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Saturday, January 19, 2013
Israeli Offsets Soar; More Local Firms Earn a Share of buyback business

Israel’s Offsets Soar; More Local Firms Earn a Share
Jan. 19, 2013 - 01:20PM By BARBARA OPALL-ROME
http://www.defensenews.com/article/20130119/DEFREG04/301190023/Israel-8217-s-Offsets-Soar-59-More-Local-Firms-Earn-Share

HERZLIYA, Israel — A growing number of Israeli firms are benefitting from a
threefold surge in government-pledged offsets, from $320 million in 2009 to
nearly $1 billion in 2011.

Data for 2012 are not yet available, but Israel’s Industrial Cooperation
Authority (ICA), the agency responsible for initiating, coordinating and
monitoring offsets, shows a considerable hike in local firms doing buyback
business with overseas suppliers to the Israeli government.

In 2011, overseas suppliers fulfilled $2.3 billion in offset obligations
with contracts to 554 local firms, 163 of them first-time recipients of
government-mandated countertrade. A year earlier, the ICA recorded nearly $2
billion in buyback contracts with 399 local firms, 81 of them newcomers to
government-generated offset awards.

Actual work orders typically exceed buyback levels pledged in exchange for
government purchases due to the quality and reliability of local industrial
partners, ICA Director-General Bina Bar-On told a recent industry gathering
at a Defense Ministry-sponsored conference here. “On each $1 of obligation,
we tend to secure about $3 or even $4,” she said.

Offsets are industrial compensation in return for defense purchases. Data
provided to Defense News does not offer yearly breakdowns of defense versus
civilian offsets, but Bar-On estimated defense sales generated 41 percent of
pledged buybacks and 29 percent of actual orders fulfilled from 2007 through
2011, the agency’s latest official five-year reporting period.

She attributed the relatively lower levels of actual defense-related
spending to the tendency of many large foreign firms to fulfill offset
obligations through indirect investments in Israel’s dual-use or civilian
sectors.

According to ICA data from the past five years, Israel’s computer,
communications and electronic sector claimed 27 percent of actual offset
orders, followed by aviation, metal, engineering and infrastructure,
software and biotechnology.

“We’re trying to enlarge the pool of Israeli firms enjoying the benefits
from offsets. But such benefits must be earned,” the ICA director told
business executives.

“Firms must be competitive, adhere to high standards and be responsive to
customer demands. When you do business with large overseas suppliers, there
can be no excuses. It doesn’t matter to them if a rocket fell on your
factory or that there’s a strike at the port. You’ve got to deliver,” Bar-On
said.

Israel demands a 50 percent offset commitment from overseas firms competing
for Israeli defense sales, which obliges winning bidders to contract locally
for at least half the value of awarded procurement. U.S. firms whose defense
sales are funded through annual U.S.-to-Israel aid are a major exception to
this rule.

Typically, the government requires competing firms to submit a so-called
industrial cooperation undertaking as part of their bid, with the extent of
proposed reciprocity playing a major role in the selection process.

Israeli regulations allow offsets to be satisfied over a period of years
through direct, indirect or umbrella agreements, depending on the type of
purchase and the nationality of the provider. Offsets on civil purchases by
the Israeli government, for example, are set at 35 percent. But civilian
sales by firms in World Trade Organization member countries party to a 1994
Government Procurement Agreement (GPA) are obligated at offset levels of
only 20 percent.

According to Bar-On, foreign firms can satisfy offset obligations in three
ways: through local subcontracts; through local investments in
infrastructure and research and development; and by convincing foreign prime
contractors to hire Israeli subcontractors for third-country sales.

In 2007, the government gave the ICA formal authority to cancel contracts,
impose blacklisting and take other punitive measures to enforce the
fulfillment of offset obligations.

Walking on Eggshells

However, Bar-On insists that Israeli defense purchases funded by annual U.S.
foreign military financing (FMF) aid are exempt from sanctions and 50
percent offset demands. Instead, U.S. defense firms are encouraged to
negotiate industrial participation contracts, with a reciprocal target value
of 35 percent.

“On FMF cases we walk on eggshells. There are no sanctions and no coercion…
just the expectation for industrial participation with local firms based on
merit,” Bar-On told the MoD business gathering.

In a follow-up interview, Bar-On said she is well aware of Washington’s
restrictions on direct offsets on FMF purchases, and sensitive to charges of
so-called double dipping by demands for reciprocity from U.S. defense firms
whose sales are funded by the U.S. government.

“The Americans have very clear demands that 100 percent of the work
associated with a particular U.S. defense procurement be done in the United
States. But at the same time, we found that other products and other items
of that same firm can be purchased here in Israel on the basis of quality
and competitiveness,” she said.

She added that U.S. firms often continue doing business in Israel well after
initial industrial participation obligations are fulfilled.

As an example, government and industry sources here cited the $1.4 billion
in local business generated from Israel’s 1999 purchase of 102 F-16I
aircraft. The U.S. firm fulfilled all obligations on the $4.5 billion
procurement deal in late 2004, years earlier than planned, and continues to
count Israeli subcontractors in their worldwide network of reliable
suppliers.

In the case of the Lockheed Martin F-35 Joint Strike Fighter, Israel’s MoD
announced that it had secured more than $4 billion in commitments as part of
its 2010 contract for its first 19 of a planned 75-aircraft buy. Pledged
reciprocity of some $4 billion in Lockheed subcontracts and another $1.3
billion from F-35 engine maker Pratt & Whitney are based on ultimate
procurement of all 75 F-35Is.

Government and industry sources estimate that Lockheed has actually pledged
only some $800 million in JSF-related work here, most of it associated with
supply of Elbit-developed helmet-mounted displays and a separate
wing-related production contract with state-owned Israel Aerospace
Industries (IAI).

In the case of a $735 million contract signed late last year with
Honeywell — suppliers of F124 engines powering Alenia Aermacchi trainer
aircraft — the U.S. engine firm has yet to conclude a formal buyback deal.
The engines are a major component of a nearly $3 billion reciprocal trade
package with Italy, in which Israel purchased Italian trainers in exchange
for Italian procurement of IAI-built early warning aircraft and a remote
sensing satellite.

The complex Israeli-Italian two-way trade deal was negotiated directly by
senior Defense Ministry officials in Rome and Tel Aviv. It ultimately
involved three governments, 12 aerospace firms and international banking
consortiums and, as such, was not subject to normal ICA-supervised buyback
procedures, sources here said.

“The Italian deal was viewed as a special case, since all the many
components were so closely interlinked,” said Avner Raz, president of Elul
Tamarynd, the Tel Aviv-based firm representing a long list of U.S. and
international firms, including Honeywell.

“But just because a buyback package, per se, did not immediately emerge from
the engine component doesn’t mean that Honeywell doesn’t intend to take
advantage of the added-value to be had from our local industries… Honeywell
is planning significant investment here on its own initiative, without being
forced by the government to do so,” Raz said.

Benny Barak, who manages Honeywell activities here on behalf of Elul
Tamarynd, said senior executives from the U.S. firm made multiple visits
here in the past year with an eye toward expanding the more than $200
million already invested in the local market.

Yet another buyback deal stemming from an Israeli FMF purchase involves
General Dynamics Land Systems (GDLS), which is producing major components
for the Israeli Namer heavy troop carrier at its Lima, Ohio, facility. GDLS
committed to $160 million in local business associated with the government’s
initial 2010 Namer production contract, with buyback orders slated to
benefit some 60 small- and medium-sized firms, sources here said.

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