The untapped potential of India’s SMEs in defence production

The untapped potential of India’s SMEs in defence production

Major General Mrinal Suman

Innovation implies sustained generation of newer ideas, views, concepts and solutions. The basic tenet of the term innovation means ‘doing things in a newer and better way’, with a view to improve upon the existing products and processes. Innovation is considered to be a dynamic catalyst to growth. Any country that fails to develop and sustain a culture of innovation is bound to become a straggler.

It is also a well recognised fact that almost all innovations are carried out by small and medium enterprises (SMEs). They are rightly called ‘the engines that spearhead technological advancement’. All developed nations owe their growth to their highly developed SMEs. Governments provide support to their SMEs to help them retain their technological lead through continuous innovations. The importance of SMEs in the defence sector gets further enhanced due to the fact that defence industry is highly technology-intensive and needs continuous upgradation of defence systems through regular infusion of innovative skills and knowledge.

In its white paper on Defence Industrial Strategy of 2005, the UK underlined the decisive role played by SMEs in producing cutting-edge technologies in critical areas and promised enhanced governmental assistance. Effective utilisation of potential and innovation of SMEs was considered to be the key factor by the European Commission for the success of the European Defence Technological and Industrial Base. Seven conferences were held in different member states between October 2009 and March 2010 to study ‘Competitiveness of European SMEs in the Defence Sector’ and to explore concrete ways to support them. 

Strength of SMEs

Compared to large companies, SMEs enjoy a number of significant advantages. 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.

Being small and focused players, they possess greater flexibility and speed. They can learn and absorb new technologies more efficiently. Due to limited administrative expenses, they have lower overhead costs. Once they establish their credentials in a supply chain, they win the confidence of their customers and move up the technology ladder. Thus the cycle continues.

All major defence contractors are integrators who procure sub-assemblies and sub-systems from SMEs to configure defence systems as per the required performance parameters prescribed by the buyers. Supplies by SMEs can be of the items which are manufactured by them as per the engineering documentation provided by the contractor; items whose development and manufacture is sub-contracted by the contractor to SMEs based on his procurement drawings/specifications; and items sourced by contractor against his procurement specifications as ‘fully finished’,  with IPR resting with the SME concerned.

Challenges Faced by SMEs

SMEs are small players with limited resources and cannot compete on their own. Defence business is characterised by long and complex procurement procedures. In the case of developmental contracts, time lag between R&D and returns can be excessively long. Due to the uncertainties of defence business, many SMEs find investment risks to be dissuasive. While venture capital is not easily available, banks are reluctant to lend. Resultantly, SMEs lack adequate financial endurance for long term sustainment.

Being deficient of adequate resources, most SMEs fail to gather timely information about future capability requirements and perspective plans. Consequently, they are unable to do advance planning for impending business opportunities. They know little about the business opportunities available in the foreign markets. At times, due to the lack of adequate visibility, they get overlooked by default.

As the government 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. For SMEs operating in niche segments, economies of scale is a matter of serious concern.

Abysmal Neglect of Indian SMEs

India has failed to recognise the potential of SMEs in defence production. It has neither provided facilitative environment to them nor tapped their huge technological prowess. Neglect of SMEs has resulted in our failure to create, stimulate and nurture an environment of innovations in the Indian defence industry. It is one of the primary reasons for the dismal state of India’s defence industry – more than 70 percent of defence requirements have to be imported even after six decades of independence.

Although SMEs have been supplying sub-assemblies and components to the public sector entities for decades, they continue to be peripheral players and produce low-tech items. Their technological competence has not kept pace as they have never been encouraged to invest in developing newer 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 the Defence Procurement Manual (DPM). Whereas DPP focuses only on major contractors and system integrators, DPM lists 358 items that have been reserved for SMEs and micro enterprises. The list is common to all government procurements and has no specific application for defence.

The reserved 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 the Government considers SMEs to be fit for commonplace products only. It does not recognise their potential for technology upgradation and innovation.

The much awaited Defence Production Policy was released on 13 January 2011. It assigned the role of indigenisation (import substitution or duplicating imported components) to SMEs. Once again, it showed Government’s lack of faith in the capabilities of SMEs to develop and master high-end technologies. That has been the bane of SMEs in India. 

 

Interestingly, 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, three years have passed and the promised fund is yet to be set up. 

According to DPP-2013, Small Industries Development Bank of India (SIDBI) has decided to set aside an amount of Rs 500 crore for providing loans. Further, a fund of Rs. 50 crore out of ‘India Opportunities Fund’ (managed by its subsidiary SIDBI Venture Capital Ltd) has been earmarked for equity support. Thus regular supply of funds to SMEs involved in the manufacture of defence products has been promised. However, SMEs are cautiously optimistic as there is a huge gap between promises and implementations.

Business Opportunities for Indian SMEs in the Defence Sector

Although enormous opportunities exist for SMEs in the Indian defence sector, they need support and encouragement to thrive and deliver. 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. 

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.

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.

Nearly 50 percent of the defence equipment held by the Indian armed forces is close to becoming obsolescent and needs upgradation for the extension of its useful life. It is estimated that business opportunities worth USD 10 billion exist in this segment. As such programmes entail multiple technologies; SMEs can profitably participate in them.

With India preferring ‘Buy (Indian)’, ‘Buy and Make (Indian)’ and “Make’ routes for defence procurements, Indian companies will have to assume the role of systems integrators. They will need to source required components, sub-assemblies and sub-systems from Indian vendors to meet stipulations of indigenous content. As the world trade is heading towards the ‘Global Village’ concept, highly competitive SMEs can establish themselves in worldwide supply chains by exploiting their specialised knowledge and skills.

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. India has a huge inventory of expensive imported equipment that requires regular backup support to include periodic maintenance, repairs and overhaul. It is likely to generate business worth USD 1.2 billion over the next 10 years.

Similarly, 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. The Defence Offset Policy allows a multiplier of 1.5 in case foreign vendors choose SMEs as their Indian offset partners. 

Homeland security is another area where defence SMEs can prosper. Unfortunately, inadequate attention is being paid to the fact that a large number of items are common to both the armed forces and the internal security organisations. They include weapons and protection systems, both for individuals and vehicles; communications, data transmission systems and mobile command & control equipment; explosive sensors and disposal equipment; early warning security and surveillance systems; radio interceptors and jammers; decontamination systems; and simulators for training. Most items are produced by SMEs.

The Ministry of Home Affairs (MHA) is responsible for India’s internal security and has a number of central police forces under it for special tasks and to supplement states’ resources. As maintenance of law and order is a state subject, all states maintain considerable police, armed police and special police forces. India has 28 states and 7 Union Territories. Provisioning and procurement of all items for the modernisation of central police forces is handled by the Police Modernisation Division (PMD) of MHA. PMD also assists and oversees modernisation of state police forces, although most of the procurements are carried out by the state governments. 

According to reports appearing in the press, the Union Government is likely to spend over USD 7.5 billion and state governments close to USD 2 billion on the modernisation of their police organisations in the near future. Commonality of equipment held by the defence forces and the internal security organisations will ensure continuous flow of orders to SMEs and help them to achieve economies of scale.

The Way Forward 

India needs to improve the competitiveness of its SMEs and enhance their role in the Indian defence industry. A supportive and facilitative environment is essential for tapping the enormous potential of SMEs.  Dynamics of defence industry pose atypical challenges to their sustenance and growth. To surmount them, regular interaction is necessary between different stake holders for bridging the existing communication gap and speedy evaluation of newer ideas and their optimum exploitation through appropriate adoption. 

To start with, the Government should evolve a national policy to nurture and protect SMEs in the defence sector with time-bound action plan. SMEs must be assured of continuity of policy; fairness and transparency of evaluation process; and probity of the whole environment.

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. Information regarding future capability requirements and impending tenders should be disseminated through fortnightly electronic bulletins, as is done in many countries. A data base should be prepared of all SMEs in the defence sector with their capabilities duly highlighted. Defence Offsets Management Wing should have a section exclusively to help SMEs with offset opportunities. 

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. As SMEs lack resources to be able to compete on their own, collective assertion is essential. They should organise themselves into focused associations and clusters. It will help them to pool their resources to reduce overheads and increase R&D spending to move up the technology ladder. SMEs should improve their visibility and position themselves in niche areas of their specialised knowledge and skills.

Finally and most importantly, it is for SMEs have to be capability driven, competent and competitive. They have to establish their credibility for performance, quality assurance and timely supplies. Hand-holding by the Government cannot be a substitute for commitment to excel. No external support can sustain SMEs that fail to innovate continuously to improve their niche expertise. Competition is tough and defence technology becomes obsolescent rapidly. As is commonly said – ‘there is no place for laggards in the defence business’.*****