Where Industry and Security Intersect
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From 1993 to 2000, 37 U.S. firms reported entering into 345 offset agreements with a total value of $29.8 billion. These offset agreements were made with foreign purchasers in 32 different countries and were associated with defense export contracts valued at $48.6 billion. The exports involved 177 U.S. weapon systems. The value of the offset agreements represented 61.3 percent of the total value of the related export contracts during the entire reporting period. 10 The average term for completing the offset agreements was 111 months, or slightly more than nine years.11 The percentage of offset agreements to export contracts (by value) reached a new high in 2000 of 89.7 percent, eclipsing the previous high of 82.3 from 1999. The lowest percentage was recorded in 1993 at 34.4 percent.
The annual values of defense export contracts and offset agreements (including offset percentages) are presented in Chart 4-1. In a sharp upward trend, the value of the offset agreements as a percentage of the value of defense export contracts increased an average of approximately six percent per year over the eight-year reporting period.12
The data reported by U.S. companies show that a small number of companies, countries, and weapon systems dominated offset agreements during the reporting period. The top five U.S. companies (of 37 companies reporting data on offsets) accounted for 80.5 percent of the defense export contracts and 81.4 percent of the offset agreements during the reporting period. This high level of market concentration reflects the high costs of modern defense systems and the small number of firms that produce them. Due to the complexity and expense involved, only a large, multi-disciplined company could produce and deliver modern defense systems. In addition, each exporter company coordinated the activities of hundreds, if not thousands, of subcontractors and suppliers that contributed to the systems production, as well as the work of thousands of employees.
Source: BIS Offsets Database
Offsets also appear to be concentrated in a few purchaser countries. The top five countries (of a total of 32 involved in the reported offset activity) accounted for 58.4 percent of the total defense system purchases and 55.6 percent of the total offset agreements. The top 10 countries represented 78.7 percent of defense system purchases and 79.2 percent of the offset agreements. The fact that relatively few countries accounted for the bulk of offset activity indicates that relatively few countries were in the market for big-ticket defense equipment. Most countries cannot afford these systems. By dominating offset activity, these few countries also dominated the impact offsets have on the U.S. defense industrial base. In addition, these countries set a visible standard for offset demands for other countries to imitate.
The data reported by U.S. companies also show that specific defense systems were in high demand overseas. The top five weapon systems (of the 177 weapon systems sold) were all aircraft. These exports accounted for 45.6 percent of the value of all export contracts and 39.2 percent of the offset agreements during the reporting period. The top 10 defense systems accounted for 61.5 percent of the export contracts and 59.4 percent of the offset agreements during the reporting period. These data show once again that big-ticket items such as aircraft constituted the bulk of offset activity.
European countries dominated offset activity during the reporting period. Europe alone accounted for more than 70 percent of offset agreements during the reporting period, while at the same time accounting for less than 50 percent of the value of U.S. defense export contracts. Asian countries ranked a distant second in both categories, accounting for only 14 percent of offset agreements and 33 percent of related U.S. export contract values. Middle Eastern and African countries also had significant shares, accounting for nearly 14 percent of offset agreements and 19 percent of U.S. export contract business. Countries in North and South America ( Canada and Brazil ) were less significant, accounting for approximately one percent of the value of both offset agreements and related U.S. defense export contracts. Chart 4-2 shows regional totals of U.S. defense export contracts and offset agreements for 1993 to 2000.
As noted above, Europe alone accounted for more than two-thirds (70.8 percent) of total offset agreements (by value), but less than half (47.5 percent) of the value of U.S. defense export contracts. These figures show the impact of the high offset percentages typically demanded by European nations in connection with U.S. defense export sales. The average offset percentage demanded by the 17 European countries involved in offset activity during the eight-year reporting period was 92.3 percent of the export contract values - a percentage which was higher than any other region. U.S. firms reported entering into 176 offset agreements with European countries during the eight-year period for a total value of $21.6 billion. These offset agreements ranged from less than $10 million to more than $1.8 billion in offset demands, and averaged $118 million per agreement. The average offset agreement had a term of 114 months, with a few agreements lasting up to 180 months.
Source: BIS Offsets Database
Many European governments require a minimum of 100 percent offsets on purchases of foreign defense systems. Of the 176 offset agreements with Europe reported, 132 (75 percent) had offset percentages of 100 percent or more. The value of the negotiated offset package was greater than 100 percent of the defense contract value on 15 occasions, including one for which the offset percentage was 200 percent. As shown in Table 4-1, the offset percentages for Europe in both 1995 and 2000 exceeded 100 percent of the export contract values. In 2000, the offset percentage for Europe reached a new high of 116.3 percent.
As shown in Table 4-1 , the 15 countries representing all other regions (i.e., non-European countries) accounted for less than one-third (29.2 percent) of offset agreements (by value), but more than half (52.5 percent) of reported U.S. defense export contracts, resulting in an offset percentage for the reporting period of 33.9 percent. Non-European countries accounted for 166 offset agreements that totaled $8.7 billion during the reporting period, or two-fifths of the European total. The average offset agreement for non-European countries was valued at $52 billion and had a term of 104 months.
| Yearly Totals | Area | # of Deals | Export Contracts (in $ millions) |
Offset Agreements (in $ millions) |
Percent Offsets |
Duration |
|---|---|---|---|---|---|---|
1993 |
Europe | 14 |
$2,932.3 |
$2,338.1 |
79.7% |
132 |
| Non-Europe | 16 |
$10,972.0 |
$2,468.7 |
22.5% |
117 |
|
| World | 30 |
$13,904.4 |
$4,806.7 |
34.6% |
124 |
|
1994 |
Europe | 20 |
$1,502.7 |
$764.8 |
50.9% |
99 |
| Non-Europe | 29 |
$3,284.2 |
$1,283.9 |
39.1% |
102 |
|
| World | 49 |
$4,786.9 |
$2,048.7 |
42.8% |
101 |
|
1995 |
Europe | 26 |
$4,944.3 |
$5,159.2 |
104.3% |
132 |
| Non-Europe | 19 |
$2,457.7 |
$874.9 |
35.6% |
98 |
|
| World | 45 |
$7,402.0 |
$6,034.1 |
81.5% |
127 |
|
1996 |
Europe | 34 |
$1,924.2 |
$1,919.1 |
99.7% |
110 |
| Non-Europe | 16 |
$1,033.6 |
$351.5 |
34.0% |
73 |
|
| World | 50 |
$2,957.7 |
$2,270.7 |
76.8% |
104 |
|
1997 |
Europe | 28 |
$3,732.6 |
$3,043.8 |
81.5% |
115 |
| Non-Europe | 29 |
$2,090.2 |
$788.0 |
37.7% |
91 |
|
| World | 57 |
$5,822.8 |
$3,831.8 |
65.8% |
110 |
|
1998 |
Europe | 21 |
$1,390.3 |
$1,200.3 |
86.3% |
115 |
| Non-Europe | 23 |
$1,867.5 |
$646.4 |
34.6% |
111 |
|
| World | 44 |
$3,257.8 |
$1,846.6 |
56.7% |
113 |
|
1999 |
Europe | 22 |
$2,968.7 |
$2,708.0 |
91.2% |
69 |
| Non-Europe | 23 |
$1,699. |
$1,143.4 |
67.3% |
94 |
|
| World | 45 |
$4,667.7 |
$3,851.4 |
82.5% |
75 |
|
2000 |
Europe | 14 |
$3,384.7 |
$3,936.6 |
116.3% |
113 |
| Non-Europe | 11 |
$2,268.4 |
$1,136.0 |
50.1% |
106 |
|
| World | 25 |
$5,653.1 |
$5,072.6 |
89.7% |
111 |
|
Grand Totals |
Europe | 179 |
$22,838.1 |
$21,069.9 |
89.9% |
114 |
| Non-Europe | 166 |
$25,672.6 |
$8,692.8 |
33.9% |
104 |
|
| World | 345 |
$48,554.3 |
$29,762.7 |
61.3% |
111 |
Source: BIS Offsets Database
Two significantly large defense export contracts in 1993 - one to Taiwan with unusually low offset requirements and another to Saudi Arabia - significantly lowered the offset percentage in non-European nations. Excluding these sales, the average offset percentage for the eight-year period would have been almost 10 points higher. In addition, Middle Eastern countries and certain countries in the Pacific Area generally demand lower offset levels. Of the 166 offset agreements with non-European countries that were reviewed, 110 (two-thirds) had offset percentages of 50 percent or less. Only 28 (one-sixth) of the offset agreements had percentages of 100 percent or more, and 10 of these had offset percentages in excess of 100 percent. Indeed, one offset agreement had an offset percentage of 333 percent, although this was associated with a relatively small defense export contract.
Of the 28 offset agreements with offset percentages of 100 percent or more, 10 were with Canada and another five were with Turkey . While the average offset percentage has been much lower in the rest of the world than in Europe , offset percentages in non-European countries appear to be rising. For example, in 1999, the offset percentage demanded by non-European countries peaked (64.8 percent), followed in 2000 by the second highest level of 50.1 percent.
In general, the data show that countries with more technically advanced economies have demanded higher levels of offsets than other countries. This could be explained by many factors, including the fact that large government expenditures on imports are likely to be closely scrutinized in the media and protested by local politicians. Thus, offsets often are used to temper political opposition to purchases of foreign defense systems. In addition, more advanced economies are able to absorb more offsets. Typically, their infrastructures are more advanced, and they are more likely than other countries to have in place already a diverse pool of industries among which to distribute offset transactions.
The data appear to show that offset demands are not only increasing, but more countries outside of Europe are demanding greater offsets. One reason for this is that the supply of defense systems greatly exceeds the demand for such items. In the last decade, shrinking worldwide defense expenditures and the overcrowding in the defense supplier sector have forced defense industries in many nations to consolidate. Overcapacity still plagues the defense sector, including in the United States , as governments have been slow to retrench.
However, as sales opportunities narrowed, competition for such sales became more intense. Because one element of competitiveness is the offset package, U.S. suppliers are forced to offer greater offsets to win sales. In addition, foreign purchasing governments are under pressure to sustain their indigenous defense companies and, accordingly, are demanding more offsets. Higher than normal overhead related to low levels of capacity utilization in defense industries coupled with competitive pressures on prices have also squeezed corporate profits. While the need to export has grown stronger, so has the exporters' willingness to meet foreign purchasers' offset demands.
In recent years, the world economy has been sluggish, with historically higher unemployment in the last decade - notably in Europe and Japan . These conditions drained national treasuries and, therefore, significant public outlays for foreign-made weapon systems become are controversial, which leads to higher offset demands to deflect political pressure.
In addition, many countries now have formalized their offset requirements by establishing a minimum percentage for offsets at which to begin negotiations. In these situations, competing firms must design a winning offset package based on the desirability of the defense system, their ability to deliver offsets, and past offset performances. Many U.S. defense systems, such as aircraft and missiles, have an edge in the international market because of their superior performance capabilities. This alone may make U.S. exports the first choice of the foreign purchasing government and may actually help keep offsets at or near a minimum. However, the actual content of the offset package often is very desirable and helps close the deal. By this logic, less desirable weapon systems would pay an offset premium, thereby driving up offsets and further enhancing the foreign government's bargaining position with respect to all potential sellers.
On a regional basis, the eight-year trend in offset percentages for European countries increased at an annual rate of 4.7 percent. For the rest of the world, the average increase in offset percentages was 4.0 percent. The fact that both regional trends are less than the world average increase in offset percentage of six percent results from commingling the very low rates of the rest of the world with the already high rates of Europe.
Offset demands are stable in many countries, while others are growing. To a large extent, the observed aggregate rates depend on the specific countries involved in offset activity in any one year. Along with country purchasing patterns, annual offset percentage calculations also are affected by the actual size of the offset agreements (i.e., one or two large offset agreements can dominate the annual figures). These annual fluctuations can be lessened somewhat by calculating three-year moving and weighted averages that are a better indicator of offset trends.13 The world trend in offset percentages was still sharply upward at 5.34 percent, but the average was exaggerated by differences between Europe and all other countries. Three-year weighted regional trends, one for Europe and one for all other countries, tell a different story, as shown in Chart 4-3.
Three-year weighted averages of offset percentages for Europe show an insignificant average annual rise of only one-tenth of a percent.14 The offset percentage for the final three-year period (1998-2000), however, was 101.3 percent, changing what would have been a downward sloping trend from previous periods into a slightly positive trend. This trend suggests that Europe 's offset requirements may be saturated at over 90 percent, although the next two years (2001 and 2002) will be buttressed at a higher level by 2000's record high offset percentage of 116.3 percent. The conclusion is that Europe 's already high offset requirements may be rising, but at a slow rate. Much depends on which countries demand offsets in the future.
Source: BIS Offsets Database
Offset demand in Eastern European countries is another factor leading to a rise in overall offset percentages. Poland 's announced intention to purchase a fighter aircraft with a requirement of offsets of up to 200 percent of the value of the contract underscores a desire on the part of Central and Eastern European countries to use offsets as a policy tool for economic development. While this percentage is high, "developmental" offsets (i.e., those calling for direct investment, credit assistance, and technology transfer) usually warrant higher multipliers, which soften the real impact of offsets on the U.S. defense industrial base. Nonetheless, it appears offset demands in Central and Eastern Europe will be high in the future.
In conclusion, Western Europe may be nearing a ceiling in offset demands, which moderates the degree offsets can be increased. The rest of the world has plenty of room to grow and has shown signs of demanding more offsets. With Western European producers providing more competition to U.S. firms in the future, offsets are almost certain to increase in other regions of the world.
10 The figure of 61.3 percent is weighted to the annual values of export contracts and agreements. An unweighted average can be calculated by averaging the annual percentages of offsets. The unweighted result was 66.1 percent.
11 A weighted average was calculated based on the value and term of each offset agreement.
12 The percent increase was calculated using a linear least-squares function of only the annual percent values.
13 Here, the value of export contracts and offset agreements is totaled for each successive three-year period, beginning with 1993-1995, followed by 1994-1996, and so forth, then the offset percentage is determined. This leads to six three-year observations over the eight-year reporting period (1993-2000).
14 The one-tenth of a percent annual calculation is based on a simple linear, least-squares average.