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Strategic Partnership Model (SPM)  Treading a Minefield

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The SPM recommended by the committee seen by many as a game changer cannot be adopted unless it lays down the criteria in detail and the finer details are worked out through a well-defined protocol for selecting the Strategic Partners (SP). Otherwise, MoD will have to tread a virtual minefield to implement the committee's recommendations...

 A committee of experts was set up by the Ministry of Defence (MoD) in May last year to recommend the contours of a policy framework and concomitant procedural changes in the Defence Procurement Procedure (DPP) 2013 to facilitate 'Make-in-India' in the defence sector, without defining the concept.

The committee did a quick job and submitted its report in July 2015 with a number of innovative recommendations which, unsurprisingly, have been under consideration since then. Every DPP since the first one promulgated in 2002 contains the solemn promise of a biennial review. In the normal course, DPP 2013 would have got revised last year but for the ministry's belated impulse to set up a committee. That effectively ruled out the possibility of the revamped procedure being notified anytime soon.

That all the recommendations made by the committee are not in a ready-to-be-implemented mode has prolonged the wait. The 'Strategic Partnership Model' (SPM) recommended by the committee  seen by many as a game changer - is a case in point. This model cannot be adopted unless the finer details are worked out. The committee itself recommended that a Task Force needs to be constituted to lay down the criteria in detail for selecting the Strategic Partners (SP) after studying the best practices.

Based on the committee's recommendation, MoD set up a Task Force which too has submitted its report in January 2016. According to some media reports, the Task Force has expanded and rearranged the strategic segments, identified by the experts' committee, in two groups and suggested stringent criteria for identifying the SPs who will undertake projects on being nominated by the MoD. Although, MoD is apparently keen to implement the recommendation and is moving fast in that direction, a few issues concerning the SPM might turn out to quite intractable. The parameters recommended by the Task Force for identification of the Strategic Partners are:

GroupSegmentsIPAs to be selected for each segmentEligibility Criteria
I Aircraft; Helicopters; Aero Engines; Submarines; Warships; Artillery; and, Armoured Vehicles one 
  • Turn over: Rs 4,000 crore in each of the previous three years
  • Capital Assets: Rs 2,000 crore
  • Growth: At least 5% in three of last five years
  • Credit rating: At least CRISIL/ICRA “A”
  • Other Conditions: Should not have defaulted on loans and also not have any declared non-performing assets
II  Metallic materials and alloys; Non-metallic materials; and, ammunition, including smart munitions two 
  • Turn over: Rs 500 crore in each of the previous three years
  • Capital Assets: Rs 100 crore
  • Growth: At least 5% in three of last five years
  • Credit rating: At least CRISIL/ICRA “A”
  • Other Conditions: Should not have defaulted on loans and also not have any declared non-performing assets

What is 'Strategic Partnership' Model?

The committee observed in its report that 'if the strengths of the private industry are to be harnessed then they must be done under well defined models, depending upon the strategic needs, quality criticality and cost competitiveness'. While recommending competition where the vendor base is large, the committee came up with the SPM for creating capacity in the private sector on a long term basis for platforms of strategic importance, classified into six groups:

Platforms

  • Aircraft fighter, transport, helicopters and their major systems
  • Warships of stated displacements and submarines and their major systems
  • Armoured Fighting Vehicles and their major systems

Weapons

  • Complex weapons that rely on guidance systems to achieve precision hits, which may include anti-ship, air defence, air to air, air to surface, anti-submarine, and land attack weapon systems

Networks

  • Command, Control, Communication and Computers, Intelligence, Surveillance, Target Acquisition and Reconnaissance

Materials

  • Critical materials (Titanium alloys, Aluminium Alloys, Carbon composites, Nickel/Cobalt alloys, etc.)

The committee went on to say that in each of these segments the SPs need to be identified through a well-defined protocol, the primary focus of the SPs being on supporting 'sustainability and incremental improvements in capability of (the) platforms through technology insertions over their lifetime'. These capacities are to be built in the private sector over and above the capacity and infrastructure that exists in the Public Sector Undertakings (DPSUs).

The SPM would be applicable to the 'Buy and Make' category, under which a certain quantity of the defence equipment, not available in India, is bought from a foreign Original Equipment Manufacturer (OEM) with Transfer of Technology (ToT) for manufacturing the remaining quantity of that equipment in India through an Indian Production Agency (IPA) nominated by the MoD.

The existing procedure permits IPA to be nominated from the private sector but in the absence of any internal guidelines that could be applied to select a private sector entity to be nominated as an IPA, only the DPSUs and Ordnance Factories (OFs) have been getting nominated. From the point of view of the MoD officials, this is also a risk and option-free option.

This, according to the committee, had its own disadvantages. The complete reliance on DPSUs meant that there was only one production source, resulting in cost and time overruns, as well as 'technical shortcomings' (sic). This also meant that the induction programme was always dependent on the capacity of only one entity and on that entity's technical and managerial capabilities.

While the committee has elaborated the SPM concept in the report with reference to indigenous warship and submarine building, quintessentially the idea of SPM is predicated on a few fundamental pre-requisites, some of which are listed below:

  • (a) Investment by the SPs would be on the basis of assured orders.
  • (b) The contracts could be on fixed price or cost plus basis, with in-built risk-sharing and risk-reward features.
  • (c)  A rigorous audit, including cost audit, mechanism would be needed.
  • (d) Teaming agreements between prime contractors and tierised industry and between the SPs and the DPSUs will need to be encouraged.
  • (e) Long term covenants between the government, SPs and the tierised partners will be needed to guide not only the first contract but also the subsequent ones to follow, so that the resources are utilised optimally over long periods of time.

One of the most significant aspects of the recommendation is that having been chosen as an SP for a platform, or for a family of complex weapons, or a major network programme, that entity or its subsidiaries will not be eligible for being chosen as an SP for any other purpose under this dispensation. The SPs will also not be allowed to have cross-holdings in each others' companies.

The model recommended by the committee 'is to prevent conglomerate monopolies emerging at the very start without production even having commenced' and 'the available capability and capacity in the concerned public sector unit will be an additional safeguard against any monopolistic tendency on the part of the Strategic Partner.'

According to the committee, self-reliance in the six segments identified by it are of strategic significance and will form the core of the nation's fighting strength and that worldwide the number of system integrators of complex defence systems in these segments is extremely limited. This, the committee expects to happen in India also.

Treading the Minefield

MoD will have to tread a virtual minefield to implement the committee's recommendations. To begin with, the concept of SPs is reminiscent of the idea of Raksha Udyog Ratnas (RURs), or the Industry Champions which was a salient feature of DPP 2006. Though it was in the context of the 'Make' procedure, while the SPM is in the context of the 'Buy and Make' programmes, there is a similarity between the two in that both these concepts are contingent upon pre-selection of private sector units as potential production agencies.

The move to notify the RURs was junked at the last moment after going through the entire process of short listing the potential players. No official explanation was given for abandoning the idea but the rumour has it that this was done under pressure from the trade unions of the DPSUs which were jittery about the consequences of the private sector crowding out the public sector units. It would be naive to assume that this factor has become irrelevant today.

Even if that was not the reason, it would be wise to keep in mind the reasons why MoD had to abandon the RUR idea and make sure that those reasons do not cast a shadow on the efforts to introduce SPM.

Second, the defence market in India is large, but not large enough, to nourish parallel capacities and capabilities in the public and the private sector for manufacturing the same or similar defence products. Exports could sustain such parallel capabilities but the possibility of the products license-made in India under 'Buy and Make' category being also exported from here needs to be carefully considered.

Third, it is difficult to understand how the problem of time/cost-over run and 'technical shortcomings' (sic), attributed by the committee to there being only production source (DPSUs) under the existing system, will go away with the adoption of SPM. In so far as the induction of the platform/equipment being manufactured by a particular SP is concerned, it will continue to be dependent on the capacity, technical competence and managerial capabilities of that SP. The presence of a potential rival (in the private or public sector) would hardly make any difference once the contract is signed with a particular SP.

For the same reason, the claim that it would prevent monopolistic interests being created is questionable. In fact, given the fact that the SPM is based on the idea of long-term relationships, possibly over the lifetime of the product and even beyond that if the project also entails life-extension/upgradation, there is a strong possibility of such monopolies getting created.

Fourth, the committee's recommendation that an SP or its subsidiaries will not be eligible for any other project in the same segment after being chosen as the SP for a particular project in that The segment and that the SPs will also not be permitted to have cross-holdings in each others' companies could make the whole idea unacceptable to the Indian private sector.

Fifth, the yardsticks recommended by the Task Force and reported in the media, could be questioned by those who do not fit the bill. Take, for example, the recommendation that for a company to be shortlisted as an SP for a project that falls in Group I, it must have a turnover of Rs 4,000 in the last three years, own capital assets of Rs 2,000 crore, should have grown at least 5 per cent in the three of the last five years and should not have declared non-performing assets.

Each of these parameters could be questioned on the grounds of being somewhat arbitrary, unless detailed justification has been given in the report. Why turnover of Rs 4,000 crore and not, say Rs 3,500 crore, or why assets worth Rs 2,000 crore and not, say Rs 2,500 crore? A financially robust company can also have a certain amount of declared non-performing assets. Why should that company be considered incapable of undertaking a 'Buy and Make' project?

In any case these parameters need to be elaborated further. Will the financials of a company include the financials of its subsidiaries? If yes, will the consolidated financials include the financials of overseas subsidiaries of a company? If not, why not? Such issues are not easy to resolve.

Sixth, instituting a robust system for audit of the contracts (including cost audit), managing cost plus contracts or establishing long term covenants between the government, SPs and the tierised partners will be a highly complex task. This is certainly beyond the competence of the MoD, as it is structured at present. It does not presently have the capability to micro-manage and monitor such arrangements. Quite frankly, this may not even be in sync with the government's objective of ensuring 'minimum government, maximum governance'.

Is there an alternative?

That there may be some difficulties in adopting a new model, as recommended by the committee, is no reason for abandoning the idea if there is a strong reason for taking the step. The success of any new step or measure to reform the system depends on how well and comprehensively the problems likely to arise have been anticipated and taken care of while promulgating the new system. But before doing that one also needs to consider if there are any alternatives which may be more easily implementable.

The SPM has been recommended by the committee in the context of the 'Buy and Make' acquisition programmes in which, as per the existing procedure, MoD is required to nominate an IPA. If the objective of evolving an entirely new  and, one dare say, fairly complicated  system is to identify the prospective IPAs from the private sector for being nominated for each project, why not consider a simpler way of doing it?

Take, for example, the Avro-replacement programme of the Indian Air Force. It bears recalling that in that 'Buy and Make' programme for acquisition of 56 transport aircraft, MoD left it to the FOEMs to select the IPA for manufacturing 40 of aircraft in India, after outright purchase of 16 aircraft in a fly-away condition. Though there has not been much progress in this case in the past couple of years, Airbus did tie up with Tatas to submit the bid. The tie-up has not been questioned by any potential rival.

If nothing else, adopting this 'Avro' model for 'Buy and Make' cases, with some modifications to forge long-term relationship lasting the life-cycle of the equipment, will save MoD the trouble of having to select an IPA out of a small cluster of fiercely competitive private sector entities in India. It would be prudent to learn from the unhappy experience of aborted RUR project, difficulties faced/being faced in short listing the Production Agencies in some 'Make' projects and the potential of the 'Avro' model before taking the final call on the Strategic Partnership Model suggested by the experts' committee.

The writer is former Financial Advisory (Acquisition) and Additional Secretary and Member, Defence Procurement Board, MoD.

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