Spurring demand in Strategic Electronics

India’s strategic electronics ecosystem has evolved a lot in the last one year with the amendment of the defence procurement policy (DPP) and the foreign direct investment (FDI) policy. Here is a sneak peek into how the changed ecosystem will create opportunities for building self-reliance and promoting growth in the field of defence electronics

By Sudeshna Das

The Indian strategic electronics (SE) sector, mainly comprising aerospace and defence, has the potential to become a vibrant industry in India over the next 10 years. India is the seventh largest aerospace and defence (A&D) market globally. The budget is sizeable and spread across the requirements of the country’s army, navy and air force. India needs to modernise its A&D capital equipment base by addressing obsolescence as well as building additional capability through new capital acquisition. This requirement is also supplemented by additional budgetary allocations from the Ministry of Home Affairs for paramilitary and state police force requirements. All of this results in India being quite attractive as an A&D electronics market.
Considering the importance of the strategic electronics industry in the electronic system design and manufacturing (ESDM) ecosystem, the September 2015 issue of Electronics For You published an article titled, ‘An Outlook for the Indian Strategic Electronics Sector’. However, given that the defence electronics industry ecosystem has evolved significantly in the last one year with respect to the implementation and amendment of government policies, as well as the investment climate and consumer demand, we decided to take a fresh peek into the Indian strategic electronics industry to understand how the opportunities and challenges within this industry have been shaping up. This time, however, rather than going only by the perspective shared by industry thought leaders, we tried to bring to you the industry trends through a small survey with a sample group of senior level industry members.

Methodology

For this report, 50 senior professionals involved in the defence electronics industry were randomly selected and contacted. We received inputs from 15 of them either directly or based on their speeches delivered at the Strategic Electronics Summit (SES) conducted by the Electronics Association of India (ELCINA) in July 2016. This sample group is a microcosmic representation of India’s strategic electronics industry ecosystem. These senior professionals shared their insights on:

1. The growth of the Indian defence electronics industry
2. The impact of policy amendments on this sector
3. Hindrances that impact the growth of this sector

A trend analysis was done on the basis of their inputs. The results of the analysis are presented here.

Opportunities galore
The panel of experts that contributed to this report unanimously stated that they feel the industry is poised for growth. Of them, 93 per cent feel that this modestly-growing industry will move at a slow but steady pace, riding on the government policy support (Figure 1).
Large-scale modernisation of defence forces is on the anvil. The next decade is likely to see an exponential growth in combat systems as well as non-platform based strategic electronics programmes.
The opportunity for electronics in India stems across both standalone systems (as part of platforms) as well as at a sub-system level for other systems. According to a report prepared by India Electronics and Semiconductor Association (IESA), NASSCOM and Roland Berger, India’s aerospace and defence (A&D) electronics opportunity may generate  business of around US$ 72 billion in the next 10-12 years. Of this, almost US$ 53 to 54 billion will be for electronics acquired as part of platforms (i.e., at Tier 1 and Tier 2 levels). A demand of US$ 17-18 billion is expected to come from projects that are traditionally called system-of-systems (non-platform based) projects like:
1. Tactical communication systems
2. Battlefield management systems
3. Network-centric warfare systems
4. Future infantry soldiers as systems
5. Tank electronics
6. Air defence systems
7. Avionics, navigation equipment, radar and sonar
8. Night-vision devices
9. A host of associated and embedded electronics
An IESA source also mentions that, currently, India has approximately 700 companies working in the strategic electronics area and once they tap the US$ 72 billion opportunities, this figure will cross 2,000 companies.
While the above market projections are for the next 10-12 years, there could be greater momentum with additional programmes being announced in the interim. Another growth opportunity is the potential to integrate into global value chains of OEMs (initially leveraging the offset route and subsequently based on product quality, service delivery advantages and cost arbitrage).
On the downside, set goals may only be achieved after much delay due to various reasons.

Revamped procurement policy
In the last one year, the strategic electronics sector got a policy boost through the amendment of the defence procurement policy (DPP). Of the respondents to the survey, 85 per cent feel that DPP 2016 plugged all the loopholes of the previous policy. However, the remaining 15 per cent feel it needs more tweaking (Figure 2). Here is a collation of their views and our analysis on the key provisions of the DPP 2016.

Inclusion of ‘Buy (Indian-IDDM)’ procurement category: DPP 2016 includes a special category called ‘Buy Indian (Indigenously Designed, Developed and Manufactured), or ‘Buy (Indian-IDDM)’ that will get the highest priority in the defence procurement process — above all other categories, namely the ‘Buy and Make (Indian)’, ‘Buy and Make’ and ‘Buy (Global)’, in that order. According to our panel of experts, inclusion of this new procurement category ‘Buy (Indian-IDDM)’ will provide a greater thrust to the ‘Make in India’ initiative in defence production.
If implemented properly, this would promote in-house design capacity and higher localisation, strengthening the role of the domestic industry, especially the private sector, in defence production. However, it is to be noted that the responsibility to prove an indigenous design rests with the industry, while the final approval would come from the government. DPP 2016 will follow a committee system comprising scientists from the Defence Research and Development Organisation (DRDO) and members of the concerned service headquarters (SHQs) to examine industry claims on levels of indigenisation. Therefore, the quick roll out of Buy (Indian-IDDM) will also depend on the efficiency and agility of the newly provisioned committee.
Flexibility in the new, higher domestic content requirements: DPP 2016 has enhanced the indigenous content requirements under the existing ‘Buy (Indian)’ category from the earlier 30 per cent to 40 per cent. This will boost the local content in procurement and drive the larger ‘Make in India’ initiative.
It is important to note that while setting the higher requirement target, the DPP has also kept flexible options to increase and decrease the indigenisation content for the unique procurement cases that need a different indigenisation requirement, depending on the merits of the projects. Considering the ground realities of some critical SE projects where local capability is a bare minimum, this flexibility in the indigenisation requirement would help the industry grow gradually.
Revamped procedures for ‘Make’ projects: DPP 2016 has attempted to simplify the complexities that were leading to ineffectiveness of ‘Make’ procedures (first articulated in 2006 with a view to promoting in-house research, design, development and production of ‘high-technology complex systems’ by the domestic industry, especially the private sector) by incorporating some changes.
First, the structure of the Annual Acquisition Plan (AAP), which is a subset of the five-year Services Capital Acquisition Plan (SCAP) and the guiding document for procurement, has been modified to include some ‘Make’ projects that have already been given in-principle approval or are to be considered for in-principle approval by the higher procurement authorities. Second, the existing Technology Perspective and Capability Roadmap (TPCR) has been made more clear by requiring it to show the “details of the acquisition plans for a period of 15 years, for use by the industry.” These two developments on the planning front are likely to lead to the greater visibility of ‘Make’ projects and, more importantly, accountability on the part of the procurement authorities.
Apart from this, changes have also been made with respect to the responsibility of Service Headquarters (SHQs), classification of ‘Make’ sub-categories, funding patterns for prototype development, and clarity as to who would be eligible for undertaking ‘Make’ projects.
Institutionalisation of  the RFI process: Institutionalisation of the request for information (RFI) process under DPP 2016 has increased the number of procurement steps involved in ‘Buy’ and ‘Buy and Make’ schemes, but also makes the process more systematic and brings clarity in the procurement procedure  in comparison with the previous DPPs. This, in turn, will also clarify different aspects such as  the source of procurement, indigenisation, the degree of competition, and more importantly, the timeliness of procurement.
Moreover, the RFI is now to be formulated by the concerned SHQ in consultation with other relevant stakeholders, including DRDO, DDP and HQ IDS (earlier the SHQs were solely responsible for preparing the RFI). This will ensure that the views of all stakeholders related to a particular procurement project are incorporated at the proposal stage, rather than being added at later stages, resulting in unnecessary delays.
Introduction of the L1-T1 methodology for selecting final bidders: DPP 2016 has introduced the L1-T1 methodology for selecting the suppliers of military goods under the ‘Buy’ and ‘Buy and Make’ schemes. The new methodology ensures that the final bidder will not be selected on the basis of price competitiveness only, but by a combination of price and superior technology offered by qualified vendors. The new methodology is intended to buy equipment with a newly introduced feature — enhanced performance parameters (EPP). These are superior to the earlier essential parameters that were to be mandatorily met by all vendors participating in MoD tenders, in order to stay in competition.
This process will attract suppliers of superior quality products, who were earlier reluctant to participate in the bidding process because their products were much superior and, therefore, expensive and uncompetitive vis-à-vis the ones fielded by rival bidders with no EPP. The suppliers offering approved EPP will get an additional credit score of a maximum of 10 per cent, with each parameter not exceeding a score of 3 per cent.
However, this new methodology may also have some drawbacks if not implemented properly. First, it may invite more complexity and implementation-related challenges. Besides that, the financial ramification could be that certain equipment with more features than the minimum inescapable parameters get procured, resulting in extra expenditure to the MoD for some not-so-critical features. Moreover, by keeping the new methodology open to foreign companies, the MoD will also incur extra foreign exchange outflows at a time when its procurement budget is under a great deal of pressure because of a hefty increase in manpower costs. Considering this, it would have been prudent to limit the new methodology for the selection of bids to the local industry only. This would ensure local companies are incentivised to make superior products, which is the core objective of the ‘Make in India’ programme.
Increased threshold limit for offsets: Under DPP 2016, the offset threshold limit has been raised to ₹ 20 billion (around US$ 305 million) from the earlier limit of ₹ 3 billion. This is in contrast to global trends in defence offset thresholds (which are between US$ 5 to US$ 15 million in many countries including Israel, Malaysia, Turkey and UAE — countries that have set the offset threshold on the basis of long-term experience).
Moreover, this increased threshold limit may lead to a situation where fewer import contracts will be eligible for offsets. This, in turn, will impact the local industry, particularly the manufacturers of parts and components who got a good boost through the existing offset policy to enhance their capability.
More scope for FDI
Seventy one per cent of those on our panel of experts believe that the removal of the 49 per cent FDI limit in the defence sector has opened up avenues for significant investments, and has given the much required impetus for many SMEs to have access to finance and technology (Figure 3).
The liberalised FDI regime permits up to 100 per cent (up to 49 per cent through the automatic route and beyond that through the Foreign Investment Promotion Board or FIPB) route) foreign equity in the defence sector as India looks ahead to increasing indigenous manufacturing in defence under the ‘Make in India’ programme.
However, the remaining 29 per cent raised concerns about the following issues:

• Considering the low volume production model followed in the SE sector, most of the OEMs outsource all systems and sub-systems (parts, components, equipment etc), procuring from a global supply chain that comprises specialised competencies. Hence, even if a foreign platform manufacturer sets up an Indian operation, there is high chance that it will import all systems, parts, components equipment through its global supply chain. The systems, components, parts and equipment constitute more than 70 per cent of the life cycle costs of the platform. Therefore, in the absence of a complete ecosystem of Tier-1, Tier-2 and Tier-3  Indian supply chain companies, the policy will only help foreign OEMs to increase their participation in Indian defence procurements. This will go against the objective of ‘self-reliance’.
• Most of the foreign OEMs that set up their Indian subsidiaries assemble their products using imported completely knocked down (CKD) kits. However, those assembled products are marked as ‘manufactured in India’. Moreover, these products can be priced lower than what Indian companies can deliver as those assembled products incur no design or development cost. This, in turn, may give an unfair competitive advantage to multinational OEMs compared to the Indian R&D and design organisations, including DRDO and DPSUs.
• Foreign OEMs with a manufacturing plant located in India can be included in the Buy (India-IDDM) category just by fulfilling the stipulated 60 per cent indigenous content clause for any of their A&D platforms. But all A&D platforms go through at least a couple of system upgrades throughout their long life cycle (an average of 40 years), and the particular foreign OEM will be selected automatically for all the upgradation projects with limited participation of genuine Indian companies or individuals. This would ultimately lead to the demise of even the few Indian enterprises that have already shown signs of meeting the challenge of IDDM.
• Foreign OEMs are less likely to create Intellectual Property (IP) in India. Therefore, the ‘design in India’ concept will not be promoted through JVs with higher FDI.

What’s next
To ensure Indian industry makes full use of this opportunity and creates world-class companies and capabilities that address not only India’s opportunities but also integrate into the global value chains of OEMs, there is a concrete need for the government to address some issues. We received consolidated policy recommendations from IESA, NASSCOM and Roland Berger for the same. They believe that these issues, for which policy recommendations have been made, can be broadly grouped into major groups and sub-groups.
The first major issue that needs attention is the lack of visibility, for companies in this segment, in the short term as well as long term, both from a technology as well as procurement perspective. This lack of visibility limits the ability of Indian companies to proactively plan and create competencies, knowing that there is a strong government orientation to look at similar segments.
It is evident from experience that one of the best ways to help establish a deep and robust industrial base is through orders placed by the industry. Electronics is a Level 2 industry, where for most programmes, companies in this segment secure contracts once OEMs are awarded contracts. Delays in awarding contracts distort the abilities of players in industrial segments like electronics, which thrive on derived demand from OEMs.
The second problem relates to some structural issues, which must be sorted out in order to streamline the transfer of technology and push manufacturing in India. The offset policy and ‘Make in India’ form two main facets of the defence electronics policy. From the manufacturing perspective, DPSUs have traditionally occupied the entire breadth of the supply chain, and limited outsourcing from DPSUs is depriving the Indian industry of considerable opportunities. On the other hand, the private industry has its own set of issues, which includes critical shortages of key infrastructure and talent. The recommendations for each of the above issues have been categorised into short term, medium term and long term action plans.
From a policy perspective, to promote exports of defence electronics, it is necessary to introduce a multiplier force that focuses on creating an export base for defence electronics around relevant technologies. It is also important to create an offset value estimation calculation criteria for ESOs to increase credibility and reduce ambiguity in calculation. In terms of offset credits, these must be provided based on the product’s value and not value-addition. Similarly, for financing the defence electronics programmes, it is critical to provide adequate financial support in order to sustain R&D, especially in cases where the developed products are T1 but not L1. This also necessitates the expansion of TDF from its current outlay, which is extremely meagre and only meets the needs of companies with nascent manufacturing and design capabilities.
It should be understood that to create a robust industry, it will be absolutely necessary to ensure that the cost base of Indian suppliers, including their profitability expectations, is aligned with global needs and norms. Currently that is difficult as the profitability expectations of Indian manufacturers, driven by their substantially higher cost of capital in India, are much above the global average. In such a scenario, it is critical to create a structure that subsidises the Indian cost structure. Hence, a model similar to that of the ESDM sector can be leveraged to provide incentives for A&D electronics manufacturing. In case of technology transfer, it is also important to encourage design by Indian OEMs so as to retain full product IP and future commercialisation potential within India.
Domestic capability building, under TPCR, may require a change in orientation—from being focused solely on the product as the final desired output, to capabilities (that can address multiple products) as a desired output. This will also require a strong focus on ‘Make’ procedure, not only for large development projects, but also for smaller projects.
Similarly, for ESOs leading electronics integration programmes, it is important to define equitable terms in programmes to create a level playing field. Policies must create separate criteria for smaller companies that have expertise in particular domains to ensure fair opportunity for Information Technology & Electronic Solution (IT&ES) players/ESOs when bidding. The outsourcing of work-share by prime players will prevent over-utilisation of large players and under-utilisation of MSMEs.
From the structural and infrastructure perspectives, the policy framework should create a comprehensive definition of what ‘Defence Electronics’ means and align the ITC-HS codes with it to streamline the import/export process. For the private industry, policies should incentivise investments in common infrastructure and allow timely access to the testing facilities of DRDO/DPSUs. Similarly, certifying agencies should be allowed to provide common certification facilities for the private sector. To develop talent in the defence electronics segment, the government should initiate steps to build a talent pipeline for the segment and encourage incubators. To improve the visibility for the private sector, the technology roadmap of the TPCR and LTIPP should be clearly drawn out. There should be a focus on developing domestic capabilities to sustain (MRO) and upgrade. Also, there should be increased involvement in DPSUs by building processes and systems that promote both private and public sector participation via outsourcing.
Availability of proper screening and approval systems is the need of the hour in the SE sector as the components used here require a high degree of reliability in extreme working environments. Considering the importance of this aspect, ELCINA has taken up a project for developing a high-tech test facility for the defence electronics sector with the objective of providing easy and cost-effective access for such facilities to MSMEs and SMEs. The facility will be open to all defence electronics manufacturers and excess capacity will be offered to manufacturers in the electronics industry.

“The last one year has been an important one. Ever since this government came to power, defence procurements have grown, and old proposals have been taken forward. In today’s dynamic times, we feel the terms of the RFPs (request for proposals) should remain flexible, based on changing requirements. One single achievement that can be seen now at our end is that we are changing the mindset of defence personnel with regard to the suppliers. There is a need to stress on being the lead integrator rather than being a manufacturer of everything. Through the Make in India campaign, the government wants to promote the overall industry and help firms develop their design and manufacturing capabilities in India. I urge the industry experts to tell me what needs to be done in a simple format— share your pain points and bottlenecks. The assurance from our end is that the government will support your initiatives to grow and mushroom.”
Manohar Parikkar, minister of defence, government of India, at SES 2016

“Today, the size of the strategic electronics industry is projected to grow to US$ 72 billion from the present US$ 1.7 billion, and this indicates immense potential as there exists a significant gap between supply and demand.  Though India is considered a ‘software power’ in this space, we are yet to witness a single Indian company that develops strong end-to-end aerospace and defence software solutions. As a result, we keep depending on foreign companies. The only option for Indian electronic component companies is to target the strategic electronics industry, and we should act now. We need to understand that the return on investments in the defence electronics industry in India is long term and the players need to have a long-term view.”
Dr V.K. Saraswat, member, NITI Aayog and former chief scientific advisor to the Indian minister of defence and the director general, DRDO

“Relaxation of FDI rules, increased investments, encouragement to participate more actively in defence requirements where we not only supply to their need but also manufacture for exports has created great enthusiasm amongst us. It’s really heartening that ever since the Make in India programme has been launched, it has enthused the industry with fresh energy. I can say, on behalf of the industry, that we are not only committed but are also capable of making a lot of what the government of India expects.”
Dr. Ajay Kumar, additional secretary, Ministry of Electronics & IT, government of India

Major contributors

1. Anil Kumar Munniswamy, MD, SLN Technologies
2. B. Malla Reddy, MD, Astra Microwave
3. G. Raj Narayan, MD, Radel
4. K.V. Sriram, executive director, Andhra Electronics Limited
5. M. Ramprasad, joint MD, Shri Vishnu Magnetics
6. Madhukar Tripathi, senior manager- marketing & sales, Anritsu India Pvt Ltd
7. Maj. Gen. Atul Mehra, ED, ECIL (Retd)
8. N. Ramchandran, MD, MEL Systems
9. Pradeep Mishra, CEO, Aviel Systems
10. Sreeram Srinivasan, CEO, Syrma Technologies
11. Subhash Goyal, MD, Digital Circuits Private Limited
12. Vedaprakash Gopinath, general manager, business development, Centum Electronics Limited
13. Vikram Ranade, executive director, AMTL
14. Vipin K. William, country manager, Airborne International
15. Vipin Tyagi, MD, CDOT