A sector on the upswing
Increasing geopolitical tensions have triggered a fundamental change in European and German security policy and establishing European defence capabilities is more important than ever. As a result, international defence budgets are increasing significantly: between 2021 and 2024, the annual defence spending of EU Member States increased by more than 30 % to EUR 326 billion. This could increase by a further EUR 100 billion by 2027.
The European defence industry is also benefiting from this development. Its turnover rose by almost 30 % to EUR 158.8 billion between 2021 and 2023 – a two-fold increase would have been possible if there had been sufficient production capacity. In view of the continuing high demand, the sector is destined to grow. Whilst other branches of industry are struggling with stagnating growth, the defence sector is experiencing a boom.
However, the defence industry, especially systems suppliers, is also facing challenges. In view of the increasing demand, these companies urgently need additional production capacity and qualified specialists.
This makes the sector increasingly attractive for companies from civilian industries. Entering the market promises considerable growth opportunities, especially for companies from economically ailing sectors such as the automotive industry, which will be given strategic alternatives for overcoming economic challenges.
Challenges when entering the defence sector
Entering the highly regulated defence sector offers great opportunities for growth, but also presents companies with several complex challenges.
Market access and competitive environment
Access to the defence market is largely determined by political framework conditions and tendering procedures. Successful market entry therefore requires the targeted development of relationships with government authorities and key players in the defence industry. Access to NATO armies is particularly challenging, as high requirements and complex procurement procedures make market entry difficult.
Technological requirements and financial investments
The requirements for processes, materials, production techniques and quality standards in the defence industry differ considerably from those of many civilian industries. Companies must adapt their production processes and invest in highly specialised technologies. Building up the necessary infrastructure and expertise requires considerable financial resources, which can be an obstacle for small and medium-sized enterprises (SMEs) in particular.
Corporate governance, image and ethics
Although acceptance of the defence sector has increased in recent years, the defence industry is often at the centre of public debate on ethical and moral issues. Companies need to carefully consider how they deal with the potential impact of their defence operations on their brand and reputation.
Legal challenges
Companies considering entering the highly regulated defence sector must also comply with numerous legal and regulatory requirements.
For example, the Bundeswehr, as a contracting authority, is subject to public pricing law, which means that companies must fulfil certain obligations to provide evidence regarding pricing and are subject to limits on pricing. In particular, the argumentation and coordination of the applicable pricing regulations with the contracting authority (also in the supply chain) can have a significant influence on the profitability of contracts.
In addition, there are specific provisions in procurement law for defence and security contracts, particularly in connection with accelerated awarding in accordance with the Bundeswehr Procurement Acceleration Act (BwBBG). This practice enables the Bundeswehr to award contracts directly, but this entails the risk of competitors being bypassed and legal protection being made more difficult.
Strict legal requirements apply around export controls to ensure that military goods do not end up in conflict regions or with unauthorised parties. Companies must also comply with international sanctions that restrict trade with certain countries or organisations and can have significant legal consequences in the event of violations.
In addition, the War Weapons Control Act (KrWaffKontrG) requires licences for products that are classified as war weapons. Companies must therefore familiarise themselves intensively with the relevant legal regulations to avoid legal consequences. However, according to the coalition agreement, the CDU/CSU and SPD want to place greater emphasis on supply contracts and purchase guarantees in particularly critical areas, which promotes investment and planning security.
Regarding existing supplier relationships, companies must review and adapt their contracts to take account of new legal requirements on product safety and due diligence (LkSG). Compliance measures such as supplier audits and non-disclosure agreements are crucial to minimise legal risks.
The handling of classified documents or classified information is subject to strict regulations, which are set out in the “Handbook of Industrial Security” (GHB). This handbook specifies how state secrets and classified information are to be protected and who is authorised to have access to this information. Strict security measures must be taken and data protection requirements observed, particularly when using IT. Furthermore, corresponding security checks are required in certain areas in accordance with the Security Screening Act (SÜG), which can also have an impact on the deployment of certain employees (particularly regarding nationality).
Cooperation and joint ventures are widespread in the defence sector, but restrictions on competition must be prevented or justified. Competition law is central here. The exchange of competitively sensitive information between (potential) competitors must be strictly regulated and Competition compliance is essential.
The relationship between the defence industry and financing is complex, particularly regarding sustainability. However, since last year, so-called “ESG funds” have also been able to invest up to 20% of their capital in non-sustainable assessed areas. The exception only applies to weapons outlawed under international law, which are considered “controversial weapons”.
Conclusion
The security and defence sector offers considerable growth potential in the coming years. For companies from economically depressed sectors, such as the automotive industry, market entry can be a strategic opportunity to overcome economic challenges. However, to successfully enter this market, companies must master the complex regulatory, political and technological challenges associated with this highly regulated sector. A sound understanding of the legal requirements and careful planning are crucial to operating successfully and sustainably in the defence industry.
