As bad as the U.S. budget picture seems, 2012 was the best year on record for the sale of U.S. weapons abroad. The administration expects to sell a whopping $51.6 billion worth of weapons overseas during fiscal 2012, soaring beyond what was a bit above a $10-billion-a-year business a decade ago. But with an increasing number of countries eyeing the same export pot, nations and companies will have to position themselves for global competitions that are growing more and more intense.

Boeing now anticipates that 30% of its defense sales will come from the international market, and Lockheed Martin is aiming for 20%. With Pentagon belt-tightening underway, U.S. defense contractors were expected to keep a low profile at this month's Farnborough air show. But business was booming at the chalet of defense electronics contractor Raytheon. “This is probably the busiest air show we've ever had,” said CEO Bill Swanson.

International customers accounted for 29% of Raytheon's bookings in 2011, and Swanson is relying on such sales to help balance what he believes will be an inflation-adjusted decline in U.S. military spending. “We see our international [sales] growing at high single digits,” he says. “If your international grows and your domestic goes down with inflation, then our company should have flat-to-slight growth.”

Raytheon has benefitted from its position in the market, capitalizing in sales of intelligence, surveillance and reconnaissance and electronic warfare equipment, and it is building ties abroad in key markets.

“Defense exports from the EU and North America have increased dramatically in recent years to Turkey, Pakistan, Singapore, the Baltic States, the UAE, Qatar, Malaysia and Japan,” a report by PwC states. “In Saudi Arabia, the growth rate of military expenditures and the growth rate of defense spending as a percentage of GDP are the highest in the world.”

Indeed, the U.S. weapons export numbers are riding high this year, in large part due to the $29.4 billion sale to Saudi Arabia of 84 Boeing F-15 aircraft amid rising tensions with Iran.

But with so many tempting deals on the horizon, U.S.-based companies are not the only ones looking beyond their borders. Swanson sees increased competition for that business—particularly from Russia and China. And close U.S. allies are warning their industrial bases to prepare to go head-to-head with more companies.

At Farnborough, where Russia's Rosboronexport—still under fire from U.S. lawmakers for exporting attack helicopters being used in the Syrian civil war—said it is counting on combat aircraft and airborne munitions to comprise 40% of its exports over the next 10-15 years.

Speaking to a panel at the Farnborough International Airshow, U.K. Defense Secretary Philip Hammond described a rapidly changing export market. Just a few years ago, many nations were happy being customers, but now those same importers want to be partners. In a few years, former customers may see themselves as first-tier competitors. “There will be huge pressure on all of you in the industry to revisit business models, to build partnerships that reflect the new reality,” Hammond said.

A study by the Stockholm International Peace Research Institute (Sipri) charts an increase in Asian demand for weapons—accounting for 44% of global imports. But those nations are gradually trying to build their own industries, following the lead of China, which is already making the transition from weapons importer to global arms broker. From 2002-06, China was the largest weapons importer. Between 2007-11, China's rank fell to fourth place and is now the sixth-largest supplier of weapons in the world.

“While the volume of China's arms exports is increasing, this is largely a result of Pakistan importing more arms from China,” said Paul Holtom, director of the Sipri Arms Transfers Program. “China has not yet achieved a major breakthrough in any other significant market.”

To maintain their edge in the future, U.S. companies will need to continue to innovate, and the U.S. government should work to improve the environment for exports, according to several industry and government officials.

“What does give us the leading edge is technology. It's innovation. It's R&D,” says Marion Blakey, president of the Aerospace Industries Association. “The key thing of course is to try to move forward in terms of composite technology, the propulsion technologies—all of the kinds of innovation that I think our companies are showing.”

But in addition to making sure its products are competitive, the U.S. needs to be smart about positioning products, particularly UAVs, an industry in which the country has built an expertise but is bound by Missile Technology Control Regime rules, Blakey says. Other nations were displaying their latest developments in UAV technology, which can be sold without the same barriers to export, she says. “It'll go the way of commercial satellites if we don't address it,” Blakey warns.

The U.S. also needs to move forward with its export control reform effort.

In a July 17 speech to the Export Control Reform (ECR) Conference, Andrew Shapiro, assistant secretary of state for political-military affairs, pushed back against skepticism about the administration's ability to streamline the nation's Byzantine export controls. The administration has been working to rewrite the U.S. Munitions List, to ensure that the most sensitive technologies are protected and that the least sensitive items can be traded more freely with allies.

“Let me be very clear: any speculation that ECR is stalled is absolutely false,” Shapiro said. “This has been a long tough slog, but we can now see the goal line. So to suggest or infer that we are somehow losing momentum when we are this close, is just wrong. By January of next year we will have either crossed the goal line, or we will be so close, that whoever is in these jobs will just need to dive into the end zone and do a touchdown dance.”

And acting Commerce Secretary Rebecca Blank says the administration expects to notify Congress of its changes to the export control list in the fall.

Another complication is what happens on the backend of a deal. While foreign sales for the U.S. are a money-making venture, they are also a diplomatic tool to deepen ties between nations. And foreign governments have long used the deals as a way to bolster local economies.

The practice has been around for ages. To sell F/A-18s to Spain, Boeing's predecessor, McDonnell Douglas, helped establish a Domino's Pizza franchise in Barcelona.

But the practice is growing. Between 2005-16, governments will have imposed $500 billion in such agreements on foreign companies, according to a study conducted by data-analysis company Avascent and Fleishman Hillard.

Despite their importance on the frontend of the deal, most companies pay little attention to offsets at a high level, says Avascent partner Jon Barney. But with increasing global competition, foreign customers are becoming more sophisticated about their offset policies. And with the possible public-perception downsides to offsets, companies should pay more attention, Barney says.

Companies can set themselves apart from the competition by making offsets a strategic priority for senior executives, building internal support for offsets, increasing their visibility and planning for them financially. “With sellers expected to incur an estimated $500 billion in offset obligations through 2016, government officials in purchasing countries have an unprecedented opportunity to create jobs, attract investment and promote sustainable growth at no extra cost to the treasury,” states a white paper on the study.

A strategic plan could help address growing concerns among second- and third-tier suppliers that often don't have the resources to produce offsets for their primes. One supplier said this is a concern moving forward; he fears that his company will be at a disadvantage because it lacks the global reach to produce offsets on a large scale for a prime contractor.

In some cases, a prime will forgo a U.S. supplier in order to meet offset requirements. “The primes are actively looking for foreign supply partners for offsets instead of us,” said one U.S. contractor. “It's going to get messy.”

In other cases, U.S. companies establish joint-venture relationships to fulfill foreign sales requirements. “There will be a transfer of technology that leads to a one-time gain for us,” the contractor said. “If [foreign officials are] buying a product, they are expecting more than just the product. They want a lasting relationship that supports their indigenous industry.”

Just finding direct jobs in-country is not always an option, even for a large prime contractor. “It is not a sustainable business,” says Chris Chadwick, president of Boeing Military Aircraft, who says that Boeing's approach is to establish long-term business relationships with partners abroad. “It is not just about the sales, but being part of the fabric of that industry.”

That is especially true in places such as Saudi Arabia, where Boeing will now be filling the order for 84 F-15s, as well as the upgrade of 70 others. “Our intention now is to ensure we are immersed in the Saudi industry,” Chadwick says.

*contract for first four to be signed soon
Recent Big-Ticket U.S. Foreign Military Sales
Qatar 24 Boeing AH-64D Apache Block 3 $3B notified July ’12
Qatar 22 Sikorsky MH-60R/S Seahawk $2.5B notified June ’12
Qatar 12 Sikorsky UH-60M Black Hawk $1.1B notified June ’12
Japan 42 Lockheed Martin F-35A $10B notified May ’12*
Saudi Arabia 84 Boeing F-15S $29.4B signed Dec. ’11
India 6 Lockheed Martin C-130J $1.2B notified Oct. ’11
Iraq 18 Lockheed Martin F-16IQ $2.3B signed Sept. ’11
Source: U.S. Defense Security Cooperation Agency