On 16 June 2021, the Government of India took the decision of converting the assets of the Ordnance Factory Board (OFB), consisting of 41 factories, 13 development centres and nine institutes of learning, into seven government owned corporate entities, on the lines of the Defence Public Sector Undertakings (DPSUs).The ordnance factories are the oldest and the largest organisation in the country’s defence industry with a history that dates back to 1787.

To assess and predict the sustainability of each corporatised entity by the Financial Year 2026-27 and their ability to meet select stated goals, Insighteon Consulting ran an inter active war- game on 26 and 27 August 2021.

Unlike other exercises, wargaming is designed to provide helpful insights for actionable strategic decision-making. With the findings of a war game, decision makers can better evaluate their alternative strategies and recognise hidden opportunities to seize and real threats to blunt.

Over 20 experts took part in the simulation, exploring the potential implications of different scenarios.

Reduced Demand to Effect Sustainability

The analysts were of the opinion that the Services will be to able to place an order of upto approximately INR 11,000 to 11,500 Cr per annum on OFB for the next 5 years ie from FY 21-22 onwards. It was deemed probable that the full economic and fiscal effects of Covid-19 will manifest only in the years beyond 2021, when the costs of the crisis are reflected in government spending policy. The inevitable reprioritisation of the central government’s expenditure in the coming union budgets would affect the defence resource allocations. Besides committed liabilities and changing nature of warfare will change priorities impacting the demand of the services on products of corporatised entities.

As 95% of the revenue of all seven corporatised entities is dependent on the government budget, the implications of reduced demand would be an increase in prices, keeping in mind the new pressures of arranging working capital as well as resources for modernisation and R&D, besides its corresponding effect on turnover.

Weapons and Equipment Group needs to ramp up Dhanush production to sustain itself till Year 2027

The analysts felt that survivability of the artillery sub group will be dependent on two aspects. Firstly, its capability to ramp up the manufacture of Dhanush guns to 48 guns per annum and simultaneously develop private vendors on priority. Secondly, support from MOD to renegotiate the up gunning contract Sharang. In case this is achieved, it can lead to an annual turn over of INR 800 Crores which will allow the Sub Group to sustain itself.

The small arms sub group will be able to sustain itself as the 5.56 INSAS would be replaced by Indo-Russia Rifles Private Limited (IRRPL) AK 203 rifles. It was further analysed that the additional workload created for manufacturing AK 203 components would optimise the capacity of Rifle Factory Ishapore and Korwa factories. Besides the sub groups’ efforts to explore on priority alternate markets namely MHA, State Police and export, for Excalibur Rifle, sniper rifle, 5.56 carbine and 7.62 mm Trichy Assault Rifle, will hold it in good stead.

However, the key point is that the Weapons and Equipment Group needs to urgently ramp up the Dhanush gun manufacturing capacity to 48 guns per annum, to achieve an average annual turnover of 5% per annum for the next 5 years, else the groups’ survivability will be in question.

Two groups may struggle as they face the brunt of disruption of existing mutual synergies and supply chains, caused by splitting the organisation into 7 Groups

The war-game led to the finding that division of OFB into seven entities has caused a disruption of existing supply chains. The Ancillary and the Opto Electronics Groups are under the threat of losing their age old customers viz Ammunition & Explosives and Vehicles Group respectively, on which they have 80 to 90 per cent dependency, without alternate markets established. The analysts felt that these groups are extremely vulnerable in the transition phase and will require “hand holding” measures.

This was recommended to be in terms of a policy directive ensuring that this inter dependency be allowed to continue for the transition phase, for a duration of three years. This needs to be addressed on priority.

Ancillary Group
The war-game brought out that the Group stayed largely dependent on SA / artillery/tank ammunition hardware orders in terms of shell casings/ cartridge cases/packing material etc, from the Ammunition and Explosives Group. Approximately 90% of the groups earnings are through inter factory demands, out of which 80% of the demand is from the Ammunition and Explosives Group.

The analysts felt that The Group is vulnerable to competition in the transition phase and will not be able to sustain itself unless either a price preference clause of 15% is provided for or the inter dependancy be allowed to continue vide a policy directive, for a three year period.

Opto Electronics Group
Presently the Opto Electronics Group was assessed to be dependent on the Vehicles Group for sustenance, as 90% of the Groups’ earnings are from the orders received from Vehicles Group. It was also assessed that the Opto Electronics is bound to face difficulties in exporting equipment, due to IP issues, thus restricting its market options. Therefore, it needs time to explore other markets/new products. Thus a policy directive ensuring that the present inter dependency be allowed to continue for the transition phase, for a duration of three years, was considered essential by the analysts. Alternately, it could be based on the fact that the Opto Electronics Group had absorbed ToT for its products from a foreign OEM and this needs to be amortised.

Troop Comfort Group is likely to face degrowth due to incrementally reducing demand

The war-game brought out that with the armed forces incrementally phasing out clothing items by Year 2024-25, group revenues will gradually reduce. On the other hand, the trend of placing of demands of a large number of troop comfort items on the private sector is increasing. The high cost structure also does not allow the Troop Comfort Group to be competitive. Therefore, the group’s turnover is gradually going to decrease from the present INR 700 Cr, from Year 2022 onwards. The Group needs to commence its restructuring by diversifying into the civil segment or into other attractive segments of the market like parachutes forthwith. A cut of 25% manpower is also required within the Group.

Three groups which have a comparatively firm starting block

Vehicle Group. The turnover of the Vehicles Group was predicted to achieve a year on year (YoY) growth of 6 % for the next five years, from the present turnover of INR 2500 Cr. The existing indents of all types of A vehicles are ensuring that the order book is full for the next five years. Prospective orders of Stallion, LPTA and Mine protected Vehicles from MHA, would also contribute to the turnover by approximately INR 800 Crores per annum.

Ammunition and Explosives Group. The group will be able to achieve YoY growth of 8% in the next five years, due to order visibility, exports and economies of scale. Its proposed diversification in the field of ammunition Life Extension Services and energetic materials, were considered likely to yield dividends.

Parachute Group. It was predicted that the Parachute Group will be able to achieve an average YoY turnover growth of 8 % due to order visibility, having a monopoly product and technology infusion.

Corporatisation will lead to an increase in prices

Contrary to the popular belief , the war-game, post a multi-layered consideration of issues, brought out that corporatisation will lead to an increase in prices.

In the past , OFB was functioning on a ‘No Profit No Loss’ basis supplying at ‘actual cost of production’, but with additional overheads. Now they will operate under corporate pressures, where cost of maintaining working capital and R&D costs will have to be taken into consideration and added to the cost of production. Sub contracting from different corporate entities due to splitting of traditional supply chains and Inter corporate taxation issues will add to the costs. Besides a reduced demand due to a reduced budget will create its own pressures in some cases. The analysts felt that the cost plus model will have to be adopted in the short term, thus making one of the aims of corporatisation ie cost reduction difficult to achieve.

Requirement of funds for R&D were analysed to be substantial and unless a grant to this effect is provided, it will have to be mobilised through a price rise. New product development in select groups were considered necessary for survival, as many top end products were at an advanced stage of completion.

It was estimated by the analysts that an average minimum profit of 7.5 per cent was necessary for sustenance, during the period under assessment, ie upto FY 2026-27.

Range of product offerings may reduce, thus increasing imports

The anticipated benefits of defence corporatisation can often be more than outweighed by unanticipated outcomes. The analysts felt that if the corporatised entities are to maximise profits in this highly specialised sector, they must focus on economies of scale. The war-game brought out that production of some ammunition items for example 14.5mmAPI/APIT, 130mm HE and 105mm HESH were at risk of being stopped as demands were erratic and therefore continued production of such items made it financially unviable for the new corporates. In addition, if requirements of select ammunition is reduced to 20-25% of previous demand levels for a considerable time, then it will be difficult to suddenly enhance production.

In the war-game it led to a situation where fast track imports had to be resorted to cater to an emergency as it was difficult for the corporates to bring those skills back when they were suddenly needed. Thus it led to import of items which had earlier been indigenised. Such a contingency can be avoided, if the government makes an immediate effort to identify items with erratic demands and then ensures fixed scales and periodicity of demands. Further, a policy directive for multi-year contracts and budget stability could promote a win win situation.

A related point was the requirement of maintaining a “surge capacity”, which has been stated as one of the aims of corporatisation. As a corporate entity with commercial accounting, cost of maintaining war reserve capacity is again financially unviable. The war-game indicated that it is not a worthwhile business strategy to have a lot of unused capacity, when no one is willing to pay for it. Therefore the analysts felt, that if a surge capacity is to be maintained, there is a requirement of additional funds for infrastructure and wages for the surplus man power. They recommended that this should be a joint decision of the armed forces and the government and needs to be taken at the start of corporatisation.

Challenges faced in the export market due to import of foreign critical components

Overall , certain corporatised Groups like Ammunition & Explosives, Weapons & Equipment and Parachute, were assessed to be able to increase their exports to about 8-10% of their per annum turnover, by FY 2026-27, due to the effort put in by the government using lines of credit to friendly foreign nations and assistance from DAs in various countries. However, in the war-game the Vehicles and Opto Electronics Groups faced challenges related to IP and contractual issues, since critical components were still imported and thus could not get clearances from OEMs, in spite of an existing demand for the end products. It would be prudent to commence measures to find a solution here with foreign OEMs at an appropriate level, as this is bound to reduce exports by a considerable degree. Further, removal of offset obligations from G2G deals also reduced export opportunities and may be reinstated.

Building confidence in the Human Resource

Keeping external factors aside, It was felt that the need of the hour is an inculcation of self belief , self esteem and confidence and removing apprehensions as to the intention of the government. Two issues need resolution by the government: One, status of the officers and workers after the initial period of two years for which the government has agreed to extend the existing terms and conditions of their employment. Two, clarifying apprehensions about golden handshake or side stepping offers to other ministries/departments/government organisations. The analysts felt that gaining the support and confidence of OFB employees at all levels will remain a crucial determinant for success and needs to be addressed with sensitivity and care.

Moreover, the existing surplus manpower is not capable of performing functions like finance, and marketing and will require personnel with experience from other PSUs/DPSUs.

Effect of an under developed local Ancillary industry

It was realised that there is an absence of strong and reliable vendors in India as a result of which the corporatised entities spend a vast amount of their resources in importing key raw materials and systems from foreign sources. This results in repeated long contractual negotiations with foreign vendors, on prices which are escalated every few months. The result is delayed delivery of products.

It was therefore recommended by the analysts, that there exists a need to formulate a vendor development policy which allows the seven entities to give long term commitments to local Indian vendors. This policy should also incentivise the local supplier network by removing the uncertainty in MoD’s programmes and bringing order visibility so that the local industry can plan and invest with confidence.

Role of the private sector post corporatisation

The war-game proceedings indicated that the Private Sector will not be too keen to form a Joint Venture with these Corporates. They seemed more keen to formalise a strategic alliance under the PPP model which will be product specific. The corporations in turn were open to function under a PPP model with the private sector as long as they are OEMs who are ready to share design and technology.