SMEs in Defence Production: Opportunities and Challenges

SMEs in Defence Production: Opportunities and Challenges

Major General Mrinal Suman, AVSM, VSM, PhD

Small and medium enterprises (SMEs) are universally accepted as engines that drive technological progress in all industrial sectors. Their importance in the defence sector gets further enhanced due to the fact that defence industry is highly technology-intensive.

Importance of SMEs can be gauged from the fact that every technologically advanced nation has accorded due recognition to their promotion. The UK Defence Industrial Strategy, published as a white paper in December 2005, seeks to drive innovations by promoting greater interaction and collaboration between the government, prime contractors and SMEs. UK’s Defence Supply Network Policy also recognises the contribution of SMEs towards the supply-networks to deliver value for money, agility and innovation.

Acknowledging the criticality of the role of SMEs in the European Defence Technological & Industrial Base (EDTIB), the European Commission adopted the Defence Package which, inter alia, contains numerous proposals for the support of SMEs. Effective utilisation of potential and innovation of SMEs was considered to be the key factor for the success of EDTIB. In follow-up to the Defence Package, seven conferences were held in different member states between October 2009 and March 2010 to study “Competitiveness of European SMEs in the Defense Sector” and to explore concrete ways to support them.

SMEs in Indian Defence Sector

Not enough attention has been paid to the promotion of SMEs in the Indian defence industry. Although they have been supplying sub-assemblies and components to public sector undertakings for decades, their technological competence has not kept pace. They continue to be peripheral players and produce low-tech items. They have never been encouraged to invest in developing new products or carrying out pioneering innovations. Resultantly, very few SMEs have acquired competence to develop, manufacture and upgrade defence systems.

Ministry of Defence (MoD) carries out capital procurements as per the Defence Procurement Procedure (DPP) and revenue procurements as per the provision of Defence Procurement Manual (DPM). DPP does not contain a word about the SMEs. As a matter of fact it completely ignores their existence and focuses only on major contractors and system integrators.

As regards DPM, 358 items have been reserved for SMEs and micro enterprises. The list is common to all government procurements and has no specific application for defence. The items are low-tech mundane products like agricultural implements, nuts/bolts/brushes, hosiery products, handicrafts and tradesmen tools. The list is also a reflection of the fact that MoD considers SMEs to be fit for commonplace products only. It does not recognise their potential for technology upgradation and innovation.

Incidentally, DPM exempts SMEs from the payment of earnest money and performance security deposit. They can also be allowed price preference of up to 15 percent in comparison to large industries, provided such a clause is mentioned upfront in the tender documents.

The much awaited Defence Production Policy was released on 13 January 2011. It turned out to be damp squib. In the absence of any radical policy initiative, the policy acquired the character of a statement of intent and not a plan of action. Whereas SMEs were hopeful of getting major incentives, they had to be satisfied with the fact that ‘enhancement of the potential of SMEs in indigenisation’ found mention in the objectives of the policy. Unfortunately, the above statement is indicative of Government’s lack of faith in the capabilities of SMEs to innovate. Only the task of indigenisation (import substitution or duplicating imported components) has been assigned to them. That has been the bane of SMEs in India.

The Defence Production Policy promised to ‘set up a separate fund to provide necessary resources to public/private sector including SMEs as well as academic and scientific institutions to support R&D of defence equipment/systems enhancing cutting edge technology’. As is the Government’s wont, one year has passed and the promised fund is yet to be set up.

Strengths

As stated earlier, SMEs have been in the forefront of technological advancement the world over. Large companies incorporate sub-systems developed by SMEs to configure defence equipment for required performance. Some major areas of strength of SMEs are as follows:-

a) As they operate in niche segments, they master manufacturing processes, acquire specialised knowledge and achieve exceptional expertise. Resultantly, they attain unique innovative and inventive capabilities. Credit for most cutting-edge break-throughs in precision machining, electronics and nano technologies goes to SMEs.

b) Being small and focused players, they possess greater flexibility and speed. They can learn and absorb new technologies more efficiently.

c) Due to limited administrative expenses, they have lower overhead costs.

d) Once they establish their credentials in a supply chain, they win the confidence of their customers. Resultantly, they are encouraged to move up the technology ladder.

The Challenges

Defence sector is dominated by multinational giants that straddle across the complete spectrum of defence equipment, thereby creating unequal playing ground. SMEs are small players with limited resources and cannot compete on their own. They need governmental support to thrive and deliver. Some of the major challenges faced by them are as follows:-

a) Awareness Deficit

i. Being unaware of future capability requirements and perspective plans, SMEs are unable to do advance planning for impending business opportunities.

ii. They are unable to obtain information about all procurement proposals for timely enrolment as vendors. Many opportunities are lost by default as no vendor can be added to the list after the issuance of tender documents.

iii. They lack accessible information on clustering/partnering opportunities and foreign partnerships.

iv. They lack knowledge about foreign markets for necessary economies of scale.

b) Financial Constraints

i. Defence business is characterised by long and complex procurement procedures. Companies need protracted staying power and adequate financial endurance for long term sustainment. They may still not get the contract. For SMEs, such investment risks can prove dissuasive.

ii. In case of developmental contracts, time lag between R&D and returns can be excessively long, resulting in cash flow problems.

iii. Due to the uncertainties of defence business, no venture capital is available to SMEs in India. Banks are equally reluctant to lend.

iv. Lack of sufficient capital inhibits their foray into export markets

c) Entry Pangs

i. A new entrant finds it hard to break into existing supply chains. Well established equations between prime contractors and current suppliers, built over a long period of partnership, inhibits entry of newcomers.

ii. It is hard for SMEs to get timely information about existence/emergence of gaps in a supply chain to be able to attempt entry.

d) Marketing Challenges

i. As MoD is the main and even sole customer of their products, subsequent variation in budgetary allocations or change of priorities of procurement proposals can adversely affect flow of orders after the creation of necessary facilities.

ii. Economies-of-scale is a constant concern as access to export markets is limited, especially for sub-assemblies independent of the complete systems.

iii. Creation of necessary visibility to make government and primary defence companies aware of their products and services is a major challenge.

iv. Fear of fresh competition can be quite unnerving for established SMEs since new entrants always cut prices to gain entry.

e) Dissuasive System

i. There are over 150 major defence procurement agencies in India. As there is no centralised procurement bulletin, SMEs have to incur considerable administrative expenses to maintain liaison with all of them

ii. Bureaucratic functioning and red tape can test perseverance of even a die-hard optimist and dampen his enthusiasm for working with defence.

iii. DPP and the Defence Production Policy provide little incentive/support to SMEs, leaving them vulnerable to exploitation by big players.

iv. Costs associated with IPR protection and user rights generate financial convolutions.

Opportunities

It is a common saying that business opportunities exist all the time but only the vigilant entrepreneurs can spot them. However, one does not have to be a visionary to recognise the existence of unprecedented opportunities that are presently available in the Indian defence sector. With India’s shopping list exceeding USD 100 billion in the next few years and corresponding inflow of offset business of up to USD 40 billion, business prospects are enormous. A fair share will certainly flow to SMEs.

Some of the areas in which SMEs can thrive are given below:-

a) For major acquisitions, SMEs can become sub-vendors to prime contractors for the supply of sub-assemblies and components. They can supply items which are developed in-house by them. Or else, items can be manufactured as per the specifications and designs supplied by the buying contractor. However, SMEs must move up the value chain as they gain experience.

b) Vast opportunities for the development and manufacture of niche items to fight asymmetrical wars, terrorism and insurgency have emerged. Demand for explosive detectors, scanners, IED suppressers, bomb disposal equipment, bullet proof jackets and such items has increased multifold. Such items can be best produced by SMEs.

c)India is undertaking many large-scale and multi-dimensional projects like F-INSAS (Future Infantry Soldier as a System), Network Centric Warfare and Tactical Communication System. SMEs can gainfully join hands with other companies to excel in the areas of their expertise.

Bulk of major weapon systems held by the Indian armed forces are closer to becoming obsolescent and need upgradation to extend their useful life. Some of the major upgradation programmes involve T-72 MBT, 133 mm M-46 Medium Gun, L-70 AD Gun, Schilka (SP) AD Gun, BMP-2 ICV, Alouette-II/III Helicopters, Sea Harrier, IL-38 MRA, Sea King and Kamov Anti-Submarine Helicopters and Fire Control Radars. Enormous business opportunities exist for SMEs in such programmes as they entail multiple technologies.

e) As the world trade is heading towards the ‘Global Village’ concept, highly competitive SMEs can secure an international position by exploiting their specialised knowledge and skills. It will help them achieve economies of scale. They can collaborate with SMEs from other countries as well.

f) Maintenance of imported equipment also throws up huge opportunities for SMEs as foreign suppliers find it more beneficial to have competent Indian partners to provide maintenance support.

g) In order to fulfill offset obligations worth billions of dollars, foreign suppliers will need to partner not only the large Indian companies but also efficient SMEs. It is for the enterprising SMEs to position themselves accordingly.

h) Policy for joint R&D under the ‘Make’ procedure for ‘High Technology Complex Systems’ and ‘Low Technology Mature Systems’ has been liberalised. SMEs are encouraged to establish joint R&D ventures with Indian public and private sector. Even DRDO is seeking joint co-development of sensitive systems.

The Way Forward

SMEs possess huge potential. However, they need support and facilitative environment for sustenance and delivery. It is time detailed studies are carried out to understand the complexities of their dynamics. It is only then that the required steps can be taken.

The following measures will go a long way in promoting SMEs and tapping their full potential:-

a) By the Government

i. A national policy to nurture and protect SMEs in the defence sector should be evolved. It should not be merely a statement of intent but contain specific time-bound action plan.

ii. The long promised special fund should be set up to provide financial support to deserving SMEs. In times of financial crisis, they should be helped through painless financing instruments. More importantly, timely payments against supplies should be ensured.

iii. Information regarding future capability requirements and impending tenders should be disseminated through fortnightly electronic bulletins, as is done in many countries.

iv. Involvement of SMEs should be strengthened in R&D projects through special financing. However, it should be ensured that all indigenous competencies are factored in and no wasteful duplication of effort takes place.

v. Regular interaction between the Government, trade/industrial associations and SMEs should take place for active engagement.

vi. A data base should be prepared of all SMEs in the defence sector with their capabilities duly highlighted.

vii. As SMEs do not get to know of all impending tenders in advance, an exception should be made in their respect as regards addition of new vendors after the issuance of tender documents.

viii. Defence Offset and Facilitation Agency should have a section exclusively to help SMEs with offset opportunities. Exports should be facilitated.

b) By Trade/Industrial Associations

i. SMEs often complain that their interests are being neglected by their trade/industrial associations as these have been hijacked to serve the interests of a few aggressive big players. Such a trend must be reversed. Big players can thrive on their own whereas SMEs need hand-holding.

ii. Regular interactions should be facilitated between prime contractors and SMEs to help them develop partnerships.

iii. Support and advice on procurement processes, administrative and legal issues should be provided through training capsules.

iv. Periodic surveys should be carried out of the functioning of SMEs and issues of concern should be projected to the Government.

v. Information dissemination should be improved regarding public procurement opportunities for SMEs.

c) By SMEs

i. They should pool their efforts, increase R&D spending and strive to move up the technology ladder.

ii. They must improve their visibility and be known to the procurement agencies and other customers.

iii. Clustering/partnering with other companies can prove mutually beneficial and cut overheads.

iv. They must develop cross-sectoral skills and acquire full knowledge about procedures and contractual obligations.

Finally

It must be remembered that there is no place for laggards in the defence business. Competition is tough and defence technology becomes obsolescent rapidly. No external support can sustain SMEs that fail to innovate continuously to improve their niche expertise.

Most importantly, SMEs must establish their credibility for performance, quality assurance and timely supplies. It is only then that they can secure a place for themselves in the supply chain and aspire to flourish in business. The Government can act as a facilitator only. It is for aspiring SMEs to make use of the enormous opportunities that the defence sector has thrown up by understanding nuances of defence business and demonstrating a strong commitment to succeed. To succeed, every SME has to be capability driven, competent and competitive – and, that is the ruling mantra.