Indigenisation by Private Sector and Single Vendor Conundrum

All countries that have a mature defence industry, each segment of major weapon systems and platforms generally have only one or at the most two OEMs, mainly in the private sector

Issue: 1/2022 By Vice Admiral A.K. Chawla (Retd)Photo(s): By Naval Group, GRSE/Facebook
The Author was the Flag Officer Commanding-in-Chief, Southern Naval Command when he retired on November 30, 2021. He is a Navigation and Direction specialist. He was also the Director General Naval Operations and the Chief of Personnel, Indian Navy.

 

Launching VELA, the fourth Indian Scorpene Class Submarine

As we come to the cusp of DefExpo 2022, and enter the eighth year of the ‘Make in India’ drive announced by Prime Minister Narendra Modi in 2014, it is a good occasion to take stock of the progress of the holy grail of defence indigenisation by the private sector in India, which was opened up for 100 per cent participation by private players only in May 2001, having till then been reserved exclusively for the public sector.

Streamlining Defence Procurement

After the Defence Procurement Procedure (DPP) was reviewed in 2002, the government appointed the Vijay Kelkar Committee in April 2004 to examine the current acquisition procedures and recommend changes in the process. An important part of the recommendations was the participation of the private sector in defence production. In its report rendered in November 2005, the Kelkar Committee recommended that selected private sector companies should be nominated to build major defence platforms such as tanks, aircraft and ships, which had been reserved since independence for Defence PSUs and Ordnance Factories (OFs). To enable this participation, DPP-2006 stipulated that defence industry leaders were to be identified as Raksha Udyog Ratnas (RURs)/Champions of Defence Industry. These were to be treated at par with Defence PSUs, which are selected by the Government for receiving technology and undertaking license production with Transfer of Technology (TOT) from overseas sources. The DPP laid down the specific criterion for private sector entities to be selected as RURs, and the details of the committee that would be appointed to vet the applications. The selected RURs were to be reimbursed 80 per cent of their R&D expenditure by the government. As a consequence, the government appointed the Prabir Sengupta Committee to screen private sector applicants. The committee examined around 40 applicants and recommended about 15 of them for RUR status, but the matter did not progress further.

Multi-vendor competition, while necessary for commonly used items is a disincentive for the private sector, which has to make a decent profit to survive

In 2013, the Ministry of Defence decided to scrap its plan to nominate RURs. The reason for doing this was stated to be the opposition from small private sector companies, who would have been ineligible for such a status. However, another reason was the opposition to the proposal from DPSU trade unions, who feared loss of orders from the more nimble and efficient private sector. The MoD also argued that the ‘Buy and Make’ procurement category, which had been introduced in DPP 2008, had obviated the need for RURs, as it allowed a private company to lead the development of a weapon system or platform by integrating its individual components, including a percentage procured from abroad – pretty much what was being done by Defence PSUs as well. However, the scrapping of the provision of RURs was opposed by the private sector industry bodies as Defence PSUs and OFs still had an unfair advantage in terms of tax and excise benefits and favourable treatment in the payment of customs duties for materials, subsystems and systems imported by them, as compared to the private sector.

Boosting the Private Sector

Consequent to the ‘Make in India’ initiative launched by Prime Minister Modi in 2014, the government has taken a number of steps to facilitate the participation of the private sector in the defence sector. These include:

  • Introduction of the ‘Buy Indian’ category (indigenous design, developed and manufactured) as the first priority for placing orders for defence equipment in DPP 2016.
  • Revision of DPP-2016 as Defence Acquisition Procedure (DAP)- 2020, which is driven by the tenets of Defence Reforms announced as part of ‘Atmanirbhar Bharat Abhiyan’.
  • The Ministry of Defence has notified a ‘Positive indigenisation list’ of systems and components for which there would be an embargo on the import beyond the timeline indicated against them, thereby offering an opportunity to the Indian defence industry to manufacture these items using their own design and development capabilities.
  • The ‘Make’ Procedure of capital procurement has been simplified with a provision for upto 70 per cent funding of development cost by the Government to Indian industry. In addition, there are specific reservations for MSMEs under the ‘Make’ procedure.
  • Procedure for ‘Make-II’ category (industry funded), introduced in DPP 2016 to encourage indigenous development and manufacture of defence equipment has number of industry friendly provisions such as relaxation of eligibility criterion, minimal documentation, provision for considering proposals suggested by industry/individual etc. By mid-2021, 58 projects have been accorded ‘Approval in Principle’.
  • FDI in the Defence Sector has been enhanced up to 74 per cent through the Automatic Route for companies seeking a new defence industrial license and up to 100 per cent by Government Route wherever it is likely to result in access to modern technology or for other reasons.
  • An innovation ecosystem for Defence titled Innovations for Defence Excellence (iDEX) was launched in April 2018 to create an ecosystem to foster innovation and technology development in Defence and Aerospace by engaging private industries, start-ups, individual innovators, R&D institutes and academia, with provision for grants/funding and other support to carry out R&D. The MoD has earmarked 1,000 crore during 2021-22 for procurement from the iDEX Startups.
  • Reforms in Offset policy have been included in DAP 2020, with thrust on attracting investment and Transfer of Technology for defence manufacturing, by assigning higher multipliers to them.
  • The ‘Strategic Partnership (SP)’ Model was promulgated in May 2017, which envisages establishment of long-term strategic partnerships with Indian entities through a transparent and competitive process, wherein they would tie up with global Original Equipment Manufacturers (OEMs) to seek technology transfers to set up domestic manufacturing infrastructure and supply chains.
  • Two Defence Industrial Corridors have been set up, one each in Uttar Pradesh and Tamil Nadu, with investments of 20,000 crore by 2024. So far, investment of approximately 3,342 crore has been made in both the corridors by public as well private sector companies. Moreover, the respective State Governments have also announced their Aerospace & Defence Policies to attract private players as well as foreign companies including Original Equipment Manufacturers (OEMs) in these two corridors.
  • An Inter-Governmental Agreement (IGA) on “Mutual Cooperation in Joint Manufacturing of Spares, Components, Aggregates and other material related to Russian/Soviet Origin Arms and Defence Equipment” was signed in September 2019. The objective of the IGA is to enhance the After Sales Support and operational availability of Russian origin equipment currently in service in Indian Armed Forces by organising production of spares and components in the territory of India by Indian Industry by way of creation of Joint Ventures/Partnership with Russian OEMs.
  • Defence Products list requiring Industrial Licenses has been rationalised and manufacture of most of parts or components does not require Industrial License. The initial validity of the Industrial License granted under the IDR Act has been increased from three years to 15 years with a provision to further extend it by three years on a case-to-case basis.
  • A Defence Investor Cell (DIC) has been created in February 2018 in the Ministry to provide all necessary information and to address queries related to investment opportunities, procedures and regulatory requirements for investment in the Defence sector.
Necessity to scale-up the private sector in the indigenous production of major defence systems still remains

As a consequence, by May 2021, 333 private companies had been issued a total of 539 industrial licenses, and 110 companies had reported the commencement of production of defence items. There is no doubt that much progress has been made in the involvement of the private sector in defence. However, a major impediment that remains is the necessity to scale-up the private sector in the indigenous production of major defence systems such as warships, submarines, aircraft, missile systems, etc, which today still remains under the exclusive purview of the DRDO and Public sector DPSUs.

The Single Vendor Dilemma

To do so, India needs to overcome the conundrum of the single vendor situation. The reason why this is important is because of a few self-evident reasons. These include: firstly, the episodic nature of major defence purchases such as ships, submarines, aircraft, tanks, etc, because of their high cost and their long life. The second factor is the necessity for OEMs to maintain design teams and infrastructure, conduct R&D, and retain the requisite human resources over long periods of time, for the equipment to be truly indigenous. In the face of these realities flies the fact that it is not cost-effective for the private sector to maintain idle infrastructure or human expertise, and continue with the R&D necessary to either upgrade or build the next generation of weapon systems during the long intervals between successive orders. Multi-vendor competition, while necessary for commonly used items is a disincentive for the private sector, which has to make a decent profit to survive. As a consequence, all countries that have a mature defence industry, each segment of major weapon systems and platforms generally have only one or at the most two OEMs, mainly in the private sector. These OEMs are able to continue in business because there is a degree of assurance that they will not only maintain the platforms and systems manufactured by them, but also be assured of further orders – either for the same item or its next generation version.

By May 2021, 333 private companies had been issued a total of 539 industrial licenses, and 110 companies had reported the commencement of production of defence items. There is no doubt that much progress has been made in the involvement of the private sector in defence.

However, the problem of having a single vendor, who could hold the buyer hostage in terms of cost or quality, is definitely a situation that needs to be avoided. This has been resolved by the United States through the contrivance of the Defence Contract Audit Agency (DCAA) and the Defence Contract Maintenance Agency (DCMA).The DCAA’s primary function is to conduct independent audits of defence contracts to determine whether the prices quoted by defence contractors are ‘allowable, allocable and reasonable’. To do this, it is empowered to examine defence contractor accounts, records and business systems to evaluate whether contractor business accounts and practices are in compliance with stipulated laws. The types of audits carried out by the DCAA include: ‘Forward Audits’ (equivalent to our benchmarking of cost); ‘Incurred Cost’ audits (to determine the accuracy of contractor cost estimations); and ‘Special Audits’ (to estimate change of cost if scope of the contract is changed). The DCAA has a healthy interaction with industry bodies and takes into account feedback given by them to streamline the audit processes. The DCAA is itself auditable for its performance by the US Government Accountability Office. In its annual report to the US Congress for 2019, it was stated that the DCAA had saved the US Government $3.7 billion in defence spending in 2019. This mainly included big ticket items, generally manufactured by single vendors. The DCAA works in concert with the DCMA, who is responsible to ensure that the government receives the highest quality and services on time and at the greatest value for the dollar.

Conclusion

While many steps have been taken by the Government of India to incentivise the private sector in defence production since 2001, the past two decades have not yet seen any world class major weapons systems being produced by the private sector. The ‘Strategic Partnership’ model is a way forward, but we need to revisit the provision of RURs available with the earlier versions of the DPP, if we truly wish to involve the private sector in the design and development of major weapon systems and platforms in a sustainable manner. It can be argued that the business could be left to the DRDO and public sector DPSUs, but if we wish to harness the inherent efficiency and ability to attract the best human resources of the private sector, then India too needs to develop its own version of the DCAA and DCMA, not just to vet all defence contracts, but also to monitor its implementation over the equipment’s entire life cycle. Only such a mechanism will provide the continuity and stability of defence orders to the private sector to enable them to invest in R&D, human resources and infrastructure. It is only when such enabling regulations are introduced will the private sector be able to embark on the business of producing major weapon systems and platforms, enable their upgrades and the production of their next generation versions.