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Israel’s Offsets Soar; More Local Firms Earn a Share

Jan. 19, 2013 - 01:20PM   |  
By BARBARA OPALL-ROME   |   Comments
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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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