DPP and its Impact on Indian Aerospace & Defence Industry

`

Writ ten & Compi led by:

Ashish Jude Michae l PGPEx

Indian Inst i tu te Of Management, Shi l l ong (THIS PUBLICATION IS ONLY FOR ACADEMICS PURPOSE AND THIS HAS NO COMMERCIAL VALUE AND SHOULD NOT BE USED FOR ANY COMMERCIAL PURPOSE)

EFFECT OF DPP (Defence Procurement Procedure) ON INDIAN AEROSPACE & DEFENCE INDUSTRY

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1. DPP 2011: A Brief Overview

2. Why DPP is important now then ever for Aerospace Sector In India?

3. Basic Terms of DPP 2011

4. Major Guidelines laid by DPP 2011 (Amended)

5. Impact of DPP Guidelines on A&D Industry (till 2012)

6. Major Amendments made in DPP 2011 and their Impact on A&D Industry in India

7. Forecasted Impact of DPP Guidelines on Aerospace Industry in India

8. Recommendation CONTENTS

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1

DPP 2011: A Brief Overview

DPP Stands for Defense Procurement

Procedure, it was first published by Ministry of

Defense (MOD) India in 2005. Now we are

following DPP 2011, which was amended in

Aug 2012.

As India is one of the worlds fastest growing

Aerospace & Defense (A&D) Market and it is

expected that during next decade India is going

to ink 100 Billion USD of A&D deals. All global

players Boeing, EADS, Lockheed Martin, BAE

Systems, Dessault Systems, Sukhoi etc all want

to grab a pie in this share.

“The objective of this procedure is to ensure expeditious

procurement of the approved requirements of the Armed

Forces in terms of capabilities sought and time frame

prescribed by optimally utilizing the allocated

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Budgetary resources. While achieving the same, it

will demonstrate the highest degree of probity and

public accountability, transparency in operations,

free competition and impartiality. In addition, the

goal of achieving self-reliance in defence equipment

will be kept in mind.”

Hence DPP becomes an important tool

which can help the government boost A&D

Industry. Though initially DPP was made to

increase the transparency & remove

corruption from the defense deals. But

with time it becomes a more of economy

development tool. With the manufacturing

Industry still struggling, the DPP has the

power to develop A&D Industry which can

revive the Manufacturing Sector of

company. .

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4 [Type text]

(Fig shown is replicated from Indian Defence Sector by KPMG )

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Basic Terms of DPP 2011 DPP 2011 is an exhaustive document and I

will not be able to cover all the aspects of

it, I will just give the gist and highlight the

points, which are important for industry.

Before jumping to guidelines I will define

the basic concepts one should know. Types

of acquisition:

“Buy Indian” it refers only to products or

services made by Indian companies. Min

30% of indigenous content and the

company should be incorporated as per

Companies Act 1956.

“Buy Global” All other products in buy

segment except produced by Indian

companies.

“Buy & Make” mean purchase from a

foreign vendor followed by licensed

production / indigenous manufacture in

the country.

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“Buy & Make (Indian)” decision would mean

purchase from an Indian vendor including an

Indian company forming joint venture /

establishing production arrangement with

OEM followed by licensed production /

indigenous manufacture in the country. ‘Buy &

Make (Indian)’ must have minimum 50 %

indigenous content on cost basis.

“Make” include high technology complex

systems to be designed, developed and

produced indigenously.

*All types of upgrades either services or product

will also fall in either of previous categories of

acquisition.

Types of Acquisition plans:

1. 15 years Long Term Integrated Perspective

Plan (LTIPP).

2. 5 years Services Capital Acquisition Plan

(SCAP).

3. Annual Acquisition Plan (AAP).

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MAJOR GUIDELINES DPP 2011 (AMMENDED-2012)

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The major guidelines are: 1. FDI

Manufacturing of defense equipment in India is subject to a 26% cap on FDI.

2. Timeline for receipt of responses of RFP

Time of receipt of responses for RFP has been reduced from 3 months to 3 weeks but

the total time period from issue of RFP to remains at 12 weeks.

3. Offset Policy

a. These provisions will apply to all Capital Acquisitions categorized as ‘Buy

(Global)’, i.e. outright purchase from foreign/Indian vendor, or ‘Buy and Make

with Transfer of Technology’, i.e. purchase from foreign vendor followed by

Licensed Production, where the estimated cost of the acquisition proposal is ` 300

crore or more.

b. A uniform offset of 30% of the estimated cost of the acquisition in ‘Buy (Global)’

category acquisitions and 30% of the foreign exchange component in ‘Buy and

Make’ category acquisitions will be the minimum required value of the offset.

Offset obligations may be discharged only with reference to “eligible” products

and eligible services.

c. The DAC may, after due deliberation, also prescribe varying offset percentages

above 30% or waive off the requirement for offset obligations in very special

cases. Such directions may be made applicable for different classes of cases or for

individual cases depending upon the factors involved such as type of acquisition,

strategic importance of the acquisition or technology, enhanced ability of Indian

defence industry to absorb the offset, export potential generated, etc. However,

offset will not be applicable in ‘Option Clause’ cases, where the same was not

envisaged in the original contract.

d. These provisions will also apply with appropriate modifications to ‘Buy’ and ‘Buy

and Make with TOT’ components for warship construction where the estimated

cost of individual contracts is ` 300 crore or more. In such cases, references to the

Acquisition Wing will mean the DDP or shipyard which is building the ship and

procuring the system or sub-‐systems.

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e. This offset condition will form a part of the RFP and, subsequently, of the contract.

Offset conditions as specified in the RFP will be binding.

f. These provisions will not apply to procurements made under Fast Track

Procedure.

g. New offset guidelines will be applicable on all capital acquisition programs

regardless of them being governed by capital acquisition procedures of DPP 2005,

2006 or 2008.

h. Training has been added to service list which brings all training services, tools &

simulators under offset policy. (Annexure for details newly inducted products &

services)

2. Defence Offset Obligations

1 For the purpose of defence purchases made under the DPP 2011, offset obligations shall

be discharged directly by any combination of the following methods:

a) Direct purchase of, or executing export orders for, eligible products and components

manufactured by, or services provided by, Indian industries, i.e. Defence Public Sector

Undertakings, the Ordnance Factory Board and private Indian industry.

b) Direct foreign investment in Indian industries for industrial infrastructure for services,

co-development, joint ventures and co-production of eligible products and components.

c) For the purpose of discharge of offsets, ‘services’ will mean maintenance, overhaul,

upgradation, life extension, engineering, design, testing of eligible products and related

software or quality assurance services with reference to eligible products as indicated in

Annexure VI and training. Training may include training services and training equipment

(e.g. simulators) but exclude civil infrastructure.

d) Direct foreign investment in Indian organisations engaged in R & D as certified by

Defence Offset Facilitation Agency (DOFA). While certifying, DOFA shall not consider

civil infrastructure and such technologies that are otherwise easily available in the open

market.

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e) Foreign vendors could consider creation of offset programs in anticipation of future

obligations. Offset credits so acquired can be banked and discharged against future

contracts. Banked offset credits would not be transferable except between the main

contractor and his sub-contractors within the same acquisition program. The main

contractor would be required to submit a list of such sub-contractors at the time of signing

the contract. Guidelines for banking of offsets are placed at Annexure-VII to the

Appendix-D.

2. The Indian industries or organisations concerned are here after referred to as the

Indian offset partner. The Indian offset partner shall, besides any other extant

regulations in force, also comply with the guidelines/licensing requirements issued

by the Department of Industrial Policy and Promotion.

3. The offset obligations are to be fulfilled co-‐terminus with the period of the main

contract.

4. All offset offers which satisfy the minimum eligibility conditions will be placed on par

and no preference will be given for any extra amount offered.

5. Monitoring Implementation of the Offset Contract

1. The vendor will submit quarterly reports in the format in Annexure-‐V on

implementing the offset contract to the Acquisition Manager concerned. The Offset

Monitoring Cell in the MoD will assist the Acquisition Manager concerned in the

Acquisition Wing in monitoring the implementation of the offset contract. Where

necessary, an audit by a nominated official or agency may be conducted to confirm

the actual status of implementation.

2. A vendor may, giving reasons, request re-‐phasing of the offset obligations within

the period of the main contract. Director General (Acquisition) may allow the request

in consultation with DOFA if the reasons are considered justified.

3. Any request on exceptional grounds for extension of the period of the offset contract

beyond the period of the main contract will be examined by the Acquisition Wing in

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5. Any differences or disputes will be settled through discussions. The decision of the

Acquisition Wing will be final. The provisions in the main contract regarding

arbitration will apply to the offset contract also.

4. Defence Offset Facilitation Agency

1. The functions of ‘Defence Offset Facilitation Agency’ (DOFA) set up under the DDP as a

single window agency are to:

(a) Facilitate implementation of the offsets policy.

(b) Assist potential vendors in interfacing with the Indian industry.

(c) Assist in vetting offset proposals technically.

(d) Assist in monitoring the offset provisions.

(e) Suggest improvements in the policy and procedures.

(f) Interact with Headquarters Integrated Defence Staff and Service Headquarters.

(g) Advise, in consultation with the Headquarters Integrated Defence staff, Services

and Defence Research and Development Organisation, areas in which offsets will be

preferred.

(h) Promote exports of eligible products and services.

4. “Acceptance of Necessity” Stage (Amendment)

For cases where the original RFP has been issued within 2 years from accord of AON

(Acceptance Of Necessity) & later retracted the RFP for any reason the AON will continue

to be valid , as long as original decision & categorization remains unchanged, provident

subsequent RFP is issued within the date of retracement of RFP.

* The RFP includes the requirement of field evaluation on a “No Cost No Commitment”

(NCNC) basis. Compliance of offers would be determined only on the parameters spelt

out in the RFP.

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Impact of DPP Guidelines on A&D Industry (till 2012)

As on 14 May 2012 those 17 contracts worth

4.27 Billion USD were signed as defence

offsets which makes offset business to 1.28

Billion USD in past 5 years. Out of this, 3.43

Billion USD were for IAF- related projects

and 843 m USD for Naval projects. Nothing

for the Army; may be some would come in

the coming months. If we calculate as per

offset policy @30% nearly 1.28 Billion USD

have been invested in Indian Aerospace &

Defense Industry.

This mother of all Indian defence deals the

“Rafael Deal” is still included. That alone will

boost about 3 Billion USD in Indian

Aerospace & Defence Industry. But one may

ask that even after so much investment we are

not able to see the results, but unfortunately

most of it is for Govt. Units, Large Private

Sector Units and DRDO /Other High-End R

& D with almost none for micro and small

enterprises. SMEs are likely to figure towards

the tail-end unless OEMs prefer them.

Offsets-Cash/Kind-given to large units are

slated to yield low returns for the Indian

Defence Industry for various reasons.

If we study the requirements it is very difficult for

SMEs to enter into aerospace & defence market as

the investment is huge. It is a high precision industry

demanding the best material, best machinery and

highly skilled labour. Govt should promote SMEs

venturing into Aerospace & Defence sector. Now it’s

the responsibility of large players and PSUs too to

concentrate on tier 1&2 supplier segment leave trier

3 & 4 supplier segment for SMEs. Also a SEZ is

required for such a rapidly developed Industry. There

is a proposal in Bangalore for A&D SEZ but things

are moving at their own slow pace. (Fig shown is replicated from Indian Defence Sector by KPMG )

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Forecasted Impact of DPP Guidelines on Aerospace Industry in India

1. Original Equipment Manufacturers (OEMs)/vendors

are to be provided with an incentive to transfer

specified technologies to the Defense Research and

Development Organization (DRDO). The revised Policy

permits a multiplier of up to 3 on technologies that are

transferred to the DRDO, which will make offsets a

viable route for obtaining key and critical required

technologies.

-‐ This has not been very successful till now. No major

TOT’s (Transfer Of Technologies) have been done; there

have been a few JVs but mostly among PSUs & Global

leaders. But when it comes to TOT, global players prefer

companies setting up their own R&D and they are

getting tax benefits from it. In a way it is creating

employment & improving skills but ultimately the

manpower it is not helping to upgrade technology

required by Indian Industry for the place India want to

achieve in the Globe.

2. Extending the validity of Banked Offset credits from 2

to 7 years.

-‐This helps in reducing working capital for the company

and hence helps the industry. But this has only received

a lukewarm response.

3. Recognizing TOT as eligible for discharge of offset

obligations:

a. Must be complete, including documentation, training,

and consultancy (but not civil infrastructure and

equipment)

b. It specifies that the TOT should be provided without a

license fee and there should be no restriction on

domestic production, sale, or export of the said

technology

The implication of this revised TOT guideline will be to

ensure that the Indian industry would be free to market

any equipment that is built using the technology

transferred as offsets.

The new Policy states that where multiple sub-‐vendors

incur offset liabilities, the sub-‐vendors can individually

discharge their own liabilities, but the main vendor shall

be responsible for ensuring that offsets are discharged in

full.

-‐ This protects the liability of local manufacturers to

limited and also lays stress on TOT.

4. Discharge of Offset obligations by a foreign vendor has

been extended by 2 years. The earlier Policy mandated

that offset liabilities must be discharged alongside the

main contract.

-‐This has been done to make industry more attractive for

Global Players. As the industry was expected to slow

down because of Euro-‐zone economic crisis.

5. Finally, the revised offset guidelines provide an

incentive to small and medium enterprises (SMEs) by

allowing foreign vendors to select micro, small and

medium enterprises (MSMEs) as their offset partners by

introducing a multiplier of 1.5 for all offsets discharged

through MSMEs. This implies that by sourcing $1 million

work from Indian MSMEs, a foreign vendor will be able to

discharge offset liabilities worth $1.5 million. The SMEs

will be identified through the monetary guidelines

specified by the Department of MSMEs of the

Government of India.

-‐This is expected to boost the offset business given to

SMEs & MSMEs as the Global Players will now be more

interested to take advantage of this clause. This will

strengthen the basic foundation, which are SMEs &

MSMEs for the Aerospace Industry.

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Multiplier Matrix (Is replicated from A Critique of India's Defence Offset Guidelines 2012 By Mr. Laxman

Behera)

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Forecasted Impact of DPP Guidelines on Aerospace Industry in India

*Offset for Medium Multi Role Combat Aircraft (MMRCA) is fixed at 50% and rest others at 30%

The above graph shows the major offset deals in India from year 2012

to 2017 the total offset business is expected to be 9.65 Billion USD in

next decade. This is only from Defence sector, we have to add Civil

Aviation and homeland security too.

This 9.65 Billion USD is approximately 7.5 times of 1.28 Billion USD

which we did in last 5 years. It’s a huge opportunity and even

government is planning to make a SEZ near Bangalore for A&D

Industry specifically.

It is a high growth Industry and with the reaching of Automobile

Industry into a mature phase (as it appears) this is the industry, which

can boost Indian GDP growth rate.

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Recommendations Though DPP 2011 is much improved than the previous version DPP 2008, but we can’t say

that it is perfect. I have some recommendations which I feel will help the growth of A&D

Industry.

1. The Inclusion of Service & Products together under the cap of 30% offset is not a good

step as this would lead all the bidders to focus on services rather than products and

this will have a negative effect on already ailing manufacturing sector. DPP should have

kept the manufacturing portion of offset intact and can increase the service portion of

offset separately.

2. Clarification on the undue advantage to non defence IOP (Indian Offset Partners), as

private Indian Defence companies are subjected to licensing and 26% FDI cap which is

not applicable for Civil Aviation inland/costal security and service sector. Or simply

companies in this companies can become IOP without licensing and FDI constrain.

3. Private help for DOMW (Defence Offset Monitoring Wing). As to improve the

monitoring capability of DOMW by taking help of private firms. But as these private

firms are mainly catering to industry there may arise a serious conflict of interest if

agencies happen to audit compliance reports of their clients. This aspect should be

addressed to avoid any risks emerging in future.

4. DPP can encourage increase the R&D investment in country by separately encouraging

bidders to take help of technological research institutes such as IITs & IISc.

5. DPP should now focus on developing assembly lines & tier 1 suppliers in India rather

than Teir 2 & 3. Encouraging JV of bidders with corporate houses can do this. At

present bidders are getting into JVs with PSUs which are not much effective and

efficient.

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References

1. Defence Procurement Procedure (DPP) 2011.

2. www.defence-‐update.com

3. Aerospace and Defense Manufacturing in India: Commencement of growth phase by

ICC (Indian Chamber of Commerce & Aviotech)

4. Changing Dynamics: Indian Aerospace Industry by CII & PWC

5. http://indiandefenceindustry.blogspot.in/

6. A Critique of India's Defence Offset Guidelines 2012 By Mr. Laxman Kumar Behera

7. www.frost.com

8. Future of India Aerospace Industry 2019 by Mr. Roger Moser, Mr. Heiko A von der

Gracth & Tobias Gnatzy.

9. Indian Defence Sector by KPMG

10. Defence Procurement Procedures 2011 by Ernst & Young

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Compiled By:

***

MBA from IIM Shillong with 5 Years of Experience in Aerospace /Electronics Industry (Quality & Production)

ASHISH JUDE MICHAEL

!  5 years of experience in Quality, Manufacturing & SCM activities of Aerospace /Electronics Industry.

!  One Year MBA in International Business from Indian Institute Of Management, Shillong and a Mechanical Engineering Graduate.

!  Worked with companies such as Bharat Electronics Ltd, ITC Ltd.

!  Served clients such as Boeing, UTC, Indian Air Force, Indian Navy.

!  Worked on prestigious Light Combat Aircraft (LCA) Project which is of national importance.

Skill Set:

TQM, AS9100, ISO14001,ISO9001,AS9102, 8D, SPSS, Mini-Tab, PPAP,FMEA,

GAP Analysis, APQP, RRCA, Quality Clinic, Project Management, Kaizen, LEAN

manufacturing, SPC, Vendor Management, Process Improvement, Poka-Yoke,

Benchmarking, FAI, Production Management, Cross Culture Team Management,

Negotiation Skills.

ADDITIONAL INFORMATION

!  Publication: Written few reports on Eurozone Crisis: Impact on

China & India, Development Opportunity: Aerospace & Defense in

BRIC and Challenges for Marketing in China all published at

www.mbaskool.com , are only for academic purpose.

!  INTRESTS: Traveling, Reading, Cooking and watching movies.

!  Languages: English (Fluent), Hindi (Native), German (Intermediate)

and Chinese (Beginner).

!  Date of Birth: 10th March 1984.

!  Linkedin:

http://www.linkedin.com/pub/ashish-michael/24/895/431

!  Contact No. +91 8974011742

!  Email D: [email protected], [email protected]

DPP and its Impact on Indian Aerospace & Defence Industry

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