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Market trends and analysis of defense offsets.

[The following is a graduate paper prepared by Mr. Khan and reflects his viewpoint supported by the sources listed at the end of the paper. These are his personal views and do not reflect the views of either the U.S. Government or his employer.]

Offsets are industrial compensation practices that are required as a condition of purchase. The seller is required to compensate the buyer for perceived losses to the local economy. This practice has been part of international trade for more than fifty years. The origin of defense offsets has been traced back to different times and events by different authors, depending on the nature of their use and the terminology used. In his article, Barry Marvel traced the origin of defense offsets to Switzerland in 1968 (Barry 2001), while other authors have traced it back to 1950 when the North Atlantic Treaty Organization (NATO) was formed (Skons 2002). Offsets are also used in other industries, such as power generation, telecommunications, and infrastructure projects. Pepsi signed an agreement with the Ukraine to expand its bottling plants and, in return, marketed approximately $1 billion worth of shipments over an eight-year period (Cateora, Gilly, Graham 2009).

The extant literature, conferences, and industry associations have indicated that the use of offsets is increasing due to their important role in international trade. There are many who favor the practice of offsets, and there are many who oppose this practice. Some refer to offsets as kickbacks (Hawkins 2006) and as being counter to the free market approach, while others, especially some people in the defense industry, view offsets as a reasonable component of market practices and as a business development tool without which there would be no sales (Barry 2001; Healey in Wessner 1999; Defense Industry Offset Association [DIOA]). The World Trade Organization (WTO) permits only civilian offsets (civil-civil) for developing countries only.

Agreements concerning offsets are usually separate from the main contract. And they can be direct offset agreements, i.e., directly related to the equipment or service being purchased; or they can be indirect offset agreements, which are unrelated to the equipment or service being purchased. An example of direct offsets is the Australian purchase of Eurocopter's Tiger attack helicopters for Australian Dollars (AUD) 1.3 billion, which included an offset agreement that required local production of components, local assembly of eighteen of the 22 helicopters, and local production of the Eurocopter EC-120 for the Asian market. The agreement between Russia and Malaysia for Russia to transport a Malaysian astronaut to the international space station was unrelated to the main contract to supply the Sukhoi Su-30 Russian fighter to Malaysia's air force, so this was an indirect offset agreement. FIGURE 1 provides the categories of offsets that are currently offered in the market (Martin 1996).

[FIGURE 1 OMITTED]

Offset agreement is implemented by one or more offset transactions with a credit value claimed against the agreement. Purchasing countries' governments use a multiplier or added credit to stimulate a particular type of transaction (U.S. Department of Commerce [DOC] Bureau of Industry and Security [BIS]).

Offsets are now an accepted practice in the international business arena, and this is especially true in the defense industry. Many countries see offsets as a means of enhancing their local economies, of politically justifying spending on defense articles, and of acquiring the latest technologies. Countries and regions have used both formal and informal defense acquisitions and offset policies. In some cases, offsets are mandatory since a percentage of the value of the main contract will be taken as a penalty unless the terms of the offset agreement are met.

Marketers should be aware of offset policies and practices of their foreign customers and governments to better prepare for the competitive bidding process. Defense firms should be aware of the trends in offsets and the demands of the respective markets, such as local partnerships and production. Many firms recognize these factors as an opportunity to advertise their offering and their capabilities to customers (SAAB 2009).

Review of Extant Literature

Several publications, conferences, and other literature have covered the topic of offsets over the last few decades. The extant literature researched for this paper on offsets can be categorized as covering:

* Theory, models, and strategies

* The defense industry, in particular the view of the aerospace industry (U.S.)

* The general literature on trade, countertrade, and barter (non-defense industries)

The related literature that has addressed offsets has, for the most part, focused on the viability of offsets as a means of economic development and on the development of economic models, policies, and strategies that can be used to assess offsets. The study of the literature in this category provided a basic understanding of the topic and helped eliminate some of the myths about offsets.

Analysis of mandatory countertrade (countertrade, local content, and bundling) transactions versus transactions without any such requirements revealed that the buyer bears the costs associated with the offset, i.e., the cost premium is transferred to the buyer (Markowski and Hall in Brauer and Dunne 2004). Thus, the justification for offsets as a means of enhancing the local economy, local production, and the local job market comes with a price premium that must be justified. The impact on the local economy can be temporary; and, in most cases, it can be achieved efficiently by other means, such as free trade and the normal economic and business development activities that lead to long-term business partnerships. This aspect of the issue is covered in detail by S. Martin (1996), Brauer and Dunne (2004), Wolf (1976), Wessner (1999), and the U.S. DOC's BIS (2007).

Three approaches are prominent when considering offset policies: 1) a policy adaptation requiring a mandatory offset component, 2) a flexible case-by-case approach based on mutual benefits, and 3) the best endeavor approach based on a partnership (Ron Matthews in Brauer and Dunne 2004). A number of countries started with one strategy; and, over a period of time and after some experience, they have used different approaches. Most of the western countries and markets covered in the next section exhibit this trend.

Mandatory offsets provide the benefit of ease of administering the offset program with set criteria established to monitor progress, and they are less rent seeking. It is advisable to use mandatory offsets in high-technology acquisitions (Taylor in Brauer and Dunne 2004). In most cases, government acquisitions depend on mandatory offsets because the available staff usually lacks experience and skill in dealing with offset agreements. The biggest drawback of mandatory offsets is their inflexibility that results from the imposition of a standard solution.

The case-by-case approach provides the ability to adapt to the complexity of acquisition technology, contract negotiations, and compromise. The best option is a compromise between mandatory and the case-by-case approach (Ron Matthews in Brauer and Dunne 2004). The next section covers the different markets and their policies and strategies. One can observe a strategy adaptation pattern in a specific country or market based on local conditions and requirements.

The U.S. defense and aerospace industry views offsets as a necessity in today's competitive business environment. Several industry associations, conferences, and publications cover the topic from different perspectives, such as economics, policy tools, and industry and job market studies related to the impact of offsets. The Defense Industry Offset Association (DIOA) was established with a charter that stated the organization's objective of educating its members about topics related to the practice of offsets. DIOA views offsets as one of the main criteria for international sales. Defense contracting firms have only two options, i.e., engage in offsets or walk away from the deal (R.E. Scott 1999).

The defense industry also views offsets as a counterbalance for trade distortions imposed by government interventions, as well as tools that provide risk mitigation and access to capital, markets, and technologies and enhance local workforce skills (Mowery 1999). In response to a survey of U.S. defense firms conducted by the U.S. Commerce Department, 59 percent of respondents agreed with the concept that offsets are essential to win contracts (Spreen 2007).

The general literature related to offsets covers civilian counter trade, barters, and other topics. Global organizations view offsets as ineffective and inconsistent with free trade. The World Trade Organization (WTO) has established a policy under Article XVI that prohibits the use of offsets. Offsets are permitted for developing countries only as means of qualifying, not for awarding contracts. The Organization for Economic Cooperation and Development (OECD) considers offsets to be a second-best solution when faced with market imperfections (Strizzi and Kindra 1995). Defense offsets are considered outside the scope of these agreements.

As a means of economic development, offsets work well when the local environment is able to take advantage of all or some of the factors involved, such as availability of a highly-skilled workforce, business and technological partnerships, appropriate infrastructure, the capability to develop foreign markets for local products, and the dual-use nature of technology (defense and civilian). South Korea and Germany are prime examples of countries that have been able to leverage these benefits over the long term after the wars.

An increase or a decrease in the world's defense spending can also act as a catalyst. It will impact the competitiveness of the process in the international markets. Based on the past transactions (FIGURE 3), offsets have proved to be one of the key decision criteria in international defense sales.

The Offset Policies and Strategies of the Markets (Country and Regional)

Several countries and regions have formally or informally used offset strategies and policies for defense acquisitions. The use of a policy is dictated by various factors, including the state of the local economy, the skill set of the workforce, infrastructure, international relationships, and national ambitions.

A summary of the strategies and policies used by a selected set of countries covering different regions of the world is presented in this section. The U.S market was not considered for this paper. The selection of countries and regions was based on several factors, such as the importance of the region in international arms trade, history, conflict in the region, and the specific country or region's involvement as an arms importer and exporter (Figures 2a, 2b).

Europe, the United Kingdom, and Germany

Europe is the birthplace of offsets, as stated in the previous section. In 2007, European Defense Ministers used the European Defence Technology and Industrial Base (EDTIB) strategy to develop an open, competitive, and sustainable Defence Technology Industrial Base (DTIB) within Europe (European Defence Agency [EDA] Background 2009). The EDA is trying to get commitment from its subscribing countries to create a market that no longer needs offsets (Scaruppe 2009). Most of the European countries have adopted one of the three policy approaches during last four to five decades. Today, seventeen European countries have official offset policies. FIGURE la provides the EDA member states and their collaborative acquisitions. France, Germany, Italy, Spain, and the United Kingdom (U.K.) are the prominent members with double digit (percentage) collaborative acquisition (EDA 2009).
2006

 Remaining Persentage of Percentage of European
 Equipment Procurement Collaborative Equipment
 Procurement

France 74.1% 25.9%
Germany 81.3% 18.7%
Italy 86.8% 13.2%
Luxembourg 65.9% 34.1%
Portugal 99.8% 0.2%
Spain 49.9% 51.1%
U.K. 69.9% 30.1%

2007

France 81.7% 18.3%
Finland 94.0% 6.0%
Germany 81.1% 18.9%
Italy 48.7% 51.3%
Lithuania 95.0% 5.0%
Luxembourg 71.6% 28.4%
Portugal 92.0% 8.0%
Spain 60.4% 39.6%
U.K. 78.7% 21.3%

Figure 1a European Collaborative Equipment Procurement as a Percentage
of Total Equipment

Note: Table made from bar graph.


The U.K. and Germany are two major exporters and importers of arms in the world (FIGURE 2a). They are members of the NATO Alliance and the European Union (E.U.). E.U. Article III-196 protects the defense industries of member countries.
Top 10 arms exporters, for the period 2004-2008

USA 31%
Russia 25%
Germany 10%
France 8%
UK 4%
Netherlands 3%
Italy 2%
Spain 2%
Ukraine 2%
Sweden 2%
Others 11%

Figure 2a Arms Exporters (Source: Stockholm International Peace
Research Institute [SIPRI] 2009)

Note: Table made from pie chart.


The official U.K. offset policy, i.e., "Industrial Participation Policy," is the responsibility of the Ministry of Defence (MOD) and the Defence Procurement Agency (DPA), while the Defence Export Services Organization (DESO) is the implementer of the policy. For exports, the U.K. offset policy focuses on support for the local defense industry and its access to the world markets (DESO 2009). For imports, all contracts of [pounds sterling]10 million or above require offsets. Offset requirements are set to 100 percent of the main contract value. Multipliers are not allowed. Thus, the U.K. follows a very traditional offsets policy with a combination of direct and indirect offsets.

Germany has no official offset policy. Germany, in principle, maintains close cooperation with NATO and the E.U. It has focused on dual-use technology, i.e., defense and civilian usage or spin-off with license production. Germany is a good example of a country that leverages offsets to build local industry, which was especially the case after World War II (Mawdsley and Brzoska in Brauer and Dunne 2004).

The formation of the European Union, trade agreements, and previous offsets have influenced the European unified approach to free market economies, leveraging partnerships and local capabilities and strengths and minimizing offsets within the E.U.

Asia (South Korea and Japan)

After World War II, Japan has been an ally of the U.S. with focus on the licensed production of arms of U.S. origin with a strict policy that bans the export of defense-related equipment. Officially, this agreement does not include an offset policy. There was, however, high-end technology transfer from U.S. and other European allies to Japan. Japan has benefited from its civilian high technology and industrial base to acquire and build an industrial base in the defense sector. It promotes local manufacturing and its design base (Chinworth in J. Brauer and Dunne 2004). It has built locally almost all its major defense articles acquired in the last four decades. Most of the U.S. acquisition involved joint production, including selective design work on F-2 fighter production, an aircraft based on F-16, and the F-l fighter-bomber based on the Anglo-French Jaguar.

Japan is now planning on revoking its ban on defense exports to start joint development of technology for export (Aviation Week and Space Technology 2009). Today, Japan is an industrial partner and financier of Boeing's new 787 Dreamliner with a major share of the complex work of designing wings (Newhouse 2007). It recently flew the prototype of the indigenous Kawasaki XP-1 Maritime Patrol Aircraft (MPA), and the prototype of the C-X transport aircraft is to follow soon (AirForces Monthly 2008). The XP-1 will replace the U.S.-built P3 aircraft, which is nearing the end of its useful life. Japan has successfully benefited from its policy of local industry participation and transfer of technology from the U.S. and other countries.

The South Korean offset policy has evolved since the time offsets were only required for very large-scale acquisitions (Kim 2008). The South Korean Ministry of National Defense (MND) is responsible for the country's offset policy, which now requires a 30 to 70 percent offset for any acquisition with a value greater than $10 million. A multiplier of six to one has been offered as an incentive (Brauer and Dunne 2004). Due to its history, geography, and the perception of being threatened. South Korea spends a tremendous amount of money on defense. Its goal is to build local production capacity for its own needs as well as excess capacity for export. The U.S. has been traditionally its partner in the programs (e.g., the F16 and F15 programs); but, recently, South Korea has been exploring new concepts with SAAB related to stealth technology and other areas, such as Active Electronically Scanned Array (AESA) radar, in order to avoid U.S. restrictions on export (Aviation Weekly & Space Technology [AW&ST] 2008).

The South Korean defense industry has been able to design and produce systems. Furthermore, its regional market development and partnership with Turkey and Malaysia have led to new sales. Today, South Korean defense exports amount to billions of U.S. dollars (Grevatt 2009).

Sub-Continent (India and Pakistan)

India and Pakistan share a common border, have had many disputes, and have similar histories. Both have fought more than three major wars and many small-scale skirmishes on their borders.

Since India has a larger economy than its neighbors, it spends large sums of money on defense and security. It is projected that India will spend close to $29 billion in 2009-2010 (F and R 2009). Its offset policy requires a mandatory offset of 30 percent on acquisitions in the category of "purchase from local/global vendor" and 30 percent on the category called "foreign exchange component." All defense acquisitions with a total value that is equal to or greater than Indian rupees 300 crore [a unit in the Indian numbering system equal to ten million] require an offset (DPP 2008). India has a long history of holding a local license to assemble weapons of European and Russian origins.

The goals of the Indian offset policy include:

* Being self-reliant in the defense industry

* Reducing the foreign exchange burden

* Becoming an exporter (Baskaran in Brauer and Dunne 2004)

India's major indigenous defense programs, which began in the 1980s, are nowhere near completion. Several programs, including the Light Combat Aircraft (LCA) and the Arjun Main Battle Tank (MBT), already have been canceled; and other programs are in trouble. At the same time, India is still the top importer of defense articles.

India's mandatory offset requirements are difficult, especially the local partnership requirements for sellers (Flightglobal 2009). Finding local partners who can bring meaningful expertise to the table is difficult. The Indian defense industrial sector is government-operated and has minimal private-public partnerships. It is mostly limited to licensed manufacturing of technologies from the former Soviet Union. Due to these difficulties and complexities associated with the offset requirement, it is difficult to ascertain the success of the policy programs (JDW 2009). India does not enjoy the same environment as Japan, South Korea, and Germany, which have highly-skilled workforces in the defense sector, private sector participation, and the necessary infrastructure in place.

Pakistan is in turmoil with disputes with its neighbor and the threat of extremism within. According to Foreign Policy magazine, Pakistan is ranked tenth on the Failed States Index (FSI). It spends a significant portion of its annual budget and gross domestic product (GDP) on defense (FIGURE 2b). It does not have an official offset policy; but, unofficially, it strives to support its defense needs locally. Mathews, in his articles on offset policy, stated that Pakistan's supply need takes precedence over offset preference (Brauer and Dunne 2004). Over the last few decades, Pakistan has faced embargos by the U.S. and other countries that have pushed its unofficial policy to become firmer on local production, support, and the export of excess capacity. It exports small arms and ammunition, and it is now formally promoting its products through a defense exhibition and seminar that is held every other year (International Defence Exhibition and Seminar [IDEAS] 2010). Recently its acquisition of work related to the Boeing 777 had a local production offset component (Pakistan Aeronautical Complex [PAC] 2009). Similarly, its recent acquisition of a role in the production of the Italian surface-to-air missile (SAM) had an unspecified amount set aside for local support and maintenance (DefenseNews 2009).
Top Arms Importers FSI Rank Weapons imported Annual military
 2006 & 2007 (in expenditure (in
 millions) * millions) **

China 56 $8,562 $63,617
Israel/West Bank 56 $3,384 $13,357

Egypt 43 $2,557 $2,995
Pakistan 10 $1,415 $4,932

Iran 38 $1,308 $7,198
Iraq 6 $850 $3,617

Azerbaijan 56 $574 $728
Bangladesh 18 $437 $747

Georgia 33 $427 $646
Colombia 41 $215 $5,819

China's Client List
Country (Rank)
Zimbabwe (2)
Sudan (3)
Pakistan (10)
Burma (13)
Nigeria (15)

* Estimated value of conventional weapons imported, 2006 &
2007 (in millions)
** Total annual military expendature, most recent year
available (in millions)
Figure 2b Top Arms Importers, Foreign Policy Magazine, July-
August, 2009


[ILLUSTRATION OMITTED]

Pakistan is not as ambitious as India in its offset requirements because it does not enjoy the same status as India in world politics and international relations. In addition, it does not have the same economic resources, skilled workforce, or infrastructure. Like India its defense industry is totally state run with almost no private-public enterprise participation.

Middle East (Saudi Arabia and United Arab Emirates)

Besides Israel and Egypt, Saudi Arabia and the United Arab Emirates (UAE) are the largest importers of defense articles and services in the Middle East. Both nations had been spending heavily on defense since the Gulf crises of the 1990s. Israel and Egypt receive a large amount of aid from the U.S. annually. This makes it very difficult to conduct an appropriate analysis that requires disentangling aid from local spending.

The Saudi Economic Offset Program (EOP), under the Ministry of Defense and Aviation, is responsible for the country's offset policy. The Saudi offset policy, as is the case for many developing countries, is focused on social and economic sector benefits and the acquisition of advanced technologies. Almost all of its recent acquisitions and some of its past acquisitions had offset components. Al-Ghrair and Hooper (Al-Ghrair and Hooper in Martin 1996) provided a detailed account of Saudi Arabia's major programs, such as Peace Shield and Al Yamamah I and II. The Saudi offset programs focused on requiring barter; the establishment of joint ventures with a 50-50 partnership with local businesses; and utilizing indirect offsets for local production in pharmaceutical, petroleum, and food processing plants.

Al Salam Aircraft repair and support facilities were also established for in-country support of commercial and military aircraft during the same period when Saudi Arabia had subcontracts from Boeing and other defense contractors. The most recent acquisition of the 72 Typhoon fighters from the U.K., Saudi Arabia's main defense supplier after the U.S., had an offset component with ambition to establish its own aerospace and defense industry (Arab News).

The UAE has one of the most successful economies in the Middle East. The UAE Offset Group (UOG), established in 1998, has goals and objectives that are similar to those of the Saudi EOP. It has mandatory offset requirements of 60 percent, with a term limit of seven to ten years to fulfill its offset requirements. It has an additional requirement of profitability, rather than just investment in the kingdom. The UAE is the first and only Arab country in the Middle East to partner with the U.S. defense industry (Northrop Grumman) by investing $500 million to develop new, Active Electronically Scan Array (AESA) radar for F-16 fighters (Knights 2003). Any future sales would provide royalty revenue for the kingdom.

Australia and New Zealand

Australia and New Zealand (ANZ) enjoy closer ties due to geographic, commercial, and other interests. The Australian-New Zealand Closer Economic Relations Trade Agreement (ANCERTA also known as CERTA) was established to further common goals and improve the treatment of local suppliers. Due to these reasons, a reference to Australian industry is regarded as one industrial base (AIC 2009).

Australia has experimented in the defense offset arena. Over a period of time, it adopted a variation of all three policy approaches. In the 1970s, the Australian Industrial Participation Program (AIPP) was based on best endeavor. In 1986, AIPP was replaced by the Australian Industry Involvement (All) program. Under the AH program, it is mandatory for contracts to include a 30 percent offset if they exceed AUD 2.5 million with imported components of at least 30 percent. A multiplier is used to entice research and development (R&D) and training (Markowski and Hall in Brauer and Dunne 2004).

Today, Australian Industry Capability (AIC) is focused on maintaining self reliance through the development of in-country industrial capabilities; but cost effectiveness is a major consideration. Offsets are no longer mandatory, but commercial competitiveness and value for money are considered to be very important. AIC requires a plan for all contracts valued over AUD 50 million with local industry activities (LIA) as one of the key performance indicators (KPI). LIA are contracts with work breakdown structures (WBS) that are undertaken by local industry using an agreed to statement of work (AIC 2009).

The New Zealand Industrial Involvement (NZII) in the twentieth century had a mandatory offset requirement and local program component, i.e., New Zealand (NZ) Industrial Participation (NZIP). It requires a mandatory offset of 30 percent, as does the Australian AII. New Zealand, much like Australia, has realized the limitations of mandatory offsets. Today, the New Zealand MOD does not advertise for mandatory offsets; rather, it encourages vendors to provide offsets and local industry participation. This policy was also influenced by regional agreement with its neighbors and regional participants. New Zealand recognizes regional bilateral agreements with Singapore (Closer Economic Relations--CER) and other entities, in addition to the Australian CERTA (NZ MOD 2009).

The example provided by Australia and New Zealand signifies the regional approach of learning and enhancing offset policies and procedures over time. This regional approach has also been used in other western markets, such as the European Union and Asia Pacific regions. The formation of broader trade agreements between different countries has enabled the creation of common markets and strategies for dealing with local defense priorities through unified offset policies.

FIGURE 3 provides a list of defense acquisitions by the set of countries presented in this section with their contract values in U.S. dollars and their offset requirements. All the contracts listed in FIGURE 3 have an offsets component.
SIPRI ARMS TRANSFERS DATABASE AND OTHER SOURCES

S. NO. SUPPLIER/RECIPIENT (R) DEFENSE ARTICLE CONTRACT VALUE
 OR LICENSE (L)

 1 FRANCE, UAE 46, LECLERC DNG, PART OF $3.4B DEAL
 ARMED RECOVERY
 VEHICLE

 2 FRANCE, L. AUSTRALIA 22, TIGER ATTCK AUD 1.3B
 HELICOPTER

 3 FRANCE, L. AUSTRALIA NH90 NAVAL AUD 1B
 HELICOPTER

 4 ITALY, PAKISTAN 10 BATTERIES, $565-656 5M
 SPADA 2000
 SURFACE TO AIR
 MISSILE (SAM)

 5 U.S., PAKISTAN 3, BOEING 777 N/A

 6 RUSSIA, INDIA 80, MIL-17 $1-12B
 HELICOPTERS

 7 U.S., INDIA P8I, MARITIME $2.1 B
 PATROL AIRCRAFT
 (MPA)

 8 U.S., AUSTRALIA 4, C17A AUD 1.9B
 TRANSPORT

 9 U.S., S. KOREA 40, F15 FIGHTERS $4.2B

10 U.S., U.K. 5, ASTOR RADARSS $1.3B

11 U.K. FGM-148 JAVEUN, ~490M + $179M
 ANTI TANK
 MISSILES

12 U.K., SAUDI 72 TYPHOON COMBAT [pounds sterling]20B
 AIRCRAFT ($30 2B)

S. NO. OFFSET VALUE COMMENTS

 1 60% OF CONTRACT VALUE DELIVERED IN 2004

 2 N/A OFFSETS INCLUDE PRODUCTION OF
 COMPONENTS AND ASSEMBLY OF 18 IN
 AUSTRALIA AND PRODUCTION OF EC-120
 HELICOPTER FOR ASIAN MARKET; AUSSIE
 TIGER VERSION, DELIVERY 2004-2009

 3 $233 M INCLUDING LOCAL ASSEMBLY, DELIVERED
 DELIVERED 2007-2009

 4 N/A TWO FACILITIES ARE BEING PREPARED
 (FORMS PART OF AN OFFSET ENGAGEMENT ON
 THE SALE), ONE FOR MAINTENANCE OF THE
 SPADA SYSTEM AND FOR GUIDANCE SYSTEM
 TESTING AND MAINTENANCE OF THE ASPID
 MISSILES, DELIVERIES BEGINS 2010

 5 N/A MANUFACTURING AVIATION PARTS FOR BOEING
 747, 767, AND 777 AIRCRAFT DELIVERY
 2010-2014

 6 $400 M DELIVERY 2010-2014

 7 30% FIRST OF EIGHT AIRCRAFT TO CONCLUDE BY
 2015

 8 AUD 345 M DELIVERED IN 2004

 9 65-83% INCLUDING LOCAL COMPONENT PRODUCTION
 FOR 32 AIRCRAFT AND ALL AH64 ATTACK
 HELICOPTERS PART OF A SEPARATE DEAL

10 100% UPGRADED RAYTHEON ASARS-2 SIDE LOOKING
 AIRBORNE RADAR, 4 RADARS PRODUCE IN
 U.K.

11 100% TWO SEPARATE ORDERS FOR ABOUT 5000
 MISSILES

12 N/A, MINIMUM OFFSET 72 AIRCRAFT TOTAL, 48 TO BE LOCALLY
 REQUIRED BY SAUDIA ASSEMBLED, 2 DELIVERIES IN 2009
 ARABIA UNDER ITS
 POLICY, 35%

Figure 3 Recent Acquisitions with Offsets for Selected Countries


Middle Eastern countries have benefited from the indirect offset programs by investing in the socio-economic sectors. The direct offset programs related to the acquisition of defense articles in the Middle East are a new phenomenon and are still in their early stages. These countries face labor shortages and especially shortages of a skilled defense industry workforce to actually benefit from the technology that is being acquired. Most of the manpower of the air force is recruited from abroad. A local defense industry is almost non-existent, and the current trend is to focus on this area of development.

Offsets exist formally and informally, in direct and indirect forms. Some countries, such as India and the UAE, have adopted mandatory offsets, while others have adopted flexible offset policies that focus on long-term partnerships and dual-use technology. Germany and Japan are both in this category. Indirect offsets are being utilized as a means of economic and social development, while direct offsets help to acquire defense technology and establish an in-country defense industry and the support it needs.

Countries with a highly-skilled workforce, private-public enterprises, and developed business and international relationships are in a better position to absorb the transfer of defense technology and benefit from offsets. The approach of regional adaptation to offsets is influenced by broader regional agreements, as was evident in the cases of the E.U. and ANZ.
Country/Region U.K. Germany

Policy Title Industrial Participation Industrial Balance,
 Policy (IPP) No Official Policy

Agency Handling MOD, Defence Export German Defence
 Services Organization Procurement Office
 (DESO) (GDPO)

Minimum Contract [pounds sterling]10 M N/A
Value for Offset

Minimum Offset 100% Minimum 100%
Required (%)

Term Contract Term N/A

Multipliers None N/A

Penalty None + Strict Enforcements N/A

Direct Versus Both Both
Indirect

web site www.deso.mod.uk/ip.htm None

Offset Yes N/A
Policy/Strategy
Evolution (Mandatory
versus Case by Case
versus Best Endeavor

Country/Region India South Korea

Policy Title Defence Procurement Policy (DPP Policy of
 2008 Offset
 Benefits (OB)

Agency Handling MOD Industrial
 Corporation
 Authority
 (ICA)

Minimum Contract Rs. 300 Crores U.S. $500,000
Value for Offset

Minimum Offset 30% Contract value procurement + 35%
Required (%) 30% Foreign Exchange

Term N/A Not Defined

Multipliers N/A 1-6 times
 depends

Penalty Yes 10% of
 unfulfilled
 value

Direct Versus Both Both
Indirect

web site http://mod.nic.in/dpm/DPP2008.pdf www.dpa.go.kr

Offset No No
Policy/Strategy
Evolution (Mandatory
versus Case by Case
versus Best Endeavor

Country/Region Saudi Arabia Australia/New Zealand

Policy Title Saudi Arabian Australian Industry
 Economic Offset Capability (AIC)
 Program

Agency Handling Economic Offset Australian Industry
 Committee (ECO) Involvement Authority
 (AHA)

Minimum Contract N/A Not Mandatory
Value for Offset

Minimum Offset 35% N/A
Required (%)

Term 10 years N/A

Multipliers Subject to ECO None
 approval

Penalty N/A N/A

Direct Versus Mix N/A
Indirect

web site www.offset.org.sa www.defencegov/au/dmo

Offset No Yes
Policy/Strategy
Evolution (Mandatory
versus Case by Case
versus Best Endeavor

Figure 3b Selected Summary of Offset Policies


Offset Analysis and Trends Based on U.S. Defense Exports

The U.S. is the largest exporter of defense-related articles in the world. Its markets include all the countries covered in the previous section. Analysis of the sales of the U.S defense industry can provide an insight into the trends and requirements for offsets related to defense articles.

The U.S. Department of Commerce's (DOC's) Bureau of Industry and Security (BIS) collects data (for reporting to the U.S. Congress) on all U.S. firms' contracts having an offset component exceeding $5 million. The following analysis is based on data obtained from the reports published by BIS (U.S. DOC BIS 2007; U.S. DOC BIS 2008). These data cover all contracts and the corresponding offset agreements completed during the period of 1993-2007.

Figure 4 provides U.S. defense exports from 1993 through 2007. As seen by the trend line (logarithmic), U.S. exports have decreased in value over the years. This may be due to increased competition from European and other defense exporters and perhaps due to regional approaches. Figure 5 shows corresponding offset agreements with a much steadier trend. Figure 6 provides the offset transactions that correspond to the contracts of Figure 4 and the offset agreements of Figure 5. The values of the transactions show a steady upward trend.

[FIGURE 4 OMITTED]

[FIGURE 5 OMITTED]

[FIGURE 6 OMITTED]

Figure 7 summarizes the trends shown in Figures 4, 5, and 6. Figure 7 shows a downward trend for the values of defense contracts; but, at the same time, the values of offset agreements show steady growth, leading to the conclusion that customers and governments are asking for larger offsets for contract acquisition.

[FIGURE 7 OMITTED]

Figure 8 charts the types of offsets (direct versus indirect) and the categories of the offsets (e.g., training, technology, and purchase). It is apparent that the subcontract, overseas investment, licensed local production, and coproduction categories are used preferably for direct offsets. Indirect offsets are comprised primarily of training, purchases, and technology transfers. Figure 9 shows a steady increase in offsets, with indirect offsets exceeding direct offsets by a factor of almost two.
Category Direct Offset Indirect Offset Value Unspecified ($,
 Value ($, Millions) Millions)

Training $431.30 $1.86

Technology $4,135.86 $151.41
Transfer

Subcontract $517.84 $0.00

Purchase $3,343.24 $16,920.87 $0.00

Overseas $10,197.17 $? $?
Investments

Miscellaneous. $2,786.40 $?

License $318.26 $174.19 $24.03
Production

Credit $568.16 $1,729.48 $0.00
Assistance

Co-Production $155.85 $0.00

Figure 8 Offset by Category

Note: Table made from bar graph.


[FIGURE 9 OMITTED]

The overall trend based on the last fifteen years of U.S. export data shows that there has been a steady increase in the demand for offsets, with indirect offsets accounting for the major portion of the demand.

Conclusion

Offsets exist in formal and informal forms. Some countries, such as India and the UAE, have adopted mandatory offsets, while others have adopted flexible offset policies that focus on long-term partnerships, dual-use technology, and regional approaches. The E.U. and ANZ are in the latter category. Indirect offsets are being utilized as a means of economic and social development, while direct offsets are used to acquire technology and establish defense industries. Countries with a highly-skilled workforce, public-private enterprises, and developed international business relationships and diplomacy are better positioned to absorb the transfer of defense technology than countries that do not have these attributes. Based on the last fifteen years of U.S. export data, the overall trend shows that there has been a steady increase in the demand for offsets.

About the Author

Asif Khan is currently with the Lockheed Martin Corporation supporting the Joint Staff, Combatant Commands, Office of the Secretary of Defense (OSD)-DOD and classified customers. His responsibilities include customer relationship management, price-proposal development, and program management. He has over 16 years of experience in the private industry. Prior to Lockheed Martin, he worked for AT&T Corporation, Goodrich Aerospace, and Rockwell Corporation, managing products and programs for U.S. and international customers. His education includes two master's degrees, one from Wayne State University, Detroit, and the other from the University of Peshawar, Pakistan. Currently he is pursuing a Master of Business Administration (MBA) in Marketing Management from Carey Business School, Johns Hopkins University. He is a member of the American Marketing Association (AMA) and Defense Industry Offset Association (DIOA).

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By Asif M. Khan Lockheed Martin Corporation
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Title Annotation:PERSPECTIVES
Author:Khan, Asif M.
Publication:DISAM Journal
Date:Jul 1, 2010
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