Increased defence budget and shift in government policy may provide non-PSU players an opportunity for unprecedented growth
By Sudeshna Das
Friday, June 19, 2009: Contrary to general perception, strategic electronics has already faced a paradigm shift due to participation of private players along with public-sector units (PSUs), even though a major part of the market is yet to explode in the country.
According to Department of Information Technology (DIT), in the year 2007-08, production of strategic electronics in India was approximately Rs 61 billion, showing a growth rate of around 35.6 per cent.
As per Sujoy Ghosh, project director, TATA Power, strategic electronics division, “Defence electronics is a strategic industry—more than mere commerce. Issues of obsolescence, technology denial and restricted trade operate here. Moreover, defence electronics is monopsony—government is the market and the market maker.”
In reality, this market is entirely governed by defence policy. In spite of being a continuous victim of terrorism, India’s defence policy has remained apparently defensive in orientation. It is only recently that the government has jacked up defence spending by 10 per cent to $26.4 billion—the steepest hike since partition of the subcontinent to fund a mammoth modernisation programme.
India plans to spend at least $30 billion additional until 2012 to modernise the military with an immediate purchase of 126 war jets costing $12 billion followed by ships, submarines, artillery and other hardware in coming years. The government has set aside $12 billion for arms purchases during the current fiscal year after the assurance that the armed forces will not face funds shortages in the drive to upgrade material.
Sharadhi Chandra Babu P., vice-president (corporate), business development and technology, Axis Aerospace and Technologies, expects that at least one-third of the total defence budget will be spent on capital acquisition. It may attract private players to explore this field more than before.
This, along with a restriction of FDI (not more than 26 per cent), is likely to bring enormous growth opportunity for indigenous strategic electronics manufacturers.
A glimpse into the market
Rapid advances in strategic electronics have radically changed the course of the industry and business. With the government all set to provide hitherto unbelievable licences, this industry is going to be a minefield for the entrepreneurs.
For example, the Tata Power SED, a leading domestic player in strategic electronics recognised for harnessing its systems and engineering capabilities, is emerging as a prime contractor to the Ministry of Defence (MoD) for indigenous defence electronics production with some special licences.
Ghosh declares, “Over the next five years these licences will open a domestic addressable market of over Rs 200 billion for Tata Power SED, which includes upgrades of existing platforms.”
The strategic electronics industry comprises lead system integrators (tier-I class) and component and sub-system manufacturers (tier-II class). System integration with outsourced components and sub-systems is the most viable business option in this segment. Components need huge production size but the chances of discouraging factors like volume rejection and technology obsolescence are limited. Sub-systems may require a good design and technology base.
Business model
After 1990, in the post-cold war era, traditional defence business model has evolved to a great extent. Domestic business focused on platforms and exports at marginal cost and improved returns are no longer regular practices. The accelerated rate of change in civilian technology is also reflected in the military systems. More and more commercial off-the-shelf (COTS) systems are replacing the old made-in-lab (MIL) systems. Nonetheless, associated with this shift are rising costs and complexities.
A well-known veteran from this field, Col. Kuber, vice-president, aerospace and defence advisory service, Religare, points out, “Public-private partnership with mission-based procurement, joint development of system architecture and integration of niche capability-based services and component suppliers may create a realistic approach to cope up with the changed business environment in the strategic electronics industry.”
His comment is supported by the success story of Axis Aerospace and Technologies. This premier supplier to ministry of defence (MoD) follows a hybrid model of organic and inorganic growth. They nurture several boutique technology firms either through acquisition or partnership. This reduces their R&D investment to a great extent.
Moreover, adoption of a new approach towards the procurement of weapons and systems is significant. In the near future, the warfighting-capability-driven approach can play a key role in the ecosystem rather than the existing general staff qualitative requirement based one.
Value chain
The “create true value first and then create an illusion of even greater value” approach of the consumer electronics industry is not applicable to the strategic electronics industry. Here an entrepreneur is expected to support near-to-future technology at the same time. The return on investment is associated with an exceptionally high silent period. These contradictory situations put India in a unique position in the global value chain. India’s legendary knowledge edge and its skilled, industrious manpower are right now upgrading it to high end as far as innovation is concerned. At the same time, the pace of development is not up to the mark due to high investment crunch.
In the value proposition term, a significant change has been observed in the last five years. Preference for domestic route over the import of technology is increasing. A steady shift towards ‘develop and make’ model is prominent from the previous ‘buy’ and ‘buy-and-make’ policy. As a result, the opportunities for the Indian talent pool are also increasing. Moreover, this new model has opened up opportunities for private players and even for the SMEs to act as prime contractors (overall responsibility), sub-contractors for design, sub-contractors for production, specific component suppliers, etc. Even the public-private partnership concept may be strengthened by sharing of prototype making and serial production activities.
In this scenario, a customised value-chain transformation is the best way to savour the changes.
Tectonic shifts in technology
No doubt, extreme dependence on technology and innovation brings continuous changes on the strategic electronics technology front. Not only the products but the testing tools are also evolving as per the stringent quality standard requirements.
Kuber sees 3G platform-based night-vision devices, non-interfering sonars and battlefield radars as the important fields requiring technological upgradation. He also puts an extra emphasis on communication technologies.
According to Ghosh, “ICTE is at the heart of network-centric operations and a force multiplier.”
For the next five years, non-platform and non-weapon based major ICTE programmes in the MoD pipeline will require over Rs 200 billion. These programmes will focus on development of tactical communication systems and battlefield management systems for the army. The other areas demanding technology upgradation are electronic warfare, Net-centric operations for navy, naval combat systems, air defence and operational data link upgrades, radar and sensor modernisation, naval combat systems and artillery and tanks systems.
Return on investment
and managing director, Alpha
Design Technologies
The return on investment (ROI) in strategic electronics depends on MoD’s procurement and offsets. The Indian defence follows a procurement policy with a room for every business model: ‘buy’ (from Indian or global firms) with a minimum of 30 per cent from indigenous sources, ‘buy and make’ (local production) with 30 per cent complete knockdown (CKD) products and 60 per cent IM products of indigenous origin and ‘make’ (through DRDO) with a 80:20 funding option with major share from the government side.
Additionally, business opportunities through OFFSET (as set out in MoD’s Defence Procurement Procedure DPP 2006) for systems design, engineering and testing services may also be targeted by the companies, opening up the export market.
As per DPP 2006, there is an option of offset to the extent of 30 per cent of the total foreign exchange. It involves export of products, components and services, investments in industrial infrastructure for services, co-development, joint ventures and co-production of defence products and components.
So high ROI is confirmed. But, it also requires high endeavour. For all the models, the ROI is preceded by a long silent period. “There is no possibility of Q1, Q2, Q3 type returns,” says Kuber.
Axis had to wait for two years before getting its first order. So long gestation period, along with the need of high-technology expertise and high capital investment, may create some challenges for the new entrepreneurs.
“Strategic electronics players need persistence, perseverance and patience. Long gestation periods and lots of investments are needed for long-term projects. There are no quick-fix solutions,” opines Col. (retd) H S Shankar, chairman and managing director, Alpha Design Technologies.
The scenario, however, seems quite enthusiastic after the silent period. Kuber explains that any organisation may elevate from original small-scale phase once it reaches the ROI period. For any serious venture in this sector, he also recommends to try for defence funding options.
Vision needed
“With network-centric operations being a force multiplier for modern warfare, India is in a unique position to leverage its world-class ICTE capabilities to create a world-class strategic electronics industry and boost the GDP and employment,” says Ghosh.
In fact, the Indian government has to pledge an ecosystem to support indigenous defence products with a clear published roadmap. All ICTE programmes that are non-platform/non-weapon based need to be opened up for the industry participation on competitive basis so that products can be developed locally and sold globally. There should be no PSU reservations.
Though immediate reduction in imports is quite difficult, for self-reliance channelised imports are important.
Ghosh suggests that a clear roadmap of import reduction by the MoD needs to be published and audited by CAG, with aggressive targets for the ICTE sector.
It is clear that India needs investments in components and composites. So wherever such investments come with full intellectual property right control, no ‘end-use’ restriction should be imposed to ensure more participation of Indian firms in strategic electronics.
Quotes
Defence electronics is a strategic industry—more than mere commerce. Issues of obsolescence, technology denial and restricted trade operate here. Moreover, it is monopsony—government is the market and the market maker
—Sujoy Ghosh, project director, TATA Power,
strategic electronics division
Public-private partnership with mission-based procurement, joint development of system architecture, and integration of niche capability-based services and component suppliers may create a realistic approach to cope with the changed business environment in strategic electronics
—Col. Kuber, vice-president, aerospace and
defence advisory service, Religare
Strategic electronics players need persistence, perseverance and patience. Long gestation periods and lots of investments are needed for long-term projects. There are no quick-fix solutions
—Col. (retd) H S Shankar, chairman and
managing director, Alpha Design Technologies
Electronics Bazaar, South Asia’s No.1 Electronics B2B magazine
