Case studyIn a series of negotiations in late 1998, the UK company GEC Marconi sold its defence interests for US$12 billion – some US$3 billion more than they had been valued several months earlier. This case explains how the company used strategy dynamics and game theory to help improve the outcome.Background – worldwide consolidation in defence industriesWith the end of the Cold War in the early 1990s, many world governments were keen to reduce their defence spending. Moreover, the cost of developing new defence weapons was continuing to rise. The result of falling sales and rising costs was pressure on the world’s leading defence companies to merge and share the costs of development and production. The first merger moves came in the USA, with a shake-out in the mid-1990s that produced three big players: Lockheed Martin, Boeing and Raytheon. Table 5.5 shows the contracts that the leading companies had with the US government in 1997. It should be noted that most companies also had civil (non-defence) contracts which are not listed in the table.European defence industry: political backgroundAlthough some European companies had defence sales in the USA, their largest sales were in Europe and outside North America. All defence companies need to make sales outside their home markets because national territories provide insufficient revenue to cover the high costs of research and development. The main customers are national governments so the tendency in Europe has been for combinations of such governments to commission new equipment – for example, the new European fighter aircraft involved the governments of the UK, Germany, Italy and Spain. France has had a long tradition of independent manufacture and sale and Sweden has also remained outside the usual consortia.In addition, European politicians were well aware that the defence spending budgets of the USA were considerably higher than individual European countries. This meant that the USA, as a country, had a competitive advantage that benefited all its home-based defence companies. The main way forward for European defence companies was to consolidate their contracts and, potentially, their companies in order to gain the same size as the American competitors.In the late 1990s, the three major European governments of Germany, France and the UK were keen to see consolidation in the European defence industry. There were three main reasons:[Insert UNFig near here]Table 5.5 Top US defence contractors in 1997(value of contracts with the US Department of Defense, US$ billion)1 The US defence consolidation meant that new larger US companies were well ahead of Europe in terms of the potential cost savings and rationalisation that were possible.2 The European governments were determined as a matter of policy to ensure that their European defences were supplied by European-manufactured equipment. The alternative was that they would be reliant on the USA, which was strategically much weaker. This meant that it was vital to secure a continued defence manufacturing base in Europe.ContractorValue of contractsLockheed Martin12.4Boeing10.9Raytheon6.5Northrop Grumman4.1GEC2.2General Dynamics2.1United Technologies1.9Litton Industries1.8Science Applications1.1ITT0.9Source: US government publications.3 Defence manufacture in Europe continued to employ large numbers of workers – roughly one million across the EU. It was important to preserve these jobs.However, it should be noted that there was some cross-Atlantic defence co-operation. For example, GEC itself was able to acquire the US defence company Tracor in 1998 for US$1.4 billion and become the fifth-largest contractor to the US government. Equally, the main US companies all had some manufacturing facilities in Europe, even though some were for civil rather than military use.In 1997, Germany, France and the UK began to put pressure on their respective companies to combine. However, apart from the French government, they did not own the companies so their direct negotiating power was limited.European defence industry: company perspectivesNaturally, the defence companies themselves could also see the case for consolidation. From their perspective, the issue was not whether this should be done, but how. During the course of 1997–98, a series of discussions and negotiations were undertaken amongst the leading players. Virtually any combination was possible but some companies already had minority stakes or strong technical links with others – useful but not conclusive. The main players are shown in Table 5.6. However, there were three companies that would have to be involved if the final concept of a consolidated European defence company was to be achieved: British Aerospace, Dasa and Aerospatiale.British Aerospace, Dasa and Aerospatiale: core companies in any European defence consolidation?These three companies already co-operated on the European Airbus – see Case 14.3 – and were thus used to working together. The aerospace activities of each were roughly of equal size in terms of turnover and numbers employed – see Table 5.7. But they each had very different ownership structures which made combination difficult. British Aerospace had been privatised many years earlier and its shares were widely held. Dasa was still a subsidiary of the German/US DaimlerChrysler car company and it had no separate share quotation at all. Aerospatiale was majority-owned by the French government but being prepared for privatisation so that it could form part of a larger European company. The main effect of such ownership variations was to complicate any negotiations and therefore slow them down.Table 5.6 The main companies in the European defence industryBritish AerospaceUKGEC MarconiUKDeutsche Aerospace: DasaGermanyAerospatialeFranceDassaultFranceThomson-CSFFranceMatra (subsidiary of Lagardère)FranceCasaSpainAleniaItalyAgustaItalySaabSwedenNevertheless, British Aerospace had entered into detailed discussions with Dasa during 1998. There was a strong willing-ness to combine the two companies and agreement had been reached on many issues, including the combined company split of 60 per cent to British Aerospace and 40 per cent to Dasa. By December 1998, the main sticking point was the problem that such an ownership split would have given effective control to Dasa: the fragmented shareholdings in British Aerospace would have meant that Dasa was the largest single shareholder.Table 5.7 Three main players in European consolidationDaimler-Benz Aerospace (Dasa): GermanyAerospatiale: FranceBritish Aerospace: UKOwnership: 100 per cent DaimlerChrysler by parentOwnership: French government 48 per cent, Lagardère 30 per cent, private shareholders the restOwnership: private, quoted on London Stock Market. The best profit record of the three leading playersSales 1997: US$7.7 billion Number of employees: 43,500Sales 1997: US$11.6 billionNumber of employees: 56,000Sales 1997: US$12.8 billionNumber of employees: 43,000Partner in Airbus and Eurofighter. Also produces other military and civil aircraft, space systems, satellites and electronic systems.Partner in Airbus but no pan-European defence interests. Also produces satellites, missiles, space systems. Owns 46 per cent of Dassault, which produces Mirage and Rafaele fighter aircraft.Partner in Airbus and Eurofighter. Also produces other military and civil aircraft, missiles, electronic systems, munitions; 36 per cent share in Saab, Sweden. Also links with Alenia, Italy.However, operating in parallel with this unresolved battle was a related strategy from GEC Marconi – and this company had its own objective as we will see shortly.GEC Marconi: UKWhen George Simpson took over as the chief executive of the GEC Group in 1996, he decided that it needed to have greater worldwide market share in a limited number of ventures. Up to that time, the company had been involved in a whole range of ventures, some of which were profitable, but they were all rather disparate. For example, it was involved in the manufacture of petrol vending machines, computer printers and power generation equipment. It also owned the large defence electronics company GEC Marconi. Simpson and his colleagues decided that the group needed more focus so it disposed of its shareholdings in some companies and concentrated on others, such as those producing telecommunications equipment.From amongst this range of business activities, the group decided to focus on the defence business of GEC Marconi. In 1998, as part of this strategy, it acquired the US defence company Tracor for US$1.4 billion. This made it one of the largest defence contractors in the US (see Table 5.5) and raised its ambitions for further developments. It began discussions with the French defence electronics company Thomson-CSF but the acquisition was blocked by the French government. As it cast around for further growth in the worldwide defence market, it made a fundamental strategic decision: either it would grow larger or it would exit the industry with a good price for its company. By mid-1998, it was again in discussions with Thomson-CSF but it had also opened up negotiations with British Aerospace, Northrop Grumman (USA) and Lockheed (USA).At least, it said that it was in discussion with the two American companies but there may have been an element of bargaining in this signal to the market. The purpose of such announcements would have been to make the real targets, British Aerospace and Thomson-CSF, more anxious to complete a deal. In fact, by late 1998, the GEC Group was using game theory to operate a special strategy called Project Superbowl. The object was to sort out GEC Marconi. It knew that its subsidiary was valued at US$9 billion and entered into discussion with this as the minimum price.From the three-way negotiations between GEC Marconi, British Aerospace and Dasa, it became clear to GEC Marconi that British Aerospace and Dasa were close to doing a deal. The GEC Marconi Group realised that this would substantially weaken its negotiating position because GEC Marconi would then become a much smaller player in a larger pool. Thus George Simpson decided to sell GEC Marconi to the highest bidder while the company still had real negotiating power. As par of its negotiating ploy, it gave the story to the Financial Times which ran the headline:BAE given ultimatum over Marconi: GEC sets end-of-week deadline for bid as other companies signal interest in defence electronics arm.After further discussion, GEC Marconi was sold to British Aerospace for US$12 billion five days later in January 1999.British Aerospace: also a game playerWhat the GEC Group did not know was that British Aerospace was also using strategy dynamics and strategic game theory to plot its moves in the consolidation battle. It had worked out that by combining with GEC Marconi it was able to ensure that it had a dominant interest in any further consolidation that would then take place. Moreover, it expected any subsequent moves towards consolidation to be more limited as a result. For these reasons, it was willing to pay rather more than the initial valuation of GEC Marconi – US$3 billion more, to be precise.Outcomes – not always predicted by game theory!After the deal was agreed, European governments were not very happy because the solution was a purely UK affair. However, British Aerospace took the view that this problem could be sorted out later. Its market position was enhanced by its new acquisition, even after paying an extra US$3 billion.After divesting its defence interests, GEC was renamed Marconi. It went on to acquire a whole series of telecommunications equipment companies during 2000 and 2001 – just before the market for telecommunications equipment went into steep decline. By mid-2002, GEC had used up its extra US$3 billion and was in deep trouble – both the chairman, George Simpson, and all his senior colleagues were forced to resign.For British Aerospace, the outcome was more positive. It used its position in UK defence and the relationship between the UK and the USA to begin acquiring US defence companies. By 2007, the company had become one of the biggest defence contractors in the USA.The British Aerospace strategy of focusing on the international defence industry and the opportunities that this presented was dented when it was investigated for the possibility of corrupt dealings with the Saudi Arabian government over contracts for fighter aircraft in the early 1990s. However, the UK government was sufficiently concerned about the political ramifications of such dealings to decide that it was not in the national interest to pursue this investigation further. British Aerospace consistently affirmed that it did not knowingly engage in any corrupt practices over such contracts. However, from a competitive dynamics perspective, it remained in the interests of rival companies to attempt to put further pressure on British Aerospace in this matter. At the time of writing this case, the American government was reported to be continuing to investigate aspects of the deal.Case questions1What are the strengths and weaknesses of using strategy dynamics to plot this strategic battle?2To what extent was game theory used in the negotiations? What other aspects of strategy dynamics were involved?3What lessons can we draw from the case on the usefulness of strategy dynamics and game theory in strategy development?Indicative answers After you have considered your answers to these questions, you might like to look on the next page for some indicative answers to the questions

Case studyIn a series of negotiations in late 1998, the UK company GEC Marconi sold its defence interests for US$12 billion – some US$3 billion more than they had been valued several months earlier. This case explains how the company used strategy dynamics and game theory to help improve the outcome.Background – worldwide consolidation in defence industriesWith the end of the Cold War in the early 1990s, many world governments were keen to reduce their defence spending. Moreover, the cost of developing new defence weapons was continuing to rise. The result of falling sales and rising costs was pressure on the world’s leading defence companies to merge and share the costs of development and production. The first merger moves came in the USA, with a shake-out in the mid-1990s that produced three big players: Lockheed Martin, Boeing and Raytheon. Table 5.5 shows the contracts that the leading companies had with the US government in 1997. It should be noted that most companies also had civil (non-defence) contracts which are not listed in the table.European defence industry: political backgroundAlthough some European companies had defence sales in the USA, their largest sales were in Europe and outside North America. All defence companies need to make sales outside their home markets because national territories provide insufficient revenue to cover the high costs of research and development. The main customers are national governments so the tendency in Europe has been for combinations of such governments to commission new equipment – for example, the new European fighter aircraft involved the governments of the UK, Germany, Italy and Spain. France has had a long tradition of independent manufacture and sale and Sweden has also remained outside the usual consortia.In addition, European politicians were well aware that the defence spending budgets of the USA were considerably higher than individual European countries. This meant that the USA, as a country, had a competitive advantage that benefited all its home-based defence companies. The main way forward for European defence companies was to consolidate their contracts and, potentially, their companies in order to gain the same size as the American competitors.In the late 1990s, the three major European governments of Germany, France and the UK were keen to see consolidation in the European defence industry. There were three main reasons:[Insert UNFig near here]Table 5.5 Top US defence contractors in 1997(value of contracts with the US Department of Defense, US$ billion)1 The US defence consolidation meant that new larger US companies were well ahead of Europe in terms of the potential cost savings and rationalisation that were possible.2 The European governments were determined as a matter of policy to ensure that their European defences were supplied by European-manufactured equipment. The alternative was that they would be reliant on the USA, which was strategically much weaker. This meant that it was vital to secure a continued defence manufacturing base in Europe.ContractorValue of contractsLockheed Martin12.4Boeing10.9Raytheon6.5Northrop Grumman4.1GEC2.2General Dynamics2.1United Technologies1.9Litton Industries1.8Science Applications1.1ITT0.9Source: US government publications.3 Defence manufacture in Europe continued to employ large numbers of workers – roughly one million across the EU. It was important to preserve these jobs.However, it should be noted that there was some cross-Atlantic defence co-operation. For example, GEC itself was able to acquire the US defence company Tracor in 1998 for US$1.4 billion and become the fifth-largest contractor to the US government. Equally, the main US companies all had some manufacturing facilities in Europe, even though some were for civil rather than military use.In 1997, Germany, France and the UK began to put pressure on their respective companies to combine. However, apart from the French government, they did not own the companies so their direct negotiating power was limited.European defence industry: company perspectivesNaturally, the defence companies themselves could also see the case for consolidation. From their perspective, the issue was not whether this should be done, but how. During the course of 1997–98, a series of discussions and negotiations were undertaken amongst the leading players. Virtually any combination was possible but some companies already had minority stakes or strong technical links with others – useful but not conclusive. The main players are shown in Table 5.6. However, there were three companies that would have to be involved if the final concept of a consolidated European defence company was to be achieved: British Aerospace, Dasa and Aerospatiale.British Aerospace, Dasa and Aerospatiale: core companies in any European defence consolidation?These three companies already co-operated on the European Airbus – see Case 14.3 – and were thus used to working together. The aerospace activities of each were roughly of equal size in terms of turnover and numbers employed – see Table 5.7. But they each had very different ownership structures which made combination difficult. British Aerospace had been privatised many years earlier and its shares were widely held. Dasa was still a subsidiary of the German/US DaimlerChrysler car company and it had no separate share quotation at all. Aerospatiale was majority-owned by the French government but being prepared for privatisation so that it could form part of a larger European company. The main effect of such ownership variations was to complicate any negotiations and therefore slow them down.Table 5.6 The main companies in the European defence industryBritish AerospaceUKGEC MarconiUKDeutsche Aerospace: DasaGermanyAerospatialeFranceDassaultFranceThomson-CSFFranceMatra (subsidiary of Lagardère)FranceCasaSpainAleniaItalyAgustaItalySaabSwedenNevertheless, British Aerospace had entered into detailed discussions with Dasa during 1998. There was a strong willing-ness to combine the two companies and agreement had been reached on many issues, including the combined company split of 60 per cent to British Aerospace and 40 per cent to Dasa. By December 1998, the main sticking point was the problem that such an ownership split would have given effective control to Dasa: the fragmented shareholdings in British Aerospace would have meant that Dasa was the largest single shareholder.Table 5.7 Three main players in European consolidationDaimler-Benz Aerospace (Dasa): GermanyAerospatiale: FranceBritish Aerospace: UKOwnership: 100 per cent DaimlerChrysler by parentOwnership: French government 48 per cent, Lagardère 30 per cent, private shareholders the restOwnership: private, quoted on London Stock Market. The best profit record of the three leading playersSales 1997: US$7.7 billion Number of employees: 43,500Sales 1997: US$11.6 billionNumber of employees: 56,000Sales 1997: US$12.8 billionNumber of employees: 43,000Partner in Airbus and Eurofighter. Also produces other military and civil aircraft, space systems, satellites and electronic systems.Partner in Airbus but no pan-European defence interests. Also produces satellites, missiles, space systems. Owns 46 per cent of Dassault, which produces Mirage and Rafaele fighter aircraft.Partner in Airbus and Eurofighter. Also produces other military and civil aircraft, missiles, electronic systems, munitions; 36 per cent share in Saab, Sweden. Also links with Alenia, Italy.However, operating in parallel with this unresolved battle was a related strategy from GEC Marconi – and this company had its own objective as we will see shortly.GEC Marconi: UKWhen George Simpson took over as the chief executive of the GEC Group in 1996, he decided that it needed to have greater worldwide market share in a limited number of ventures. Up to that time, the company had been involved in a whole range of ventures, some of which were profitable, but they were all rather disparate. For example, it was involved in the manufacture of petrol vending machines, computer printers and power generation equipment. It also owned the large defence electronics company GEC Marconi. Simpson and his colleagues decided that the group needed more focus so it disposed of its shareholdings in some companies and concentrated on others, such as those producing telecommunications equipment.From amongst this range of business activities, the group decided to focus on the defence business of GEC Marconi. In 1998, as part of this strategy, it acquired the US defence company Tracor for US$1.4 billion. This made it one of the largest defence contractors in the US (see Table 5.5) and raised its ambitions for further developments. It began discussions with the French defence electronics company Thomson-CSF but the acquisition was blocked by the French government. As it cast around for further growth in the worldwide defence market, it made a fundamental strategic decision: either it would grow larger or it would exit the industry with a good price for its company. By mid-1998, it was again in discussions with Thomson-CSF but it had also opened up negotiations with British Aerospace, Northrop Grumman (USA) and Lockheed (USA).At least, it said that it was in discussion with the two American companies but there may have been an element of bargaining in this signal to the market. The purpose of such announcements would have been to make the real targets, British Aerospace and Thomson-CSF, more anxious to complete a deal. In fact, by late 1998, the GEC Group was using game theory to operate a special strategy called Project Superbowl. The object was to sort out GEC Marconi. It knew that its subsidiary was valued at US$9 billion and entered into discussion with this as the minimum price.From the three-way negotiations between GEC Marconi, British Aerospace and Dasa, it became clear to GEC Marconi that British Aerospace and Dasa were close to doing a deal. The GEC Marconi Group realised that this would substantially weaken its negotiating position because GEC Marconi would then become a much smaller player in a larger pool. Thus George Simpson decided to sell GEC Marconi to the highest bidder while the company still had real negotiating power. As par of its negotiating ploy, it gave the story to the Financial Times which ran the headline:BAE given ultimatum over Marconi: GEC sets end-of-week deadline for bid as other companies signal interest in defence electronics arm.After further discussion, GEC Marconi was sold to British Aerospace for US$12 billion five days later in January 1999.British Aerospace: also a game playerWhat the GEC Group did not know was that British Aerospace was also using strategy dynamics and strategic game theory to plot its moves in the consolidation battle. It had worked out that by combining with GEC Marconi it was able to ensure that it had a dominant interest in any further consolidation that would then take place. Moreover, it expected any subsequent moves towards consolidation to be more limited as a result. For these reasons, it was willing to pay rather more than the initial valuation of GEC Marconi – US$3 billion more, to be precise.Outcomes – not always predicted by game theory!After the deal was agreed, European governments were not very happy because the solution was a purely UK affair. However, British Aerospace took the view that this problem could be sorted out later. Its market position was enhanced by its new acquisition, even after paying an extra US$3 billion.After divesting its defence interests, GEC was renamed Marconi. It went on to acquire a whole series of telecommunications equipment companies during 2000 and 2001 – just before the market for telecommunications equipment went into steep decline. By mid-2002, GEC had used up its extra US$3 billion and was in deep trouble – both the chairman, George Simpson, and all his senior colleagues were forced to resign.For British Aerospace, the outcome was more positive. It used its position in UK defence and the relationship between the UK and the USA to begin acquiring US defence companies. By 2007, the company had become one of the biggest defence contractors in the USA.The British Aerospace strategy of focusing on the international defence industry and the opportunities that this presented was dented when it was investigated for the possibility of corrupt dealings with the Saudi Arabian government over contracts for fighter aircraft in the early 1990s. However, the UK government was sufficiently concerned about the political ramifications of such dealings to decide that it was not in the national interest to pursue this investigation further. British Aerospace consistently affirmed that it did not knowingly engage in any corrupt practices over such contracts. However, from a competitive dynamics perspective, it remained in the interests of rival companies to attempt to put further pressure on British Aerospace in this matter. At the time of writing this case, the American government was reported to be continuing to investigate aspects of the deal.Case questions1What are the strengths and weaknesses of using strategy dynamics to plot this strategic battle?2To what extent was game theory used in the negotiations? What other aspects of strategy dynamics were involved?3What lessons can we draw from the case on the usefulness of strategy dynamics and game theory in strategy development?Indicative answers After you have considered your answers to these questions, you might like to look on the next page for some indicative answers to the questions.