Defence procurement is conducted from three sources, foreign entities, defence public sectors undertakings (DPSUs) and the domestic private sector. The domestic private sector is comprised of large players (like Tata, Mahindra, Larsen and Tubro, Bharat Forge) and SMEs. Imports from abroad constitute almost 60% share of defence procurements. DPSUs and Ordnance Factories fulfil anywhere between 35-36% of the remaining procurements, which leaves approximately, only 4% of domestic defence procurement for the private sector. In the private sector, the large players account for a greater share of defence procurement while SMEs are largely relegated to the side lines. These market shares alone show that the private sector, especially SMEs, have relatively few opportunities when it comes to defence manufacturing and procurement in India.
SMEs form a part of supply chains in defence manufacturing by DPSUs and large private players. SMEs will often be the suppliers of raw materials, components and spare parts. DPSUs and their manufacturing efficiency warrants separate discussion. When one focuses on the private sector, specifically SMEs, by virtue of being a disaggregated sector it remains largely neglected in defence manufacturing and production. The private sector has seen a flurry of activity since June 2014 due to three reasons;
the announcement of ‘Make in India in Defence’,
approval of increase in FDI limits for defence manufacturing, which would lead to offsets flowing into MSMEs and,
simplification of procurement procedures and reducing entry barriers for domestic private sector entities in the recently released Defence Procurement Policy (DPP) 2016.
The policies and amendments are all geared towards indigenization of defence manufacturing and innovation in design and development. The aim – self-reliance in defence production. The emphasis on indigenization of defence manufacturing will act as a stimulus for defence SMEs.
The immediate impact of these policy changes has benefited the large players in the private sector. Over the past year, the proposals that have been cleared show that while there is a significant role for the private sector in defence manufacturing, this segment is dominated by the larger players. For example, Hindustan Aeronautics Limited (HAL) and Bharat Electronics Limited (BEL) have signed an agreement to share competencies on manufacturing advanced avionics for the armed forces. Mahindra Defence Limited and Airbus Helicopters have signed an in-principle agreement to set up a joint venture that will manufacture helicopters for the Indian Air Force. Reliance Unmanned Systems Limited and Augur Overseas Operation (Singapore) have entered into a 51:49 joint venture for development, production and maintenance of various aerostats and airships for both Indian and global markets. Similarly, Tata Advanced Systems Limited and Boeing signed a framework agreement for collaboration in manufacture of defence equipment, especially UAVs, in India. What is conspicuously missing in the picture is the involvement of SMEs or any impact the policies have had on their functioning.
There is no baseline for estimating the impact of policies on SMEs. As the work of SMEs in this sector is sensitive, it is difficult to gather information on the details of activities or processes. In the absence of baseline data, there is no way of determining what is happening on the ground. The Defence Innovators and Industry Association (DIIA) is an association of SMEs in defence manufacturing who aim to push for indigenization of design, development, R&D and manufacturing of defence equipment. The association held their inaugural conference on ‘Self-Reliance in Defence through Design and Development’ on 25th February 2016. During an interaction between the Raksha Mantri (RM) and SME heads, a number of issues that both practitioners and manufacturers face were brought up.
A lack of communication between buyers and manufacturers with regard to design requirements and testing of products was cited as a major issue. This is usually as a result of technological advances occurring far faster than practitioners have the time to revise service qualitative requirements (SQRs), operational requirements as well as adopting new technology. The bidding process is not a level playing field for SMEs and regulatory restraints often compel them to quote equipment specifications that may not be deemed field-worthy by practitioners. Even for relatively smaller contracts, SMEs would not be able to meet indigenous design, development and manufacture (IDDM) requirements. In the interest of service obligations on existing products, SMEs have to forego innovation and the ability to build or share intellectual property (IP).
SMEs in the defence sector have been investing in intense R&D efforts to indigenize defence equipment and sub-systems. However, for their businesses to succeed and for them to continue with innovation in indigenous design and development, SMEs need new contracts. They are often overlooked as vendors by PSUs and larger private companies because even now, the preference for imported components or equipment is greater. Replacement of imported components or equipment with indigenous ones necessitates re-trials and fresh product testing. A process that the Ministry of Defence and Department of Defence Production are more than willing to facilitate (as mentioned by the RM in his interaction with the industry heads), but which usually requires the input of the armed forces – who are the end-users of the products.
However, the new DPP 2016 has taken this into account and some changes have been made in order to make the policy SME friendly. Under the indigenously designed, developed and manufactured (IDDM) category the requirement of indigenous content has been reduced from 70% to 40%. The contract threshold for offset obligations has been increased from Rs. 300 crore to Rs. 2,000 crore. This will lead to larger amounts being directed into the domestic SMEs sector to fulfil offset obligations.
The policy of awarding contracts to L1 (or lowest bidder) has also been adjusted, as the requirement for field-worthy equipment has been recognized as a critical need. However, quality issues would be better addressed when L1 and T1 (technical bids or best technical solution) are made as criteria for awarding contracts. If the L1+T1 criteria is adopted, it would give SMEs a better chance when it comes to bidding for contracts. Furthermore, it is important that an enabling IP regime for SMEs is put in place that will allow them to retain or share either part or full IP when they are involved in joint projects with foreign or domestic companies. This will require multiple rounds of stakeholder interaction and engagement.
While SMEs have so far not been able to get a foot in the door with regard to defence manufacturing, the new DPP 2016 and interactions between industry and the armed forces promise an easier environment for conducting business in the future. Bringing the long neglected SME sector into the fold of defence manufacturing is the only way of becoming self-reliant in defence production.
P. R. Sanjai, ‘Govt opens up 25% share of defence production to private firms’, LiveMint, 17th February 2016. http://www.livemint.com/Politics/3NVkn0x7E7wFWinHvoYz6M/Govt-opens-up-25-share-of-defence-production-to-private-fir.html
Laxman Kumar Behera, ‘Make in India: Big role for private firms in defence’, Live Mint, 15th February 2016. http://www.livemint.com/Opinion/xdix0RjSNhvuX4QBeVSm7I/Make-in-India-Big-role-for-private-firms-in-defence.html