1 As Russia plans to cut back on its own military procurement [1], revenues from international arms sales will become more important as a financing source for maintenance and further development of its defence industrial sector. The ability of the Russian industry to adapt to the continuous adjustment of the international arms trade environment will therefore have a significant impact on its future.

2 Despite the fact that its defence companies are rather small compared to major Western companies, Russia has managed to become a key supplier to the global arms market [2]. In 2012–2016, according to SIPRI, its share in international arms transfers amounted to 23%, second only to the U.S. share (33%). It was followed by China, France, Germany and the United Kingdom—all lagging behind Russia with as much as 17 to 19 percentage points [3]. In total, SIPRI identified 57 countries as exporters of major weapons in 2012–2016. However, according to the so-called Herfindahl Index—a number equivalent of supplier concentration—the concentration rate of the international arms market corresponds to a market of 5.5 equally sized selling countries. The international arms market has thus more features in common with an oligopoly market, i.e. a market dominated by a small number of sellers, than of a market with perfect competition where no single seller is large enough to influence the market price.

3 At first sight, Russia seems to have a strong position in this setting, in particular as the global volume of international arms transfers has grown more or less continuously since 2002. Russian arms and military equipment have usually been considered to be good enough for their purpose and for reasonable prices—an attractive formula for middle-income countries. However, this comparative advantage has faded in later years. What is more, the financial value of Russian international deliveries of conventional arms peaked at 15.7 billion U.S. dollars in 2013, and has since then stagnated at 15 billion U.S. dollars per annum [4].

4 What are the strategic strengths and weaknesses of the Russian defence industry that will form its future ? The purpose of this article is to analyse the prospects of the Russian defence industry related to the global arms market, and the forces that will have a decisive impact on its further performance : customers, competitors, subcontractors and the threats from possible substitutes or new entrants.

The evolving global arms market and Russia’s customer base

5 The global arms market is usually perceived as highly competitive. However, its politicised nature implies that the competitive intensity might differ from one purchasing country to another. It is also plausible that many arms selling countries have benefited by the expanding arms market in later years that ought to have created more opportunities for all, thus somewhat mitigating competition. This expansive trend has so far been driven by oil-producing countries, such as Saudi Arabia, United Arab Emirates, Qatar, Algeria, and Venezuela, as they have invested their excess oil profits in military hardware. Their purchases have overlapped with the start of new armament cycles for a number of Asian countries like India, Pakistan and Vietnam. The global arms market is now likely to go through some new upheavals regarding sales volumes and ranking order of recipient countries, given an average lower oil price and the anticipated completion of the Asian armament cycles. The competition intensity is therefore likely to increase in the next coming years until a new market equilibrium is obtained.

6 In this environment, two of Russia’s apparent advantages are that it already enjoys a fairly broad customer base and that the Russian government does not impose strong political constraints on arms exports. For instance, its close defence industrial cooperation with India has not prevented Russia from selling arms to Pakistan. Russia also manages to sell arms to countries that are neither able nor interested in buying U.S. or Western military systems—for example Venezuela, Syria or Iran. In addition, Russia banks on trade relations dating back to the Soviet period. It sells arms both to Armenia, a close Russian ally, and to Azerbaijan, which is on the other side of the conflict over Nagorno-Karabakh. And it tries to strengthen or recreate its trade relationship with former buyers of Soviet arms such as Iraq, Algeria, Libya, and Vietnam.

7 As compared to that of the United States, however, the structure of Russia’s customer base is concentrated around a handful of large and regular buyers, making its arms export portfolio highly exposed to economic and foreign political risks. Although, according to SIPRI, Russia sold arms to 38 countries in 2012–2016, 74% of its arms exports went to five countries : India, Vietnam, China, Algeria and Venezuela. India was by far the largest purchaser, with a share of 38% [5]. Russia’s portfolio of outstanding contracts is a mitigating factor to such fluctuations. At the turn of 2015–2016, its contract portfolio peaked at 56 billion U.S. dollars in current value. The volume thereafter shrunk to an estimated 50 billion dollars in late 2016 as orders were completed. This was the lowest yearly figure for new contracts since 2011. While this trough had been anticipated, it still emphasises the weaknesses of the present structure and composition of the Russian customer base. Given the increased probability for higher competitive intensity in the next coming years, this is a source of vulnerability. In contrast to Russia’s arms export to countries with difficult relations with the West, which seems to have solid prospects, it is likely that its efforts to expand into price-sensitive countries in Africa, the Middle East and South-East Asia will meet resistance from already established arms-selling countries.

8 A special concern for Russia is markets that it shares with other arms selling countries and where its present position is perceived to be under pressure. India is a particular worry in this regard. Although both sides assure that the defence industrial cooperation remains strong, France (Dassault Mirage 2000 and Rafale combat aircraft, missiles), Israel (radar systems, missile systems, UCAVs/UAVs) and the United States (transport aircraft, helicopters) have managed to make more or less serious inroads into the Indian arms market. As India’s goal is to become more self-reliant in defence, foreign companies prepared to share technology with the Indian defence industry have an edge. Given the joint development of the BrahMos cruise missile project, Russia at first sights appears to have that edge. On the other hand, the co-development of a fifth generation fighter aircraft has taken a hit as India had expected more technology transfers from Russia than Russia seems willing to give away. As India strives for a more independent and technologically advanced defence industrial sector, it has clearly begun to hedge its special relations with Russia on other relationships, thus improving its bargaining power.

Russian arms export and supply base 

9 The Russian arms export portfolio is rather robust and diversified when it comes to the sheer number of different arms systems. At a global level, however, it appears more unbalanced due to the large predominance of aircraft systems — 40 % of Russian total arms export in 2012–2016 according to SIPRI figures [6]. One post-Soviet export success in this segment is fighter aircraft from the Su-27 family : the Su-27 and Su-30/MK/MKI, and, since 2015, the Su-35. Other aircraft that have figured in Russian export contracts since 2012 according to the SIPRI Arms Trade Register are the MiG-29 family, the Su-25, the Yak-130 as well as helicopters (the medium transport Mi-8MT/Mi-17, the combat helicopters Mi-28N, Ka-52 and the Mi-24/35 family) [7].

10 The air defence segment of Russia’s export portfolio has fluctuated around 7% over the past five years—not counting the record year 2013, when it reached almost 14%. A main product is medium-range systems based on the S-300 family tree. In recent years the S-300PMU-1/2, S-300PS and S-300VMK/Antey-2500 have featured in contracts with Iran, Kazakhstan and Venezuela. Russia also exports the short-to-medium-range Tor, Buk, Pechora-2M systems and the combined short-range missile and anti-aircraft artillery system Pantsir-S1.

11 In the same period the missile segment corresponded to 13% of the Russian arms export portfolio. It is a well-diversified complement to other segments such as aircraft, air defence and ships. The armoured vehicle segment accounted for 10% of the Russian export portfolio. One of the key products is the export version of the main battle tank T-90, the T-90S. This tank is also produced under license in India. Some other prominent products are the infantry fighting vehicle BMP-3 and the armoured personnel carrier BTR-82A. The ship segment share varies significantly over time due to high production costs and long lead times from order to delivery. For instance, some of the most notable contracts with Vietnam in the past five years relate to the fast attack craft Project-1241/Tarantul, the patrol craft Project-10412/Svetlyak, the Project-636E/Kilo submarine and the Gepard-3 frigate.

12 However, a shared weak point in many of these export products is that they are in fact modernised versions of Soviet systems and equipment, and the need to replace them with new generation systems is rapidly getting more pressing. The export market for the Su-35 fighter will probably decline in the mid-2020s. The light fighter MiG-35 that Russia had hoped to sell to India before the contract was lost to the French Rafale has yet to be accepted for service by the Russian Defence Ministry. It is therefore nearly imperative that Russia releases an export version of the fifth generation PAK-FA T-50 under development in the mid-2020s.

13 On a more positive note, it should be stressed that the performance of the Su-34 strike fighter over Syria has opened up the market for the Su-32, the export version. Algeria ordered 12 planes in 2016, and Morocco, Nigeria and possibly Uganda have also expressed their interest. In the air defence segment a generational shift to the S-400 and the cheaper and simplified S-350 Vityaz is under way. The current short and medium range systems are still in demand, but some systems will probably have to be replaced in the early 2020s. A generational shift is particularly urgent within the vehicle segment. The T-90SM (the export version of T-90AM) is most likely the last main battle tank of its kin, as this tank concept is just a modern version of the T-72, which will turn 50 soon. It is expected that the BMP-3 and BTR-82A will reach their technological age limit by 2020. Export deliveries of vehicles based on the new Armata, Kurganets-25, Bumerang and Taifun platforms will most likely start by the mid-2020s at the earliest, as Russia will probably upgrade its own ground forces first.

14 The necessary transition from modernised Soviet arms systems to contemporary ones will certainly increase the cost of Russian arms and make them less obtainable for present low-budget buyers. To retain and secure more affluent buyer countries, it will have to put more emphasis on quality, technological sophistication and overall competitiveness of its defence industry. A particular concern, from this point of view, is related to the effectiveness—or lack thereof—of its organisational structure. After a decade of consolidation, it now seems that the Russian defence industry has reverted into much of the previous Soviet structure. The state has resumed control by obtaining majority stakes in the most important industrial entities and recreating links between suppliers and those prime contractors they had previously served. Companies have also been grouped into sector-specific holding structures with a view to pooling resources and rationalising the industry. A probable reason why companies have not been merged altogether is to uphold a semblance of residual competition, at least on paper, and to maintain continuity of established brand names. This top-down organisational structure implies a weak bargaining position for Russian suppliers as they usually depend on a single prime contractor. The lack of competition between domestic subcontractors entails lower efficiency, which, in the end, might hit back at the prime contractors as well. Overall, the current industrial organisation appears as one of the weakest points in Russia’s adaption to the global arms trade environment [8].

15 It was also a major setback to Russia that its military-industrial cooperation with Ukraine and Western countries came to a halt in 2014 after its annexation of Crimea and the beginning of the war in Donbass. The Ukrainian moratoriums and the Western sanctions will have a negative impact on Russia’s armament plans and arms exports well into the next decade, maybe longer. Allegedly, 400 Russian defence companies were dependent on supplies from Ukraine for more than 3,000 parts, components and final products for more than 200 different arms systems, including engines for helicopters, aircraft and surface ships. Western sanctions did not only cause the premature termination of some notable contracts, such as those on the French Mistral and the German combat training centre. At the much less visible component level, especially as regards electronic components, Western sanctions are a potential threat to the technological modernisation of Russia’s defence industrial sector. Western efforts to restrict Russia’s access to dual-use technology, such as machine tools, also complicate its ambitions to modernise its production base [9]. This might undermine its position on the global arms markets and hurt its prospects in terms of gaining more markets.

Substitutes and potential new entrants

16 Given that Russia has more traits of a fairly adept follower rather than of a leader in arms technology development, it is exposed to threats from substitutes or larger leaps in weapons technology. Russia missed, for instance, the development of modern UAVs based on the maturing and miniaturisation of applicable technologies in the 1980s and 1990s, and it is still catching up with this development. Stealth technology is another area where Russia has lagged behind.

17 Public statements from leading Russian defence officials suggest that the next soon-to-be-launched Russian procurement programme remains committed to more high-technology assets – including systems “based on new physical principles”. Should Russia succeed in this regard, it would strengthen its export portfolio as well. However, Ukrainian and Western sanctions combined with its own policies has put Russia on a path towards technological solitude and limited industrial cooperation with others, which is at odds with the dominating trend towards more transnational defence industrial collaboration. Russia’s long-term technological development therefore risks becoming suboptimal and hampering the country’s ability to defend and develop its position as a reasonably advanced arms provider.

18 The threat of new entrants on the global arms market is usually weak, as incumbents normally benefit from a stronger bargaining position. The potential threat comes from countries aiming to move upwards on the defence-technological ladder and limit their dependence on foreign arms providers and foreign ownership of their defence industries. Hence the increased interest for technology transfers in arms deals and for industrial participation (offsets [10]) that has emerged in purchasing countries like India. However, to bulk up business and diffuse fixed costs over more produced units, countries aspiring for a more capable domestic defence industry ultimately need to move into overseas markets.

19 In this context, the most obvious potential competitor to Russia is China. China is not exactly a new actor on the global arms market, but its growing technological capability implies that it prepares to move beyond its traditional role of a low-cost, low-capability arms provider and to claim the market niche that Russia currently occupies. Much of China’s defence technology is based on Russian technology, which it has obtained through arms purchases, technology transfers, license production as well as reverse engineering in violation of Russian property rights.

20 Although technology transfers and offsets have become a common feature of the global arms trade, it threatens to erode the technological lead of the major exporters. To keep its current position, Russia needs to move itself into the upper market of arms, which, inevitably, will meet resistance from Western arms providers within this niche.

21 * * *

22 Russia’s arms export revenues of 15 billion U.S. dollars are dwarfed by its export of fuel and energy products that amounted to 134.7 billion U.S. dollars in 2016, according to the UN Comtrade database. Since 2014, export of agricultural products and foodstuffs have surpassed Russia’s arms export; for 2016 this line amounted to 17 billion U.S. dollars. Still, arms account for approximately 70% of Russia’s export of machinery and equipment. It is also an important source for complementary revenues without which defence industrial marginal costs would be higher.

23 Russia’s strategic strengths are its low-cost leadership in certain markets, focus on specific markets (countries) and the diversity of its portfolio. It also benefits by the investments in industrial capacities and their modernisation that has accompanied the rapid growth in arms procurement since 2011. Its involvement in the Syrian conflict has so far opened up interest for Russia’s export Su-32 fighter bomber, and renewed interest in the T-90 main battle tank, for which it might reap the fruits in the coming years.

24 One strategic weakness resides in the relatively low level of attention Russia has devoted to after-sales support. This is, however, an area were Russia has recently taken steps to improve performance. Another weakness is its strong reliance on the Chinese and Indian markets. The Chinese market peaked already in the mid-2000s, and its long-term stabilisation will probably be conditional on Russia’s commitment to collaborative projects in order to support the Chinese defence industry. India is Russia’s most important arms market, but given the importance that India attaches to its ‘Make in India’ policy, Russia has been compelled to increasingly rely on joint ventures offers and technology transfers to protect its market shares. In the longer run, China and later on India are thinkable competitors to Russia in the low-budget segment.

25 Possible ways for Russia to stay relevant in this environment are to remain at least one technological step ahead of its customers and potential competitors and to further develop its after-sales support. It could also choose to move into more affluent countries, aiming for a new cost leadership position in this more advanced market segment.