Avascent is the leading manage-ment and strategy consulting firm advising clients who serve govern-ment and related commercial markets.

Avascent’s work is focused on driving strategic growth and value capture for our clients.

We help senior executives define and act decisively on their growth agenda through strategy formula-tion, new market entry, mergers and acquisitions, price-to-win and organizational development.

With a combination of core strat-egy experience, senior level advi-sors, and a proprietary 050 data product, Avascent brings deep subject matter knowledge and a pragmatic, results-oriented ap-proach to international markets.

As defense budgets flatten and decline in traditional US and European domestic markets, emerging international markets are becoming an increasingly important component of future growth forecasts for leading global aerospace & defense com-panies. While international expansion presents a number of challenges for firms, one that stands out is navigating the complex, changing, and frequently opaque offset requirements for each country. These offset policies are increasingly sophisti-cated and their enforcement is becoming more rigorous. Companies with offset strategies conceived after contract signature or lacking in analytical rigor are likely to see reduced profitability, increased exposure to risk and a potentially negative impact on the corporate brand abroad. Many leaders are beginning to grasp that changes in offset regimes will impact their international growth, although few truly understand the magnitude of this chal-lenge. While specific market data on offsets is difficult to measure comprehensive-ly, Avascent has used its proprietary 050 data tool to build a comprehensive bottom-up financial model to determine the size of global offset obligations. Avascent’s analysis shows there is going to be approximately $500 billion in global offset obligations from 2005 – 2016 (cumulative to date; future based on country by country analysis and individual company projected future sales). The magnitude of offset obligations and growth in the coming years makes this an area of strategic importance for any global Aerospace & Defense (A&D) firm looking to expand its international presence in the coming years.

Foreign customers are moving away from penalty pay-ment schemes that allow obligors to indefinitely postpone the fulfillment of their offset obligations. Many foreign customers are also increasing the value of sales subject to offsets, with some requiring obligations equal to or ex-ceeding 50 percent of an awarded contract’s total non-indigenous value. This trend is especially true for larger, more prominent programs. As countries become stricter about implementation timelines and more demanding in the make-up of their desired offset output, A&D firms are struggling to develop effective plans to manage their obli-gations. The challenging offset environment is compounded by poor data on global offset obligations, which constrain the ability of obligors to as-sess the magnitude of the challenge and develop efficient and holistic discharging strategies. Avascent conducted research into the current state of offset obligations to arm obligors with a foundational un-derstanding necessary to begin thinking strategically and creatively about how to discharge current and future obli-gations. Bearing in mind the opaque character of this marketplace, Avascent estimates show that over the last seven years (2005 – 2011) ap-proximately $214 billion in total offset obli-gations were generated around the world. While exact figures on the scale of dis-charged obligations are not publicly availa-ble, anecdotal evidence suggests a signifi-cant portion remain outstanding. Driven by pockets of strong spending in the Middle East, Asia and Latin America, and by the pro-liferation of increasingly complex and de-manding offset policies, firms are expected to accumulate an additional $225 billion in offset obligations on new sales through 2016. The analysis of global offset markets is divid-ed into four regions: Middle East and North Africa (MENA), Asia, Europe & Canada, and Latin America, each of which is evaluated individually to generate growth rate forecasts for total new obligations and which high-light important country and region-specific trends.

Data on offset obligations are derived from Avascent 050, a proprietary database and decision support tool on inter-national defense sales. Using past and projected future sales as the baseline, Avascent derived offset obligations:

Defined sales for countries with active offset policies from 2005-2016

Segmented sales by contractor, country, size and sales type Applied country specific offset criteria Adjustments to Avascent’s projections were made for sales not subject to offset (e.g., trade between members of the European Un-ion) and for programs where a sale is antici-pated in the future, but no contract has been awarded.

New obligations derived from Middle Eastern countries are estimated at over $12 billion in 2011 and will exhibit an 8% CAGR through 2016. This growth is primarily driven by the UAE and Saudi Arabia, both of which have devel-oped more sophisticated offset policies that largely em-phasize social and economic sector interests and the attainment of advanced technologies. For example, UAE’s revamped offset guidelines emphasize profits from newly

formed offset ventures, job creation for Emirati nationals and the transfer of exporta-ble technologies and capabilities. Other Mid-dle Eastern countries with robust offset poli-cies include Kuwait, Turkey, and Israel. From 2005 to 2016, an estimated $156 billion worth of cumulative new offset obligations will be accumulated by contractors, a formidable sum to absorb by an economically diverse and fairly sparsely populated region

Offset obligations derived from Asian coun-tries are estimated at approximately $10 bil-lion in 2011 and will exhibit a 5% CAGR on new obligations generated each year through 2016. Asian offsets are dominated by the two vastly different offset regimes of India and

South Korea, which collectively comprise approximately 60% of the region’s offset obligations. India’s offset policy has proven a challenge for aerospace & defense firms as it does not award multipliers nor qualify technology transfer for offset credits, but does require local partnership for

foreign providers. Conversely, South Korea offers a more traditional policy, with the stated goal of building local production and excess export capacity. Other prominent Asian countries with growing offset demands are Singa-pore, Malaysia, and Taiwan. Through 2016, an estimated $122 billion worth of offset obligations will exist.

European and Canadian offset regimes will generate an estimated $10 billion in new obligations for 2011 but will exhibit only a 3% CAGR through 2016, the lowest rate of the four regions. The lower growth rate in Europe is due to efforts to control military spending and a counter offset trend, embodied in a 2008 Code of Conduct on Offsets signed by 26 European nations. Despite such develop-ments, many European countries such as Italy, Sweden, and the Netherlands have robust offset policies that de-mand indirect defense offsets as a tool for providing op-portunities to their large defense industries. Other European countries with demanding offset require-ments are Finland, Greece, Poland, Spain, and Portugal. Canada also has a sector-driven offset policy, which re-quires defense primes to place sub-contracts and invest-ments in Canada’s high-tech sectors. From 2005 to 2016, an estimated $118 billion worth of cumulative new offset obligations will have been created.

Latin American countries generated offset obligations to-taling $2.8 billion in 2011 and will exhibit a 10% CAGR

through 2016, the highest rate among the four regions. This growth will be driven by military upgrades and mod-ernization efforts in Brazil, Colombia, and Chile, which have implemented more stringent, formal offset policies over the past decade stressing local production, technolo-gy transfers, and broader social benefits. The Brazilian offset guidelines, for example, emphasize training, technology transfer, and joint development of systems to foster innovation, recently showcased in the Brazilian Air Force’s KC-390 program. From 2005 to 2016, an estimated $41 billion worth of cumulative new offset obligations will be created.

The sheer size of offset obligations (estimated at nearly half a trillion by 2016) and rapid growth in the complexity of offset policies are fundamentally reshaping the offset landscape. Current and future obligors face two main challenges in this new environment.

First and foremost, offset regimes around the world are becoming more sophisticated. Countries are seeking to pair offset policies with development objectives. These goals also vary significantly by country: Brazil is highly fo-

cused on technology transfer, while neighboring Colombia is focused on jobs and developing indigenous industries. The means by which obligors can discharge offsets is also changing. For example, the UAE recently migrated to a policy requiring the majority of credits to be generated from the net profits of offset funded startups while India does not allow for multipliers, which is a fun-damental assessment metric of virtually all other offset regimes. Finally, coun-tries are changing the amount subject to offset and enforcing previously ignored rules. An obligor could, in the past, get by paying the penalty on lapsed obliga-tions—this is no longer true for many countries.

Fundamental changes to offset regimes are exposing weaknesses in obligors’ internal capacity to discharge off-sets. Many A&D companies are in the habit of fully ad-dressing offsets only after the contract is signed and treating each obligation as a standalone event. Disjointed and ad hoc efforts are needlessly expensive and loaded with undue risk. Moreover, even those firms with a robust international sales history tend to lack internal capacity for discharging offset obligations in a holistic manner. Unfor-tunately, external support available to obligors has typical-ly lacked independent, data driven approaches based on sound business fundamentals. More often than not, the rigorous business planning that characterizes a company’s corporate development or business development strategy is not employed when it comes to fulfilling the resulting offset obligations. As A&D companies look abroad to counteract softness in domestic markets, a coherent offset strategy will become a critical enabler of success.

While countertrade and offset are familiar concepts to most A&D companies, the growing sophistication of offset regimes around the world is outpacing the internal capaci-ty of most obligors. Avascent suggests current or aspiring obligors take six critical steps to better prepare for the efficient discharge of offset obligations:

component for glob-al, regional and country-specific sales strategies; take a proactive (vice reactive) approach.

and focus on developing internal capacity for effi-ciently discharging offset obligations glob-ally; the offset strategy should guide are-as of internal capacity development. early on offsets and the benefits of a successful and proactive strategy as part of the sales capture effort. At the same time, broad-en the set of stakeholders involved in off-set discussions to include corporate strat-

egy, corporate development, and finance, particu-larly in strategically important countries.

Integrating offsets into the capture stage will have a major impact on the profitability of a contract after award and can even increase the chance of winning a contract in certain countries.

(financial metrics and planning) when developing offset concepts.

Con-sider a broader range of partners and create a ro-bust network of partners and advisors. Develop-ing a strategy for offset related partnering is a pru-dent first step.

Over the coming months, Avascent will be publishing a series of thought leadership articles on the global aero-space & defense marketplace. If you would like to discuss in more detail, contact: Jon Barney at jbar-ney@avascent.com or (202) 280-6812.

Partner directing many of Avascent’s offset and international market engagements. Contact: jbarney@avascent.com

Senior Associate at Avascent Contact: ajovovic@avascent.com

Associate at Avascent Contact: cmeissner@avascent.com

Senior Analyst

Analyst