Defence Company Services

A1: In the vast majority of countries, offset is only required in respect of defence contracts. There are exceptions, such as Kuwait, where offset is also required in relation to civil contracts over a certain value.

Offset is normally triggered by contract value, i.e. the contract being placed by the purchasing government on your company. The value at which offset becomes a requirement is known as the ‘offset threshold’, and is different for each country. Offset thresholds can be quite low and therefore can apply to small companies and large companies alike. Most countries publish their offset guidelines on their web site, and they normally include details on the offset threshold.

Offset can also apply to the ‘cumulative’ value of business that a company receives over a period of time. For example, a company may win several small value contracts from a single country, and each contract may not call for offset. However, there are many situations where defence companies incur an offset obligation based on the cumulative value of business if this exceeds the threshold. This raises a number of issues, particularly where companies are operating as part of a group.

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A2: There are a number of trade associations in the UK, such as the DMA, that can give advice on offset, and possibly put you in touch with experts such as us in the industry. The trade associations are therefore a good place to start. In the UK, companies can also speak to DESO that can give advice on offset.

There are also a number of conferences and workshops organised each year, which draw together speakers from government and industry.  They are a good source for learning about policies and market trends, and also about problems and best practice.

It is in the long-term interest of companies to create a knowledge base on offset so that when the occasion arises, there is sufficient awareness to understand its requirements and implications. It is best not to wait until a bid is being prepared, or worse still, you are in the middle of contract negotiations before you think about how you might take on an offset obligation. The preparations for offset should be made at the early planning stage of a bid so that the requirements can be fully evaluated and a plan prepared.

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A3: SMEs can, and do, engage successfully in offset. Remember, that offset applies to the contract value, not the size of the company engaged in the contract. That said, offset raises some specific issues for small companies that need careful consideration. For example, most countries require a performance bond to guarantee the delivery of the offset. This can be additional to other types of bond related to the performance of the ‘supply’ element of the contract. The offset bond creates an additional risk, which when taken, as a percentage of the company’s business, may be unacceptably large. It is a matter for each company to decide whether this risk is acceptable or not.

Large Defence Companies often discharge their offset obligations by facilitating business through their various other divisions, perhaps by purchasing a wide range of components and materials from the client country. This is known as ‘indirect’ offset, i.e. it is business not directly connected with the ‘supply’ contract. Small companies do not have such a wide breadth of business and therefore are limited in the ‘indirect’ offset they can provide.

Direct offset is generally more difficult to provide as it can disrupt the whole production process (e.g. sub-contracting the manufacture of key parts of the product to a foreign company may not be feasible.) Companies should develop an offset plan early on in the bidding process to establish exactly how they can successfully deliver the offset without running the risk of defaulting and paying a penalty.

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A4: This depends on whether your customer requires a high amount of direct (product related) offset (see Question above.) Countries, such as the UAE, prioritise indirect offset through investments in civil projects. In such cases, the defence contractor is not required to get involved in sub-contracting its defence work. Countries such as South Africa, allow a mix of ‘direct’ and ‘indirect’ offset, taking the pressure off defence companies to outsource their core business.

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A5: As a minimum, you should study the offset requirements so that you have a clear understanding of how much offset you will be required to deliver, what type of offset is required, and over what time span. This can be developed into an offset plan, which can be refined during the tender planning stage. An offset plan will also help you to evaluate the possible risk involved so that you can make the necessary contingency provision.

In studying what you might be able to offer as offset, there is no substitute for visiting the client country and speaking with local organisations, including the government offset agency, to improve your understanding of the rules and taking soundings on the type of offset that would (a) be considered eligible under the rules and (b) be financially viable. It is often the case however, that through no fault of anyone involved, that many offset projects conceived during the pre-tender stage, fall away for various reasons and are not enacted post contract. For this reason, it is imperative that a short list of projects is continually developed (as back-up) throughout the life of the project until the offset obligation is fully discharged.

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A6: If you have followed the advice given above and developed an offset plan during the pre-tender phase, then you will have some basis for deciding what you have to do to discharge your offset obligation. However, apart from the top six Defence Companies, there is a real scarcity of offset professionals that are experienced in how to manage an offset programme and the majority of companies do not have their own skilled resources.

Based on our experience over the past few years, the following is suggested:

• A person should be appointed in the company to be responsible for the co-ordination of the offset project. Although the company may only have one contract with offset, the work that is necessary for successful delivery will require a full-time commitment. It is also suggested that the person appointed is part of the project team involved with the ‘supply’ element of the contract, and that performance is managed and reported as an integral part of it.
• The offset manager should have a ‘dotted line’ reporting link to senior management. This is needed to overcome any clashes in priority that may occur between the objectives of the ‘supply’ element of the contract with the offset objectives. Where these instances occur, it is necessary that a ‘strategic’ vision be required to consider the ‘bigger picture’.
• A budget should be set aside to deliver the offset project. This would normally be between 3% to 5% of the ‘supply’ contract value and would cover management costs, travel and transaction costs. (NB: Although offset is required to be ‘free of charge’ to the end customer, it is seldom delivered ‘free of cost’! It is important that this budget is set aside in the pricing of the contract.)

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A7: Offset is not permitted to result in an increase in the tender or contract price. Experience suggests, however, that offset does incur additional costs for Defence Companies and therefore this needs to be taken into consideration when formulating prices and risk contingencies.

Possible areas for cost are:

• Additional management overhead, including travel etc.
• Purchasing costs
• Commission payments to 3rd Parties (if used)

On contract start-up, this cost provision should be used to create a budget to manage the offset requirement. The challenge of the offset manager is to deliver the offset quota within this budget.

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A8: The amount of offset to be delivered is known as the ‘Offset Quota’.

The size of the Offset Quota is defined in the Defence Contract, which is dictated by legislation. Offset volumes are often expressed in terms as percentages of contract value, e.g. 60% (UAE), 100% (Norway) 35% (Kuwait) etc.

To achieve 100% offset is, of course, a major challenge. Much depends on whether the customer allows a ‘multiplier’ to the offset project value. For example, to incentivise offset projects into high priority areas, governments can apply a multiplier (or value coefficient) to purchases or investments made by the defence company. For example, an investment of £1 Million in an attractive project may be rewarded with a multiplier of 5, for which the Defence Contractor will be awarded £5 Million in Offset credits.

Multipliers are often set out in Defence Contracts against certain broad categories of offset transactions (e.g. Investments, Technology Transfer). This requires Defence Companies to negotiate with the government offset authorities the specific multiplier that will apply to a certain project. The negotiation of multipliers is not an exact scientific or mathematical equation, as much will depend on the relative merits of each offset project. A project that brings employment, investment and training to an impoverished or developing area ‘should’ in theory qualify for the highest multiplier available, but again, the emphasis will vary between countries.

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