Both military procurement agency Armscor and the defence industry offsets concluded in terms of the government’s R57-billion arms deal are coming in for sustained flak from a surprising quarter: troubled defence parastatal Denel.
Tight budgets, international competition and internal inefficiencies are pushing the conglomerate deeper and deeper into the red, and its usually tight-lipped management team is now speaking publicly about what it characterises as “severe tension” with Armscor, its biggest client, and an offset programme which, it says, has forced loss-making projects on the local defence industry.
Denel lost R377-million last year, and is beset by an increasingly unmanageable debt pile. Like the similarly burdened Transnet, the corporation plans to restructure, shedding non-core interests ranging from property to food and plastics. But that will not be enough to return it to long-term solvency.
To get there it needs a major injection of cash from the government: between R1,2-billion and R2-billion, and reforms in defence procurement policy to favour local manufacturers, according to chief financial officer Pottie Potgieter.
Potgieter says that capital expenditure in the defence force was severely squeezed during the 1990s as spending was diverted to pay for the integration of non-statutory forces like Umkhonto weSizwe and the Azanian People’s Liberation Army into the new South African National Defence Force.
“It was necessary, but it almost led to the demise of the local industry.”
The next blow came from the arms deal, which sourced major weapons systems offshore, with local companies invited to participate in elements of each process — Denel builds part of the fuselage for Saab-Grippen fighter jets, for example. These offsets were supposed to ensure that the deal generated benefits for the local economy to match the massive outflows.
According to Potgieter, they did no such thing for Denel: “We weren’t involved in the initial contracting, BAE Systems and others had already won their bids, so we were negotiating from a position of weakness. We make little or no profit on these contracts.”
CEO Victor Moche goes further, saying 80% incur losses, and the rest have insignificant operating margins. Contracts are already being renegotiated, he says, and others have been cancelled. But it is not just major international players Denel argues are outmuscling it.
“We were bullied into contracts with Armscor,” Potgieter told the Mail & Guardian, “so we are reviewing them.” A lease of Rooivalk helicopters has already been cancelled.
He says there is also considerable anger over the resale by Armscor of surplus materiel to Denel’s export clients. The same ammunition may cost R10 from Denel and R6 from Armscor, which undermines client relationships and “causes confusion”.
But the company’s most urgent plea is for more favourable treatment in the procurement process.
“Anywhere you go there is a bias toward the local industry,” Potgieter says, citing the preference of European and United States weapons buyers for contractors from inside their borders.
“Without this kind of support, Denel won’t survive.”
There seems to be increasing political support for some kind of favourable treatment for South African firms.
“Job creation and the retention of these engineering skills is important,” says policy chief at the defence secretariat Thabo Mothumi, echoing recent remarks of Minister of Public Enterprises Alec Erwin. And Lionel October of the Department of Trade and Industry says it is possible the government went “overboard” in its desire to introduce international competition to the sector.
Nevertheless, the trade and industry department, BAE Systems (the supplier of Hawk and Grippen aircraft) and Armscor insist that Denel’s high internal costs and inability to compete on price are at the root of its problems.
Armscor CEO Sipho Thomo told the Mail & Guardian that Denel’s prices were routinely between 10% and 100% higher than those asked by international suppliers: “We want them to be able to compete internationally by having comparable prices. We want them to export, we don’t want to subsidise their inefficiency,” he said.
October concedes that Denel and other local firms might have been squeezed into accepting low prices for some offset deals. “We have to be sympathetic and tell companies not to be ridiculous.
“But Denel’s cost structure could well be too high … We’ve got to be strict, and Armscor has got to be strict, in order to ensure serious competition. In many cases — SAA technical, parts of Denel, Grintek — it is now paying off.”
October maintains that most offset programmes are delivering value and that a report on both defence and industrial participation programmes currently making its way through Cabinet will reflect that.
BAE Systems insists that it is investing millions of dollars in improving manufacturing capacity at the firm and is ahead of it’s targeted offset obligations.
“It demonstrates what everyone has known for some time: that there are major inefficiencies that Denel has to deal with,” BAE Systems spokesperson Linden Burns told the M&G.
“It is our obligation to deliver R1,5-billion in economic activity, how local companies make out their own costing is up to them,” he added.
Arguments from both sides about the benefits of subsidising the local industry, and claims that offsets are delivering real economic benefits are likely to be interrogated in Parliament’s defence committee, where chairperson Kader Asmal last week described them as “untested assumptions”.