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The enactment of the Law on the Defense Industry (LoDI) is seen as
a significant breakthrough since it mandates the government to prioritize
the domestic industry in arms procurement. The law implies that the
government is willing to take advantage of defense procurement as a tool
of industrial policy, that is to create, maintain and protect necessary
industrial capability at a certain cost premium (costs incurred due to
local content requirements).
A cautious approach is crucial in translating this spirit into practical
guidelines, however.
The Indonesian Military’s (TNI) Minimum Essential Forces (MEF), under
which the procurement program is listed, is set to conclude within 15
years (2010-2024). The first-three years have passed, and yet the value
of local procurement remains small: 13 percent of total arms in 2011. The
figure is expected to rise significantly from Rp 1.3 trillion (US$134
million) in 2012 to Rp 11 trillion in 2013.
Optimization of local procurement necessitates adjustments in procurement
procedures. Arms procurement has been regulated separately from other
public procurement, but is not sufficiently tailored to the unique
characteristics of defense such as higher technology standards, longer
life cycles and security considerations. Debate remains as to whether
arms procurement should be spared from the competition that is the basis
of any public procurement under good governance principles. Here,
confidentiality seems to take precedence over value-for-money. Thus, only
two mechanisms are used: limited bid and direct appointment (in the case
of urgent requirement).
Defense Ministry Regulation No. 34/2011 on procurement of weapons systems
divides the procurement into five sequential stages as shown in the
diagram.
This procedure contains several weaknesses. First, it does not
regulate procurement of developmental items, which entail longer life
cycles and R&D spending. Second, the pre-preparation stage is crammed
with activities that determine the succeeding stages. Most importantly,
the technology assessment procedure required to translate operational
requirements (OR) into technical specifications (TS) is often criticized
as the gateway for the intervention of brokers. Since defense technology
is highly specialized, it is difficult to expect competition once the
tech specs are hard-wired to the benefit of a certain provider. This
explains why the preference for off-the-shelf (OTS), especially foreign
OTS, is still prevalent.
At the same time, the procedure also creates obstacles to national
industrial participation. First, it expects industrial participation to
begin only after the requirement planning is hard-wired, which means the
defense industry is not involved in technology assessment and pricing
(therefore economic scales for industry are not considered). Second,
procurement contracts must be concluded within the same budget year,
which risks penalties for late delivery. Third, in many cases the bulk of
procurement is not synchronized with industrial capacity. Industry is
either choked with too many orders in a short period of time, or starved
of them.
The most problematic issues with local procurement are underperformance,
overpricing and late delivery. As much as it is the defense industry’s
fault, the administrative complexity of multiple sources of funding
(there are three different sources of funding for national industry) and
slow procurement (sometimes it takes eight months just to issue a
contract) must also bear partial blame. A High Level Committee is to be
created at the Defense Ministry/TNI, Finance Ministry and the House of
Representatives to speed up the procurement process from 31 months to
eight months.
The absence of R&D support and economies of scale in procurement
ordering means industry struggles to run production competitively. This
implies higher cost premiums for the state, higher unit production prices
for the user and greater barriers for the defense industry to enter the
international market. To support defense industry development, the
government created a defense technology and industry development fund last
year. Its impact, however, remains to be seen.
It is amid the scattered efforts to accommodate local procurement that
LoDI’s significance stands out: It (indirectly) mandates substantial
changes in the procurement procedure to ensure that optimization of local
procurement is feasible. Paragraph 21, 25 and 27 of the law commands
synchronization of arms requirement planning with domestic industry’s
production master plans.
Central to ensuring the implementation of LoDI is the Committee for
Defense Industrial Policy (KKIP), whose role falls somewhere between
coordinator and enabler. The law envisions a new structure with permanent
support staff, without which it would be impossible for the KKIP to
undertake a huge expansion of roles.
A limited form of life-cycle approach is adopted in Paragraph 61 and 62
that stipulates the application of multi-year contracts across various
activities like R&D, engineering, technology transfer, financing,
purchasing, production capacity improvement and marketing. Paragraph 43
creates a safety net in the case of foreign procurement, by regulating
domestic industry participation through the mechanism of offset or
collaboration. It is expected that kickbacks and the like will be
transformed into industrial participation benefits.
In a nutshell, LoDI wants to address problems that have hampered previous
attempts at optimizing local procurement in a comprehensive way.
There are two recommendations to foster arms procurement improvements.
First, more attention should be given to the pre-preparation stage. If
necessary, technological assessment should be put into a separate stage
in which experts from various backgrounds will be involved in calculating
the most cost-efficient solution — that is “effective” for the military
and “economic” for the defense industry.
Second, partnership with industry is imperative and this means
involvement at an earlier stage, intensive communication, as well as a
shared understanding of the risks, costs and difficulties in weapon
systems production compared to the commercial market.
For a small defense economy like Indonesia, the existence of a defense
industrial base rests on the willingness of the national government to
buy locally. Industry is expected to meet up with TNI’s requirements, but
the TNI/Defense Ministry is also required to adjust its procurement
procedures to accommodate industrial sustainability. It takes two to
tango. ●
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