Offset obligations challenge industry
Aerospace and defense companies face an unprecedented challenge as the foreign markets that are essential for topline growth impose new offset requirements that are stricter, larger and more complex than ever before, says a study by Avascent.
The analysis suggests governments will have imposed $500 billion in global offset obligations on foreign companies through 2016. That number is likely to grow as emerging markets move away from penalty payment schemes. A greater emphasis on enforcement of these increasingly sophisticated policies amplifies this challenge.
Additionally, the new requirements are often complex, unpredictable, and opaque. Some governments are even lowering the threshold for sales that are subject to offsets and requiring obligations that exceed 50 percent of an awarded contract’s total non-indigenous value.
Bearing in mind the opaque character of this marketplace, Avascent estimates show that over the last seven years (2005 – 2011) approximately $214 billion in total offset obligations were generated around the world. While exact figures on the scale of discharged obligations are not publicly available, anecdotal evidence suggests a significant portion remain outstanding.
Driven by pockets of strong spending in the Middle East, Asia and Latin America, and by the proliferation of increasingly complex and demanding offset policies, firms are expected to accumulate an additional $225 billion in offset obligations on new sales through 2016.
New obligations derived from Middle Eastern countries are estimated at over $12 billion in 2011 and will exhibit an 8% compound annual growth rate (CAGR) through 2016. This growth is primarily driven by the UAE and Saudi Arabia, both of which have developed more sophisticated offset policies that largely emphasize social and economic sector interests and the attainment of advanced technologies.
Offset obligations derived from Asian countries are estimated at approximately $10 billion in 2011 and will exhibit a 5% CAGR on new obligations generated each year through 2016. Asian offsets are dominated by the two vastly different offset regimes of India and South Korea, which collectively comprise approximately 60% of the region’s offset obligations.
India’s offset regulations have proven a challenge for aerospace and defense firms as its stated policy awards no multipliers nor qualifies technology transfer for offset credits, but does require local partnership for foreign providers. Conversely, South Korea offers a more traditional policy, with the stated goal of building local production and excess export capacity.
European and Canadian offset regimes will generate an estimated $10 billion in new obligations for 2011 but will exhibit only a 3% CAGR through 2016, the lowest rate of the four regions. The lower growth rate in Europe is due to efforts to control military spending and a counter offset trend, embodied in a 2008 Code of Conduct on Offsets signed by 26 European nations.
Latin American countries generated offset obligations totaling $2.8 billion in 2011 and will exhibit a 10% CAGR through 2016, the highest rate among the four regions. This growth will be driven by military upgrades and modernization efforts in Brazil, Colombia, and Chile, which have implemented more stringent, formal offset policies over the past decade stressing local production, technology transfers, and broader social benefits
The Brazilian offset guidelines, for example, emphasize technology transfer, joint development of systems to foster innovation, and training perhaps most prominently showcased in the ongoing highly contested FX-2 fighter competition. From 2005 to 2016, an estimated $41 billion worth of cumulative new offset obligations will be created.