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QUESTION: Why do governments typically take an unsupportive stance on countertrade arrangements?

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The Bell Boeing V-22 Program, a strategic alliance between Bell Helicopter, a Textron Company, and the Boeing Company,1,2 announced the V-22 Osprey tiltrotor will be featured at the Dubai International Air Show in the United Arab Emirates (UAE) from November 13 to 17, 2011. The Air Show, held biennially, is organized in cooperation with the government of Dubai, the Department of Civil Aviation, and Dubai International Airport in collaboration with the UAE Union Defense Forces. Now in its 22nd year, the Dubai Air Show is one of the world’s fastest growing aerospace events with industry and government participants from around the world.3 The Air Show offers an excellent opportunity for Bell Boeing to showcase the Osprey’s one-of-a-kind tiltrotor capability.

The V-22 is a hybrid aircraft combining helicopter and traditional winged aircraft performance. The engines and rotor blades point vertically up (like a helicopter) to allow the aircraft to take off and land vertically without need of a runway. Once off the ground, the massive engines and rotor blades begin to tilt forward to propel the aircraft upward and forward, gaining lift from the aircraft’s wing as it speeds forward. In about a minute, the engines and rotor blades tilt to full forward flight, allowing the aircraft to fly with the speed and the efficiency of a traditional winged airplane. When in flight, the aircraft can slow, tilting its engines and rotor blades back to vertical, so the aircraft can hover or land like a traditional helicopter. This hybrid tiltrotor capability is an attractive solution for customers requiring helicopterlike vertical take-off and landing capability but seeking the longer range, higher speeds, and larger payloads of a traditional winged airplane.

The multicapable V-22 provides operators with tremendous flexibility for military and humanitarian missions. Mission flexibility is the basis of the value proposition for the tiltrotor V-22 Osprey. To understand the mission flexibility value proposition, one only needs to look at the variety of customers considering the V-22. In the United States, the U.S. Marine Corps uses the V-22 as its primary amphibious air assault vehicle to transport troops and equipment from ships to the battlefield. The U.S. Air Force Special Operations uses the V-22 for worldwide deployment of U.S. Special Forces. The United Kingdom’s Royal Navy has evaluated the V-22 for maritime airborne surveillance and control operations to replace its aging Sea King helicopters, while the Royal Norwegian Air Force included the Osprey as a candidate for the Norwegian All Weather Search and Rescue Helicopter. Recent media reports suggest the Israeli Defense Forces are considering theV-22 for their own special-operations forces and for combat search-and-rescue missions. This hybrid tiltrotor aircraft is being considered to replace existing helicopters and winged aircraft, as well as to perform missions that helicopters and winged aircraft are not able to perform.

Defense and commercial trade offsets are valued in the tens of billions of dollars each year and often accompany the export of advanced technological goods. An offset is any type of nonmonetary compensation that a procuring government requires an exporting firm to provide as a condition of the sale and generally commits the exporting firm to spend a certain percentage of the value of the sale in the procuring country. Although U.S. defense firms generally see offsets as a reality of the marketplace in order to compete for international defense sales, the U.S. government’s lack of a proactive policy that addresses the impact of offsets may undermine its economic and national security interests.

Obligations are imposed on the seller in major (most often military hardware) purchases by or for foreign governments to minimize any trade imbalance or other adverse economic impact caused by the outflow of currency required to pay for such purchases. In wealthier countries, offsets are often used for establishing infrastructure. Two basic types of offset arrangements exist: direct and indirect. Although offsets have long been associated only with the defense sector, there are now increasing demands for offsets in commercial sales where the government is the purchaser or user.

The Bureau of Industry and Security (BIS) collects data annually from U.S. firms involved in defense exports with associated offset agreements in order to assess the impact of offsets in defense trade. In 2009, U.S. defense contractors reported entering into 56 new offset agreements with 21 countries valued at $6.69 billion. The value of these agreements equaled 62.65 percent of the $10.68 billion in reported contracts for sales of defense articles and services to foreign entities with associated offset agreements. In 2009, U.S. firms reported 664 offset transactions (transactions conducted to fulfill offset agreement obligations) with 28 countries with an actual value of $3.50 billion and an offset credit value of $4.04 billion. During 2009, reported offset agreements ranged from a low of 9 percent of the defense export sales contract value to a high of 128.6 percent.

Direct offsets consist of product-related manufacturing or assembly either for the purposes of the project in question only or for a longer-term partnership. The purchase therefore, enables the purchaser to be involved in the manufacturing process. As an example, various Spanish companies produced rudders, fuselage components, and speed brakes for the Spanish Air Force’s EF/A-18s. In addition to component coproduction, complete products are produced under license. Examples of these include Egyptian production of U.S. M1-Al tanks, Chinese production of 719 aircraft, and Korean assembly of F-16 fighters. An integral part of these arrangements is the training of the local employees. Training is not only for production and assembly purposes but also for maintenance and overhaul of the equipment in the longer term. Some offsets have buyback provisions; that is, the seller is obligated to purchase output from the facility or operations it has set up or licensed. For example, Westland takes up an agreed level of parts and components from the Korean plant that produces Lynx Helicopters under license. In practice, therefore, direct offsets amount to technology transfer.

Indirect offsets are deals involving products, investments, and so forth that are not to be used in the original sales contract but that will satisfy part of the seller’s “local” obligation. Direct purchases of raw materials, equipment, or supplies by the seller or its suppliers from the offset customer country present the clearest case of indirect offsets. These offset arrangements are analogous to counterpurchases and switch trading. Sellers faced with offset obligations work closely with their supplier base, some having goals of increasing supplier participation in excess of 50 percent. Teamwork can make the process more effective and efficient. As an example, a seller or supplier may have a business transaction in a specific country, but the company has no offset obligation in that country. A second seller or supplier, through a credit agreement, may be allowed to use the initial company’s transaction to fulfill the second seller’s indirect offset obligation.

Many governments see offsets as a mechanism to develop their indigenous business and industrial sectors. Training in management techniques may be attractive to both parties. The upgrading of skills may be seen by the government as more critical for improving international competitiveness than efforts focused only on hardware. For the seller, training is relatively inexpensive, and training is often perceived to be politically desirable by government buyers.

An important dimension of the developmental effort will relate to exports. This may involve the analysis of business sectors showing the greatest foreign market potential, improving organizational and product readiness, conducting market research (e.g., estimating demand or assessing competition), identifying buyers or partners for foreign market development, or assisting in the export process (e.g., company visits, support in negotiations and reaching a final agreement, facilitating trial/ sample shipments, handling documentation needs).

Sales are often won or lost on the availability of financing and favorable credit terms to the buyer. Financing packages put together by one of the seller’s entities, if it is critical in winning the bid, will earn offset credits. Sellers also can offer financing assistance to help close third-party transactions for industries in buyer nations. In these cases, credit is based on the value of the third-party transaction.

Buyer nations focusing on industrial development and technology transfer have negotiated contracts that call for offsetting the cost of their purchases through investments. Recently, Saudi Arabian purchases of military technology have been tied to a seller’s willingness to invest in manufacturing plants, defense-related industries, or special-interest projects in the country. British Aerospace, for example, has agreed to invest in factories for the production of farm feed and sanitary ware.

Most often, the complete offset package includes a combination of activities, both direct and indirect visà-vis the sale, and no two offset deals are alike. With increasing frequency, governments are requiring predeal counterpurchases as a sign of commitment and a demonstration of a seller’s ability to deliver a successful offset program should the seller be awarded the contract. Some companies, such as United Technologies, argue there is limited advantage in carrying out offset activities in advance of the contract unless the buyer agrees to a firm commitment. While none of the bidders may like the advanced contract offset requirement, buyer’s market conditions give bidders very little leverage to argue. If a bidder loses the deal, it can attempt to sell its offset credits to the winner or bank its credits for a future sale.

While previous deals were executed on a one-on-one basis, the government now wants, through the use of multipliers, direct purchases to certain industries or types of companies. For example, in the case of small- or medium-sized companies, a multiplier of two may be used; that is, a purchase of $500,000 from such a firm will satisfy a $1 million share of the counterpurchaser’s requirement. Attractive multipliers also may be used that may generate long-term export opportunities or support indigenous arms or other targeted industry. Similarly, the seller may also insist on the use of multipliers. In the case of technology transfer, the seller may request a high multiplier because of the high initial cost of research and development that may have gone into the technology licensed or provided to the joint venture as well as its relative importance to the recipient country’s economic development.

With the speed of an airplane and the vertical agility of a helicopter, the V-22 Osprey is a true multimission aircraft. An Osprey can carry 24 combat troops, 20,000 pounds of internal cargo, or 15,000 pounds of external cargo using its vertical takeoff and landing capabilities. On the ground, the rotors can fold and the wing rotate to parallel the fuselage so the aircraft can be stored compactly aboard an aircraft carrier or assault ship. The aircraft also can be refueled in air to provide worldwide self-deployment.

The V-22 provides a significant increase in operational range over the legacy helicopters it will replace. It also is the only vertical-lift platform capable of rapid self-deployment to any theater of operation worldwide. Current variants with the U.S. Marine Corps and U.S. Air Force provide the following multimission capabilities: ? Amphibious assault ? Combat support and transport ? Long-range special ops infiltration and exfiltration ? Combat search and rescue ? Medevac

The Boeing Company is responsible for design and production of the fuselage, the empennage, the avionics, and other subsystems contained in the fuselage. Boeing’s partner, Bell Helicopter Textron, Inc., is responsible for the design and production of the wing, transmissions, and rotor systems and for the aircraft final assembly.

The United States government maintains a “hands-off” policy regarding offset negotiation and implementation.6 This approach creates a situation where offset agreements and the impacts from these agreements are determined by the private sector firms’ and the international customer nations. Essentially, the federal government has ceded its policymaking and regulatory authority over offsets to market participants. The United States is likely to continue to experience offset arrangements running counter to U.S. interests because the goals of private sector firms and other governments are not necessarily aligned with U.S. economic and national security interests.

Defense offsets can have an adverse impact on national security. First, offsets may undermine national security interests if they exacerbate the decline in the defense industrial base or disrupt critical parts of the defense supply chain. Second, offsets may undermine national security if the offsets result in the loss of critical skills in the defense industry’s workforce that cannot later be replaced or expanded quickly. And third, while the United States has export licensing requirements, offsets multiply the chances that “leading edge weapons and the technology for producing them” may go to countries that represent a threat to U.S. national security interests.

Despite the risks that are raised by the use of offsets, the United States has yet to develop a proactive offset strategy. Therefore, the Department of Commerce, tasked with monitoring defense offsets, should take the lead in developing a comprehensive, proactive strategy to identify the policies and the actions necessary to address the risks posed by defense and commercial trade offsets. Moreover, this offset strategy should be developed as expeditiously as possible and incorporated in national strategy documents as appropriate.

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