BY Larry Stenger
Call them what you will—compensation, countertrade, reciprocal purchase obligation, or industrial participation—offset agreements between U.S. military contractors and foreign governments are a fact of life and a crucial aspect of a winning aerospace or defense bid.
Although the U.S. has no official offset policy and considers these trade practices a necessary evil, most other governments worldwide formally support offsets. In particular, emerging powers such as China, India, and Brazil require offsets from foreign contractors as a means of furthering national economic growth and technological advancement.
Offsets can take many different forms. These range from an agreement by the contractor to co-produce the components at a location within the foreign country to boost local employment and transfer technology expertise (direct offset), to an arrangement whereby the contractor assists the importing country in ways unrelated to the deal or industry (indirect offset).
Foreign governments carefully evaluate these different offset proposals to find the best offer among bidders. They may play one contractor against the others to obtain their demands. In a classic example, in 2003, Lockheed Martin agreed to deliver more than $9 billion in offsets (primarily job creation and technology transfer) to the government of Poland as a condition of the $6 billion sale of 48 F-16 fighter aircraft.
In view of shrinking opportunities and extremely tough competition for international sales, particularly in commercial aviation, contractors must strive to design offset agreements that not only address the specific demands of the foreign government, but also provide a favorable cost/benefit balance for themselves.
One proven approach is the use of electronic manufacturing services (EMS) providers with established facilities in the target nation. By engaging with an EMS provider, aerospace and defense contractors can design offsets featuring local employment, training, or technology transfer while avoiding many of the capital costs and time requirements for establishing their own plants or creating a joint venture with a local manufacturer.
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Offloading offset requirements
Aerospace and defense contractors are looking to the BRIC (Brazil, Russia, India, and China) nations and other developing countries with deep pockets and strong industrial and military growth for potential sales of their products. In the process, they face the increasing popularity, sophistication, and prevalence of the offset as a tool of government procurement. Among the most common requirements of offset agreements are the creation of local jobs for economic stimulus (a key issue for many countries) and technology training or transfer to help an emerging industry sector compete more effectively in the global marketplace.
Unless the contractor already has a manufacturing facility in the country to which it seeks to export, these demands may be difficult to meet. Constructing a local manufacturing facility, hiring and training local workers, and putting systems in place to ensure a high level of quality and regulatory compliance might take years and would certainly call for a major capital investment. Another alternative—finding an in-country partner to do the manufacturing—also requires training, probable investment in equipment and facilities, and quality assurance and compliance efforts. In both cases, there could be a significant impact on time-to-market, as well as very real concerns about protection of intellectual property and the quality of outbound product during early production.
Many of these issues can be avoided by engaging with an EMS provider that is already established in China, Brazil, Poland, or other nations and has experience in the defense/aerospace electronics sector. By partnering with an EMS company, contractors can demonstrate to the foreign government that they are employing local workers, providing training in the latest technologies to these employees, and even using local suppliers of goods and services to support the operation.
Following are key advantages that EMS companies can provide to contractors drawing up an offset agreement:
- Capital cost avoidance: Although a deal typically would not be won without a successful offset proposal, the costs involved with satisfaction of the offset detract from the overall value of the sale. Therefore, it is important for contractors to minimize these offset costs as much as they can. By using an EMS provider instead of making substantial capital investments for a new facility, contractors can deliver valuable benefits to the foreign government at a lower price point. For low-volume devices, in particular, manufacturers may find it cost-prohibitive to hire the experts and purchase the technologies that are required.
- Faster time-to-market: An EMS provider with sophisticated expertise, technology, and equipment and highly trained staff can play a major role in accelerating time-to-market for aerospace or defense electronics. The EMS company can begin design, optimization, testing, or manufacturing more quickly. This factor can be extremely useful to the contractor in preparing a winning proposal.
- Rapid prototyping: In contrast to normal production, creating a prototype often involves a hectic pace, many changes and low-volume supplies. Contractors that are proposing a new product or a customized version of an existing product to a foreign government may not be set up to deliver in a narrow window of opportunity. Attempting to develop a prototype using the regular manufacturing environment can be disruptive and challenging. An EMS provider with a new product introduction (NPI) facility or area within its plant can solve this issue. Such a company offers dedicated resources for prototyping to accelerate the process, procurement experts who know how to source a small number of components, and design optimization expertise to plan for and ensure a seamless transition to production.
- Proven quality and compliance: Two of the big concerns about manufacturing in emerging countries are high quality standards and regulatory compliance, which are non-negotiable requirements for critical aerospace and defense systems. Due to their size, scope of work, and experience, many global EMS providers have the knowledge, quality processes, regulatory expertise, and controls to deliver consistent, high-quality components that meet Federal Aviation Administration (FAA) and European Aviation Safety Agency (EASA) regulations. From their experience operating in different countries, they often also have a broad and deep understanding of local regulations and requirements.
- Supply chain optimization: Highly complex aerospace and defense components often call for hundreds of parts and materials, each with specific requirements, associated standards, and applicable regulations. A robust supply chain established, qualified, and managed by the EMS company can help contractors simplify production, ensure consistent quality, and provide alternatives in the case of an interruption. Further, with their high purchase volumes, economies of scale, and global scope, EMS partners can often drive down costs to help defray offset expenses.
FOR MORE INFORMATION visit Jabil Defense & Aerospace Services online at www.jabil.com.
Larry Stenger is global director of commercial aviation for Jabil Defense & Aerospace Services.