Aerospace & Defence: How MSMEs can build a sustainable business
The Indian defence sector has come off age with refreshing policy shifts over the last 2-3 years. As the country looks to build indigenous defence industrial capability and reduce dependence on imports, how can MSMEs benefit and build a sustainabl...
Beyond this, the Indian defence sector has come off age with refreshing policy shifts over the last 2-3 years. As a result, the government has been able to drive key programs with speed to bridge the critical asset gaps for the military---the 'primary objective'. However, much more is desired from the Indian Government to address the 'secondary objective' of building indigenous defence industrial capability in India and towards reducing dependence on imports. Given this background, we discuss in this article how MSMEs have built or can build a sustainable defence business in India
Choose a product/service core to company DNA
The A&D sector is picking up in India, and may seem a lucrative option given the amount of white spaces and margins that are possible. However, these upsides come with a set of risk factors inherent to the sector - being lumpy and highly regulated - as well as added issues of Indian market being perceived as quite difficult to operate in.
In such a scenario, it is critical for MSMEs not to stretch themselves thin by taking multiple un-related positions for the sake of growth, rather should "commit to an identity" by getting into A&D portfolio elements closest to their DNA and build a solid value proposition for the long term.
Dynamatic Technologies is a classic example, a company which took a leap into A&D manufacturing pretty early, into areas close to their DNA of engineered products, and are now seen as the foremost success stories in the emerging A&D sector in India leading with their position in aerostructures supplied to the top OEMs and their tier-1s globally.
Another dimension is to commit to an identity, which is what MKU did starting with supply fiber-reinforced plastic products to the Army. They positioned themselves as a "trusted supplier to the Indian Army", building products and capabilities to support their diverse needs to drive a scalable business ranging from ballistic helmets, armour inserts, bulletproof vests, and electro-optical devices like night vision
Positions at tier 2/3 level will allow MSMEs to lead with their capabilities and play across platforms and program, thereby de-risking the business portfolio. Added to this, the additional capability of Indian MSMEs to be flexible and agile enough allows them to rapidly move into new competitive arenas where their identity makes them well equipped to win.
Articulate a medium term go-to-market approach
While India still imports a majority of its defence platforms and content, defence public sector undertakings (PSUs) like Hindustan Aeronautics Ltd (HAL), Bharat Dynamics Ltd (BDL), Bharat Electronics Ltd (BEL), Mazagaon Docks Ltd (MDL) and the Defence Research & Development Organisation (DRDO) labs have been making headway into defence production and R&D at their own pace over time. Due to lack of a local support structure, a lot of these DPSUs built capabilities across the tiered value chain to be able to deliver platforms, which led to a relatively inefficient delivery structure.
With time, ex-DPSU/DRDO officials and some forward looking entrepreneurs have established small, but sustainable enterprises building upon the outsourcing demand of these public sector enterprises. This continues to be a feasible initial go-to-market option for MSMEs given the relatively easier customer certification process (compared to that required with a foreign company), and the increasing need for DPSUs to outsource non-core activities and value chain elements to improve their delivery efficiency and delivered quality.
Further, with the private sector increasingly being included into defence production, MSMEs can have another set of customers to target - with companies like Tata Advanced Systems Ltd. winning the C-295 order in partnership with Airbus and L&T as also securing the 155mm tracked gun order in partnership with Samsung. The north-star always is to be able to get included in the global supply chain of OEMs/major Tier-1 companies, however, there is no short cut for the same. However, once you are there, you are sorted for at least a decade of margin-rich sustainable business.
Focus on capability building
The committed identity and go-to-market approach needs to be followed up with a clear articulation by MSMEs on what capabilities will support the right execution. In the A&D sector, consistent quality tends to be a hygiene with most parts having precision specifications and being critical to platform performance and reliability. The aspect of capability building is not just limited to adopting industry best practices or developing functional expertise, but rather building bespoke capabilities which allows the MSME company to 'live' its chosen identity.
Further, capability building in India tends to mean 'getting a foreign partner' which is a flawed approach as companies seldom realize (a) what it takes to present oneself as an attractive partner, where attractiveness cannot be the ability to sign cheques, and (b) how they would 'institutionalise' capabilities even if they get a partner, so as to incrementally reduce the dependence.
Regarding being considered as lower cost, companies must not look at spreading investments across a wide range of attractive opportunities and going lean everywhere, rather identifying capabilities which are most important for long-term success and going on a minimum on everything else.
Latest trend in the Indian market is of asset-light startups taking up the initiative, which rely on low cost commercial off-the-shelf (COTS) parts and focus on building customer relationships and relevance as well as own IP to compete in the market with an 'Indian' solution. The road has not been easy for these companies, who have been in existence for the last 4-8 years, but had committed to an identity and direction, and put their energies behind the cause, key to win in the Indian A&D sector---and are now candidates for very attractive valuations.
Tonbo Imaging is one such example, a company started few years back on the back of indigenous technology development of world class standards, rather than taking a traditional asset-heavy manufacturing approach, and is now at an inflexion point winning orders from Indian and foreign MoDs and OEMs.
The government has recognised the importance of MSMEs in developing A&D supply base in India with Defence Procurement Procedure (DPP) 2016 reserving specific categories and size of 'Make' programs for MSMEs, beyond initiatives in general to:
* Liberalise the A&D sector (example, FDI allowed up to 100%, de-licensing most categories)
* Allow movement with speed (example, awarding programs at great speed, granting of licenses fast where required)
* Drive indigenisation (e.g. IDDM program category, pending 'strategic partnerships' chapter in DPP 2016)
* Encouraging measures taken in India's Union Budget FY17-18:
* 10% increase in Defence Capital budget to Rs 86,000 crore, making India's Defence Budget one of the fastest growing within the top 10 global spenders
* Abolition of FIPB, expected to be followed up with reforms to allow FDI under automatic route in most areas, means easier FDI inflow
* Reduced corporate tax burden of MSMEs with turnover less than Rs 50 crore, from effective 30%+ in FY16-17 to 25%.
A&D is an involved business, and cannot just be 'topped-up' onto an existing line of business - you are either in it for the right reasons and with the right expectations, or out of it. This is the cost of getting into a business where entry barriers are high, but so are switching costs of your customers once you are in the game.
(Anurag Garg is a Director with Strategy& (formerly Booz & Co.), PwC's strategy consulting group, and is based in Delhi NCR. He currently leads the Aerospace, Defence and Security practice, advising Indian and international companies looking to enter or expand in the defense sector. Follow Garg's blog on LinkedIN: linkedin.com/in/garganurag)