“Defense Offsets – From ‘contractual burden’ to competitive weapon”

Defense offset deals

The above is the title from a McKinsey & Company report published 2014. The authors were Kevin Dehoff, John Dowdy and O. Sung Kwon. I came across this paper through an Internet search a few days ago and it caught my attention.

It also triggered me to write this article. You might say that 6 years is a long time so why bother about a report from 2014. Because the report is still valid from the bigger picture as defence contracts and relations around offset deals are long term commitments. But underlying and enabling technology from the IT domain has progressed and this post is about some of these new capabilities and how offset deals can be better supported in 2020 than in 2014.

The nature of offset deals

Offset deals are typically more complex than a ”classic” sales deal. The winner will have to have a very good product to offer but it takes more than that. As products are frequently fairly similar to the extras coming with the offset deal, these can be the reason for winning. The extras could include knowledge transfer and a license to use the seller’s intellectual property (IP). It is based on a commitment to deliver more than the core product and the buyer will follow up that the obligations are met. If not, there might be penalties.

As stated in the report, the receiving countries are looking for different outcomes in their offset deals.

Offsets are contracted obligations that are typically regulated by ministries of defense or government partners, and they can take one of two forms. Direct offsets are agreements that are directly related to the defense products being sold. For instance, as part of its bid, Kongsberg Defence Systems agreed to subcontract work locally and transfer certain forms of technology to the Polish Navy to support the sale of its Naval Strike Missile Coastal Defense System. Indirect offsets are agreements that are not related to the defense products being sold. For instance, Sukhoi, one of Russia’s major aircraft manufacturers, transferred various space technologies to the Malaysian National Space Agency to fulfil obligations related to the sale of 18 Su-30MKM aircraft.

Part of offset deals can be ”very indirect”, as an agreement to create job opportunities or import/export of goods and services that are not related to the defence system.

To make sure that the potential for IP transfer and industrial collaboration is realised, offset deals can use a “multiplier” to put emphasis on the technology transfer share. Such arrangements are a way to meet the offset quota but it also reflects the desire from the buying country to build up certain knowledge.

Offset deals are used in all defence areas including air, land and sea. With some countries representing and consolidating their defence industry and buyers in other countries looking to build up their technical skill and jumpstarting by reusing IP, offset deals are here to stay. Caution needs to be applied here as the seller is basically helping a potential competitor to grow and be stronger and the selling company will naturally hesitate to share the most sensitive IP. Protecting the overall systems detailed IP is key and companies will of course not share anything that cannot be licensed under export control.

From the McKinsey&Company report:

“Although they are not usually reported in annual filings, offset contracts are increasingly becoming a C-suite agenda item. Over the past 20 years, US defense contractors have typically entered into an average of 30 to 60 offset agreements each year, representing between $3 billion and $7 billion in obligations per year. Lockheed Martin, the world’s largest defense contractor, reported $9.3 billion worth of outstanding offset agreements as of year-end 2012, and a recent analysis by the Financial Times and IHS Jane’s estimated that ten other companies have accumulated obligations in excess of $1 billion each.”

So what can be done to make offset business less of a burden and more of an opportunity

McKinsey & Company is proposing the framework below:

Offset Strategies core areas

There is a lot to be considered here but for this blog post, we will view the framework, relevant parts of it, from the IT perspective with digital transformation in mind. Digital transformation and technical readiness are important in all industries and all processes and the idea is that the offset business should also be able to benefit from recent development in IT.

A typical offset deal with industrial collaboration may have all or most of the following to manage:

  • Protection of intellectual property is key. Share what is agreed, not less and certainly not more.
  •  The business partners can be a mix of large companies and SMEs.
  • The data sharing should work from day 1 or at least it is expected to.
  • Partners have a diversity of IT systems and even in the rare case where they have the same IT systems, those systems are customized and effectively different.
  • Data to be shared is a mix of documents and fine-grained engineering data.
  • Detailed engineering data is not of interest to C-level but analytics and business intelligence data might be, as offset deals are typically significant in size.
  • The collaboration must work with minimal friction and transparency during the contract period but it is also very important that the data sharing and integration can be stopped once the contract is fulfilled or if there is a breach or change causing the contract to be stopped or re-negotiated. This could include a change in ownership of companies but also an undesired political change.
  • As the exchange of information crosses enterprise and national borders, it is necessary to have a definitive record of what has been shared, with whom and when.

Recommendations related to the IT part of the offset (industrial collaboration) and the management of data to be shared

If offset business is seen as a burden from the product data and IT viewpoint it might be the case that the selling organization decides that it is too much extra work to meet the needs for a ”one-off” opportunity. One-off efforts also come with increased risks and potentially a risk premium making them unnecessarily costly. But instead of viewing it as a one-off – why not preconfigure the systems and industrialize offset business? Why not go to the market positioned as a company that is “easy to do business with”?

  • Architect the supporting IT system to be agile but also resilient – offset deals are different, and things change during a deal.
  • Design the system that is fit for business in air, sea, land and other potential offset areas.
  • Use COTS software.
  • Manage the system as a product with a roadmap and proper change management.
  • Start with an offset partner that understands it is in everyone’s interest to have a system working well with rich capabilities.
  • Exploit ISO standards for the data representation to avoid lock in to a particular software vendor and to build resilience into the system.
  • Use the PLCS (ISO 10303-239 Product Lifecycle Support) standard as core as it covers the complete lifecycle of products. It enables the sharing of anything from requirement, design, manufacturing, and product support data including the ASD ILS standards.
  • Prepare for cloud adoption as the cloud is increasingly becoming an option.

Final words from the McKinsey & Company report:

“The companies that have developed a strong infrastructure and process for monitoring their offset programs will have an advantage in this regard.

As globalization in the defense industry continues, offsets will become an increasingly important strategic tool. Some contractors have adopted the view that offsets are a burden—a “tax” that has to be paid in order to play. From our perspective, offsets are a key enabler for international growth. Those players that follow a holistic, structured approach to defining their offset strategies will find them less a burden than a competitive weapon..”

For more than 20 years, Eurostep has delivered the ShareAspace software to support collaboration and data sharing between organizations. One of the first customers was Hägglunds (now part of BAE Systems) who had just won a deal for CV 90 combat vehicles with the Swiss Army. The deal came with offset requirements for a significant part of the contract to be carried out in Switzerland. Hence the need for Hägglunds to share engineering data with a number of Swiss suppliers for the first time. Hägglunds then repeated the same concept for the CV 90 deals in the Netherlands and Denmark.

The ShareAspace software has since been implemented to support controlled data sharing in industries like aerospace and defence, architecture, engineering and construction (AEC), automotive, heavy automotive, manufacturing and more where the setup has been very similar to any offset deal.

Eurostep is a Gold Partner to Microsoft and ShareAspace can run on-premise as well as on the cloud. In 2020 Eurostep has released ShareAspace for Export Control to manage the sharing of licensed data.

To learn more about ShareAspace Cloud specifically, please visit www.shareaspace.com