A study by the Indian arm of Munich-based consultant Roland Berger has come up with a provocative conclusion: Indian defence public sector undertakings (DPSUs) make better bedfellows for foreign companies than their private sector counterparts a" and the ones with the worst record are the large private companies. While several defence analysts see this report as a "statement of fact" based on historical experience, there is more to "this phenomenon" than meets the eye, they add.
"[Defence] JVs [joint ventures] with medium-sized Indian groups have survived longer than with larger groups. DPSUs have a good track record of sustaining partnerships," declares the report. Rahul Gangal, defence analyst and principal, Roland Berger Strategy Consultants, says JVs and partnerships between overseas defence companies and DPSUs enjoy a 100% success rate. The report, parts of which have been shared with ET Magazine, also makes another observation: government-to-government defence deals are far more successful than business-to-government ones.
Sure, the ratio of defence programmes awarded in India is skewed towards government-to-government contracts as opposed to business-to-government ones. Which is perhaps why Russia, Israel and the US often use the government-to-government route to enter into deals. On the other hand, several European companies, which approach the government directly, find the going tougher.
According to consultants Frost & Sullivan, Russia, Israel and the US are the top three suppliers of defence equipment to India, the world's largest arms importer. The country accounts for 12% of global arms imports, almost twice as much as China, according to the Stockholm International Peace Research Institute (Sipri).
Why are JVs or other partnerships with big local private players mostly short-lived? Washington-based defence analyst Robert Metzger, a specialist in Indo-US defence ties, has watched the Indian defence sector for long. "A principal problem," he says, "is in sustaining the 'business case' for long-term commitments with Indian industrial partners." JVs often face great delays in terms of approvals, he notes, adding that "it is too difficult to obtain necessary organisational licences and business permits".
A case in point is the much-celebrated joint venture between Mahindra & Mahindra (M&M) and British multinational giant BAE Systems, which joined hands in 2009 to pursue opportunities in the infantry space. M&M owned 74% of the entity, called Defence Land Systems India (DLSI), and the rest was held by BAE Systems. In February this year, the two companies parted ways.
"It was a well-thought-out, mutually agreed plan," says a BAE Systems official who asked not to be named because he is not authorised to speak to the media. In fact, both companies didn't see any "commercial viability" in keeping the marriage intact, says a Mahindra & Mahindra official who also spoke on condition of anonymity.
Explains Dean McCumiskey, managing director and chief executive, India, BAE Systems: "No tenders or contracts were being placed with commercial entities in DLSI's target market." Which simply means the $12-billion Futuristic Infantry Vehicle (FICV) programme a" which envisages building a prototype of a state-of-the-art combat vehicle and then making 2,600 such vehicles (by the winning company) a" is in cold storage.
The proposed project is now expected to be built in the "make India" category and that means local companies alone will be able to take part in the bidding. Besides, the project had already been delayed. In fact, according to a ministry of defence official who spoke on condition of anonymity, Russia successfully lobbied to get New Delhi's go-ahead for an alternative programme for the time being: upgrading some 1,500 of Indian Army's Russian-made BMP-2 infantry combat vehicles for $1.2 billion over the next five years. ET Magazine couldn't independently verify the claim. However, the ministry of defence has already cleared the project.
"Naturally, in the absence of signs of a return on investment, it is not reasonable for commercial organisations to continue to bear costs and build up a skill base," Mc-Cumiskey points out.
A top official of a Mumbai-headquartered conglomerate says he agrees "broadly with theRoland Berger report". He goes on to argue that "isolating fact from truth isn't what studies should attempt to do". According to him: "The content of work and outcome should define the relationship between companies, not mere longevity."
Another senior official of an Indian company with varied business interests and who has been close to negotiations between the Tatas and Boeing a" who failed to form a joint venture a" notes: "Private companies have their business interests to take care of. They are answerable to shareholders. They have to weigh the pros and cons before they arrive at a decision. Some deals work. Others don't."
"Let's not forget that Tata Advanced SystemsLtd [TASL, a unit of the Tata Group] has a successful JV with Sikorsky AircraftCorporation to manufacture the Sikorsky S-92 helicopters in India," he adds. The JV also makes aerospace components for other original equipment manufacturers (OEMs). TASL also has a JV with US defence company Lockheed Martin to make aerostructures for the C-130 Hercules and the C-130J Super Hercules.
PSUs have a historical advantage in India's defence sector. According to Metzger, DPSUs have had other inherent advantages too: they have been comparatively low-risk, in terms of approvals, funding and payment. American military historian and strategist Edward Luttwak is of the view that they (DPSUs) have an edge over others thanks to the system that has been in place for long. They have been a monopoly.
He adds: "They thrive because they hold the gun to the head of the foreign partner. DPSUs such as Hindustan Aeronautics Ltd [HAL] are deeply hated but in India there used to be hardly any choice a"you either work with them or you are out."
True, companies such as HAL enjoy long partnerships with foreign players such as BAE Systems, Russia's United Aircraft Corporation (UAC, which makes Sukhoi aircraft), Rolls-Royce and so on. UAC and HAL are partnering to make the Multirole Transport Aircraft to replace IAF's ageing fleet of Antonov An-32 transport aircraft. Luttwak can't hide his scorn: "As I have always said, it [HAL] is a fossil of a company famous for not delivering operationally ready Tejas Light Combat Aircraft after 30 years of trying."
Neelu Khatri, head of defence and security advisory services at KPMG India, feels that times are changing: "HAL is overbooked [with orders]. Private players will have to play a larger role now to meet demand." India faces the daunting task of replacing its obsolete weaponry. Former army general VK Singh had said in an interview last year that 97% of the country's defence equipment is obsolete. Dhiraj Mathur, executive director at PricewaterhouseCoopers (PwC), has no doubts about what he calls "the growing role" in "such a scenario" of the private sector.
Winds of Change
Even defence minister AK Antony, a socialist by political inclination, has promised winds of change in his meetings with the Indian industry, confirming his commitment to offer local private players a good slice of the local defence pie. Antony has brought in many amendments to defence procurement policy (DPP), including doing away with the "process of nomination" for choosing companies that maintain, repair and overhaul (MRO) aircraft. Many private players have welcomed the amendments cleared by the defence advisory council (DAC), saying that it opens up a lot of opportunities for them.
Metzger affirms that most foreign majors welcome "acts" that will encourage the development of capable, private-sector Indian firms. They are likely to be more agile and aggressive, and more attentive to efficiency and profitability than DPSUs, he adds. What India needs is not DPSUs, but a level-playing field for Indian and foreign private companies, declares Luttwak. "Their [DPSUs'] performance is treasonous," he alleges.
India amended its DPP recently to give more room to local private players in the wake of corruption scandals in defence transactions involving foreign players. According to the amended policy, "buy Indian" comes on top in the hierarchy of preferences for purchases. The next is "buy and make Indian" (through joint ventures with foreign vendors); then comes "make Indian" (where local firms design, develop and build systems). "Buy and make" (with transfer of technology) comes next. The last on the list is "buy global" (getting overseas equipment).
Though Antony has hit out at his ministerial colleagues for lobbying to raise the FDI cap in defence from 26% to 49% as a step to encourage JVs, he offered to consider on a "case-to-case" basis requests for 49% FDI from MNCs. For his part, Kishore Jayaraman, president, Rolls-Royce India and South Asia, says that the Centre's "consideration" to raise the FDI cap and ongoing debates and discussions on the same are reflective of its openness of working in collaboration with private vendors to build a strong supply chain and an indigenous defence sector."
Metzger is of the view that one reason why many defence JVs are short-lived is "because foreign companies don't treat their Indian partners responsibly". Overseas MNCs have reportedly engaged in "sharp" business practices that exploit rather than promote mutually successful outcomes, he observes. "A trust-based relationship takes time to develop and commitment to sustain," he adds.
He, however, concedes that MNCs, too, have their set of concerns. They are often unsure of their ability to protect IP and satisfy their national integrity laws when they have 26% or less investment in Indian JVs. "All of these make JVs in India a very long-term proposition, with high costs of pursuit and uncertain return. And that is where the biggest problem resides — namely, JVs do not now have confidence that the government of India will purchase their supplies and services," he argues.
New 'Home' Markets
Of course, the centre of gravity of arms trade is shifting east. According to Frost & Sullivan, India and China are among the most preferred Asian countries forinvestments in the aerospace business, including in defence aerospace, thanks to lower costs.
As a percentage of GDP, India has been maintaining defence expenditure in a range of 2-3% of GDP, in line with major developed nations, signifying a fairly steady focus on defence within the economy to date, says a KPMG report.
The government, as the sole purchaser of defence equipment, spends heavily with defence expenditure accounting for close to 15% of the central government expenditure, it adds. In fact, India is expected to purchase arms worth $100 billion by 2022 as western countries cut defence budgets.
That is why, although officials of a few foreign defence companies talk of "the India fatigue," — thanks to numerous delays in orders and the famous India red tape besides corruption — people like McCumiskey of BAE Systems call the country a home market. He says his company is driven in India by its "success in transferring knowledge and skills to domestic industry as evidenced in the Jaguar and Hawk programmes".
"In the six decades we've been here, we have seen considerable opportunity in the country's determination to modernise its military and develop an indigenous industrial base," he adds.
Meanwhile, Luttwak says he has no doubts about why western companies are heading eastwards. "These large western general contractors are in a miserable industrial situation: ministries of defence are buying aircraft, armoured vehicles, ships, etc at very, very slow rates. Six to seven aircraft a year itself is a lot. There is a lot of overcapacity," he says emphasising that "nobody needs more general contractors".
"Sub-system outfits are in better shape — there is more business — and moreover not being huge companies, they welcome co-investment deals. That is how good deals are done," he avers.
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