When EADS CEO Tom Enders announced a major strategic review of the group's defense and space business earlier this year, he inadvertently raised expectations for a plan to overcome the structural limitations of operating in Europe.

As it turns out, the grand plan has a lot more to do with cutting jobs and finding internal efficiencies than with a new approach to markets.

“It is the first time since 1970, that we've had to accept that we have a non-growing business” says EADS's head of strategy and marketing, Marwan Lahoud, recalling that Airbus and the defense and space companies it merged with to form EADS in 2000 have always sought top-line growth. In the nearly 14 years since, he says the company has not seen such a mismatch between growth in its commercial business and stagnation in defense and space, an area he dubbed “the consolidation sector.”

“We are so used to growing in all directions that accepting the fact that we are in some areas just consolidating is quite a challenge,” Lahoud says, adding that the company is now more focused on profitability and improving market share. “There is no need to chase growth at any cost.”

The shift in strategy comes as EADS details plans to combine its Cassidian, Airbus Military and Astrium units into a single Airbus Defense and Space division (Airbus DS) beginning Jan. 1. Over the next three years, the new entity will seek to reduce its 42,000-strong workforce by 5,290 people while shrinking its product portfolio in line with an expected return on sales of 7-8% by 2015.

“We will not continue with all products, but we still have to decide which ones to discontinue,” says Bernhard Gerwert, future CEO of the new unit.

Had things gone according to Enders' original plan, EADS would by now have long been merged with Britain's BAE Systems, and its own subscale defense business would have become part of the larger unit. In that case, layoffs would have been averted as EADS traded job security for government approval of the merger, through which Enders sought to give Cassidian the advantage of BAE's more global reach.

After the collapse of merger talks in late 2012, however, owing to strong opposition by the German government, Enders left no doubt that the EADS defense structure on its own is too large for current demand. Because it is also too small relative to its much larger U.S. and U.K. rivals, it was clear that something had to change.

Some suggested EADS should exit the defense area altogether and focus on what sells best—Airbus aircraft and helicopters—and others believed another merger attempt would be the way to go. Instead, Airbus DS is simply lowering its cost base and industrial capacity to match reduced demand.

“We have deliberately, consciously decided to stick with our defense business, our space business, but to make it stronger,” Enders says.

But some analysts warn that the move to cut jobs in factories and offices across Europe indicates EADS is backing steadily away from its military equipment business through a restructuring that bodes ill for European defense. “EADS is really quite a good barometer of the state of the defense sector in Europe at the moment,” says Daniel Flott, a researcher with the Institute for European Studies at VUB in Brussels. “It's a symbol of governments in Europe not being able to get their act together on defense and having a quite sizeable market impact.”

Under the restructuring, Enders says Airbus DS will comprise three primary units: Military Aircraft, a €6 billion ($8.2 billion) business that includes the Eurofighter Typhoon combat jet, A400M tactical airlifter and aerial refuelers; Space Systems, which brings in €4 billion annually through production of the Ariane 5 launch vehicle, M51 missile and military and civilian satellites; and Communication, Intelligence and Security, a mixed-bag worth €3 billion a year that will exploit synergies between Cassidian and Astrium, including the latter's space services business. Supporting each of those units is the division's €1-billion electronics business, which Enders says will also be free to market products to Airbus DS competitors.

Enders would not provide expected savings and cost figures inherent in the restructuring, indicating such amounts depend on the outcome of union negotiations in the coming months. It is clear, however, that unions and politicians will try to minimize the number of forced redundancies. In response to the restructuring, French Finance Minister Pierre Moscovici emphasizes that the government, as an EADS shareholder, has certain means at its disposal and that, given the group's financial health and its state support, EADS must be “exemplary in the management of this restructuring,” which, he says, means there are to be no layoffs in France.

Flott says government stakeholders can be expected to closely manage the numbers and types of jobs that are ultimately eliminated. EADS plans to close its Paris headquarters as part of a culling of executive-level jobs, reducing its total French workforce by 1,260 in the next three years.

Some 2,000 jobs will be eliminated in Germany, where the group plans to divest its Cassidian headquarters at Unterschleibheim and locate Airbus DS headquarters in Ottobrunn, with some 1,000 jobs currently based in Unterschleibheim relocated there. Spain will lose 557 jobs and the U.K. 450 as EADS seeks to consolidate activities around three major sites: Stevenage, Portsmouth and Newport.

Rudiger Lutjen, head of EADS's European works council, says any concessions in productivity gains would have to be linked to long-term job guarantees. With the uncertainty surrounding key programs, it is unlikely management will be prepared to agree to it.

Unfazed by the reaction of government officials, Enders says he expects to hear more from politicians in the coming days. In the meantime, the company is focused on finding synergies among the group's civil and military product lines in at least four key areas: Digital air traffic control systems and network-centric aircraft; cybersecurity; new materials for structures, engines and equipment; and unmanned and optionally piloted aircraft.

Despite flat defense budgets in Europe, Lahoud says Airbus DS is still expected to deliver returns, so long as its government customers agree to fund platform development and promote products in international growth markets, notably Japan, Saudi Arabia, India, Russia and Brazil.

“Export contracts deliver high returns, which allow the business all-in-all to be very strong financially,” he says.

To that end, Gerwert says the company is working on five sales campaigns of the Typhoon, Cassidian's top-margin contributor via the four-nation Eurofighter consortium in which the company is the largest investor, followed by BAE and Italy's Finmeccanica. Although he is “quite optimistic we will get one or two out of them in the next two years,” with the Typhoon's third production tranche secured through 2017, more jobs will be cut if the fighter does not win more orders. In the meantime, he says, the partners are discussing a consortium restructuring that could close one or more of the four Typhoon final assembly lines.

Buoyed by Typhoon, Enders says Cassidian has seen remarkable improvements in the past year and is on track to achieve a nearly 7% pretax profit by the end of 2013. But margins at Airbus DS still face several years of profit erosion from other defense and space programs, notably Airbus Military's new A400M tactical airlifter.

“A400M is a burden, but obviously it should be an attractive platform, provided we are able to cut costs on [it] and not provide an overly sophisticated weapons system or transport system to the air forces,” Enders says.

Airbus DS will also need to dramatically streamline its space business, starting with a plan to cut 2,470 of 18,000 Astrium jobs. Describing the company as “not at all profitable,” Gerwert says Astrium needs to greatly increase competitiveness in export markets, notably in the launch sector, where new entrant Space Exploration Technologies (SpaceX) of Hawthorne, Calif., is offering prices roughly 30% less than the Astrium-built Ariane 5 rocket marketed by European launch consortium Arianespace.

Enders says that inefficiencies plaguing Ariane 5 production are comparable to those of the Eurofighter.

“Look at the Ariane launch business,” he says. “That is certainly another good example of inefficient industrial structures” that must evolve as Europe forges ahead with plans to develop an Ariane 5 successor, the Ariane 6. “This will require a shakeup of the launch industry and the institutional players around it if we want in the future to be the leading launch provider for space.”