Seminar on Outsourcing Possibilities in Defence: Some Impressions

The Ministry of Defence (Finance) organised a day-long seminar on March 24, 2007 on Outsourcing Possibilities in Defence. The seminar brought together a variety of perspectives – of the Services, the Ministry of Defence, industry, academia and think tanks. The March 24 event was a follow-up to the first-of-its-kind International Seminar on Defence Finance and Economics held in November 2006. Its importance lies in the fact that not long ago ‘defence’ was considered a ‘strategic’ affair and thereby excluded from public scrutiny and economic analysis. The Ministry’s efforts to bring greater efficiency through outsourcing is indicative not only of budgetary constraints but also of the fact that defence business could be successfully run by adopting the best private business practices. The wider intention of the seminar was to explore ways for indigenisation and self-reliance in the field of defence production and military technology by means of outsourcing defence activities to efficient and reliable private partners who could offer services in a cost-competitive, time-bound manner and remain trustworthy in the long run. The various perspectives discussed in the seminar are highlighted in the succeeding paragraphs.

From a theoretical perspective, there are four compelling factors – cost minimisation/value maximisation, resource access, superior resource leverage, and risk diversification – that drive an organisation to opt for outsourcing. The outsourcing decision is based on ‘core’ and ‘non-core’ activities that determine which activities need to be retained in-house and which are to be purchased from the market. However, in the extremely competitive global market, there exists a very thin demarcation line defining ‘core’ and ‘non-core’ activities. Also, the outsourcing decision taken by the authorities of an organisation is based on estimation of economic costs and benefits and on the assumption that transactions are carried out to the optimum ability of the organisation in drawing and enforcing proper contracts – the last being susceptible to ignorance of market-player behaviour, thus becoming the key determining element for the success of any decision.

From the perspective of industry, the Indian private sector is suitably placed to work closely with their defence public sector counterparts. Private industry strongly feels that so far its prowess has not been optimally harnessed for domestic defence requirements, while in the global front it has been successful in providing services to large multinational companies like Boeing, Airbus, Lockheed Martin, etc. While the benefits of defence outsourcing to the private sector is endless and includes import independence, technological self reliance, faster and cheaper supply of logistics, the areas where they can play a meaningful role is virtually exhaustive. However, not so long ago, the private sector’s role in defence was confined merely to providing raw materials, semi-finished products and parts and components to Ordnance Factories and Defence Public Sector Units. But, with the government allowing private participation including foreign direct investment, the private sector has been able to produce high-end defence products, demonstrating its effectiveness in translating its civil prowess into defence business. With the rising profile of Indian private industries on the global scene backed by competitiveness, quality standards and efficiency there is enough confidence among the private enterprises to delve into hardcore development and production of hi-tech defence equipment. To accommodate private industry, in recent years the government has initiated policy measures like for instance the Defence Procurement Policy, 2006 to boost greater private participation. But what is needed is that along with policy measures, there should be a concerted effort to encourage public private partnership (PPP) and greater outsourcing to the private sector. Some of the items that could be easily outsourced to the private sector include land systems, vehicles, engineering equipment, marine systems, aviation systems, arms and ammunitions, UAVs, surveillance systems, IT and communication radars and radio sets. Besides, private industry feels that the existing Defence Supply and Storage Network, vast Defence Estates, Armed Forces Medical Services and Defence Personnel Recruitment could be outsourced to private players for better management, speedy and quality services and for revenue generation. Similarly, the government should address the concern of the private players arising out of the discriminatory benefits enjoyed by the public sector in producing equipment the prototypes of which are developed by private players.

The Indian Army views outsourcing as a form of privatisation wherein some or all of its logistics function is performed by an outside organisation. There is a degree of suspicion on the part of the Army vis-à-vis outsourcing and this suspicion arises out of security of supply and timely availability of required quantity and quality. While feeling the need for greater outsourcing, at the same time it does not want to relinquish control over its dedicated logistics units. However, it identifies three broad areas for possible outsourcing: ‘system support’ related to maintenance and repair of equipment; ‘services’ linked to transportation, medicare and security; ‘contingency and competitive’ related to services and civil contracts, etc. In its proposed methodology of outsourcing, the army divides logistics support into three levels: strategic, operational, and tactical or direct support. On analysing three levels of logistics, the Army does not recommend outsourcing of tactical logistics as it forms the first and second line of support to troops and provides them confidence during operations. The Army feels that due to inhospitable terrain and war-like circumstances, private operators may find it difficult to do business in some cases. So the army suggests categorising all functions into core and non-core functions. While the core functions are to be retained in-house because of their criticality during military missions, the non-core functions, which are non-operational in nature, could be outsourced.

Outsourcing in the Indian Air Force (IAF) goes back to as early as 1940 and the experience so far has been mixed. A number of activities like security of IAF installations, repair, overhaul and upgradation of various weapons systems and equipment and refuelling operations at various IAF bases have been outsourced at varying proportions. Further outsourcing is contingent upon the suppliers’ flexibility and willingness to take up additional tasks. The experience that the IAF has gained relates to poor quality of the supplies and the prolonged time for corrective measures which are not to its satisfaction. In case of obsolescence of products, the IAF found that the outsourced agencies find it commercially unviable because of the changing situations with respect to design, development and cost escalation over a long period, resulting in low availability of product upgrades. Besides, a limited vendor base escalates repair costs and greater concentration on high-end products by original equipment manufactures (OEM) creates problems for product upgradations. Similarly, the IAF found lack of accountability among private suppliers.

Based on its experience, the IAF wants to tread the outsourcing path cautiously. It feels that outsourcing creates critical dependencies that do not bode well during crisis situations, since legally private contractors could not be compelled to go to war zones. The core functions of air warfare like self-sufficiency of combat units, operation of combat aircraft and first line maintenance are not to be outsourced. However, the IAF is in the process of drawing up an action plan to pursue outsourcing in the years ahead, and has set an immediate target of fifty per cent, which would be increased depending upon the satisfaction level.

The Indian Navy, by decentralising financial powers, has been able to outsource many activities for the purpose of inducting modern technology and increasing levels of synergy and co-ordination. At present, these areas broadly include: operational requirements like ship refit and overhaul, ship engineering, and engine overhaul; technical support related to maintenance of equipment, building conservancy, IT, and dredging of channels; administrative support for ferry service, etc. The three areas which the Navy wants exclusive control over and out of the ambit of outsourcing are: weapons and sensors; networking and communication; and basic ship design. The Navy contends that these need heavy doses of Research and Development costs or need to be under its control for operational security reasons. It has identified outsourcing and private participation as means of greater indigenisation and self-reliance. Towards this end, it has set up institutional mechanisms, the Directorate of Indigenisation and Local Units at the Command level to encourage Indian Industry to enter into collaborations/partnerships with their foreign counterparts and thus ensure the supply of latest technology to the force.

At present, the Indian Navy faces certain difficulties in its outsourcing efforts. Most DPSUs that cater to the Navy’s requirements of building warships either lack facilities close to naval bases or do not possess adequate capacity to handle the workload. However, in recent years the government has been encouraging private player participation and the result is visible with Larsen and Toubro building a huge shipyard at Hazira. Also, the Navy wants a strong defence industrial base at major naval bases – Mumbai, Visakhapatnam, Kochi, Port Blair and Karwar – as a major prerequisite to serve the outsourced activities of the Navy more efficiently. Another problem facing the Navy is the absence of firm guidelines, leading to uncertainty regarding the procedures to be followed for execution.

While the seminar was successful in bringing to the fore the perspectives of various stakeholders, concerted follow-up action at higher levels is needed to proceed along this path. So far, outsourcing activities of the Armed Forces have been left to the individual Services who perform this important activity on their own in varying proportions depending on their convenience and needs. Among the three Services, the Navy is more outsource-oriented than the others and has institutional mechanisms to promote this. While the Army and Air Force could learn from the Navy’s experiences and practices, there is an urgent need for an overarching mechanism to guide this important aspect in all the three Services. In this regard, the Ministry of Defence could take a cue from its British counterpart in formulating a policy paper on outsourcing. The UK MoD Policy Paper on Defence Acquisition, released in 2001, has clearly laid out principles which, besides promoting Public Private Partnership (PPP) and Private Finance Initiatives (PFI), identify potential areas that could best be served by private parties. Under this policy, only when the PFI has been found to be ‘unworkable, inappropriate or uneconomic’, can the Ministry use its own capital funds. The Ministry has no “dogmatic preference for private over public or vice versa.” This British initiative has not only transferred the Ministry’s risk but has also benefited it from savings in capital investment. The PFI initiative has saved up to ‘forty per cent in forecast costs compared with other (read government initiated) forms of procurement’. A number of contracts awarded to private players, including some in strategic areas, are testimony to both the competency level and trust in handling strategic matters by the private sector. A similar exercise in India will not only benefit the country’s security establishment in terms of savings in time and costs but also help in realising self-sufficiency in ‘defence production and military technology’, the cherished long-term objective of the Government of India.