Putin’s Defense Procurement Challenge

By Richard Weitz

One of newly reelected President Vladimir Putin’s major challenges will be defense acquisition reform.

In his February 20 Rossiiskaya Gazeta pre-election article on Russia’s military-industrial complex, Putin writes that “the goal for the decade is to equip our Armed Forces with next-generation armaments, which boast better visibility, higher precision, and faster response than the similar systems of any potential adversary.”

As Putin acknowledges, achieving this objective will require a dramatic improvement in Russia’s defense procurement system and its supporting processes: “We will have to address several interconnected tasks at the same time: to increase by an order of magnitude the delivery of advanced and next-generation equipment; to form forward-looking scientific and technological capabilities, to develop and master technologies of critical importance to the manufacture of competitive military products; and, finally, to upgrade the technological base of the industries that specialise in the production of advanced weapons and military equipment.”

The MOD has become sterner in resisting paying for the massive price increases demanded by the Russian shipping industry for the latest strategic submarines or by the Ural Wagon Factory for the T-90 tank

As noted in my SLD previous article, Putin has pledged to spend almost $800 billion in the next decade to pay for these new weapons systems. My previous article reviewed all the reasons why Russia might not be able to afford such sums given competing demands and constraints on Russia’s economic growth.

Even if the money becomes available, it is still questionable whether Russia’s troubled military-industrial complex can achieve the Kremlin’s ambitious military modernization plans. Cost overruns and production delays remain endemic in the Russian defense industry.

http://www.sldinfo.com/putin%E2%80%99s-rearmament-can-moscow-afford-it/

Putin calls for using for modernizing defense industries, enhancing the skills of defense managers, elevating quality standards, offering more education and on-the-job training opportunities, creating education institutions that specialize in defense employment, and raising the pay and prestige of defense sector workers. The Ministry of Defense (MOD) has employed various administrative measures to overcome recurring procurement problems and achieve Putin’s goals, ranging from restructuring its defense industry oversight mechanisms, to buying weapons from foreign suppliers, to encouraging indigenous weapons makers to improve the quality and lower the cost of their goods and services, to aggressively challenging gouging by defense contractors–but thus far little progress has been achieved.

In his article, Putin lists Russia’s procurement priorities for the next ten years as strategic nuclear forces, air-and-space defenses, C4I systems, radio and electronic technologies, unmanned strike systems, transport aviation, personal protection equipment, and precision-guided munitions as well as the means to counter them. Deputy Prime Minister Dmitry Rogozin, who recently assumed responsibility for reforming Russia’s military-industrial complex after serving for several years as Moscow’s ambassador to NATO, has identified hypersonic and laser technologies as additional MOD priorities.

Despite the spending boosts of recent years, Russia’s military-industrial complex has proven unable to mass-produce even less sophisticated weapons systems. Its defense industries have yet to recover from the collapse of the integrated Soviet command economy, whose planners gave national security projects priority over non-security sectors in resource allocations. According to one expert, a mere 10 percent of the Russian defense industry’s equipment is modern; the rest dates from the Soviet era and often the early 1970s.

“Clearly,” Putin writes,” we need to thoroughly revise the economic activities that military and industrial complex enterprises are pursuing. They are plagued by numerous inefficiencies, such as vast unjustified expenses, overhead costs which often run into the thousands of percentage points, as well as tangled and obscure relations with contractors, where a parent company is balancing on the brink of bankruptcy and its subsidiaries and suppliers are generating profits running into two or three figures.”

The industry needs to improve its cost cutting by reducing corruption, making prices and decisions more transparent, eliminating excess plant capacity and office space, and other measures. The defense industry devotes inadequate attention to quality control, especially at the sub-contractor level. The age of the average Russian defense worker exceeds the minimal retirement level due to the industry’s inability to attract new employees.

They also have a poor work culture, seen in a lack of discipline, tolerance for low standards, and other problems that contribute to embarrassing accidents. Pending the modernization of their equipment and business practices, many defense firms will prove unable to design and produce sophisticated weapons without more cost overruns and production delays. As a result, the MOD will continue to receive many weapons still based on Soviet-era designs.

As in the past, some of whatever increase that does survive the cutbacks will be negated by the exceptionally high inflation in Russia’s defense sector.

Critics of the military-industrial complex such as former Finance Minister Alexei Kudrin argue that the defense companies simply raise their prices to match any military budget increases. Inflation in the defense industry is typically considerably higher than in the civilian sectors. Deputy Defense Minister Mikhail Mokretsov has attributed the high rate of defense inflation to their being too many subcontractors in the sector as well as a lack of transparency. He cited how companies would regularly offer large price reductions in negotiations with Ministry without explaining why they originally priced the item in question so high. This perspective would imply the need to drive some companies out of business while requiring that others merge into a smaller number of larger firms whose operations could be more easily monitored by MOD procurement personnel.

Perhaps a more important reason for the above average inflation in the military sector is the limited impact of market forces such as price and quality competition and transparency in containing costs. In addition, the military will need to use some of the additional funds to purchase housing for the many retired officers, who receive this privilege by law.

Corruption will also eat away at the proposed spending boost.

Last year, Russia’s Military Prosecutor General Sergei Fridinsky estimated that about one-fifth of all government money allocated in procuring new weapons was stolen due to the irresistible opportunities for graft undertaken behind the veil of military secrecy. Rogozin called those involved “traitors” since their act “causes harm to Russia’s defense capabilities and its security” and this “the bribe-taker directly collaborates with a potential enemy.”  Transparency International ranks  Russia 154th out of 178 states in terms of relative corruption. “We will aggressively combat corruption in the defence industry and the Armed Forces and hold fast to the principle of the unavoidability of punishment,” Putin writes. “Indeed, corruption in the sphere of national security amounts to no less than high treason.”

Torn between a desire to contain costs and the imperative of modernizing national defense enterprises, Russian leaders have been debating the acceptable profit level for the defense industry.

In May 2011, Prime Minister Putin said that defense enterprises’ rate of profit should be at least 15%, but that price gouging on standard items was unacceptable. In early 2012, Putin told the press that the government would use penalties and other financial sanctions to prevent gouging by defense contractors.

Putin believed that defense manufacturers should enjoy profit margins of between 13 and 20 percent, which would allow them to retain skilled workers and invest in modern machinery. In his February 20 article, Putin writes that, “We should also bear in mind that the purchase price in all cases has to be fair and sufficient to recover the costs of investments and also pay for development, modernisation, recruitment of skilled labour and staff training.”

Rogozin has recognized the general need to strengthen the links between weapons designers, defense manufacturers, and the Russian armed forces to avoid the Soviet-era problem of producing an enormous amount of weapons that the military does not need. But the MOD has yet to detail a new procurement process that would achieve this result.

For now, Defense Minister Anatoly Serdyukov has said that the MOD has simply stopped procuring weapons that have not been fully tested or that do not have an identified military requirement. According to Serdyukov, this rule has resulted in the exclusion from the 2012 SAP of various armored vehicles, artillery pieces, and other defense equipment.

During the past decade, the Russian government has encouraged the establishment of several large vertical holding companies in key defense sectors, such as the United Shipbuilding Corporation and United Aircraft Corporation. This consolidation has helped these defense firms pool their limited human and financial resources as well as curb destructive competition for export sales.

But this approach has also forced some of Russia’s best companies to divert funds and other resources to support the most troubled firms. In some cases this has allowed them to recover (such as successful support Sukhoi has provided the MiG Corporation), but in other instances it has simply hobbled the industry leaders. Even so, Russia looks set to create yet another single holding company for the air and missile defense sector. It will support a new unified strategic command, established in December 2011, that includes all air, missile and space defense forces (such as missile early-warning systems and airspace monitoring) under a single structure.

The MOD has also become sterner in resisting paying for the massive price increases demanded by the Russian shipping industry for the latest strategic submarines or by the Ural Wagon Factory for the T-90 tank.

In response, Russia’s leading ballistic missile designer, Yuri Solomonov, complained to the media that the MOD had “turned into a tax inspectorate.”  He claimed that the demands to review and negotiate price cuts had delayed the signing of new contracts and therefore the production and delivery of needed defense equipment. Solomonov, perhaps Russia’s most famous missile designer, has warned that the delays threaten to undermine Russia’s planned strategic nuclear buildup. Last year, the MOD missed many deadlines for important defense contracts. A large number of senior military and defense industry officials were dismissed or reprimanded over this issue.

In his February 20 article, Putin says that, “To enable defense companies to make long-term plans, we have decided to stagger the state’s defense order over three to five or even seven years,” which, by making their future orders more predictable, should help the companies to optimize their scale of production. To this end, “Adjustments in the government defense order after it has been approved by the government must be kept to a minimum.”

Putin wants to encourage rivalries and greater quality competition at the concept and research phases of the development of a new weapons system, to increase the choices and quality offered defense managers, but then wants to simplify and standardize the production process in order to reduce duplication and minimize delays and costs overruns.

We must “prioritise successful research projects… so as not to duplicate specific weapons systems.” He also called for establishing a “search engine, a common database, common standards and a transparent mechanism of pricing for defence industry projects” in order to limit duplicate research projects.

In his article, Putin again raised the recurring proposal to establish a single agency to make and oversee defense contracts. At present, each service and ministry and other entity has its own contracting agency, which leads to excessive duplication, incongruous standards, reduced government buying power, unnecessary price differentials, and, given the limited pool of acquisition talent, poor oversight. Furthermore, “We should work for more integration and cooperation between various companies, and … standardize production facilities.”

Putin called for strengthening the relationships between defense firms, military departments, and civilian research and academic institutions to “generate breakthrough ideas.” Citing the American example, Putin writes “we must also more actively involve the potential of civilian universities in implementing programs for the modernization of the defense industry. Large-scale defense contracts can be another source of university and research center development.”

During a February 2012 trip to the Russian Far East, Putin applauded the Surgutneftegas and TNK energy companies for helping finance the renovation of the Vilyuchinsk base for Russia’s strategic submarines at Kamchatka in 2002 that the General Staff otherwise might have had to close.

In his article, Putin says “we should start breaking departmental stereotypes and engage civilian enterprises and private businesses in the manufacturing of military equipment and defense engineering.” He cites the example of Europe and the United States in arguing that, “The development of the military-industrial complex by the state alone is already ineffective and will cease to be economically viable in the mid-term.”

Therefore, “It is important to promote the partnership between the state and private businesses in the defense industry and make the procedures involved in establishing new defense enterprises less complicated.” To overcome the barriers to entry caused by the opaqueness of Russia’s state-owned military-industrial complex, Putin wants to create a database that indicates where private investment and production in the defense industry is most needed.

Putin also writes that the government is creating models of enterprises that will be capable of “acting as a kind of broker between military, industrial, scientific and political circles.” Without providing details, he adds that, “Such companies must be able to single out and support the best aspects of national innovation projects, while circumventing excessive bureaucracy involving too many discussions.”

The government is also completing plans to create a special body like the U.S. Defense Advanced Research Projects Agency (DARPA) to fund risky but promising military research and development projects. It might also fulfill Putin’s requirement to develop mechanisms that can “look ahead, ‘over the horizon’, and estimate threats for 30-50 years ahead.”

Putin calls this “a serious task that requires that we mobilize the resources of civilian and military science and algorithms of reliable long-term forecasting” that can answer such questions as: “What kind of weapons will the Russian Army need? What kind of technical requirements will our defense industry have? “

That is, precisely the kinds of questions that interest SLD readers and the Hudson Institute.

Credit Photo: http://www.fprado.com/armorsite/T-90S.htm

For a comprehensive forecast of the evolution of the Russian defense sector see the ICD Research Report

http://www.sldinfo.com/products/the-russian-defense-sector-n-market-opportunities-and-entry-strategies-analyses-and-forecasts-to-2015/

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