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Heinz-Axel Kirchwehm
School of Business Administration Turība, Latvia

The knowledge about the link between purchases of equipment and offset obligations is almost unknown in many areas of economy. The requests of the offset primarily occur in the area of arms exports and cover the full range of industrial and commercial benefits that firms provide to foreign governments as inducements or conditions for the purchase of military goods and services. Due to their market power and possible risk sharing more and more prime contractors are handing over offset obligations in the lower stages of their supply chain. The result is that Small and Medium Enterprises (SMEs) and, therefore, usually less experienced companies, are faced with handling offset demands. The goal of this paper is to establish if any research has been done dealing with the impact of offset obligations on the business processes of SMEs. The data for the current investigation were obtained from secondary sources which were mainly accessible via internet. After the data collection the analysis was performed through a simple filter which checks if there is a reference to offset obligations and SMEs and then, if there is a reference to their business processes. The first research activities showed that currently there are  some empirical papers available on arms trade offsets, but very few - focusing on the SMEs and, in particular, no studies have been done regarding the impact of offset on their business processes. The paper concludes that further extensive research is necessary to determine the impact of offset on business processes.

Key words: Offset, Small and Medium Enterprises, Business Processes.


Today it is a common practice that procurement projects are associated with offset obligations. Not only because  the importance of these offset transactions increases from year to year, but also due to the fact that this type is one of the most complex Business-to-Business (B2B) and Business-to-Administration (B2A) relationships. Despite it, the knowledge of almost every aspect of offsets, including their history, their pattern of use and their operations is scarce (Sköns 2002, p.2). The most serious lack of knowledge is, perhaps, connected with ​​the impact of offsets on the business processes of the involved companies. When we take into account the actual competitive conditions in most of the industries and the fact that during executing offset obligations it comes to a close integration of business processes (temporary building of a Collaborative Business), it is precisely this lack of knowledge that could also prove to be disadvantageous (Sköns 2002, p.2).

The significance of offset in defence deals

More and more states start to develop their national industries by linking their most important procurement projects (especially defence projects) with requests for offset. It means that the basis from which offset transactions are developing is the global arms exports. In 2010, the world's seven largest nations of military expenditures delivered equipment with a value of U.S. $ 21.3bn, Europe’s share of this was U.S. $ 5.22bn (SIPRI 2010, Database). Such  offset is required not only by the emerging and developing countries, it also highlights the case of the European Union (EU). According to the study done by the European Defence Agency (EDA) of 2007 and covering the period of 2000 to 2006, an average of 93.4 per cent of all arms imports in the EU are linked with offset obligations (Eriksson 2007, Table 3.1, p. 21.). The same study also concludes that on average 74 per cent of the offset obligation are realized in the participating defence industry and only 26 per cent in the civilian industries (Eriksson 2007, Table 3.1, p. 21.). The actual estimates of Blenheim Capital show that currently there are more than U.S. $ 100bn of offset obligations outstanding in the world and in the next five years another U.S. $ 150bn of obligations are expected to be generated (Blenheim 2008, p. 2.).

Problem statement

 In addition to the aspects of distorting competition through the offset, another problem exists. Prime contractors are handing over offset obligations in the lower stages of their supply chain (Europe Economics 2009, p. 55.).This approach of Risk Sharing can be implemented by the companies through their market power. The result is that more and more SMEs and, therefore, usually less experienced companies, are faced with offset demands. These obligations are either realized in the original supply chain or even in direct interaction with the participating industry.

Focus on Small and Medium Enterprises (SMEs)

Due to their crucial importance for the supply chain of large defence firms, SMEs play an essential role in the European defence industry. Nevertheless, even the SMEs suffer from the inefficient  structure of this industry which is characterized as follows: parallel development of weapons systems, too small lots, steadily rising costs in development, tough competition, a market dominated by large companies, and so on(Burmeister 2010, p. 10.).These circumstances are particularly reflected in the fact that the share of SMEs in the value of the EU arms industry is much lower than their respective share of the European Gross Domestic Product (GDP).

The goal of the research 

The goal of this paper is to establish if there is any research done dealing with the impact of offset obligations on the business processes of SMEs. The hypothesis of the research is: in the context of knowledge transfer to not so experienced companies, the handling of offset requirements should be simplified.

1. Background information

Definition and categorization of offset

Offset transactions are a special type of countertrade, which are occuring increasingly in the procurement of arms. Offsets are defined as follows: Offsets are simply goods and services which form elements of complex voluntary transactions negotiated between governments as purchasers and foreign suppliers … they are those goods and services on which a government chooses to place the label offsets (Hall and Markowski 1994, p. 179). A distinction must be made between a direct and indirect offset, as well as a hybrid of these two types (BIS 2009, p. 35.). A direct offset is directly related to the arms to be delivered, or services. Different types of direct offset include  subcontracting, co-production, technology transfers, licensed production, training, and investment and financing activities in the country of the contracting authority (buyer). An indirect offset is not directly related to the arms or services and typically includes purchasing and marketing / export assistance and investment, education, finance, and technology transfer (BIS 2009, p. 34.).

The aims of offsets 

The national and political reasons for requesting offset obligations vary from state to state, but the most important reasons are reflected in the following objectives (Pretoria 2011, p. 90):

The civilian side of the offset

The demand of offset obligations occurs not only in the sector of the defence industry; it exists also in civilian procurement programs such as the procurement of Railway systems, Commercial Aircrafts, overland or satellite telecommunication systems and so on. The basic objectives and procedures of civil and military offset are identical (Sylvain 2010, p. 8.). The study focusing on the defence industry first of all showed that offset is very widespread in this business sector. For example, 70.96% of all arms exports to the U.S. were in the period from 1993 to 2008 and associated with the demand for offset (BIS 2009, p. 4.). The second fact highlights the complexity of the offset requirements in the defence industry. The complexity arises from the following circumstances:

2. Literature Research and Review


A systematic review was done in accordance with the goal of the research having the following structure: the first step was defining the necessary keywords such as: Offset, Small and Medium Enterprises (SME), Business Processes and a combination of all of them. The second step was a thorough search of  literature for relevant papers. This part was mainly done via internet with a keyword research in GOOGLE© and METASEARCH©, and took place in the period from July 2010 to November 2011; it resulted in 230 selected scientific articles, papers, as well as master and doctoral theses for a more detailed analysis.

This analysis was performed through a simple filter which checks if there is a reference to offset obligations and SMEs and then, if there is a reference to their business processes. Paralelly, such analysis was used for the literature review.

Literature review

This chapter reviews the available literature on the three main themes: Offset; Business Processes and their Management, and Small and Medium Enterprises.

The so-called offset transactions with their linked demands for technology transfer, local content, etc. are unknown in many sections of economy. It has two main reasons: firstly, the fact that this type of transaction mostly takes place in the defence industry, which limites the number of the involved people and, secondly, this type of business transactions has not yet been scientifically analyzed so intensively in comparison to other types.

The first contributions which offer a definition and structure of this subject were published by Neuman (1985), Udi and Maskus (1991), Hartley (1995), as well as Martin (1996). The publications by Matthews (1996), as well as Brauer and Dunne (2004) deepened the subject even further in terms of the economic impact of offset. According to the study done by Brauer and Dunne (2009), which deals with the question: Arms Trade Offsets - What Do We Know? shows that in the examined period from 2004 to 2009 no new empirical papers were published on the subject of arms trade offsets.

Besides these general reflections, several case studies consider the effects of offset under specific conditions. So, in  the USA the Bureau of Industry and Security (BIS) elaborates an annual report for the U.S. Congress (e.g. BIS, 2007) from the perspective of an offset providing economy. In Europe various studies exist with the view of the participating economies such as Sköns, (2002), Eriksson (2007), Swiss Federal Finance Controll - EFK (2007) and Europe Economics (2009). Furthermore, some studies were published on the countries which are developing their national industries by offset, e.g. Batchelor and Dunne (2000) for South Africa, and Balakrishnan (2007) for Malaysia. One thing that is common in all these publications is: they didn't examine the effects of offset on the business process level of the companies, and, particularly, SMEs.

Another area to be considered in the present paper is ​​business processes and their management.

According to Davenport and Short (1990), Business Processes are defined as a set of logically related tasks performed to achieve defined business actions. This simple view was expanded by Keen and Knapp (1996); they state  that there are two other views which must be considered, firstly, the "process as a workflow" and, secondly, the “process as a coordination of work”.  To sum up, a business process may be interpreted as 

Business processes as a transformation are explained in the classical definition of Hammer & Champy (1993) and  defined as  "a collection of activities that takes one or more input and creates output that is of value on to the customer". Similar definitions have been provided by Davenport (1993), Johansson et al (1993) and Rummler & Brache (1995), but their definitions are based on the value aspect of Porter (1985). The increasing engagement with the business processes has also changed the view on organizations. The traditional vertical view on organizations took into account only the hierarchical aspect; it has been increasingly replaced by a horizontal approach across the business processes. This approach takes into account both the customer and the workflow. Based on the idea of ​​Flores & Ludlow (1980) that communication means both providing information and also action (speech act-based conceptualisation), the third perspective on business processes has emerged. Business processes are mainly coordination processes in this communicative view.One thing that is common in these views on the transformative and  coordinative processes is a strict horizontal view of organizations. Vertical aspects such as power and authority are usually not considered.

Today a business process is mostly interpreted as a transformation (e.g. Davenport, 1993; Rummler & Brache, 1995) which also envisages different types of a business process. This distinction has its roots in Porters (1985) value chain, in which a distinction is made between primary and supportive activities. When we discuss different types of business processes today, the three-part approach of Rummler & Brache (1995), which made a distinction in management, primary and supportive  processes, is more or less considered as the standard. This differentiation allows organizations to focus their activities (business process management) within the framework of certain economic principles.

According to Schmelzer and Sesselmann (2001), 'Business Process Management' is defined as an integrated concept of leadership, organization, controlling and optimization, which provides a targeted control of business processes and enables the whole organization to fulfil the  customer needs and the needs of other stakeholders. The objective of the business process management is to increase the effectiveness and efficiency of the company. The growing importance of these objectives is underpinned by Ould (2005) with the following statement: "Today Business Process Management is a field that has evolved into a central part when developing the business, the organization, or its information resources".

The third relevant theme for reviewing is the field of Small and Medium Enterprises (SME)

When comparing the available literature, a lack of consensus on a single definition of SMEs is visible. Each definition is usually made against the background of the national industrial development and the particular requirements of the business. The classification of industries in eight different sizes by Stanley and Morse (1965) characterized SMEs as follows: little specialization, close personal contact of management with production workers and lack of access to capital. Despite these similarities, Taylor and Murphy (2004), as well as Martin and Matlay (2001) found out that each individual SME is different and should be treated as such. Another important point has already been identified by Southern and Tilley (2000), namely - many SMEs are owner-managed businesses. It means that the success of SMEs depends basically on the figure of the entrepreneur-owner, who is personally responsible for managing the activities of the company.

Due to their advantages in comparison with Prime Contractors, SMEs have the function as a specialized supplier of components, parts and assemblies in the supply chain of their industries (Singh et al., 2010). These advantages result from the fact that the majority of SMEs have simple systems and procedures, which allows flexibility, immediate feedback, short decision-making chain, better understanding and quicker response to customer needs than larger organizations (Singh et al. 2008).

SMEs can be found in all economic sectors and they are playing an important role: they account for more than 95% of the companies and 60% -70% of jobs and generate a large share of new jobs in OECD economies (OECD, 2002). According to Thassanabanjong et al., (2009), they are crucial for a sustainable, long-term growth dynamics and employment. As new technologies and globalization reduce the importance of economies of scale in many activities, the potential contribution of smaller firms is increasing. However, many of the classical problems of SMEs - such as lack of financing, difficulties in the use of technology, limited management skills, low productivity and regulatory failures - become even more acute in a global, technology-driven environment. SMEs are the backbone of economic growth in all countries (Singh et al, 2008; Garengo et al, 2005; McAdam et al, 2000).

According to the European Commission (EC), definitions for SME are categorized as: companies employing less than 10 workers are very small sized or micro companies, 10 - 50 worker employing companies are small sized, companies with 50 – 250 workers are medium sized and companies employing more than 250 workers are accepted as large sized companies. In the definitions of the EU for SME, micro companies have a sales volume less than 2 million Euros per year, small sized companies less than 10 million Euros, and medium sized companies have a sales volume less than 50 million Euros (EC 2005).

3. Results

The research shows that currently there exist some empirical papers on arms trade offsets, but only a few of them - in combination with SMEs. When analyzed in the context of the impact of offset on the business processes, they did not provide any tangible results. All the examined papers stopped at a company level.

4. Discussion and Conclusion

The study done was not entirely free from limitations, especially, because of its limited sample size. Therefore, the results must be treated with caution. Nevertheless, the following conclusion can be made:

offset is one of the key challenges for SMEs and it is even more important to understand its impact on their business processes and management. Only then the right set of tools for the process optimization could be chosen. The results of the study confirm that this special field of research has several gaps. Therefore, the present work concludes with the recommendation for a further extensive research.


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