26/3/2014 Ami Rojkes Dombe - .israeldefense.com
Israel is one of the world's largest arms exporters, so why do the Israeli defense industries find it so hard to maintain their status at the top of the global UAV market?
The State of Israel has been known as a world leader in defense exports in the last few decades, and that includes the success of the Israeli UAV industry. According to a report by the consulting agency Frost & Sullivan, the sales turnover generated by this particular field was US$ 4.6 billion over the last eight years. Much of this success may be attributed to sales of such Unmanned Airborne Vehicles as IAI's Heron, Elbit Systems' Hermes and Aeronautics' Orbiter.
Behind the various news reports that bolster Israeli national pride, lurks a truth that has the potential of overshadowing the accomplishments of this industry in the future. Like other sectors of the Israeli defense industry, the UAV industry also relies primarily on sales to overseas clients, with a ratio of about 20% sales to the local market and about 80% to foreign countries. However, unlike other industries that also focus on exports, like agriculture, fashion or diamonds, the operations of the Israeli UAV manufacturers is subject to the supervision of the Israel Ministry of Defense (IMOD).
This situation has created a complex reality. On the one hand, you have the manufacturers, who need the money from the sales of UAVs to foreign countries in order to exist. On the other hand you have IMOD, which is responsible for promoting their exports while at the same time supervising those exports as well as promoting the development of new technologies. On the face of it, these are two conflicting functions being run under the same umbrella. Support for weapon system sales is provided by SIBAT – IMOD's Defense Export & Cooperation Agency; development of future technologies is the responsibility of MAFAT – IMOD's Administration for the Development of Weapon Systems and Technological Infrastructure, and the regulation of defense exports is the responsibility of API, IMOD's Defense Export Controls Agency (DECA). This reality has created tensions between the Israeli UAV manufacturers and IMOD as the business interests of the industries are not always consistent with government and political interests.
Sources in the industry claim that the State of Israel, through the three IMOD agencies outlined above, fails to manage the UAV market in a manner that would maintain Israel's advantage. "We should bear in mind that this is a small country. The budgets of the IDF and MAFAT are small compared to the USA, Europe or China, so the budgets must be managed intelligently, so as to enable all of the companies to compete in Israel as well as abroad. Instead, every company attempts to eliminate the others in the war over tenders."
The processes that take place under the surface are the result of the UAV export procedures. The first stage involves developing a product or a capability, establishing a company and registering a patent. After the entrepreneur has completed these initial moves, which cost him a lot of money, he should apply to DECA for two permit types. One for marketing (defense marketing permit) and the other for export (defense export permit). The marketing permit allows him to engage in marketing activities, such as meeting with prospective clients, submitting quotes and so forth. The export permit allows him to fulfill deals that had been closed, namely – to actually export the product or knowledge to the foreign client. From that moment on, every activity he initiates in order to carry out a sale overseas must be reported to and sanctioned by the Ministry of Defense.
Sources in the industry claim that this procedure is nothing but over-complicated and burdensome red tape, while IMOD officials claim that these mechanisms were intended to prevent classified technologies from reaching countries that are hostile to Israel – which could undermine the qualitative advantage of the IDF or cause diplomatic problems for Israel vis-à-vis friendly countries: two different viewing angles of the same reality.
As this field is evolving worldwide, it attracts new entrepreneurs: more than 30 UAV companies operate in Israel today. Some of these companies are capable of manufacturing a complete UAV system, which includes the unmanned vehicle and its support systems. This category includes IAI, Elbit Systems and Aeronautics. Other companies manufacture auxiliary and complementary systems such as payloads, control systems or specialized capabilities such as imagery analysis, et al.
What is the actual scope of the global UAV market? According to the National Defense Magazine website, about 4,000 UAVs have been operating worldwide in May 2013. The sales turnover of this market in 2013 was US$ 11 billion according to an AVUSI survey. According to Frost & Sullivan, the global (cumulative) sales turnover in 2011-2020 is expected to exceed US$ 61 billion and according to a report by the Aerospace America organization, some 270 manufacturers from 57 countries, producing a total of 960 different models, are competing for that money.
Like other major technological markets in the world, including cyber, software and biomed, the UAV market provides a field of activity for many entrepreneurs – possibly too many for a small country like Israel. Many of those entrepreneurs had grown up in the major industries or in the military, and made the spin-off into smaller industries. Not all of these smaller industries present new or innovative technologies. This is possibly one of the causes of the fierce competition in the Israeli UAV market. Is the State of Israel simply too small to accommodate so many manufacturers in the same line of business? The answer depends on the party being asked. In effect, IMOD officials say that there is not enough money to promote everyone. On the other hand, the manufacturers expect government support: once again – two different viewing angles of the same reality.
In comparison, the USA has four major UAV manufacturers: General Atomics (which, financially, accounts for one half of the USA UAV market), Northrop-Grumman, Lockheed-Martin and the partnership between Boeing and AAI Textron. Most of the sales of these industries are aimed at the US military, and only 20% of their revenue stems from exports – just the opposite of the situation in Israel.
"The fierce competition notwithstanding, it is the task of the State of Israel to continue to lead the market. Export transactions are the economic engine that enables the continued development of the industry and provides IMOD with the ability to implement the development of cutting-edge operational capabilities for its own needs," says a source in the industry. "Without the exports, we will lose the UAV capabilities that we know today. It is a business cycle that necessitates the promotion of export transactions by the defense establishment."
The importance of the UAV industry to Israel stems from a number of reasons. Firstly, this industry provides the IDF with a qualitative advantage. Today, Israel is second only to the USA in the development of UAV technology. Another reason pertains to business. The sales of the UAV industry generate proceeds from taxes to the national treasure, contribute to the increase in national exports and provide employment to some 3,000 households directly, plus several thousands of households indirectly.
Defense Venture Capital Fund
One of the most important arms of IMOD in the context of assisting UAV manufacturers is MAFAT. Although the budget of this unit is never published openly, it is, in fact, Israel's largest government-owned venture capital fund – larger even than the Chief Scientist, an agency that operates under the Ministry of Economy. Why venture capital? Because the money comes from the taxes paid by the Israeli citizens (a part of the national defense budget) and is invested in the development of future technologies. Some of these investments will succeed while others will fail. IMOD invests the money in academic institutions and business companies, and most of it goes to defense industries. There, IMOD says, they know how to develop the weapon systems needed by IDF.
In cases where the research activity succeeds, the resulting technologies can be converted into products ('spin-off') which may be sold to clients overseas. In such cases, the State of Israel is paid a percentage for the initial investment made by MAFAT only for government-to-government (G2G) sales. Hence, IMOD as the fund owner has an interest in investing in the major UAV companies, which stand a better chance of selling their products to other countries. Such transactions will yield, for the State of Israel, a return on its investment.
According to sources in the industry, in the USA, for example, the state compels the winning industry – which is normally one of the major players – to assign parts of the project to smaller companies. In this way, the state looks after everyone. Over there, they also have tenders that are intended exclusively for small industries. "Every small UAV company in Israel would love to work for IAI or Elbit, as that would exempt them from investing in marketing channels on the one hand, while allowing them to continue developing their proprietary technologies on the other hand," say sources in the industry. IMOD officials say, on the other hand, that in the USA there is a process of merging and unification of companies owing to the competition. "Out of ten manufacturers of fighter aircraft they had in the past, only three remained. The same process is underway in the UAV industry as well."
The manufacturers' claims notwithstanding, one should bear in mind that IMOD, as a government agency, takes into account considerations other than just business considerations. For example, upholding the MTCR Treaty – a treaty intended to prevent the proliferation of platforms capable of carrying nuclear weapons. This definition includes long-range missiles and supporting technologies, as well as large UAVs – those capable of flying to a range of more than 300 kilometers while carrying a payload of more than 500 kilograms (Category 1), or those capable of flying to a range of more than 300 kilometers while carrying a payload of less than 500 kilograms (Category 2). Although Israel did not sign this treaty, it upholds it.
The implication of upholding this treaty is that in effect, Category 1 UAVs cannot be exported except by the state, while the exportation of Category 2 UAVs requires the authorization of a special committee, including the attachment of a user's declaration on behalf of the purchasing party. In response to the claims made by some manufacturers, according to which this treaty damages Israel's competitiveness, sources at IMOD explained that the treaty actually contributes to the business interests of the State of Israel. "In the long run, deviating from the treaty will damage the exports of the entire defense industry," says an IMOD official. Beyond that, the State of Israel has a national defense interest in promoting international mechanisms that would restrict the proliferation of technologies designed to carry nuclear weapons.
Along with the MTCR Treaty, Israel also upholds the Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods & Technologies – another agreement it did not sign. This international agreement is intended to prevent the proliferation of dual-use goods and technologies, namely – goods and technologies that may be used for civilian as well as for military purposes. This agreement applies to the smaller UAVs that cannot reach ranges of 300 kilometers and are not covered by the MTCR Treaty. In this case, too, it is the interest of the State of Israel to make it difficult for the terrorist organizations to obtain advanced technological resources in the guise of civilian technologies.
On the other hand, sources in the industry claim that this is just another hindrance imposed on Israel's competitiveness in the global market, especially with regard to such sectors as agriculture, energy or homeland security (HLS), where the need for small UAVs is currently evolving. "Today, all UAV elements may be obtained through the civilian market worldwide, which makes it possible for any private party to build a system and operate it under no supervision whatsoever, while we still have to cope with the same supervision as for military systems. If we fail to see to it that the rules are changed, we will not be able to compete in the future world and our technological superiority will vanish," say sources in the industry.
Elbit Systems' Heron 900 (Photo: Elbit Systems)
In arms transactions vis-à-vis international parties, one of the first questions raised by the client is "Is this technology used by the IDF?" Both IMOD and the industry understand that the IDF's seal of approval is an effective opener of doors and pockets abroad.
In this context, sources in the industry say that the larger manufacturers have an advantage, and in effect the smaller manufacturers find it hard to work opposite the IDF and are therefore unable to compete for international tenders. "In the case of the larger industries, a development tender is linked to purchasing and then everything is registered under purchasing and that is reflected in the tender. The small and medium manufacturers cannot even participate in these tenders," say sources in the industry.
In response, sources at IMOD say that in many of the tenders issued for the benefit of the IDF, the smaller manufacturers did not want to participate at all. On the contrary, they say at IMOD, the government sometimes promotes products that are not used by IDF. As an example, the IMOD sources point to the support provided to Urban Aeronautics, a small company from the town of Yavne. Despite the fact that the product in question is not used by IDF, IMOD thought that the technology was unique and invested several millions in R&D and marketing for the company, as well as introducing the company to potential clients in the USA and Europe.
"Defense - Not Business"
In addition to the restrictions on exportation, controlled by the government of Israel, another, external variable should be addressed here – the competition in the global market. Although Israel has done well over the last eight years, the evolving UAV market has produced new manufacturers in places where they had never existed before. In addition to the USA, which is regarded as the global leader of this industry, China has begun manufacturing UAVs as well. As with other product categories, China aspires to become the global leader in this field, too – and the prices match its ambitions.
Additionally, UAV manufacturers can now be found in Europe, in Iran, in the United Arab Emirates, in South Africa and in South America. Admittedly, some of these manufacturers have not demonstrated any commercial capabilities yet, but they are definitely on the way. Also, in 2013 France, Italy and Holland, along with Britain, preferred to purchase US-made Predator UAV systems over Israeli systems of the same category. This trend is expected to intensify with the expected pullout of the US forces from Afghanistan and the subsequent 'flooding' of the global market with unmanned systems they had been using over there. Only last year, the US government granted permits for export to 66 countries.
Sources in the industry claim that the gap between the reality of the global market and the export control mechanism of IMOD hinders the growth of exports and could damage Israel's competitiveness in the future. "This cannot work. Defense people cannot supervise business people," they explain. "A former IAF officer does not understand the interests of a UAV manufacturer who sells to clients on four continents. He does not understand the dynamics of doing business in those places. He understands the needs of the IAF and IDF, but he does not know that today you can buy UAV technologies from many sources around the world. If we do not sell, the client will buy it elsewhere."
Apparently, there is a certain degree of consensus around this particular claim, and sources at IMOD say that one of the objectives for the coming year is to improve the UAV export authorization procedure. "This involves streamlining and improving the efficiency of processes, which would shorten the response interval of the manufacturer vis-à-vis the client," IMOD sources explain. If everything goes well, these improvements are expected to become effective in a few months.
Conversely, IMOD sources claim that the fact that the Israeli industry tops the global UAV export charts, even above the US industry, proves the Ministry's liberalism compared to similar agencies in the USA or Europe. These sources further claim that Israeli policy maintains that politicians do not promote specific transactions, but endeavor to promote Israeli industry generally.
So, what can be done after all to overcome the difficulties? Firstly, the supervision and involvement of IMOD in export processes should be adapted to the changes that are taking place in the global UAV market. The technological changes in this market call for procedures and directives that would enable the manufacturer to respond promptly to the client's demands.
IMOD can also compel the larger industries to enable the smaller industries to participate in the tenders it issues as well as in the export permit terms. In most cases, it is public money that finances the technological development and the global marketing of the products by MAFAT and SIBAT, respectively. These funds can be channeled to maintaining the qualitative advantage of the IDF as well as for maintaining the industry. At the same time, it should be emphasized that the budget in question is limited and should be used to support many companies. Consequently, say sources at IMOD, the manufacturers' expectations should match this fact.
Another option is to incorporate the Ministry of Economy in the export control process. At the present time, the decision as to where to export to, how much to export and what to export is an outcome of meetings between SIBAT, API (DECA), MAFAT, MALMAB (the agency in charge of security within IMOD) – all IMOD agencies, other intelligence agencies and the Ministry of Foreign Affairs. All of these elements share the same defense or political concept, and adding a body with an economic concept can balance the picture. Admittedly, at IMOD they claim that the contrast between SIBAT and API (DECA) serves this purpose, but in effect, almost all of the officials in these agencies had grown up within the defense establishment and consequently that claim is only partially true.
Yet another move – possibly the most important one – that may be initiated is to encourage an open dialog between the industry and IMOD. This should enable the manufacturers, on the one hand, to present their difficulties and raise them for discussion, while on the other hand providing IMOD with the opportunity to explain its business, political and defense/security considerations. The understanding that there is a direct connection between the successful sales of Israeli UAV systems around the world and the need to maintain and promote the operational advantage of the IDF should constitute the foundation for the claims of both sides. Eventually, the cooperation between the commercial sector and the government sector will determine Israel's share in a highly competitive market.