Behind the onset of offset

Technology transfer deals can significantly boost a domestic nation’s research and production capabilities and inject valuable investment into defence industries hungry for a share of export-led growth in the worldwide market.

It is also, vitally, an invaluable way for those countries benefiting from strengthening economies and relaxed US and European export laws, to fast-track the establishment of their own skills and manufacturing base by taking advantage of a market hungry for new customers.

As one of the fastest growing defence markets in the world, the Middle East is shaking up its offset practises in government defence contracts.

The work being done in the UAE was the focus of a conference held at Eurosatory 2012 in June, where the wider framework within which government offset operates was discussed by representatives from the European Club for Countertrade and Offset (ECCO), an association that brings together European companies and individuals involved in offset and countertrade; the Tawazun Economic Council (previously the UAE Offset Programme Bureau); and Tawazun Holdings, the investment vehicle of the Tawazun Economic Council established in 2007 to develop profitable ventures with international partners that add to Abu Dhabi’s industrial manufacturing layer in the areas of defence, manufacturing and technology.

The Tawazun Economic Council is the organisation mandated to oversee implementation of the UAE’s offset programme and was established to promote industrial partnerships, facilitate technology and knowledge transfer, as well as build capacity in specialised fields – in particular defence systems and components for land and naval systems, munitions and weapons systems, autonomous systems, aerospace systems, and advanced materials. The group has seen a number of high profile successes, and has partnered with world-class manufacturers to create multi-million joint ventures (JVs) in the UAE.

Overall the aim of offset is to enforce the establishment of infrastructures that directly contribute to the development of a nation’s economy and industry; more specifically this can relate to products, equipment, technology or activities directly linked to the purchase contract, that may include transfer of technologies related to the product; a subcontract to include a minimum share of the contract to local companies; or to train the end-user to effectively use and maintain the product purchased.

Offset contracts usually include definitions of work that will be performed by foreign and local suppliers, as well as the conditions of such performance, such as the value to be added, timeline, stakeholders and penalties for under-performance. As a result, establishing offset agreements is about more than the end goal; it relies on a strong amount of talent and skills in-country to ensure the agreements can be created and carried through effectively.

There have been a lot of changes recently in the UAE in terms of the defence offset policy as the country’s defence industry gathers pace, with new guidelines adopted last year. Speaking at the symposium, Matar Al Romaithi, chief officer IDU, Tawazun Economic Council, spoke about putting the new guidelines into practice, and gave insight into the council’s vision with regards to its goals.

“The council’s programme is all about creating an economic balance, guiding defence contractors to create partnerships with local companies in order to create economic benefits,” he said. “Our objectives are to develop a modern defence industry in the UAE through building the required infrastructure and also to help, promote and facilitate modern technology transfer and employment opportunities for UAE nationals.” 

Outlining the procurement process, Romaithi said: “It is very important to start working early with the council in order to get initial plans into place to ensure that all obligations can be fulfilled. In the past we got involved at a later stage, after the supply contract had been signed with our armed forces; now we figure if we can start earlier in the negotiation phase we can help guide contractors towards the most suitable partners to do business with.”

With a threshold of $10 million dollars over a period of five years, the UAE’s new offset requirement is 60% of the supplied contract value. The programme runs for seven years, during which time the contractor is expected to have established a JV with a local company, the performance of which will be evaluated over the period with annual milestones to be reached. The JV needs to fulfil 5% of the total obligation in the first year and this amount rises throughout the period until complete fulfilment in the seventh year.

A goodwill grace period may be issued at the start of the programme, during which there is time for the contractor to establish facilities and there will be no evaluations, but there is an expectation that the JV will be making progress. Any grace period issued will be determined by the complexity of the project and how many phases it will require.

The model used to evaluate the offset project by the council is a hybrid that consists of input and output. The maximum the defence contractor can input in terms of obligation is 30% (equity contribution that may include capital contributions for cash investments and tangible assets). Input elements are evaluated on three fronts: industry enablers, knowledge empowerment and equity contribution.

The output of the JV is measured in terms of profit (net profit/export sales) and the hiring of UAE nationals in order to sustain projects in the long run and build capability.

In the case of underperforming there are penalties. “But this is a last resort,” Romaithi said. “We try to find solutions before it comes to that.”

It used to be that in the case of underperforming, the contractor paid a penalty that discharged the entire obligation. Now, a penalty of 8.5% will be applied on the shortfall amount, but this will discharge only 50% of the shortfall. The remaining 50% will be placed in a default account where it will remain until the end of the programme, at which point, if the contractor has generated credits that satisfy and exceed its obligation, those credits may be used to fulfil the outstanding obligations of the default account, and the penalty will be repaid. If there is not enough to cover the default account, a new programme will be signed to fulfil obligations.

As the council pushes forward with its objectives, Tawazun Holdings will focus on key areas for the 2012-2013 period, including creating new projects within the ammunitions, automotive and aerospace sectors.

For ammunition, to develop individual local facilities capable of producing, assembling, testing and supplying customers locally and internationally with a range of munitions, as well as bringing parts of existing supply chains into the UAE to lessen external dependencies; for automotive, to expand 4x4, 6x6 and 8x8 vehicle production and customer support in the UAE; and for Aerospace, to expand build-to-print capabilities in aero structures, as well as increasing work on UAV air-ground components.

The defence sector is expected to make up 80% of efforts as the country moves towards a strong, growing market with diversification from traditional areas, toward a future where the UAE has a world-class defence industry able to compete at the international level.