Industrial Cooperation Offsets

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Industrial Cooperation (Offsets) A US
Contractors View Presented by Tom McKinney
Director, International New Business
Development Raytheon Missile Systems Telephone
1-520-794-4260 eMail tamckinney_at_raytheon.com
2 November 2002
Raytheon
TAM 10/02
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What is Offset?
INDUSTRIAL COMPENSATION
INDUSTRIAL BENEFITS
BUY BACK
OFFSET as used at Raytheon refers to any
requirement imposed by an international
customer for Reciprocal Obligations.
(Associated primarily with defense purchases.)
INDUSTRIAL PARTICIPATION
BARTER
COUNTERPURCHASE/COUNTERTRADE
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History of Offset/Countertrade

• Supposedly originated in the Netherlands in the
  early 1970s
• -- Purpose was to help compensate governments
  for currency export and to
• support declining defense industries and
  thereby contribute to national
• security
• Matured with the F-16 C-130 Aircraft
  Multinational Programs in the 1980s
• Today Its much more sophisticated - -
• -- Countertrade is limited mostly to developing
  economies
• in South America and the Asia-Pacific
  region
• -- Commitment expressed as a percent of the
  main contract value
• Usually a 100 Requirement e.g. 10M Contract
  10M Offset
• -- Concept and application of multipliers
  (credit coefficients) helps
• contractors fulfill obligations
• Offset has become a key to developing
  international business relationships
• WE DONT SELL MANY DEFENSE PRODUCTS
  INTERNATIONALLY WITHOUT DEALING WITH IT!

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Offset Program Phases
Two Distinct Phases of Offset

• Pre-Contract Selling Phase plan development and
  negotiations with customer results in formal
  Industrial Cooperation Agreement (ICA)
• Post-Contract Performance Phase implementing
  the plan, reporting and fulfilling the overall
  ICA commitment

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Different Types of Offset
DIRECT OFFSET Related to the product sold
INDIRECT OFFSET Unrelated to the product sold
Training Technology Transfers Grants to Industry
or Govt Subcontracts to Customers
Industry Equity Investments in Local
Companies Countertrade/counterpurchase Licensing
arrangements Co-Production/Co-Development Marketin
g Assistance Anything of Value to Customer or
Local Industry
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Offset/Countertrade Supports Our Customers Needs

• Promotes Exports (Balance of Trade)
• Acquisition of Modern Technology
• Supports Their Defense Industrial Base
• Employment
• Contributes to National Prestige
• Offset Has Become a Customer Satisfaction Issue

Offset by itself generally wont win a
competition, but ignoring offset could lose it
for you. US Govt cant get directly involved
in offset! Its not just price anymore, its
POLITICS.
Here to Stay -- Critical Component of
International Defense Sales
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Politics of Offset/Countertrade

• Price, technical, quality schedule only are
  no longer sufficient
• to win international programs in most cases.
• Bidders must formalize offset commitments with
  the customer
• usually prior to the main
  contract award.
• Unlike the US, many international politicians
  are held accountable for their defense industrys
  survival.
• Demand is increasing for direct in-country work.
• Offset is supported by strong labor unions,
  industry groups and
• established governmental bureaucracies.
• Contractors can do everything right and still
  lose politically.
• Example Buy European bias to enhance chances
  of a country
• being admitted to the European Union.
• Partnering with a strong and politically
  well-connected international
• company can be critical to winning.
• Still some instances of procurement corruption
  by Customer government
• officials and mostly non-US companies
  (although they seem to be
• decreasing in frequency).

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Common Issues Encounteredby US Contractors

• Contractors must often deal with a
  non-competitive international industry
• Learning curve issues, low production
  quantities, foreign currency
• issues, competing with established US
  suppliers, etc.
• Maturity of many US production programs makes
  it very difficult
• for international industry to
  be cost competitive.
• Many international companies are state-owned
  with inefficiencies
• and a reluctance to compete for work.
• This is offset - - we dont have to be
  competitive!
• US Government imposed technology transfer
  export limitations
• Official Hands-off policy results in limited
  help by the US Government
• Offset is an unpopular concept with the US
  Congress.
• US Foreign Military Sales (FMS) System versus
  commercial competition
• FMS procedures severely limit US
  contractors options.
• The ability to fund investments, qualify new
  defense suppliers, etc. is
• much more limited due to aggressive FMS
  pricing restrictions.

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Common Issues Encountered by US Contractors
(Contd)

• US Export Licensing Process
• Very slow and frustrating. Early applications
  are critical in reducing
• contractors risk and for developing a firm
  offset plan.
• Our international competitors are not subject
  to the US Foreign Corrupt
• Practices Act (FCPA).
• Can create a non-level playing field in
  competitions.
• OFFSET COSTS MONEY! (although offset
  customers usually say that
• it doesnt).
• Must be bid as part of proposal - firm priced
  input (or percent
• mark-up factor on FMS procurements).
• FMF/FMS Grant Funding Dilemma.
• In FMS sales, were dependent upon the US
  Government to
• include our fees in the FMS Case LOA (Letter
  of Offer/Acceptance).

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Offset Issues for Central and Eastern Europe (CEE)

• Often unrealistic expectations from defense
  industry by the Customer.
• Desired offset commitments can be higher than
  100.
• Excessive financial penalties for
  non-performance.
• Direct offset requirements are often too high
  for most US products.
• Offset commitment will generally not be
  provided on FMF grant-type
• procurements (some minor US FMF funding is
  available in CEE).
• Commitment is usually provided on the
  Contractors actual contract
• value from the US Govt not on the higher
  FMS Case value.
• Limited availability of high technology
  electronics manufacturing in CEE.
• Relatively few privatized companies compared to
  the rest of Europe.
• Unfamiliarity with CEE industry due to being a
  new market for most US companies.
• Limited use of multipliers by most CEE customers.
• Situation made worse by limited offset funding
  available to US
• defense contractors due to FMS rules or
  overall competitive pressure.

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Offset Trends
Before Now Avoidance Marketing Tool by
Contractors Best Efforts Performance Penalties/Li
quidated Damages 30 Obligations 100
sometimes with escalation 8 - 12 Years to
Satisfy 3 - 7 Years to Satisfy On Direct Sales
Only On Direct Sales and FMS Credit for Full
P.O. Added Value (country content)
Only Countertrade Acceptable Often not allowed
demand for hi-tech 3rd Party Assistance OK Very
restricted use of 3rd parties No Causality
Reqts Work must be consequence of sale
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The Future of Offsets

• Likely to be around for a long time especially
  in CEE.
• Increased international competition offset will
  remain a competitive discriminator.
• Slow consolidation of international industry.
• Perceived free benefit to customers industry.
• Emerging markets for US are rapidly developing
  (e.g. South America, Southeast Asia-Pacific, CEE)
  with high offset expectations.
• Increased competition world-wide supports a trend
  toward higher percentages and forced investments
  narrower range of allowed projects and more
  limited use of multipliers by most countries.

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Summary

• Offset commitments are like any other contract
• and must be treated accordingly.
• Each country and obligation is different.
  Contractors
• are rarely able to use a cookbook approach.
• Advance planning in offset is critical to
  winning international defense business.
• Most things are negotiable with Customers.
  Successful offset contractors keep an
  entrepreneurial attitude.
• Expect the offset environment to continue to
  become more difficult for contractors.

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QUESTIONS?