Defence ministry unveils “strategic partner” policy for defence production

By Ajai Shukla

Business Standard, 12th May 17

On Thursday, before a closed-door gathering of private defence industry chiefs in New Delhi, the ministry of defence (MoD) unveiled its long-delayed policy for identifying “strategic partners” (SPs) – chosen companies that will partner global “original equipment manufacturers” (OEMs) in building defence platforms in India.

While the MoD has not released details of the new policy, three individuals present at the meeting have shared with Business Standard the new policy’s scope, and the criteria and procedures for selecting SPs and foreign OEMs that they would partner.

The policy’s initial aim is to shortlist six top companies as SPs in four technology segments – single engine fighter aircraft, helicopters, submarines and armoured fighting vehicles. A company can be nominated an SP in only one segment, and will have to indicate its preferences while applying.

In 2015, the Dhirendra Singh Committee had recommended selecting SPs to build defence equipment. Last year the VK Aatre Task Force laid down criteria for selecting SPs in ten technology segments, including aero engines, artillery guns, ammunition and smart materials. For now, however, the SP policy has been confined to just four segments to cater for urgently needed battlefield equipment.

This includes single-engine fighters, for which the air force has already initiated procurement. The navy has framed its requirements for its next six submarines under Project 75-I. And the army, after exploring the indigenous option of developing its Future Main Battle Tank with the Defence R&D Organisation, has changed its mind and issued specifications for buying foreign tanks.

For these procurements, which will all involve substantial in-country manufacture, the new policy envisages shortlisting Indian SPs and foreign OEMs through separate, but simultaneous, processes.

Shortlisting of Indian SPs

The first six SPs will be chosen from amongst Indian private firms in a two-stage process. To make it past the “first gate”, aspirant companies would have to meet stipulated financial and technical criteria. They must be Indian companies, as defined in the Companies Act, 2013; and have no more than 49 per cent foreign holding, with no “pyramiding” of foreign holding.

The MoD’s stipulated financial criteria weed out all except large, established firms. These include: consolidated turnover of at least Rs 4,000 crore rupees for each of the last three financial years; capital assets of Rs 2,000 crore; and a minimum credit rating of CRISIL/ICRA “A” (stable).

The MoD will also consider companies’ records of wilful default, debt restructuring and non-performing assets.

Companies making it past the “first gate” would undergo “site verification” in what is termed “Stage II evaluation”. A MoD team would visit company facilities to evaluate financial parameters and technical capability, with equal weightage given to both.

In this second round of financial evaluation, it will be ensured that the applicant company’s solvency ratio (external debt to net worth ratio) is no higher than 1.5:1; and its modified solvency ratio (external debt plus financial guarantees to net worth ratio) is no higher than 2.5:1. The debt to EBIDTA (earnings before interest, depreciation, tax and amortisation) ratio can be no higher than 3.

The “technical evaluation” will scrutinise the companies’ projects (launched, on-going, and also completed) over the last five years; the vendors it has developed; its research & development (R&D) budget and successes; certification and accreditation; and the number of certified quality auditors and quality assurance/control professionals as a percentage of its total employees.

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Strategic Partner requirements

Financial criteria	Technical criteria
Stage I evaluation
Should be an Indian company, as per Companies Act, 2013	Company should demonstrate “system of systems” integration capability
More than 50% capital owned by Indian citizens or companies
Controlled and managed by Indian residents
Majority Indian representation on Board of Directors
Maximum 49% FDI in company, without pyramiding
Consolidated turnover of at least Rs 4,000 crore for last three years
Capital assets of at least Rs 2,000 crore
Minimum credit rating of CRISIL/ICRA “A” (stable)
Will consider past record of wilful default, debt restructuring and non-performing assets
Stage II evaluation
Company’s solvency ratio (external debt to net worth ratio) no higher than 1.5:1	Company projects (launched, on-going, and completed) over the last five years
Modified solvency ratio (external debt + financial guarantees to net worth ratio) no higher than 2.5:1	Certification and accreditation; and the certified quality auditors as a percentage of total employees
Debt to EBIDTA (earnings before interest, depreciation, tax and amortisation) ratio no higher than 3	Research & development (R&D) budget as percentage of turnover; and R&D successes in last 5 years
Return on invested capital (RoI): EBIDTA divided by average invested capital	Vendors the company has developed
	CAPEX for plant and machinery annual and aggregated (for last 5 years)

Shortlisting of foreign OEMs

OEMs for each weapons platform will be selected primarily based on the “range and depth of transfer of technology” they offer India. The indigenous content they propose, the eco-system and supplier base they will develop, their plan for skilling Indian workers and future R&D in India will be evaluated in shortlisting OEMs.

Preferably two or more OEMs will be shortlisted for each technology segment, but acquisitions will be taken forward even if just a single OEM makes the cut.

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Shortlisting of foreign OEMs

Main factor: range, depth and scope of technology transfer offered to Indian SP

Extent of indigenous content proposed

Extent of eco-system of Indian vendors

Measures to support SP in integrating platform

Plans to train skilled Indian manpower

Extent of future R&D planned in India

Finalising a procurement

Once a shortlist of SPs and OEMs is available in a particular technology segment, the MoD can proceed with procuring that platform by issuing a “request for proposals” (RFP) to SPs in that technology segment. The RFP will mention shortlisted OEMs, so that the SPs can engage with them, choose an OEM partner, and submit an offer in collaboration with that company.

The MoD would then evaluate the offers, giving 80 per cent weightage to the price bid and 20 per cent to “segment specific capabilities”. The winning company, which has the best aggregate score, would have to sign a contract that includes a ten-year “performance based logistics” contract (which guarantees a certain equipment availability at all times), life-cycle support, including the establishment of testing and proving laboratories, and equipment upgrades further down the line.

After the meeting, a MoD release stated: “Industry representatives welcomed efforts of the Ministry to put in place such a framework and offered several positive and constructive suggestions. The Ministry has taken due note of these proposals, which would be considered while finalising the policy in this regard.”

Sources say the policy, largely in its present form, will be cleared in a meeting of the MoD’s apex Defence Acquisition Council on May 15.

The finalised SP policy will be included as Chapter VI of the Defence Procurement Policy of 2016, which was published last year with Chapter VI blank.