Vickers/Kvaerner Govan, 2600 people were employed. Today, one year later, 800-1000 are still working. In 1993 when the contract was awarded, comments in the press referred to differences in quality between the naval yard and the merchant shipyard. It is difficult to have a specific opinion on such matters, but these kind of comments are quite common when industry changes and clients change their priorities. Today, one year later, Swan Hunter is still bidding on smaller naval contracts. There are speculations about a French group being interested in taking over the company, provided contracts to keep it going can be secured. Otherwise, it is expected that the yard will close down in the near future. Kvaerner Warnow Werft, Warnemunde, Germany ------------------------------------------ This yard was founded after World War II in East Germany and privatised as a part of the Treuhandanstalt mission to become part of Kvaerner. This conversion includes privatisation as well as the initial investment to build an entirely new and modern yard, introducing the latest technologies in shipbuilding. The conversion happened soon after the reunion of Germany and therefore in parallel with the conversion of the political system, including the social security system. The reunification of Germany is easing the conversion process for the earlier employees compared to what is expected for industries in the other former socialist countries. By 1990, the Warnowerft employed 5,700. The conversion will bring this down to 2,400. At Warnow, the yard had started on a program to produce consumer goods, a pattern well known at the larger industries from the later period of the Soviet communist system. They produced things like trailer hitches, refrigerators etc. which in the market-driven West are found as parts of completely by different industry groups than shipbuilding. These activities were lifted out of the new company and privatised separately with other owners. Some continued for a while in the old buildings at the wharf, some moved and some were shut down. From the remaining workforce it was the administrative personnel more than the skilled labour that faced the most difficulties. Something like 70% of the administrative staff had to be laid off. Early pension and redundancy were part of the conversion package. Unemployment after the initial period was not. It is therefore not possible to give a comprehensive picture of the cost of conversion, but it is surely beyond the cost for starting up an entirely new yard in any of the western countries. In the case of Warnow, the heavy burdens were laid on German taxpayers, and there were motives and financial capacity to support such a development. Support of this kind is not available in Russia. Therefore the sufferings will be harder there and the speed with which conversion takes place will be much slower. Horten Verft, Horten, Norway ---------------------------- (Earlier The Main Naval Yard of Norway) Horten Verft was founded in 1818 as the main yard of the Norwegian Navy. It was converted to commercial operations in 1948 (together with other Norwegian Defence industries Kongsberg, Raufoss). Still owned by the state, it went bankrupt in 1986 caused by the general collapse in the shipbuilding market. In the 1970s it produced excellent merchant vessels which, combined with naval and other state orders, kept it alive for longer than many of its European competitors. Operations stopped completely after the bankruptcy. The different facilities and departments of the yard were privatised as single companies as an "Industrial park" taking advantage of its location in a more densely populated part of the country than most other yards. The activities are, however, low compared to before the bankruptcy. Recently, a local entrepreneur with background in the earlier shipbuilding industry in the area has obtained an order for a ship, where the hull is bought cheaply abroad and where the outfitting is going to take place at the facilities in Horten using the small private companies in the "industrial park" as subcontractors on the order. It still remains to be seen if the skills are available, but it could be the start of a trend since there are parallels in the area of ship repairs. The history of Horten Verft also illustrates other trends. The yard dominated the building of the national Navy up to the mid '60s, although several vessels were imported just after the War. Since then the Royal Norwegian Navy went for small fast vessels made out of thin plate steel. New private yards were engaged for this task. After the initial naval order, the yard(s) obtained a series of contracts for fast vessels that were used for passenger transport. The original navy design was adjusted to accommodate aluminium as material and was also redesigned as catamarans. The first orders were for the Norwegian coastal traffic, and later it became an export success. This developed a cluster of fast vessels producers in the country and although location and ownership shifted over time, the industry is a sizeable supplier of fast vessels on the world market today. The current building program of the Norwegian Navy is dominated by advanced catamarans in GRP material. It remains to be seen if this could be the start of a similar success as the aluminium vessels. Haugesund Mekaniske Verksted, Norwegian West Coast -------------------------------------------------- This yard has been successfully kept alive by combining construction and installation work for the North Sea oil and gas activities with ship repair, which is a continuation of their long-standing traditions. This is unlike the other Norwegian shipyards, where the way to success seemed to be either to convert completely to offshore fabrication or to specialise within narrow niches of merchant shipbuilding. Those who did not, died. Also unlike the other yards that survived the difficult '70s and '80s in Norway, the Haugesund yard has until lately not become a financial success. Two major events caused the change Major layoffs were made in 1991 and the yard was thereafter sold to an expanding shipowner who obtained the yard for around 5 million pounds. The yard has land and facilities that would cost more than 50 million pounds if they were built and procured today. All costs related to the layoffs and restructuring were met before the sale. Kvaerner Rosenberg , Stavanger Norway ------------------------------------- Founded in 1896 it had a difficult life until it expanded rapidly in the '50s and the '60s under a Norwegian shipowner and became among the world leaders in building the largest crude oil carriers of the time. It lost out to the Japanese when ship sizes exceeded 150,000 DWT. It was taken over by Kvaerner in 1970 pioneering the construction of carriers for Liquefied Natural Gas (LNG). In the shipbuilding crises of the late '70s it was rescued by conversion to an offshore fabrication yard. It benefited by its geographical location and government policies to support national participation in the supplies to the oil and gas investments. Today that market is also declining. It has been opened for international competition following both the national policies and the development of technologies and the industry. In a study of its further development, the yard found that the conversion from a shipyard to an offshore fabrication yard would require importing labour from Finland and the UK with additional skills in welding and engineering. Just five year later, as a consequence of conscious programmes, the yard had fully developed these skills. The skills had also been spread to local subcontractors so that on later projects, when the yard doubled its activities, most additional labour was taken from the local infrastructure and very few imports were necessary. It was also found that on average, the yard kept busy an equal number of employees at its local subcontractors as it employed itself. Many of the subcontractorsÕ employees were people that earlier were employed by the yard. While the yard trained their young apprentices into the new skills, it was a flow out of the yard, partly by layoffs and partly through the natural turnover of the workforce. This flow ended up in new businesses that were partly engaged by the yard where they came from and partly engaged by other business opportunities in the area. Later on the yard made a comparison of its activities with similar companies in the UK and the US. It found that the UK yards had simpler facilities and benefited from the larger infrastructure of the area. The UK yards rented equipment and services on a part-time basis which the Norwegian yard owned and kept itself and therefore paid for full-time. In the US, this was almost developed into the extreme where even welders operated as contractors on an individual basis, taking care of their own transport and maintenance of their own equipment. Coming to Russia we found the extreme opposite situation. The yards are much more vertically integrated and the yard produces a number of parts that its Western colleagues buy on the market. Some examples are furniture, castings, flanges, bolts, etc., etc., which they today also are trying to sell directly on domestic and export markets. Such things were out-sourced by the Norwegian yards in the '60s and '70s, some even earlier. The Russian yards are also trying to increase sales by changing the product range to consumer goods that can be made in their existing facilities. This difference of structure leads to extremely difficult management tasks for the leaders of the industry that have to cope with a number of markets and technologies while their western colleagues have the luxury of specialising into a few. Trends in European Yards and Fabrication Industries --------------------------------------------------- From these examples, certain trends appear that are relevant for consideration by those developing conversion programs for Russia. - Many shipyards and fabrication facilities in western Europe have been privatised in such a way that they bear no or at least very modest financial costs from the investments. Merchant shipbuilding is also subsidised to balance the competition from the Far East, although such subsidies are expected to end. - Modern shipyards are very automated in constructing the hull. This and their other functions like berths, docks and outfitting facilities favours repetition of similar sizes and designs. To exploit this, they stay within niches in the market, selling their types world-wide. - There is a trend towards out-sourcing, meaning that functions that earlier were integrated in the organisation of a shipyard or a fabrication facility are more and more taken over by subcontractors in the market. This out sourcing is driven partly by the need for more flexibility, to absorb the peaks and valleys of the activities by sharing the resources with others. It is also driven by the trend towards more sophisticated and more professional ways of operation. - Military customers accept to an increasing extent standard commercial technology for their new vessels. - There is a trend towards more and more rapid change of technologies. If the end - user owns the industry supplying him, he tends to adopt more slowly to the new technologies. Tasks to Consider ----------------- The basic question is how the reorganisation of the political system in Russia will take place and how and when new, stable conditions are established to define the split between the private sector and the public sector. This will take some time and the solution will obviously Russian and not a copy of any other nation. But it is critical for the stability of local communities that intermediate solutions are sought that will allow the industry to develop and not just wait. Russian shipyards hardly can be expected to cover the costs of conversion. Such costs will have to be supported by the state or by other sources outside the yard. This applies both to the cost of preserving the skills of personnel during the conversion process and the investments in the upgrading of the facilities. In order to become competitive, investments and physical changes of the facilities have to be made. Protecting the industry by giving them certain rights in the national markets only has meaning if there is a relevant national market. Such markets will only follow if there are effective strategies to develop the natural resources in the area, which further requires acceptable conditions for foreign capital to invest. Further, the protection only gives a short-term benefit. The story about British Shipbuilders and its parallels in other countries lasted only ten years and gave no competitive advantage for the future. An initial out-sourcing could simplify the management task of conversion. If foreign partners are being sought, different partners are relevant to different elements of the existing organisations. The out-sourced elements may contribute to different future activities both within the defence industry and the exploration of natural resources of different kinds more easily than if they remained a part of one comprehensive organisation. Standard technology for civilian applications often meet the requirements of the military forces, giving less needs to distinguish between defence and civilian sectors (although with some exceptions). The breaking up of the large complexes are necessary to adapt to technology developments more rapidly. ---------------------------------------------------------- Copyright 1994 NATO All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic tape, mechanical, photocopying, recording or otherwise, without permission in writing from the copyright holders. Authorization may be requested for redistribution of the text on a non commercial base by research and educational services. Requests should be addressed to the Economics Directorate, NATO, via e-mail 'scheurweghs@hq.nato.int'. First edition 1994 ISBN 92-845-0079-6 This is the latest in a series bringing together papers presented at the NATO colloquia organised by the NATO Economics Directorate and Office of Information and Press on economic issues in the former USSR and Central and East European countries. For further information please write to the Director, Office of Information and Press, 1110 Brussels, Belgium. The articles contained in this volume represent the views of the authors and do not necessarily reflect the official opinion or policy of member governments or NATO.