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RUR in SP’s Clothing or Worse?

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The concept of a Strategic Partner (SP) is itself not in tune with democratic free market political economy. The philosophical approach should first have been objectively resolved in such an exercise, may be the “post facto” approach where the SP is selected only after verified physical performance following the regular RFP process.

In 2005, the Vijay Kelkar Committee had recommended selected private sector companies should be permitted to build major defence platforms and be treated at par with the DPSUs and OFBs. Such companies would be termed as Raksha Udyog Ratnas (RUR). The qualification criteria for the RURs were more or less the same as recommended by the recently constituted Task Force (TF). Later on another Committee recommended 12 companies for accord of RUR status. However, after five years of examination in 2012, the proposal was shelved. The MoD decided to introduce a 'Buy and Make' Procedure which obviated the need for RURs.

In a bid to rewrite the DNA of the Defence Procurement Procedure the MoD began a new exercise in 2014, the Dhirendra Singh Committee of Experts (CoE) recommended that Strategic Partnerships (SP) were necessary for the growth of the A&D Sector. The CoE noted “that if the strengths of private industry are to be harnessed then they must be done under well defined models… we are recommending the 'Strategic Partnership Model' for creating capacity in the private sector on a long term basis. Such a capacity will be created over and above the capacity and infrastructure that exists in Public Sector units.”

The CoE also recommended that the MoD would identify the private sector Strategic Partners through a well-defined protocol to create capacity in them over and above the capacity in the Public Sector. However, there was no spelling out what was the capacity deficiency that the MoD would support the SPs with.  The CoE noted “the primary focus of strategic partners would be to support sustainability and the incremental improvements in capability of platforms through technology insertions over their lifetimes. Thus, the key competence that one should be looking at in such partners is (i) their competence in system engineering; (ii) supply chain management to manage life cycle support; and (iii) companies that are looking for assured revenue streams based on such long term partnerships. The CoE noted that the selection procedure for such SPs is the most crucial element in operationalising the idea and coolly passed the buck to another Task Force “to lay down the criteria in detail after studying best practices”. It also suggested that L1 commercial bids were not appropriate for selection of the SP and “a rational, fair, scientific and transparent procedure should be worked out and the Task Force reasoning be spelt out in detail.” The CoE barely disguised SP idea which was simply the RUR in a wolfs clothing or worse.

Notice the following. First the partnership itself remains unclear.  The selected SP would have to invest in the segment “allocated” to him with no visibility on the demand for that segment except that the SP would get orders “over and above the capacity and infrastructure that exists in the public sector” and that MoD despite the partnership reserves the right to be “at liberty to utilise all these entities (DPSUs and OFBs) for its needs”. Further as recent budgets have shown there is no budgetary support for anything over the capacity of the DPSUs.

Also, nominations to DPSUs continue which include, the nomination of the 12 Mine Counter Measure Vessel worth INR 32,000 Crs project to GSL, five Fleet Support Ships worth INR 9,000 Crs to HSL, 8 LCUs worth INR 2170 Crs to GRSE, BMP-II to OFB and the INR 20,000 Crs Ka-226 to HAL all of which has sent conflicting signals to the private sector. The DPSUs/OFBs continue to retain clout within the MoD to diversify private sector business to them as was stated by a CMD of a PSU in a conference that they were 'national' investments and its employees a national work force and therefore Government was duty bound to support them in any manner. These were projects well within private sector capability to undertake and competition would have led to “real price discovery”, better quality and delivery schedules which would ultimately benefit the armed forces reeling under tight budgets. Hence there is little confidence that the MoD would actually 'walk the talk'.

With regard to the 'philosophy' the TF has approached the selection of the SP on “a priori” basis of 'inherent capacity and ability of the entity and not on the lowest bidder principle and consequently competitive bids are not being contemplated.  Since there is, in the opinion of the TF, no expertise within the Indian private sector for integration of complex defence systems the TF has accepted the recommendations of the Expert Committee that the SP's competence would be judged on the basis of competence in system engineering, supply chain management and companies looking at long term revenue streams rather than one off projects. The other philosophical pillars are that the SP would form collaborative arrangements with MSMEs for undertaking 'distributed manufacturing' in India. Other caveats include 'selection criterion for the SP should be fair, reasonable, transparent and rational apart from the enduring, abiding and perpetually over riding subjective googly of 'national security concerns'.

Several other statements of the TF are unsettling to the private sector. For example the TF believes that, for example, companies that have system integration skills in chemical plants such as manufacturing sulphuric acid or power plants such as hydroelectric projects etc are stated to be competent to build aircraft, warships and submarines. However, it differentiates the technology in making helicopters from that of aircraft and submarines from that of warships in the same breath seeking that these platforms be all different segments. In support of this argument it states that this is the norm worldwide, failing to note that Boeing, Airbus and closer home HAL all make aircraft and helicopters. Similarly, DCNS, BAe Systems, TKMS and closer home MDL make both submarines and warships. Until recently, Northrop Grumman and BAe systems made warships submarines and aircraft. Therefore, the central logic for such segmentation is fallacious.

In deciding the industries under Segment 2 the TF notes that “the technology for manufacture of ammunition, though very special….may not qualify as a 'system of system'. Missiles and Torpedo systems are also ammunition and within each ammunition the sub categories require considerable system integration technologies certainly as, if not more, complicated than making cargo or utility aircraft and helicopters. The Aegis and Patriot or the S-400 are system of systems. Therefore, ammunition should have been a Segment 1 article.

The TF has also decided that the GoI may have the right to acquire control of the IP used and facilities developed by the SP in times of 'extreme circumstances of conflict like war'. This is open ended and typical authoritarian approach to partnership. All the business risks have to be taken by the SP and the GoI will neither commit to assured orders nor even guarantee the longevity, ownership or sustainability of the business reflecting its pathological distrust to anything private even if it is a partnership signed on a deed of covenant.

The TF has also sown other 'rules' such as only one company of a Group may be applicant for Group 1 or 2 segments and that not more than one applicant company from the same Group company can be a SP for Group 1 segments and has created an interesting matrix of eliminating applicant companies to finally select the SP based on the company's preference and its ranking as per the evaluation criteria. But, MoD will have the 'flexibility to sub-divide any such segment' and as a further 'comfort' to the SP the TF notes 'no monopoly will emerge as the DPSUs, OFs and the DRDO will remain competitors in the segments'. Not content with introducing the above archaic conditions the TF has also advised that the FDI regime in the A&D sector be severely restricted for SPs and has advocated that the FDI regime status prior November 24, 2015 be restored for SPs. In addition the TF has recommended that a notification under Section 54 of the Competition Act, 2002 may be issued by the Ministry of Corporate Affairs and duly gazetted so that the selection of the SP and their carrying on activities are exempted. It is a matter of conjecture on how long would such 'unreasonable and protective' gazette notifications require in a parliamentary democratic system.

The TF has spelt out a point based evaluation criteria basis the technical, financial and segment specific competence of the applicant company which though objective amounts to a cooperative due diligence and audit on the affairs of a company by an extra legal body. The TF has not recognised that the Global manufacturing model requires that as much as 66-70% of work is outsourced by OEMs to specialist SMEs such as special processing, specialised machining etc.

To fathom all these criteria the TF has suggested that yet another committee be formed called the Evaluation Committee which would be assisted by yet another committee called the Verification Committee. The TF has also recommended that for the 'proper regulation and development of the SP' an independent regulatory body would be required'.

Whilst the concept of a SP is itself is not in tune with modern democratic free market political economy at least the philosophical approach should first have been objectively resolved in such an exercise. In my view the selection of SP can be basis of two approaches:-

  • The first is the “a priori” approach where the SP is selected first basis various criteria and then RFPs are only issued to the SP for that segment.
  • Second is the “post facto” approach where the SP is selected only after verified physical performance following the regular RFP process.

The TF has adopted the first approach and has not considered the second approach. I recommend the second approach be at least examined on its merits. In the second approach (the post facto) the proposed process for selection of the SP could be as follows:-

  • Basis of the LTIPP the total demand for a platform (example all helicopters requirements) or equipment (example guns or missiles) is first aggregated for the three services and the coast guard for the 15 year time horizon. This could be undertaken by HQ IDS.
  • The intended delivery schedules over each year are determined by the Service HQs.
  • These delivery schedules are compared with existing capacity, if any, in Indian industry including DPSU/OFB to objectively determine the national deficiency. This could be undertaken by the Department of Defence Production. (Of course it is unlikely that the DPSUs/OFB will admit by themselves to any under capacity in any segment).
  • Seek Expression of Interest from Indian Company, as defined in the Company Act 2013, for the total 'deficient' package detailing specifications, numbers and the required delivery periods.
  • Broad business terms and conditions for capacity building, capability development and skill building would be specified in the EoI. This would help the Company prepare its business case for approval of shareholders/BoD to raise the required resources and hire the right talent.
  • Provide adequate time for the response, maybe 6-9 months, since teaming agreements may be required between foreign OEM and maybe DRDO/consortia of Indian companies and these being legal in nature take time for conclusion.
  • Evaluate the compliance to the EoI and short list companies if required.
  • Issue RFP to short list/all companies who responded to EoI for the aggregate deficient quantities.
  • Evaluate proposals as per existing DPP process.
  • Rank best two bids on T1 (60%) and L1 (40%) basis.
  • Award contract to best two bids (maybe) on 60:40 basis where 60% is awarded to best bid and 40% to second best bid.
  • Monitor quality, cost and delivery performance of both companies by an Integrated Project Management Team of independent industry/domain experts reporting to Secretary DIPP for objectivity.
  • Declare one company as SP basis demonstrated better performance of cost, quality, indigenisation levels and timely delivery of agreed initial lot as specified in RFP.

The covenant between MoD and the SP would mainly be:-

  • MoD would only be responsible for initial award and further orders are not guaranteed.
  • Business sustainability of the enterprise would be the sole responsibility of the SP. However, limited but not contractually committed handholding would be provided by the GoI as is prevalent in other democracies for export promotion of defence goods. Following business terms to encourage the growth of the SP may be considered:-
    • Assured RoI of about PLR + 10-15%; break even at not more than 7 years of production; Initial order book should be greater than payback period.
    • Taxation and Incentives in line with that available to Infra projects for duration of payback period.
    • Hand holding and all other incentives are withdrawn after agreed payback period.
  • Life cycle maintenance and support of the supplied equipment, upgrades and life extension, would be on nomination basis to SP as OEM law with GFR 2005
  • Pricing would be on cost plus agreed margin basis for subsequent contracts including MRO activities.
  • The SP would agree to 'open book contracts' with full visibility on costs and accounts for future orders as a SP.
  • Exports would be permitted and perhaps encouraged under G to G route with prospective countries in which India has strategic interest.
  • GoI would guarantee a stable regulatory regime in terms of the national policies on licensing, FDI, competition law and other applicable regulations and tax incentives and exemptions for the duration of the first contract.

The 'a priori' process suggested by the Atre Committee would require complex and subjective calculations, substantial due diligence and high risk absorption by MoD.  Also the TF has recommended a slew of “anti liberalisation measures”, challenged free enterprise, limits entrepreneurial “start up” opportunity, restricts FDI, seeks exemption of sections of the Competition Act by gazette notification, imposes arbitrary financial gates irrespective of the sub-segment and advocates a return to the licence and regulatory Raj once again by reintroducing a Regulator. It equates competency in building chemical plants with manufacturing aircraft as a demonstration of competency in System Integration.  In addition, it advocates yet more committees and a new 'wing” in the MoD to oversee the SP process. This process if adopted may or may not favour Indian industry but would certainly bolster the business of lawyers and CAs on the one hand and add substantial bureaucratic load on the MoD.

The concept of SP itself is not justified. However, should the concept be accepted at all, then at the very least the Post facto approach would be simple, logical and risk free and I recommend this may be examined further.

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