GCC Defense Offset

Programs: The TrillionDollar Opportunity

The GCC countries now rank among the worlds
leaders in defense spending, offering a vast economicdevelopment opportunity for the region. Offset
programs are the key to unlocking that opportunity.

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

The Gulf Cooperation Council (GCC) countriesBahrain, Kuwait, Oman, Qatar, Saudi Arabia,
and the United Arab Emiratestogether spend nearly $80 billion a year on defense, ranking the
region third among the worlds biggest defense spenders, behind the United States and China.1
At more than $48 billion a year, Saudi Arabia leads the GCC countries in defense spending
(see figure 1).

Figure 1
Saudi Arabias military budget is the highest in the GCC
(2011; $ billion)
711.0

143.0

78.9
48.5
16.7

United
States

China

GCC

5.6

Saudi
United
Kuwait
Arabia Arab Emirates

4.2

3.0

0.9

Oman

Qatar

Bahrain

A.T. Kearney estimate based on 2008 data, Stockholm International Peace Research Institute (SIPRI)

Sources: SIPRI; A.T. Kearney analysis

The real significance of these expenditures goes beyond their massive totals: They signal a
unique growth opportunity for the regions manufacturing and knowledge sectors. Consider
this: Between 2013 and 2025, GCC countries will have spent about $1 trillion on defense and
roughly 30 percent of this is dedicated to capital expenditures. If a 35 percent offset requirement is enforced, this means a whopping $105 billion could be either reinvested or sourced
domestically, creating more than 280,000 advanced jobs84,000 in Saudi Arabia aloneand
an opportunity to build sustainable value chains in the regions nascent aerospace, automotive,
and marine sectors. Because these opportunities have gone largely untapped, defense offset
programs are essential to tapping them.2
Around the world, defense offset programs have drawn criticism because of inconsistencies
in generating economic value. Indeed, transferring knowledge and technology to boost
manufacturing, information communications technology (ICT), or other industries in recipient
countries can be tricky. Yet it can be done with the right incentives in place for the various
participants: Exporting countries want to keep jobs, contractors want to maintain control
of intellectual property, and recipient countries want to remove barriers to building industrial
ecosystemsimproving prepared human capital pools, supply chains, and ancillary services
to take advantage of the opportunity.
Stockholm International Peace Research Institute (SIPRI)

An offset program is a mechanism to compensate the local industry for foreign purchases and to offset the effects of that purchase on
the trade balance of a country. More precisely, it is the practice of requiring foreign contractors that receive government contracts to
contribute to the local economy.

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

Aligning these incentives and overcoming other challenges takes more than well-orchestrated
combinations of offset policies and national strategies. It requires business pragmatism and
active incentive management to bring together the interests of the public and private sectors
and of the exporting and recipient countries.

Mixed Outcomes
Offset programs in the GCC have produced defense and non-defense companies, but with
varying degrees of success. In past years, major GCC offset programs have focused on indirect
offsets, mainly through off-the-shelf purchases, capital investments, and joint ventures in civilian
sectors (electronics, pharmaceuticals, petrochemicals, healthcare, education, shipbuilding,
aquaculture, and aircraft MRO). Direct offsets have also been tapped, but it is too early to gauge
their degree of success.

The point is clear: There is a sizable opportunity to maximize the commercial and
economic impact of offset ventures, and
thereby better support the GCC nations'
hyperspeed growth.
For example, according to Saudi Arabias Economic Offset Program (EOP), by the end of 2006,
36 companies had been established with a total capitalization of $4.5 billion. However, these
figures pale in comparison with the military capital expenditures of $150 billion between 1988 and
2006 or $45 billion to $55 billion in offsets due to the enforcement of a 35 percent requirement.3
On the employment front, EOP reports the creation of about 6,500 jobs, or 120 to 150 advanced
jobs for every $1 billion in contract value. Comparing this to ratios of average foreign direct
investment (FDI) to advanced employment reveals that an additional 750 to 2,600 jobs per
$1 billion spent could be created.
The differences in value and job creation can be partly explained by multipliers in offset calculation,
but the point is clear: There is a sizable opportunity to maximize the commercial and economic
impact of offset ventures, and thereby better support the GCC nations hyperspeed growth.

Conflicting Interests
A number of GCC offset companies face a common pitfall: They maintain a contract manufacturing view of their operations, and in doing so miss the opportunity to expand beyond fulfilling
the original offset obligation, be it the manufacturing of a particular subsystem, the MRO of
a particular type of equipment, or the maintenance of a software solution. High reliance on a
particular system or platform renders the offset company unable to compete in other market
segments after fulfilling its offset obligation.
SIPRI; A.T. Kearney analysis, 2013

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

Our advice for avoiding this pitfall is to realign ostensibly conflicting stakeholder interests with
the right incentives for OEMs, local partners, and offsets government agencies to work jointly to
create economic-development and commercial value beyond the asset being procured at the
time. Incentives to expand into adjacencies in the value chain early in the program life, to seek
export leadership, and to capitalize on other simultaneous programs in the country, are examples.
Mature ventures will achieve the coveted position of engines of not only commercial gains, but
also of economic-development outcomes (see figure 2). Following is a look at the various
stakeholder interests:
Home government interests: Employment retention and exports. The aerospace and defense
sectors are essential not only to the national security of exporting countries, but also to their
economic and strategic interests. Economically, these are high-value sectors replete with
intellectual property, advanced jobs, and export potential. Strategically, they secure national
capabilities. As a result, home governments of most defense exporters regulate and create
incentives to keep vital operations on their home turf.
Host government interests: Employment creation and capability building. Recipient governments interests are similar, if diametrically opposed, to those of exporting governmentsthat
is, recipient governments also seek the benefits that aerospace and defense sectors offer.
Contractor interests: Fiduciary duty to shareholders. Defense contractors are driven by two
main shareholder imperatives. The first of these is profit, which requires contractors to focus
on their bottom line with levers such as low-cost outsourcing, operational improvements, and
improved sales-effectiveness. Growth, the second imperative, dictates a focus on sustaining
revenues, expanding into attractive markets, and protecting intellectual property. Thus, the
contractors optimum environment is one where it can strike a balance between these imperatives and the requirements of its home and host governments.

Figure 2
A well-run offset program can help reconcile conflicting interests of stakeholders
Exporter

Importer

Home government

Host government

Retain jobs and investment

Secure strategic technology
Boost export revenues
Sustain nations industrial base

Attract investment and create jobs

Acquire strategic technologies
Minimize procurement costs
Build national industrial capabilities

Conflicting
interests
Contractor

Armed forces

Maximize profits
Ensure long-term business
prospects
Expand into attractive markets
Protect intellectual property

Minimize life-cycle costs and

delivery risks
Insource mission-critical capabilities
Maximize capabilities
Sustain operational readiness

Source: A.T. Kearney analysis

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

 Armed forces interests: Capability building and readiness. The armed forces primary concern
is to quickly build defense capabilities and readiness. Thus, avoiding delivery risks, building
mission-critical capabilities, and managing life-cycle costs are primary concerns. However, this
can lead to conflict between a nations defense apparatus and its economic-development priorities. For instance, sustainment provided by an international supplier may ensure operational
readiness, but may limit economic-development agencies efforts to build national capability.

Changing the Dynamics

While aligning all these disparate interests may be left to time, market dynamics, and externalities, the process can be accelerated to a span of only two or three decades by end-to-end
defense industry orchestration that includes effective offset policies and programs.4 The key
is to create value for all parties involved, which can be achieved through a gradual process
that culminates in all parties attaining economic, commercial, and defense-capability value.
However, arriving at this point requires a stage-by-stage evolution that initially generates limited
economic value to the host country (see figure 3). This is where the GCC defense industry is
today: in nascent and initial value chain participation stages, but facing a major opportunity
to evolve and create value.

Figure 3
The gradual evolution of defense offset programs
Stage 1

Nascent sector

Seed

Value to
government

Value to
vendor

Stage 2

Stage 3

Value chain
participation

Domestic
market maker

Discounts or rebates
in the form of pure
financial investments
(do not rely on contractors expertise or
owned technologies)

Job and infrastructure

creation in select
sectors

Gross domestic product

diversification, using
capabilities in adjacent
segments

Export leadership via

advanced expertise
across value chains

Contractual burden

Opportunistic
compromise (such as
low-cost foreign labor)

Emerging high-growth
opportunity

High-value international
asset

Less international
dependency

Control of technology

Expansion from
simulation to assembly
and testing in aerospace and automotive

Regional and global

leadership in aerospace
and automotive exports

Capabilities acquired

Capabilities acquired

Example

Stage 4

Consolidated sector

Rebate in the form

of financing local
agriculture startup

Commercial
and defense
capabilities

Foreign-domestic joint
ventures in flight
simulation

Value created

Export
leadership

Economic,
commercial, and
defense capabilities

Source: A.T. Kearney analysis

For example, externalities such as war, as happened with the United States, the United Kingdom, and France

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

Offset programs vary widely What

successful offset programs have in
common, however, is their ability to
address three nagging issues.
Offset programs can play a vital part in accelerating this evolution, but there is no one-size-fitsall set of measures that will guarantee success. From Japan banning technology re-exports, to
Turkey actively integrating into original equipment manufacturer (OEM) supply chains, offset
programs vary widely in the strategies they follow, the policies they enforce, and the technology
niches they develop (see sidebar: What Worked in South Korea, Turkey, and Japan on page 7).
What successful offset programs do have in common, however, is that they effectively address
three nagging issuesthe ones the GCC countries face today in the strategies chosen, the
enablers developed, and the ways in which deals are executed (see figure 4).
1. Securing technology transfer. Technology transfer ensures that value created goes beyond
just financial transfers. Countries achieve it by creating incentives for OEMs to transfer niches

Figure 4
Success factors for defense offset programs

Integration
Ensure interoperability. Empower a strong, high-level agency to orchestrate ecosystem, integrate offsets with national
defense industrial strategy and other national efforts, actively manage performance, and recommend updates to policy

Strategy

Enablers

Execution

Connect strategies. Create a national

defense industrial strategy, coherent
with and leveraging civilian national
strategies and programs

Orchestrate the ecosystem.

Establish and manage a complete
ecosystem of public and private
sector institutions

Address risks of buyers. Find

practical ways to hedge risks of
buyers (for example, 50 percent
domestic, 50 percent international)

Define winning scenarios. Prepare

for an uncertain future (for example,
self-sufficiency on a platform,
C4ISTAR systems export leadership)

Technology, innovation, R&D.

Secure technology seed and
co-fund R&D in target sectors to
expand it

Choose battles. Determine value

chain starting points and expand
to defense and civilian adjacencies
under a clear timeline aligned
with national defense-capability
building plans

Build talent pool. Implement joint

HR development programs to further
technical and commercial talent
pool for targeted skills

Nurture start-ups. Pragmatically align

vendor and local partner interests:
Clear timelines, goals, KPIs
Additional subsidies in early years
Additional credits for expansion
into adjacent spaces

Adapt to terrain. Tailor approach

to national priorities, strengths, and
weaknesses (for example, focus on
areas requiring self-sufficiency,
proximity, or localization)

Establish conducive regulation.

Enforce intellectual property
protection and other legal
framework as necessary
Create clusters. Develop dedicated
industrial clusters with supply
chain-friendly infrastructure and
facilities

Create national champions.

Build from established base to:
Transfer codified technology
and licenses
Integrate with global OEM
supply chains
Develop OEM exit strategies
(reducing equity holdings over time)
Manage portfolio. Maintain
coherent venture portfolio with
strategy and country priorities

Notes: C4ISTAR is command, control, communications, computers, intelligence, surveillance, target acquisition, and reconnaissance.
KPIs are key performance indicators.
Source: A.T. Kearney analysis

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

of technology through licensing or co-production. The key is to create enablersa talent pool,
R&D sponsorship, taking advantage of established industrial playersthat allow the sector to
not only assimilate but also commercialize the technology.
2. Fostering win-win joint venture (JV) dynamics. There are three main components to this:
First, the JV ownership structure must create an incentive for the venture to expand to value
chain adjacencies, innovate, and create value for shareholders. The local partner must have
an incentive to develop and manage long-term capabilities, as opposed to focusing only on
short-term dividends. An ownership structure in which the OEM eventually exits can create
such an incentive. Second, government support in the form of financial investments, talent
supply, and R&D is vital. Third, an ongoing working relationship with international partners
through co-marketing efforts, for examplecan create win-win opportunities for all partners,
local and international.

What Worked in South Korea, Turkey, and Japan

South Korea, Turkey, and Japan
successfully developed defenseindustry sectors. Their stories
reveal instructive examples of
what workedand what
ultimately did not.
South Korea. Acquiring top-tier
military technology and initiating
local manufacturing form the
cornerstone of South Koreas
industrial policy. With its
burgeoning economy and
growing defense budget, South
Korea has transformed its 1970s
nascent defense sector to one
that designs, develops, and
manufactures a full range of
leading-edge weapons systems.
South Koreas defense industry
provides more than 70 percent
of its own domestic needs and is
a leading exporter. The country
employed its civilian industrial
base, U.S. and Japanese technological assistance, and a
motivated workforce to form
the basis of its offset program.
The strategy not only produced
government-backed strategic
joint ventures, but also trained
hundreds of Korean engineers,
secured the right management
control policies, and facilitated
joint global marketing efforts
with defense partners.

Turkey. Following an arms

embargo in the 1970s, Turkey
set out to build a self-sufficient,
indigenous defense industry,
thereby reducing dependence on
foreign arms procurement and,
in time, becoming an exporter.
To this end, the country implemented rigorous policies to
support R&D in aerospace and
ICT niches, consolidated
decision making, and brought
together strong players. Today,
Turkey is a global player,
partnering with industry giants
to develop systems such as
the T-129 helicopter (with
AgustaWestland), the F-35
fighter (with Lockheed Martin),
the A400M transport aircraft
(with Airbus), and Type 214
submarines (with HDW). Turkey
has since integrated government
authorities with leading domestic
firms, R&D houses, educational
institutions, subcontractors, and
financing entities.
Japan. Since the early 1960s,
Japan has used technology
cross-selling to bring domestic
civilian companiesled by large
conglomerates such as
Mitsubishi, Kawasaki, and
NEC Corp.into the defense
sector, contributing to the

development of the countrys

aerospace, electronics, telecom,
and automotive industries.
From 1950 to the early 1980s,
Japan grew its defense industry
with the help of $10 billion in
advanced technology from the
United States. By the 1970s, the
country was manufacturing its
own military ground vehicles,
artillery, and naval vessels, with
most under U.S. defense
contractor licenses; Japan has
since made notable strides in
aircraft, developing the F-2
fighter jet, the P-1 maritime
patrol, and the C-2 transport.
A ban on arms exports to all but
the United States and NATO
countries has prevented Japan
from establishing a strong
presence in the international
defense market. Add to this the
countrys declining domestic
military expenditures over the
past 20 years, and it does not
bode well for the Japanese
industry. In the summer of 2013,
however, the Japanese Defense
Ministry announced a review of
its decades-old ban, auguring
opportunities for national
contractors.

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

3. Facilitating operational readiness. Ultimately, concerns about a new company supplying

strategic systems or services must be resolved. Assuring that international OEM expertise is
present in the recipient country, and then transferring it to the JV, is one way to do it. Another
is to mandate a JV of an OEM with trusted national champions who have a track record of
delivering. It is important to remember this: The offset venture must be a true partner of the
armed forces. Its leaders understand the client countrys capability requirements, long-term
plans to support them, and realign to changing priorities when necessary.

The most important factor in securing

technology transfer is the creation of
enablers that allow the sector to not only
assimilate but also commercialize the
technology.
Applying Lessons Learned
GCC countries can take immediate actions to accelerate their evolution from the seed stage
to the export-leadership stage and capitalize on the trillion-dollar opportunity of defense
offset programs. The trick is to go beyond the essential strategy to enable the ecosystem and
to execute sustainable deals that engage parties constructively. Following are four practical
actions:
Connect strategies and choose your battles. Now is the perfect time for GCC governments
to create national defense industrial strategies that align with civilian national strategies and
programs. Applying scenario-based planning to develop these strategies will help countries
succeed in virtually any event in uncertain times. It is vital to focus on building specific value
chain areas, tailoring the offset policy to national circumstances, and to align military with
civilian interests.
Orchestrate the ecosystem enablers. Establish and manage a complete ecosystem of public
and private sector institutions. Take an active role in bringing together partners that offer what
is needed to build a true defense industry ecosystem: technology acquisition, targeted R&D,
abundant talent pools, favorable regulations that enforce intellectual property protection and
minimize investor risk, and a supply chain-friendly infrastructure.
Execute smartly. The execution is where many well-conceived programs falter. Smart
execution requires juggling and aligning the interests of all stakeholders, deal by deal.
It minimizes the risks for military buyers but ensures that economic-development goals
are met. It nurtures startups, with clear time lines, goals, and key performance indicators,
but takes advantage of national champions and builds new ones. It extracts value from
the presence of international OEMs but ensures that local JV partners are pulling their
weight. Finally, smart execution requires managing the portfolio to maintain coherence
with national priorities.
GCC Defense Offset Programs: The Trillion-Dollar Opportunity

 Integrate, integrate, integrate. An imperative to capture the value of defense offsets is

integrating defense industrial strategy with other national development strategies and
programsaccomplished by creating a strong agency charged with orchestrating defense
industry strategy, monitoring offset-program performance, recommending policy changes,
and taking part in high-level government decision making.

Seizing the Moment

GCC countries have a once-in-a-lifetime opportunity to capitalize on their significant investments in defense over the next decade. The window of opportunity may remain open for
decades to come, but not seizing the moment today is an opportunity lost.
At the national level, seizing the moment requires aligning conflicting interests of defense
industry stakeholders. It requires accelerating the industry evolution from seed stage to export
leadership. It requires government commitment from the highest levels and integrating defense
industry strategy, enablers, and execution under one roof. And it requires the commercially
pragmatic development of direct offset ventures today that can become the national industrial
champions of tomorrow.
Regionally, seizing the moment means increased collaboration in building capability at a GCC
level, and carving out niches in defense industry supply chains. And while sharing the task of
building supply chains for different platforms, the GCC could collectively create a defense
industry network that secures each countrys specific strategic requirements.
There is huge potential to accelerate growth in the GCC defense industries and in turn spur
overall national industrialization. It is a trillion-dollar opportunity to create true winners in the
global export race.

Authors
Anshu Vats, partner,
Middle East
anshu.vats@atkearney.com

Mauricio Zuazua, principal,

Middle East
mauricio.zuazua@atkearney.com

Matthieu de Clercq, principal,

Middle East
matthieu.declercq@atkearney.com

GCC Defense Offset Programs: The Trillion-Dollar Opportunity

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