Israel’s Four Large Defense Companies Fear Knowhow Leak to Customers

Israel’s four large defense companies have established a special forum to examine ways to keep their proprietary knowhow in the country. The decision to set up the forum was taken in response to greater demands by foreign customers for reciprocal procurement as part of deals.

The forum’s participants are Israel Aerospace Industries Ltd. (IAI) (TASE: ARSP.B1),  Israel Military Industries Ltd. (IMI),  Elbit Systems Ltd. (Nasdaq: ESLT; TASE: ESLT), and Rafael Advanced Defense Systems Ltd. Most of the companies participating in the new forum obtain most of their income from the sale of weapon systems to foreign defense enterprises and armies, subject to permits from the Ministry of Defense. But extensive cutbacks in recent years in procurement budgets of players in the Israeli companies’ target markets has intensified the competition for every tender published and increased the number of companies bidding in them.

“Whereas in the past, big companies would have ignored some tenders because they were up to their necks with big tenders, today almost no company is willing to forego any tender, and the competition is fierce, ” says an executive at one of the Israeli companies.

According to Ministry of Defense figures, Israeli defense companies exported $7.5 billion worth of systems in 2012. Managers at the Israeli companies say that foreign customers understand that market conditions enable them to make greater demands for reciprocal procurements in their countries. Israeli companies are concerned that meeting these extreme demands, which are sometimes threshold conditions for a deal, will expose them to the risk of leakage of proprietary knowhow. This is priceless knowhow in which years of R&D has been invested.

“The transfer of knowhow by defense companies as part of the realization of these commitments is liable to change the balance of power in the market and create new competitors for these companies. The concern is that a developing country will gain technologies without the development costs, and, together with the low-cost labor that is available in some of them, will be able to offer a product line similar to that of the Israeli companies, but at much more attractive prices, ” says IAI VP business development and subsidiaries Yehoshua Eldar.

“In view of the defense cuts in many countries, competition is growing, and companies sometimes show much greater willingness to forego in the agreements certain components that in the past they would never have been prepared to hand over. This is, of course, subject to permits by agencies such as the Defense Exports Control Agency at the Ministry of Defense, ” adds Eldar.

IAI initiated the new forum. The company emphasizes that it is not an organization for coordinating positions ahead of negotiations with potential foreign customers. “Reciprocal procurements is a very broad area, which allows a great deal of creativity. Every company engaged in the matter has accumulated knowledge and experience over many years, and the forum’s objective is to share this with the other companies, ” says IAI reciprocal procurements administration head Hadas Har-Zvi.

“There have been cases in the past of negotiations with a certain East Asian country, which demanded the source code of a particular device. Transferring this code would have given that country full understanding of the product’s software and all the knowhow associated with it. We refused. However, it is possible during negotiations to please the customer in other ways, such as providing spare parts for the system for free, ” Har Zvi adds.

The new forum held its first meeting a few weeks ago and the defense companies believe that more meetings will be held soon.

Foreign companies estimate the defense companies’ reciprocal procurements commitments for the next ten years at $500 billion.

Published by Globes [online], Israel business news – www.globes-online.com