Amid the Russian invasion that has made the country into a war zone since February 2022, Britain’s largest defence contractor BAE Systems has recently set up a business in Ukraine. It has agreed to supply arms to Ukraine’s military and possibly set up local production facilities in the future.
Unlike other companies and business sectors, BAE and the global defence sector are major beneficiaries of Russia’s invasion of Ukraine. BAE reportedly won a record £21.1 billion of new orders in the first six months of 2023 alone. The UK government has struck a £280 million deal with BAE to buy arms to donate to Ukraine’s war effort.
But BAE’s entry into Ukraine presents both opportunities and risks for the company, as well as the Ukrainian government.
Short-terms risks but long-term gains
Establishing a new business operation in a war zone is not common practice. Companies typically avoid entering such markets, while those already in afflicted regions typically downsize or divest to manage the risk of violence to their assets and their employees, according to my research.
But war is central to the business model of defence companies, so they are not averse to entering war zones to capture new business and better supply their government customers. Not only does BAE’s recent move into Ukraine encourage its government to place direct orders with the company, but it’s also a sensible way for BAE to strengthen the relationship.
Direct market entry can mean different things. Low-risk models can involve establishing a trading office to facilitate exports, while high-risk options can mean a fully fledged factory. It appears BAE will start with the low-risk model by setting up a management office to coordinate sales and services.
Of course, with war raging, this makes sense. But any kind of international entry carries risk. As mentioned, operating within a war zone risks the destruction of company assets and endangering its people. To account for this risk, governments in war zones sometimes pledge substantial security to a company, as well as offering compensation if its operations are damaged or destroyed.
For BAE in Ukraine, this will be a vital consideration considering Russia’s hostile response to companies facilitating Ukraine’s war effort. For example, when the German manufacturer Rheinmetall announced its plan in July of this year to establish a production site in Ukraine, Russia vowed it would hit the planned facility with missiles.
Russia has also said BAE’s new business in Ukraine will be “an object of special attention” for its military, according to the BBC. As such, BAE’s modest initial operations will help the company gauge and manage the security risks to its business. It also faces possible infrastructure-related risks from operating inside Ukraine, including a lack of partners and suppliers, particularly those with the experience and capabilities needed to work in a warzone.
A raging war is only one barrier Ukraine faces in attracting investors like BAE. It has tough competition from other eastern economies, such as Poland and Bulgaria, that could offer better trading conditions for defence contractors. For example, other countries might provide cheaper or more skilled labour, more favourable regulation and stronger local supply chains. As a result, other major defence companies may find it more feasible to export into Ukraine from nearby countries.
More generally, whether a company selects Ukraine as a business location also depends on its home government. The US, for example, is sensitive to its defence companies setting up in foreign markets.
BAE executives are thinking strategically, however. Unfortunately, Ukraine could be a potentially lucrative market for defence companies in the long term, if the war continues. Early entry allows BAE to gain a better understanding of the market and forge exclusive relationships with local suppliers, as well as preferential government treatment. The latter could include direct subsidies and tax breaks.
BAE’s decision to enter Ukraine could also yield substantial political capital with the British and Ukrainian governments, as well as among Ukraine’s people. “We highly appreciate when private companies open their offices in our country at such a time,” Ukrainian president Volodymyr Zelenskyy said of the deal, adding: “this is a very important signal of support for our people”.
The Ukrainian government is looking to the future
Ukraine has much to gain from BAE’s setting up shop in the country. This deal provides the direct supply of arms and equipment for the war, which is even more important since western government support is not guaranteed for the long term. For this reason, Ukraine is right to try to secure local production of military hardware.
As a leading player in the defence sector, BAE’s commitment to the Ukrainian market is an important signal of confidence to other companies. Ukraine will hope other companies will follow BAE, creating more jobs in a struggling wartime economy. Ukraine may also hope that if western companies help it strengthen its military, it will deter future aggression.
How governments structure deals like this is critical. To maintain BAE’s presence over the long term – during and beyond the conflict – Ukraine must build the foundations for the right market conditions in the post-conflict period. This will make Ukraine an attractive location for western defence company operations now and in the future.
by : Martin Owens, Senior Lecturer in International Business, Sheffield Hallam University