Critical Factors Behind Successful Offset Strategies

Critical Factors Behind Successful Offset Strategies

Adapted from a paper delivered by Gilles Charveriat, the Consultancy Manager of ACECO, Paris, at the International Business & Offset in Emerging Asia Conference, Kuala Lumpur, March 24-25, 1997.

The constant evolution and increase of offset requirements in the world defense export market, as well as civil exports in the field of high technology and infrastructure, brings us to analyze briefly the critical factors behind a successful offset strategy.

From the point of view of the purchasing country, the necessity to gain economic benefits in return for offshore procurement has driven more than a hundred countries to require direct and indirect offsets.

Two separate attitudes can be identified: mandatory offsets, with guide lines specified in the bids; and suggested offsets, when the purchaser will favor suppliers which make attractive offset proposals without specifying the content, to be discussed on a case-by-case basis. In both cases the trend is towards more and more structured rules.

Over a hundred countries now require direct and indirect offsets.

From the point of view of the potential supplier, the pressure of competition brings about a dependence on the offset requirement. Again, there are two attitudes. In the first, offset can be considered as a marketing tool, and suppliers can turn the obligation to their advantage, taking a pro-active attitude.

If offset is regarded purely as an obligation, the supplier meets only the offset request, and does not foresee the offset proposal as an advanced marketing strategy. This is a reactive, defensive attitude towards offsets and is not conducive to a proper positive approach to marketing. In either case, offset has become a fact of life.

Globally...The Rules Are Changing

Today the trend indicates that there is a "hardening of the game." Offset ratios are increasing from 20-30 percent to 100 percent, and sometimes even as high as 300 percent because of competition between suppliers. Multipliers are falling, and can affect the core of the offset (the technological transfer and the R&D provisions).

Penalties are frequently imposed and are increasing in severity. Fulfillment periods are often reduced, but this can have a negative outcome as it can affect the desired cooperation, at least for the direct offset.

The fulfillment of the offset obligation is being more tightly controlled by the purchasing side, though this is not a bad thing in itself. But globally speaking the rules are creating more and more constraints.

Where there is a shift towards more indirect offsets, the eligible sectors are often confined to high technology, and technology transfer investments, either through direct investment or joint ventures, which are the most favored.

The trend is towards more and more structured rules. And globally speaking, the rules are creating more constraints.

The contracts include more and more financial components, and counter-purchase is frequently employed.

Offsets have become a worldwide technological, industrial and financial phenomenon. Requests for offsets are increasing, they are becoming more complex, and suppliers have to become more involved.

Diversified professional skills at a high level are required. At the same time offsets are a risky operation: there is a loss of technology, and a loss of working hours for the seller.

A Good Offset Is A Partnership

Three main factors have to be considered by the supplier: the industrial, the commercial, and the financial.

The Industrial Factor... It is necessary to integrate the possibility of technology transfer and sub-contracting from the very beginning of the product's conception.

The design engineers must anticipate that some parts of the product will have to be produced abroad without affecting the good health of the company.

All future markets will need to be considered so as to evaluate the possibility of cooperation, the capacity to integrate technologies, and the economic interest of the country to do so. This is not always an easy task, as the country requiring offset is often asking more than it can really do.

Offsets should not be considered as an obligation, but as a partnership. The objective is not to do a one-off operation, but to establish a long-term cooperation. It is also necessary to establish close cooperation with the sub-contractors.

Offsets should not be considered as an obligation, but as a partnership.

The Commercial Factor... It is important to continually monitor the practice and development of the offset requirements in the targeted customer country and to analyze its economic needs.

The supplier will need to study these needs through its network of contacts and to identify suitable partners, in conjunction with a local lobbying task force in order to penetrate local industrial circles which can often influence the decision of the purchaser.

The Financial Factor... An attractive financial package is also part of a successful deal, possibly including investments and joint ventures.

More and more, the fulfillment of the offset requires financial engineering involving the financial department of the supplying company as well as third parties such as banks and investment services companies.

Offset Demands

The authorities concerned in the country requiring offsets should define its objectives clearly, in the framework of a global economic approach and the stage of development of the country.

The government is the only entity having a broad overview of the country's economic situation, and so is in the best position to arbitrate between the local beneficiaries of industrial benefits.

The end-user of the import, such as the Ministry of Defense, should not be the only party to the decision.

In the Netherlands, for example, the Ministry of Economic Affairs is responsible for negotiating and implementing the industrial offset policy, and is continually being pressed by the industrial lobby to attract foreign partners through current offset contracts.

Also, in the Philippines the offset rules seem to have adopted a fair balance between the defense industrial sector and the other sectors of the economy. The Philippine International Trading Corporation works closely with the Board of Investment in this way.

Moderating The Request

If the purchasing side's offset rules seem to become tighter and more structured, it emphasizes the need for a balance between the request of the purchasing party and the offer of the foreign supplier. Each party must find its real interest in the transaction: it is more valuable to ask for less and obtain more than to ask for more and obtain less.

Many countries have succeeded through offsets to obtain important industrial plants, but once the contract has ended these plants do not have enough work load.

A successful strategy should bring the two parties to analyze fairly the real interest of the purchasing party, to use technology transfer to establish industries which are truly competitive, which produce goods and services which will continue to bring benefits after the completion of the contract, and not to establish industries which require subsidies and which are not economically viable.

Belgium is a typical case where there is excess capacity in the defense industry. In one factory producing armored vehicles through a direct offset technology transfer, the work-force fell from 300 to 60 when the contract was completed.

This moderate request should be translated into a permanent dialogue and exchange of information. This is particularly true in the case of indirect offset obligations, where new opportunities may be proposed by either party.

Four Priorities

All these points can be summed up in four priorities:

Dialogue between the parties.
A fair share between direct and indirect offset.
Indirect offsets more easily satisfy requirements of the socio-economic development, because larger benefits can be realized in the civil sectors.

French suppliers have in some deals fulfilled their obligations through indirect offsets related to sales of missiles, in South Korea, for example, with a technology transfer concerning the production of telephone components, and in Norway and Spain with the production of motor vehicle
components.

Direct offsets are not always the key for winning a contract. A French manufacturer of military equipment proposed a significant technology transfer as a direct offset to Britain, but the offer was rejected.

The British judged the proposal too risky for a top technology. They instead selected an Israeli supplier which had proposed 100% indirect offset.

Also, counterpurchase can be of help when used in some economic sectors.
An adapted evaluation of technology transfer.
Technology transfer must be evaluated with an incentive through reasonable offset multipliers, which give the foreign supplier more reason to propose a good level of technology. Too high a level of direct offset with too low multipliers can lead to a non-feasible operation.
A wide vision of offset.
Technology transfer does not only apply to the defense sector. There is a technical and financial bridge between the military and the civil sector, and many military technologies can also apply to civil sectors.

Two Interesting Examples

Switzerland
This country had adopted a well-balanced and flexible offset policy. The choice of industrial partners is not dictated to the supplier, and the balance between direct and indirect offset obligations is not defined by fixed rules but is subject to negotiations between the parties.

The rules of eligibility are flexible, and the counterpurchase of industrial goods of an agreed technological level is acceptable (from elevators to machine tools or precision instruments).

The offset committee is well informed about the country's economic needs.

Direct offsets are managed by an administrative body including members of the Swiss Armament Group, representing industrial companies, and indirect offsets are managed by the Swiss Association of Machine Building Industry.

France
France has also adopted a flexible approach with no fixed rules, negotiating each contract on its merits. There is no fixed proportion between direct and indirect offset.

Technology transfer, investments, marketing support and counterpurchase are mainly applicable but not exclusively to the defense and aeronautical sectors. Multipliers are used to favor transactions with small and medium sized industrial companies.

General Conclusions

A good offset policy is one that respects the economic situation of the country requesting the offset and the situation of the country wishing to make the sale.
The difficult task in managing an offset policy is to reach a just balance between the obligations to be imposed, and the cooperation it seeks to establish.
Countertrade and offsets can be used as a tool of development and positive commercial cooperation.
Five key words: realism, anticipation, dialogue, moderation, and imagination.
A good offset should give a competitive edge that could be critical.