Frost & Sullivan MI: Military offsets & in country industrialisation

Military Offsets & InMilitary Offsets & In--country country IndustrialisationIndustrialisation

Market InsightMarket Insight

Top 20 Military Offsets MarketsTop 20 Military Offsets MarketsTop 20 Military Offsets MarketsTop 20 Military Offsets Markets

March 2013March 2013

Dominik Kimla – Industry Analyst

Contents

Section Slide Numbers

Executive Summary 3

CEO 360 Perspective 4

Market Overview-Definitions 5

Military Offsets Trends 9

• External Challenges: Drivers and Restraints 10

• Forecasts and Trends 15

2

• Forecasts and Trends 15

• Key Military Offsets Issues—Legal Aspects 23

• Key Military Offsets Issues—Industrialisation and Technology Transfer 25

• Key Military Offsets Issues—Corruption Threats 26

Selected Key Future Military Offsets Program Analysis 27

Military Offsets Process—Decision Making Factors 30

Military Offsets Market—Critical Success Factors 31

Strategic Recommendations 32

About Frost & Sullivan 33

Executive Summary

� Despite global economic downturns, military offsets market presents strong dynamicsfuelled by significant defence procurement programmes in APAC and Middle Eastcountries.

� As end users are more price conscious, higher military offsets obligations, withsignificant technology transfer will be expected from the suppliers side during theprocurement process.

� End-users are expected to tighten their military offsets guidelines and increasepenalties for non-performance of the offset obligation, which will contribute to growth of

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penalties for non-performance of the offset obligation, which will contribute to growth ofthe military offsets markets but could also adversely impact OEMs net revenues.

� Demand is expected to grow at a compound annual growth rate (CAGR) of 3.5 percent between 2012 - 2021 and present opportunities up to $424.57 billion available tothe industry which consists of 20 military offset markets. The military offsets obligationsare expected to increase from $36.36 billion in 2012 to $49.61 billion in 2021.

� Saudi Arabia will be the biggest military offsets market among the analysed countrieswith a CAGR of 3.9 per cent; the country’s military offsets obligations is expected tosurpass $62.63 billion by 2021.

Source: Frost & Sullivan analysis.

CEO’s Perspective

2A robust network of potential military offsetspartners and advisors is essential duringimplementation of compensation projects.

Corruption presents substantial risk inCorruption presents substantial risk in

1

The highest growth of the military offsets

Korea and Taiwan.

The highest growth of the military offsetsmarkets, in terms of CAGR will be witnessedin APAC countries such as: Indonesia, SouthKorea and Taiwan.

4

3code of conduct.

Corruption presents substantial risk inmilitary offsets projects, therefore OEMsshould implement internal anti-corruptioncode of conduct.

4

The technology transfer and long-termeffects of the military offsets investments forlocal economy are the most important factorsfor decision makers that determine selectionof the offsets package.


Military Offsets Market Overview—Definitions

This market insight (MI) assesses the value of military offsets obligations of leading 20 markets.

Military Offsets definition is very broad with varied interpretations from each stakeholder. In some countries

industrial cooperation, industrial participation or some other terms are used instead of offsets. In general,

military offsets is a compensation mechanism agreed between purchasing government and foreign supplier(s)

of military related products or services. As a result of a defence deal, the foreign supplier(s) agree to conduct a

number of additional investments, projects in local economy, mainly in defence sector, to offset the costs of

weapon procurement up to 100.00 per cent or even more of the contract value. There are two main types of

5

military offsets direct and indirect.

� Direct offsets - compensation transactions that are directly linked to the initial weapon or services

contract, mainly in form of: co-production, subcontracting, licensed production, training and technology

transfer.

� Indirect offsets - compensation transactions that are not directly linked to the initial weapon or services

contract. The indirect offsets can take form of: purchases, investment, training, exporting assistance,

and technology transfer. In framework of indirect offsets two further subdivisions can be distinguished:

� Military-related indirect offsets

� Non military-related indirect offsetsSource: Frost & Sullivan analysis.

Military Offsets Market Overview—Definitions

•Technology Transfer •Training

• Licensed Production

• Subcontracts

• Co-production

• Purchases

• Export Assistance

Direct Offsets Indirect Offsets

Direct vs. Indirect Military Offsets

Mixed Offsets

6

•Investment• Credit Assistance

• Co-production • Export Assistance

� The term mixed offsets refers to mixtures of military offsets transaction types. For large defencecontracts the military offset agreement will cover many compensation projects both direct and indirect.

� Among top the most popular military offsets transaction categories: are purchases, subcontracting, andtechnology transfer.

� From industry perspective indirect offsets is cheaper than direct one, so original equipmentmanufacturers (OEMs) are more willing to offer these type of projects in their compensation packages.


Top 20 Military Offsets Markets

Military Offsets Markets: Top 20 Markets, 2012-2021

�Germany

�Greece

�Italy

�Netherlands

�Norway

�Poland

�Turkey

�UK

7

�South Africa

�Australia

�India

�Indonesia

�South Korea

�Singapore

�Taiwan

�Brazil

�Chile

�Colombia

�Saudi Arabia

�UAESource: Frost & Sullivan analysis.

Forecast Assumptions

� This MI assesses the value of military offsets obligations of top 20 markets for the forecast period from2012 to 2021.

� Market Size: The market size is the representation of total military offsets transactions without takinginto account multipliers or intangible factors.

� Forecast Methodology: The forecast model takes into account different parameters: defence budgetassessment, national strategic intent, local industry evaluation, the announced and anticipated defencecontracts, as well as end-user capability requirements to address the defence capability gaps over the

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contracts, as well as end-user capability requirements to address the defence capability gaps over theforecast period based on the information that was gathered mainly through secondary research. In theforecast process top 20 military offsets markets were selected out of leading 60 countries in terms ofmilitary procurement spending. Only countries with formal and informal offsets policies were taken intoaccount.

� The United States was excluded from the forecast scope due to limited amount of weapons procuredfrom abroad. However, it is important to note that ‘buy American’ rule is similar to the military offset-likepolicies. The clause requires that defence platforms procured by the Pentagon have to be builtsubstantially in-country. In this case ‘substantially’ means that at least 50.00 per cent of weaponcomponents have to be produced on American soil. This approach is against official rhetoric of the USgovernment which is against military offsets practices.


The dynamically evolving nature of the defence sectorand growing end-users’ expectations have resulted ina significant demand for military offsets programs.

Defence Procurement & Budget Limitations:As end-users modernise obsolete assets to maintain minimum battle readiness through modernisation andprocurement programs, the need for sustaining these advanced capabilities, both in context of aftermarketsupport and future supply drives the need for military offset market. Asia-Pacific and Middle East countrieshave implemented extensive re-armament programs that lead to increase of weapon import and relatedmilitary offsets’ projects. However, economic downturn led to consequent significant pressure on defenceprocurement projects particularly in Europe. In this case, budget cuts are forcing procurement programs tobe scaled back, postponed or cancelled, inadvertently impacting military offsets.

Legislation & Policy:

Military Offsets Trends

9

Industrial Policy:

Military offsets programs are perceived by decision makers of developing countries as a stimulus of local

economy industrial development including indigenous defence sector. However, countries aiming to

develop a competitive edge based on the technology transfer through military offset deals, need to ensure

that the local industry presents skills and capabilities that are necessary for proper absorption of

technology transfer. This is a pre-requisite to build competitive technological competence.

Legislation & Policy:The offsets legislative and political environment is complex, though evolving fast. The European Unionrecently implemented regulations which significantly narrow military offsets’ requirements among the EUmember states, which cause a decrease of the military offsets market in the EU or cover it under offsets-like practice. On the other hand, offsets markets in other regions / countries straiten their legislations toenforce implementation of offsets obligations in line with signed military offsets agreements.


Military Offsets Drivers and Restraints

Military Offsets Market: Key Market Drivers and Restraints, Top 20 Markets, 2013-2021

1-2 years 3-5 years 6-9 years

Implementation of extensive re-armamentprograms in APAC and Middle East countries causeincrease of weapon import and related military offsets’projects.

Military offsets programs as stimulus of industrial

development and capabilities of indigenous defence

sector.

Countries drive to enforce military offset

Mark

et

Dri

vers

10


European Union (EU) legislation diminish military offsets obligations in the EU.

Lack of transparency in procurement and military offsets decision making.

Economic downturn causes significant pressure on defence procurement .

Countries drive to enforce military offset

obligations.

Mark

et

Restr

ain

ts

High Medium-High Medium Low-Medium Low

Drivers Explained

Driver Description Impact

Implementation of anextensive re-armament programsin APAC and MiddleEast countries causeincrease of weaponimport and relatedmilitary offsets.

Due to the tense situation over Iranin Middle East and regional arms-race in South East Asia, defencebudgets in countries such as SaudiArabia, UAE, China, Vietnam,amongst others are growing ratherthan being cut back.

In line with massive procurement programsin APAC and Middle East countries highvalue military offsets deals are expected.Military offsets packages have to beattractive both in terms of the scale and addvalue of investments as customers in theregions are more demanding in terms of longterm effects of military offsets projects.

Military offsets Military offsets programs present the Military offsets programs could increase

11


Military offsetsprograms asstimulus of industrialdevelopment andcapabilities ofindigenous defencesector.

Military offsets programs present theopportunity to increase technologicalunderstanding and industrial capacitythrough technology transfer. It is alsoan industrial policy tool to stimulatelocal economy development.

Military offsets programs could increaseindustrial potential of local defence sector.However, to fully exploit military offsetsopportunities, the indigenous defenceindustry have to have competencies toabsorb technology transfer.

Drivers Explained (continued)

Driver Description Impact

Countries drive to

enforce military

offset obligations.

Defence market is a buyer’s markettherefore customers are moredemanding in terms of militaryoffsets’ packages content and theirimplementations into local economy.

Customers tighten their military offsetsguidelines and increase penalties for non-performance of the military offset obligation.It will contribute to growth of military offsetsmarkets but could also adversely impactOEMs net revenues because companies willhave to provide to customers more tailoredmilitary offsets packages.

12


Restraints Explained

Restraint Description Impact

European Unionlegislation diminishmilitary offsetsobligations in theEU.

Implementation of DefenceProcurement Directive 2009/81/ECby the Member Stats of the EU,publication by the EuropeanCommission Guidance Notes onOffsets and launching Code ofConduct on Offsets by the EuropeanDefence Agency.

The European Commission (EC) views militaryoffsets as a violation of the free market andprinciples of the EU. The member states areallowed to demand military offsets only when itis necessary for their “essential security

interests”. Frost & Sullivan indicates that thisapproach presents a challenge for countrieswhich are developing their defence industrialbase, because their companies will not be able

13


base, because their companies will not be ableto exploit opportunities that come from militaryoffsets investments .

Lack oftransparency inprocurement andmilitary offsetsdecision makingprocess.

In many countries politicians stillwield considerable influence overdefence procurement and militaryoffsets decisions.

Uncertainty and delays are caused by lack oftransparency in procurement and decisionmaking process, which also increase corruptionrisk. Theses can create an extra costs forOEMs which have to adjust military offsets tofrequently changing customer’s requirements.

Restraints Explained (continued)

Restraint Description Impact

Economicdownturn causessignificantpressure ondefenceprocurement .

The global economic downturn has seriousimplications for defence procurementbudgets. Some of the major defenceprograms are being postponed orcancelled. Limited procurement funds are asubstantial restraint especially in Westerncountries during the forecast period.

The defence budget cuts have createddelays for procurement programs, some ofthem were canceled. Therefore, the cost-efficient aspect of defence contracts andthe add value of related military offsetspackage will be the prime decision makingfactors.

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Military Offsets Market Value Forecast

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

10.00

20.00

30.00

40.00

50.00

60.00

Gro

wth

Rate

(%

)

Rev

en

ue (

$ B

illio

n)

Military Offsets Market: Top 20 Markets Value Forecast, 2012-2021CAGR = 3.5%

15

Note: All figures are rounded. The base year is 2012. Source: Frost & Sullivan analysis.

0.0

0.5

0.002012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Revenue 36.36 37.32 38.34 39.81 41.35 42.97 44.66 46.25 47.90 49.61

Growth Rate 2.7 2.7 3.8 3.9 3.9 3.9 3.6 3.6 3.6

� Despite austerity measures implemented by most of the Western countries, the cumulative value ofmilitary offsets obligations by top 20 countries is predicted to be $424.57 billion during the forecast period.

� The market will experience growth of CAGR at 3.5 per cent, due to ambitious military platformprocurement plans and the related military offsets packages across APAC, Middle East and Latin Americacountries.

� Governments in these countries are interested in using military offsets projects mainly as a tool to developindustrial capabilities of the local defence sector.

� It is expected that Saudi Arabia market will generate the biggest cumulative value of military offsetobligation at $62.63 billion.

Military Offsets Market Forecast by Country

40.00

50.00

60.00

Military Offsets Market: Value Forecast by Country, Top 20 Markets, 2012-2021

UAE

Saudi Arabia

Colombia

Chile

Brazil

Taiwan

Singapore

South Korea

36.36

49.61

Saudi Arabia and India are expected to be the largest offsets markets representing a total Saudi Arabia and India are expected to be the largest offsets markets representing a total of $112.87 billion during the forecast period.

16

Note: All figures are rounded; the base year is 2012. Source: Frost & Sullivan analysis.

0.00

10.00

20.00

30.00

40.00

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

($B

illi

on

)

Year

South Korea

Indonesia

India

Australia

South Africa

UK

Turkey

Poland

Norway

Netherlands

Italy

Greece

Germany

Military Offsets Market By Country (continued)

Military Offsets Market: Value Forecast by Country, 2012-2021 ($Billion)

Year Germany Greece Italy Netherlands Norway Poland Turkey UKSouth Africa

Australia

2012 0.87 1.49 1.32 1.10 1.04 1.04 1.28 1.58 0.67 2.31

2013 0.85 1.42 1.26 1.08 1.09 1.09 1.35 1.55 0.69 2.38

2014 0.84 1.35 1.19 1.05 1.15 1.14 1.42 1.52 0.71 2.45

2015 0.86 1.32 1.17 1.09 1.18 1.23 1.46 1.56 0.74 2.53

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2015 0.86 1.32 1.17 1.09 1.18 1.23 1.46 1.56 0.74 2.53

2016 0.89 1.29 1.15 1.12 1.22 1.32 1.50 1.61 0.76 2.60

2017 0.91 1.27 1.12 1.15 1.25 1.42 1.55 1.66 0.78 2.68

2018 0.94 1.24 1.10 1.19 1.29 1.53 1.59 1.71 0.80 2.76

2019 0.97 1.28 1.14 1.22 1.33 1.60 1.64 1.76 0.84 2.90

2020 1.00 1.32 1.17 1.26 1.37 1.68 1.69 1.81 0.89 3.04

2021 1.03 1.36 1.20 1.30 1.41 1.77 1.74 1.87 0.93 3.20

CAGR 1.9% (1.0) % (1.0)% 1.9% 3.4% 6.1% 3.4% 1.9% 3.7% 3.7%

Military Offsets Market By Country (continued)

Military Offsets Market: Value Forecast by Country, 2012-2021 ($Billion)

Year India IndonesiaSouth Korea

Singapore Taiwan Brazil Chile ColombiaSaudi Arabia

UAE

2012 4.38 0.75 2.61 0.76 0.94 3.40 1.27 1.77 5.22 2.53

2013 4.51 0.81 2.74 0.83 0.99 3.50 1.31 1.83 5.38 2.66

2014 4.65 0.87 2.88 0.92 1.04 3.61 1.35 1.88 5.54 2.79

2015 4.79 0.93 3.02 0.94 1.09 3.79 1.39 1.98 5.82 2.93

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2015 4.79 0.93 3.02 0.94 1.09 3.79 1.39 1.98 5.82 2.93

2016 4.93 1.00 3.18 0.97 1.14 3.98 1.43 2.07 6.11 3.08

2017 5.08 1.08 3.33 1.00 1.20 4.18 1.48 2.18 6.41 3.23

2018 5.23 1.16 3.50 1.03 1.26 4.39 1.52 2.29 6.73 3.39

2019 5.39 1.25 3.68 1.06 1.32 4.52 1.57 2.36 6.93 3.49

2020 5.55 1.34 3.86 1.09 1.39 4.65 1.61 2.43 7.14 3.60

2021 5.72 1.44 4.05 1.13 1.46 4.79 1.66 2.50 7.36 3.71

CAGR 3.0% 7.5% 5.0% 4.5% 5.0% 3.9% 3.0% 3.9% 3.9% 4.3%

Military Offsets Market Forecast by Country Discussion

� Research indicates that Saudi Arabia will generate the largest cumulative value of military offsetobligation at $62.63 billion. This is a direct consequence of defence procurement projects such as F-15SAand Eurofighter Typhoon combat aircrafts, A330 MRTT refuelling aircraft, BAE Hawk advanced jettrainers, Leopard 2A7+ main battle tanks and Piranha armoured personnel carriers, amongst others.Similar to the Saudi’s though on a somewhat modest scale, United Arab Emirates is projected to havecumulative offset market estimated at $31.40 billion during the forecast period.

� The growth of the military offsets market in Asia-Pacific region is fuelled by regional arms race betweenChina and their neighbours, susceptible to occasional escalation in context of the unstable situation onthe Korean peninsula. In this region the cumulative offsets markets in India, South Korea and Taiwan areestimated at $50.24, $32.86 and $11.82 billion respectively.

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� In Europe, due to severe austerity measures that directly impact defence procurement programs, mostcountries will experience limited or even negative CAGR of military offsets market. For instance, bothGreece and Italy will register negative offsets market growth of circa one per cent. Nonetheless, Poland isprojected to register high growth in offsets investments due to implementation of notable defencemodernisation programs such as: air and missile defense system, multi-role helicopters and the advancedjet trainer. However, as a result of implementation of the EU regulations, which significantly narrow themilitary offsets practice among the members states, it is expected that Polish military offsets requirementswill be at least partially covered under indigenisation practice.

� Research indicated growth in military offsets market in Latin America, specifically in Brazil. Despitegrowing power of Brazil on the international scene, their armed forces have to struggle with belt-tighteningmeasures and recurring indecisiveness. For example, the F-X2 jet fighter program that was recentlypostponed the fifth time in a row. Despite, it is expected that Brazilian market will generate $40.80 billionof military offsets obligations across Air, Land and Naval programs. Source: Frost & Sullivan analysis.

Military Offsets Market By Country

APAC countries such as Indonesia, South Korea and Taiwan will experience the highest CAGR growth 7.5, 5.0 and 5.0 per cent respectively during the forecast period 2012-2021.

2.4% 4.1%3.6%

3.0%

2.9%14.4%

7.0%

2012Germany

Greece

Italy

Netherlands

Norway

Poland

Turkey

2.1% 2.7%2.4% 2.6%

2.8%

3.6%14.8%

7.5%

2021

Military Offsets Market: Per cent Revenue Forecast by Country, 2012 and 2021

20


2.9%

3.5%

4.3%

1.9%

6.4%

12.1%

2.1%7.2%2.1%

2.6%

9.4%

3.5%

4.9%

Turkey

UK

South Africa

Australia

India

Indonesia

South Korea

Singapore

Taiwan

Brazil

Chile

Colombia

Saudi Arabia

UAE

3.5%

3.8%

1.9%

6.4%

11.5%

2.9%8.2%

2.3%2.9%

9.7%

3.4%

5.0%

Military Offsets Market Attractiveness Map

Ma

rke

t G

row

th R

ate

High

Medium

1

2

3

4

5

6

1236

4

57

89

10

11

13

Saudi Arabia

(0-4%)

(5-9%)

Brazil

India

UAE

South Korea

Australia

15

Military Offsets Market: Market Attractiveness Map, Top 20 Markets, 2012-2021

16

17

1819

20

21

Ma

rke

t G

row

th R

ate

Market Size

Low

Low Medium High

6

7

8

9

12

(0-20 billion) (20-40 billion) ( > 40 billion)

(<0%)

(0-4%)Australia

Colombia

Chile

UK

Turkey

Norway

Taiwan

Greece

Poland


Italy

14

Indonesia

Netherlands

South Africa

Germany

Singapore

10

11

12

13

14

15

16

17

18

19

20

Military Offsets Market Attractiveness Map Discussion

�Saudi Arabia presents the biggest military offsets market during the forecast period. However, it is worthnoting that the biggest defence OEMs from the US, UK, Germany and France are already present on themarket with extensive experience in terms of Saudi’s military offsets deals. Therefore, making it somewhatchallenging to break into this market.

�The OEMs that are interested in the second largest military offset market should pay a particular attention torevised Indian’s Defence Offset Guidelines introducing the Defence Offset Monitoring Wing as an institutionto monitor the military offsets obligation fulfillment. The positive aspect of revised requirements is expandinga list of Indian Offset Partners that now also contains governmental institutions and R&D centers.Additionally, multipliers were introduced to incentivise military offsets investment in two areas such as Smalland Medium Enterprises and technology transfer to Defence Research and Development Organisation.

22

�On the Latin American continent, it is also expected that Colombia generates substantial offsets market. Inthe past, the country received significant military aid from the US in framework of ‘War on Drugs’ policy.However, this program has been significantly reduced by the Obama administration. With further reductionof US defence aid support, it is highly probable that Colombia will look to source more of its defenceequipment needs from its neighbors, as is evident from its participation in the the KC-390 program. In thiscontext, offsets is seen as an instrument which will help to partially compensate decreasing US aid.Colombian offsets is concentrated on self-sufficiency in terms of operation and maintenance of procuredweapon systems.

�According to Frost & Sullivan, Indonesia will experience the highest CAGR military offsets market growth at7.5 per cent with a value of the military offsets obligation of $10.65 billion for the period 2012-2021. This is adirect consequence of expected implementation of procurement programs that are in line with country’s“Minimum Essential Forces” strategy. The goal is to upgrade Indonesian defence platforms in line with themodernised / ing weapons systems of neighboring countries. Source: Frost & Sullivan analysis.

Key Military Offsets Issues—Legal Aspects

�Any compensation procedures are prohibited in light of the World Trade Organisation (WTO), however,

article XXIII of Agreement on Government Procurement (GPA) allows countries to “taking any action or

not disclosing any information which it considers necessary for the protection of its essential security

interests relating to the procurement of arms, ammunition or war materials, or to procurement

indispensable for national security or for national defence purposes.” This clause is overused by the

majority of states, to legitimize the military offset requirement from foreign defence suppliers.

23

�On the European Union level Article 346 Treaty on the Functioning of the European Union (TFEU) allows

Member States to “take such measures as it considers necessary for the protection of the essential

interests of its security which are connected with the production of or trade in arms, munitions and war

material” However, recently taken actions such as implementation of Defence Procurement Directive

2009/81/EC, publication Guidance Notes on Offsets and launching Code of Conduct on Offsets intend to

limit, in the first place, and then eliminate military offsets from business practices among EU member stats

as an illegal constraint of free trade under EU law.


Key Military Offsets Issues—Legal Aspects (continued)

�Currently, internal military offsets regulations are under revision, in most of the EU member states, to

inline them with the Commission’s guidelines. Frost & Sullivan predicts that the EU law restrictions on

military offsets will cause a switch in the member states’ approach and implementation of military offsets-

like practices such as industrial engagement or participation policies.

� In contrast to the military offsets requirement limitation in the EU countries, other key markets for defence

suppliers in APAC and Middle East are further expanding their relevant regulations. Defence sector

24

suppliers in APAC and Middle East are further expanding their relevant regulations. Defence sector

customers are expected to further tighten the military offsets guidelines and increase penalties for non-

performance. The penalties differ, starting from fulfilment of unfulfilled obligations, through to increases in

the military offsets obligation amount, reduction of the defence contract value and ending with exclusion

from the future defence procurement processes. Therefore, a proper assessment of realistic selection of

military offsets package from both supplier and receiver side is a key to avoid misunderstandings and

legal disputes that may effect the realisation and profitability of main defence contract.


Key Military Offsets Issues—Industrialisation and technology transfer

� Military offset is perceived by receiving countries as industrial policy tool to stimulate and develop theindigenous arms industry and to some extent other sectors of local economy through targetedinterventions. However, there are mixed opinions regarding the long-term effects of military offsets onlocal economies. It is important to note that for some, e.g. APAC economies, efficient absorption of largemilitary offsets investments could be a challenge due to limited local industrial capacity to absorb militaryoffsets transaction of this scale.

� In absence of previous, at least limited technological competence, military offsets will have very limitedlong-term impact on competitive position of receiving company. Therefore, from military offsets receiver’sperspective compensation project(s) should be linked with relevant internal research and development(R&D) programs to accumulate and maximize company's technological competence. Only in this case,

25

(R&D) programs to accumulate and maximize company's technological competence. Only in this case,the military offsets beneficiary company will have a chance to enter the supply chain of defence OEM.Otherwise, narrowing military offsets just to manufacturing weapon parts or sub-systems will causealmost no long-term military offsets effect on the receiving company and may even lead to thedeterioration of the company market position after the end of the military offsets project(s).

� If tailored correctly, military offsets allow the receiving country to develop domestic industries in areas inwhich it had limited capabilities. However, it is worth noting two aspects of military offsets transactions;

� Firstly, defence procurement with military offsets is more expensive way of weapon purchases (from10.0 to 30.0 per cent of the main defence contract value) than ‘off-the-shelf’ transactions.

� Secondly, the receiver of military offsets investments should have necessary recourses to properlyaccumulate know-how and technology granted in framework of military offsets projects.


Key Military Offsets Issues—Corruption Threats

� Corruption risk in defence procurements is substantial due to the high levelof secrecy. The corruption risk in associated military offsets programs iseven higher because in general, transparency in these projects is lowerthan the primary / main defence contracts.

� OEMs should carefully assess the military offset intermediaries’ reputationbefore commissioning their services. Research indicates that the militaryoffsets brokers and intermediaries are the most vulnerable to corruptionpractices. Disproportionally high intermediary's fee should raise a concernfor company’s decision makers. Therefore, OEMs should implement

Germany 13

Greece 94

Italy 72

Netherlands 9

Norway 7

Poland 41

Turkey 54

UK 17

South Africa 69

Corruption Perceptions Index 2012

26

for company’s decision makers. Therefore, OEMs should implementinternal corruption risk assessment of military offsets projects to minimisethe risk of corruption which could have far-reaching consequences for thecompany’s reputation and profitability.

� An interesting correlation identified in this research indicates that thebiggest military offsets market and the highest military offsets marketgrowth (CAGR), respectively Saudi Arabia, India and Indonesia, are listedas countries with high value of Corruption Perception Index.

Source: Transparency International.

South Africa 69

Australia 7

India 94

Indonesia 118

South Korea 45

Singapore 5

Taiwan 37

Brazil 69

Chile 20

Colombia 94

Saudi Arabia 66

UAE 27

Frost & Sullivan analysis.

Military Offsets Program Analysis: India

Indian Medium Multi-Role Combat Aircraft (MMRCA)

Approximately 2013–2020

On 31 January 2012, the Indian government announced selection of Dassault Rafale overthe Eurofighter Typhoon as preferred bidder for MMRCA. The deal for 126 French Rafalesfighters is estimated at $12.00 billion. However, the agreement has not been signed yet.This could be potentially increased in numbers by additional 60+ jets. Such a decision willincrease the value of MMCRA program for another $5.00-6.00 billion. The Indian Air Force

Approximately $6.00 billion

Overview

27

increase the value of MMCRA program for another $5.00-6.00 billion. The Indian Air Forceexpects to finally complete negotiations and sign the contract by the end of the 2013.

As a result of the contract for 126 fighters, 50.0 per cent military offsets will be required byIndian government. India is mainly interested in technology transfer, manufacturing aircraftstructures, sub-systems and military avionics including active electronically scanned array(AESA) radars and electronic warfare suits. The prime receiver of the military offsets will beHindustan Aeronautics Ltd, where 108 out of 126 fighters will be assembled. However, othercompanies of Indian aviation sector such as: Reliance Industries Ltd, Tata Technologies andmany more will benefit from the French military offsets projects.

Military Offsets Requirements /Opportunities


Military Offsets Program Analysis: Brazil

FX-2Approximately 2014–2020

The FX-2 is the largest Air Force program. It is the prominent example of delays in Braziliandefence procurement practice. Brazil is expected to procure 36+ multi-role fighter aircrafts toreplace the obsolete jet combat fleet. The main competitors for the program are: Boeing’s F-18 E/F, the Dassault Rafale and the Saab Gripen NG. According to Brazil’s President DilmaRousseff the aircraft selection calendar will depend on country’s economy, which has been


Overview

28

Rousseff the aircraft selection calendar will depend on country’s economy, which has beenaffected by the global slowdown.

seems to be in a privileged position.

It is expected that the winner of FX-2 program will offer military offsets obligations whichexceed the value of the main contract, estimated at $5-6 billion. Brazilian authoritiesemphasis on direct military offsets, with a focus on the aerospace industry. Brazilianauthorities see the military offsets as a tool to increase capability of domestic defencesector. Therefore, significant technology transfer, mainly to Embraer and other companiessuch as: Avibras, Omnisys Engenharia is expected as a consequence of FX-2 programimplementation. Due to strong local presence and extensive collaboration, French proposalseems to be in a privileged position.

Military Offsets Requirements / Opportunities


Military Offsets Program Analysis: Australia

Collins Class Submarine Replacement

Approximately 2020–2040

In framework of SEA 1000 project, Australia will procure twelve conventional poweredsubmarines to replace six Collins class submarines. The new submarine will be equippedwith cruise missiles, torpedoes and anti-ship missiles, and be able to conduct surveillanceand intelligence-gathering missions. The cost of the program is estimated at $38 billion. Theprogram is single the most expensive defence project implemented by Australian


Overview

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program is single the most expensive defence project implemented by AustralianDepartment of Defence. Currently, the project is in design and studies phase.

shipyard.

Among the most probable options for SEA 1000 project are: buy a military-off-the-shelf(MOTS) vessel or buy a MOTS design and modify for Australian specific requirements.Regardless of the path chosen, due to Australian Industry Capability (AIC) programobligations, Australian industry will be given the opportunity to participate in realisation ofSEA 1000 project. It is expected that through AIC plan, Australian industry, mainly from thenaval sector, will receive orders value at least half of the SEA 1000 project cost. Australiangovernment already declared that the future submarines will be constructed at ASC'sshipyard.

Military Offsets Requirements / Opportunities


Ministry of Defence or designated procurement agency publish a

procurement procedure. Military offsetscould be one of criterions in defence

procurement competitions.

Military offsets authority define the military offsets investment priorities and

framework.

Monitoring and evaluation of the military offsets projects,

implementation in a triangle: military offsets authority,

supplier and receiver of the military offsets.

1.0

2.0

3.0

4.0

5.0Partnership with Local Industry

Technology TransferValue of Military Offsets Package

Military Offsets Process-Decision Making Factors

Technology transfer & long-term impact for local economy of the military offsets investments are important decision making factors for end-users.

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Intermediaries, with knowledge of the local

industrial base and realities, support preparation and next implementation of the military offsets projects.

Selection of the military offsets package, final agreement regarding the scope and size of

the military offsets projects.

Military offsets receivers, mostly local companies and research centers which benefit from the

military offsets projects.

0.0

1.0

Long-Term Impact for Local Economy

Defence Platform Capability


Military Offsets Market—Critical Success Factors

� In most cases, the governments policies regarding military offsets is to promote local industrialproduction and develop indigenous capabilities, mainly defence. Therefore, the technology transferand long-term effects of the military offsets investments for the local economy are the most importantpriorities for decision makers in terms of military offsets packages’ selection and implementation.

� Partnership with local industry and the total value of military offset investments are also substantialfactors considered during the military offset selection process. Therefore, due to the fact that militaryoffsets is also used as an industrial policy tool, the military offsets’ spillover effects to the economy andjob creation effect, particularly high-skilled jobs, are important factors specifically for developingcountries.

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countries.

� The value and technological quality of military offset package is gaining importance as an awardcriterion, specially among APAC and Middle Eastern countries. However, an attractive military offsetspackage can further add value and / or act as a product / service differentiator over and above meetingthe technical requirements in the defence contract selection process.


Strategic Recommendations

• From military offsets receivers point of view partnering or engaging in development

Global Industry: Deliverer

• OEMs need to incorporate military offsets as a standard business practices inrelevant defence markets as it is gaining importance as one of critical successfactors in defence contract selection process.

• Due to the fact that APAC and Middle East regions present the highest growth ofmilitary offsets obligations, companies interested to enter these markets shouldregularly assess the market for potential offset receivers and set-up workingrelations with them far before the announcement of arms contracts.

• A robust network of potential military offsets partners and advisers, and stringentselection / wetting process is essential during procurement process.

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Domestic Industry: Receiver

• From military offsets receivers point of view partnering or engaging in developmentof indigenous defence industry capabilities are particularly important factors.

• However, these countries should define clear goals of military offsetspolicy, prioritise military offsets investments and consider to set up the militaryoffsets hub(s) / centres, where the investments can be accumulated to maximisethe opportunities for robust technology transfer with sustainable long-termdevelopment.

Industry Awareness

• The offsets association such as: the Global Offset and CountertradeAssociation, the Defense Industry Offsets Association and the European Club forCountertrade and Offset should stimulate discussion within defence industry andamong potential customers on creation of the military offsets good practicesguidelines to efficiently implement military offsets in practice.


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