Perspective

Suvojoy SenguptaBob MarkVikram RamakrishnanSamrat Sharma

Investing inIndias FutureKeys to SuccessFor Indias DefenceOffset Policy

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Contact Information
CanberraDavid VrancicPrincipal+61 2 6279 1903david.vrancic@booz.com
ClevelandSamrat SharmaSenior
Associate+1 216 902 4233samrat.sharma@booz.com
LondonBob MarkPrincipal+44 20 7393 3477bob.mark@booz.com
Viniti MahbubaniAssociate+44 20 7393 3433viniti.mahbubani@booz.com
McLean, VAMarty BollingerSenior
Partner+1 703 902 3819marty.bollinger@booz.com
MumbaiSuvojoy SenguptaPartner+91 99302 62101suvojoy.sengupta@booz.com
Vikram RamakrishnanPrincipal+91 99302 62105vikram.ramakrishnan@booz.com

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EXECUTIVESUMMARY
Indias defence offset policy could be the instrument thecountry needs to grow and
modernise its defence industry andfurther build its domestic technological capabilities.
However,experience from other countries indicates that implementing asuccessful and
efcient offset programme is no easy task.
By failing to clearly dene their objectives and trying toachieve too many things at once,
many offsetting venturesdo not realise their potential, do not show positive long-termreturns
on the additional costs, and do not create the localindustry capabilities that the country
actually requires. Clearobjectives, along with specic success criteria, are crucial
toensuring sustained success. Similarly, companies seeking tocapitalise on the offset
programmes, both international suppli-ers and domestic recipients, need to follow a
focussed strategy.Offsets should be viewed as a means to an end, allowing coun-tries to
build their own defence capabilities that will endurewhen the offsetting period ends.
Indias plans for increased defence spending will attract for-eign investment. The
government, international suppliers, anddomestic recipients would benet greatly from the
develop-ment of a clear and well thought out offset strategy to captureall the potential gains
from this spending and investment.

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The Indian government currentlyranks number 11 among the topmilitary spenders
worldwide andremains committed to robust militaryspending in the foreseeable future
(seeExhibit 1). The country is expectedto spend $100 billion on defencein the next three to
four years,with its military budget exceeding$36 billion by 2013.1 Because theIndian
government allows privateparticipation in the industry, with
2
THE STATE OFSPENDING ININDIAN DEFENCE
Exhibit 1Military Spending by Country
Source: Center for Arms Control and Non Proliferation, The FY 2009 Pentagon Spending
RequestGlobal Military Spending, February 22, 2008
foreign investment capped at 26percent ownership, numerousdomestic and foreign
companiesare focusing their attention on thepotential opportunities for investmentthat
Indias growing defence spendingwill provide. Clearly, while fundinglevels and outside
interest will notinhibit the development of Indiasmilitary capabilities, nonstrategic
andinefcient application of these fundscould hold the industry back.
711
Military Spending, global top 20
UnitedStates
122
China
70
Russia
55
UnitedKingdom
54
France
41
Japan
38
Germany
31
Italy
30
SaudiArabia
25
SouthKorea
22
India
17
Australia
16
Brazil
15
Canada
14
Spain
12
Turkey
11
Israel
10
Nether lands
10
UnitedArabEmirates
8
Taiwan

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What Are Offsets?
Offsets are mechanisms for rerouting procurement funds paid to foreign con tractors back
into the spending country. The main goals of the offset policy of theIndian Ministry of
Defence (MoD) are to build world class capabilities, improvetechnical know how for
self sustainability, and increase domestic employment inthe defence sector. To help
achieve these goals, all global defence vendors do ing business with India are required to
reinvest in India at least 30 percent of anydefence procurement contract worth more than
Rs. 300 crores (US$75 million).Such reinvestment could include purchasing equipment or
services from publicor private defence suppliers, channelling funds into domestic
production, or sup porting indigenous defence related research and development.
As its military spending has grown,the Indian government has introducedan offset policy,
which requiresforeign suppliers to reinvest 30percent of their total procurementspending in
Indian defence-relatedindustries. The offset policy, whichhas been implemented with
varyingdegrees of success in other countries,springs from the governmentsunderstandable
desire to developindigenous defence capabilities.

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The introduction of an offset policypresents as many challenges as oppor-tunities.
Examples of setbacks aboundall over the world: Under Japansoffset policy, for instance,
domesticdefence manufacturers produce goodson licence from international rms,but not
at cost-competitive rates.Australia nally abandoned its offsetpolicy after 10 years in which
thepolicy did not deliver on expectedobjectives (see Australia AbandonsOffsets after 10
Years). Offset policyfailures in these countries could beattributed to governments attempts
toachieve too many objectives at once.In implementing their offset strategies,policymakers
did not clearly prioritisewhich defence capabilities were ofthe greatest strategic importance
tothe country.
A well-crafted offset policy can helpIndias domestic defence industryavoid these mistakes.
The governmentunderstands that optimizing Indiasdefence capabilities will require aninow
of skills and knowledge fromthe most experienced industry players,as well as strong
coordination across
the armed forces, industry, academia,and defence research institutes.
In addition, India has already expe-rienced in a limited way some ofthe pitfalls that can
come from aninadequately considered offset policy.Mistakes made from the rst offset-ting
exercisesuch as lack of clarityand specicity surrounding policyrulesare now being
addressed.The function of the Defence OffsetFacilitation Agency (DOFA), which istaking on
a prominent role in linkinginternational vendors with domesticrms, has been redened in
hopes thatthe pace of defence industry develop-ment and formation of partnershipscan
accelerate: Between 2006 and2008, only three deals were made.2
As it develops its own defence offsetpolicy, India can learn from thepast successes and
errors of othercountries. An important rst step,which can go far in helping avoidpitfalls in
developing the mosteffective offset policies, is to developa battle-winning strategy that
focuseson targeted areas and a longer-term
THECHALLENGESOFIMPLEMENTINGDEFENCEOFFSETS

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outlook for domestic defence industrygrowth. Policymakers must ask thesekey questions:
Which manufacturing operationsand platforms do we identify asareas in which domestic
control isnecessary and desirable, and whichcan be more protably outsourcedto
international suppliers?
How do we build domesticcapabilities for a protable exportcapacity in the future,
whileadhering to end-user monitoringclauses from supplying countries?
How do we evaluate projectcosts and benets based on theprojects entire life cycle,
lookingwell beyond simply the near-termacquisition cost?
How can we build the rightincentives into our offset strategy tosatisfy the plethora of
stakeholders:the government, Indian publicsector units, Indian private players,and
international companies?
Australia Abandons Offsets after 10 Years
Australia originally introduced an offset scheme in the 1970s. The programmewas revised
to create the Australian Industry Involvement Programme in 1991,a time when Australias
military expenditures were US$7.9 billion per annum (in1997 dollars). The main directive of
the programme was to promote self reliancein the domestic defence industry; foreign
suppliers were required to ensure thattheir proposals matched the Australian governments
objectives or they were notgranted contracts. The programme applied to all defence
procurement aboveA$5 million.
The success of Australias offset policy was marred by a number of difculties.Local
suppliers, with little incentive to become competitive, were not as efcientas their foreign
counterparts, driving up programme costs. These local supplierswere also attempting
projects far beyond their technological capabilities and skilllevels, thereby increasing the
risks of nondelivery. The local suppliers also usedthe offsets to fund individual projects
instead of deploying the offsets in a strate gic manner to create competitive market
niches. Offsets often created low value,short term jobs, such as labour on assembly
lines, as opposed to high value jobsfocused on system engineering, system integration,
and research and develop ment. Once the initial production contract ended, these
low value jobs disap peared. Offsets also provided incentives for high costs and
inefciency amongforeign suppliers, as some contractors took the opportunity to transfer
old,outdated support and test equipment, at inated prices, to the Australian
defencemarket. Foreign contractors also at times didnt provide associated training
andinstruction manuals, essentially rendering the test equipment useless.
Over time, Australias offset policy earned a reputation for supporting inefcientlocal
industry and permitting shortsighted development of Australias defencecapabilities. The
offset strategy was not clearly enough dened, or focusedenough, to warrant success in
the long term. Australia has since revamped itsoffset strategy, and todays programme
promotes desirable local industries in astrategic and planned manner.
Source: U.S. Department of State, Bureau of Verication and Compliance,
WorldwideMilitary Expenditures and Arms Transfers, January 2000

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If India wants its defence capabilityto grow at a rate that matches itsrapid economic growth,
policymakersmust rst develop a thoroughunderstanding of defence industrydynamics and
devote carefulattention to drawing out the detailsof the defence offset policy. Based
oninternational case studies and pastproject experience, Booz & Companyhas identied
ve areas in which theIndian government can act to shape asuccessful defence offset
policy.
Selecting domains: Indias defencecapabilities should be developedacross air, land, sea,
and electronics tobuild a comprehensive armed forcesbase. However, right now the
UnitedStates is probably the only countrythat can afford to adopt a cradle-to-grave
approach to developing all
these platforms. Most countries willneed to be selective in choosing whichdomains to
develop most extensivelyin order to best grow their domesticindustrial capabilities.
For example, designing andmanufacturing military aircraft isan area that requires
signicantamounts of capital and expertise.India took a step towards buildingits aircraft
inventory earlier thisyear by purchasing eight P-8Ireconnaissance planes from Boeing,a
leading aerospace companyand manufacturer of defence andcommercial aircraft. In
return,Boeing is purchasing $600 millionworth of avionics and aerostructuresfrom Indian
companies, includingcommunication equipment, radar, andelectronic warfare systems.3
Under
DEVELOPING AFIT-FOR-PURPOSEOFFSETSTRATEGY
Boeing is purchasing $600 millionworth of avionics and aerostructuresfrom Indian
companies.

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this arrangement, India stands to gaintechnologically advanced equipmentwhile
simultaneously developingits own operations, support, andtechnology base for military
aircraft.
Building an acquisitions business case:The acquisitions business case denesthe
acquisition strategy and alignsit with a countrys national strategyfor associated defence
industries. Indeveloping military capabilities, sometypes of equipment may be morevital to
national security than others,requiring greater sovereign control.The manufacture and
design of suchkey defence products ideally should becompleted inside the country.
Otherequipment may offer no militaryadvantage, in which case procuringitems at the
cheapest price may be thebest acquisition strategy. It is thereforenot ideal to apply an
equal offset per-centage for combat boots, surveillancesensors, unmanned aerial vehicles,
andsearch and rescue helicopters. Gettingthese fundamentals right can make orbreak the
development of indigenousdefence capabilities.
Focusing on specic stages of the lifecycle: The life cycle of military deci-sion making
involves dening strategyand requirements, acquiring or
producing equipment, handling serviceoperations, and ultimately disposing ofequipment.
The military can operatedefence equipment for decades onceit has been built or acquired,
depend-ing on a countrys ability to providesuperior maintenance and enhancedoperational
support over time.
India therefore could focus onbuilding capabilities around supportand service, enabling it to
servicedefence equipment during periodswhen it would not be building oracquiring
equipment.
Setting up in natural geographies:The capital intensity of manufacturingmilitary equipment
is extremelyhigh; choosing advantageouslocations to develop manufacturingfacilities
such as proximity to partssuppliers or ports and railroadscansignicantly enhance the
cost-effectiveness of the entire venture.
With more than 5,000 Indiancompanies supplying only 25 percentof the components and
subassembliesrequired by the Defence PublicSector Units (DPSUs)4, selectingand building
around other suppliersand manufacturers for militaryinfrastructure will ensure that capital
is concentrated in areas where it canbe used efciently and effectively.
Benchmarking and assessingcapabilities: To understand inherentstrengths and
weaknesses, Indiashould benchmark itself against othermilitary powers. India has
alreadyestablished itself as a leading softwareplayer: In fact, the offset programmeis likely
to generate US$700 million inrevenue for the countrys IT industryover the next 10 years.
Players suchas Tata Consultancy Services andWipro Technologies actively targetforeign
defence contracts, and Wiproplans to set up a Centre of Excellencefor Network Centric
Operationsabattleeld management environmentencompassing equipment,
commandand control, and logistics. Focusingon such core strengths ensures thatthe
countrys resources are not spreadtoo thinly (see Defence IndustrialStrategy in the U.K.,
page 8).
Another consideration in determin-ing the best areas in which to buildcapabilities is which
countries couldpotentially be markets for Indiasfuture technology and productsand what
requirements exist regard-ing associated end-user monitoringclauses. Tact and diplomacy
should be

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Defence Industrial Strategy in the U.K.
In the United Kingdom, the Defence Industrial Strategy (DIS) is based on twoguiding
principles: (1) achieving operational independence with an appropriatelevel of sovereignty
and (2) building through life management capabilities. Thisentails shifting away from
design and towards supporting and enhancing variouscategories of military equipment and
services.
The benets for the U.K. of choosing a capabilities-based programme (focusedon
through life management and maintenance) instead of a platform orientedprogramme
(focused on design and development) include enhanced domes tic productivity,
long term contracts, and access to the most technologicallyadvanced machinery at the
best possible price. Foreign vendors have vestedinterests in the U.K.s domestic success,
as contracts are not one off purchasesbut ongoing technological improvement
engagements. At the same time, do mestic suppliers, spurred on by open international
competition, are continuallymotivated to improve performance.
exercised when exporting to coun-tries that might be under sanctionsfrom supplier
nationsfor instance,Myanmar, which is under sanctionfrom the E.U.
Conducting these exercises willalso provide guidance on how thecountry can best manage
periods ofuctuation. Defence industries arevery cyclical, making it difcult formost
countries to sustain ongoingproduction levels. While politicalconict tends to trigger
investmentand production, facilities may sit idleduring periods of relative peace.
Forexample, during the late 1950s, Indiasunderutilised defence units switched toproducing
commercial goods such ascoffee percolators, consumer electricalitems, and construction
equipment.5
To avoid situations like this, the offsetpolicy needs to align its productionplan with overall
strategy, anddirect resources towards building oracquiring appropriate capabilitiesover the
long term.

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Endnotes
1Newswire Today, Indian Defence Industry: $100 Billion Investment Opportunities,May
28, 20082The Economic Times, Getting the Defence Offset Policy Right, December 5,
20083Mint Corporate News, Boeing to Buy Products Worth $600mn from Seven
IndianCompanies, February 1, 20094Cygnus Business Consulting & Research, Indian
Defence Industry Report, July 20075Deba R. Mohanty, Changing Times? Indias
Defence Industry in the 21st Century,Bonn International Center for Conversion 2004
The Indian governments goals forincreasing its self-reliance in defenceprocurement are
ambitious: The gov-ernment plans to increase domesticshare of this industry from 30
percentto more than 70 percent in thecoming years. In order to achieve itstargets and at
the same time obtainthe highest-quality military capabil-ity, the MoD needs to ensure that
itsdefence offset policy does not becomea shield for inefcient practices orfor the
production of substandard,poorly supported military platforms.A successful policy cannot
merelystipulate a percentage of reinvest-ment and compel foreign partici-pants to comply.
Instead, a properlyconstructed defence offset policycan work to achieve the objective
ofpromoting foreign collaboration indefence production while support-ing the upgrade of
Indias defencetechnology and product base. If doneproperlyand with the high targetsthe
government has setIndiasdefence offset policy not only couldbe successful but could
prove to be amodel for other countries to follow.
THE WAYFORWARD

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