The existing system for handing out state defense contracts is flawed and inefficient. Only by changing the system will Russia be able to compete with America’s biggest defense companies

Alexei Khazbiev

According to data from the Stockholm International Peace Research Institute, last year military spending by the world’s governments rose by 11% to almost a trillion dollars. This is the highest level since the end of the Cold War. According to Elisabeth Sköns, leader of SIPRI’s Military Expenditure Project, the world peak in military spending came in 1987. At that time, almost $1.36 trillion in today’s dollars were spent on the military. If today’s trends continue, the Cold War record could easily be broken in the next five years.
Russia will most likely lose this arms race. Western corporations are absorbing most of the growing military budgets, while Russian defense companies’ share of the world arms market declines with each passing year, which means billions in losses.

Falling behind

Military spending has been growing consistently for the seventh year in a row. In only the last five years, the leaders in this arms race—the US, China, France, Japan, and the UK—increased their funding for military projects by one and a half times. At present these countries account for almost two thirds of the world’s military spending.
The US spends more than anyone else. Back in the mid-1990s, the American military budget totaled approximately $260 billion a year. At that time, the US share in world military spending did not even reach 30%. But by 2003, military spending in the US had risen to almost $400 billion and its share of the total world military budget exceeded 40%. The war against terrorism has nothing to do with this increase.
Currently, the US sells around $15 billion in weapons to the rest of the world each year, while number two Russia sells around $5.5 billion a year. Most of this money comes from aviation technology contracts. But when the new generation of F-35 fighter jets enters the American fleet, the US military will start selling off older planes—F-15s, F-16s, and F/A-18s—at rock-bottom prices. This means that in markets such as Malaysia, Brazil, and Indonesia, Russia will lose out to American aviation technology. The same thing will happen with tanks, missile systems, and warships. Moreover, the faster Europe develops its own military programs, the more inevitable this outcome will become. Europe would also love to increase its share of the world arms trade.
But that is just the beginning. The Chinese are also trying to get always from Russian imports as quickly as possible. This means that if China’s national defense programs succeed, Russia will lose around $1.5 billion a year, what China currently hands over to Russian defense companies.
All this convinces us that very soon Russia stands to lose at first hundreds of million and then billions of dollars on the world market each year. And until recently, the money from sales formed the only stable basis for developing new weaponry.
The way out of this impasse is state military orders.
In the last four years, state military orders added up to almost $10 billion all told. This was enough to build to two aircraft carriers along with the accompanying fleet of ships and land-based equipment. In other words, the level of state orders is already more or less sufficient to counteract the negative consequences of Russia’s diminishing share in the world arms trade.
Officials state that the lion’s share of resources goes to various defense-oriented research and development projects. According to Minister of Defense Sergei Ivanov, over the last few years his ministry has consciously increased the share of R & D in military spending so that up-to-date military technology would reach the armed forces in the next 5-10 years. The Defense Ministry today is indeed funding more than 150 final versions of various weapons as part of so-called federal target programs. However, all of these programs, according to Ruslan Pukhov, Director of the Center for Analysis of Strategies and Technologies, are only funded at 15-20% of their projected budgets, and as a result deadlines for getting new technology to the troops are constantly postponed. It seems that this situation, in which the Ministry of Defense is not funding the development of new technology at appropriate levels and defense companies are purposefully not putting new developments into mass production, suits everyone involved. Defense companies, claiming that they are underfunded, can drag out contracts indefinitely. The Ministry of Defense can keep pretending it does not notice. Over the last ten years, the ministry has not fined a single company or plant for not meeting state order deadlines.

New order

There are only two ways to combat the feebleness of the defense industry and the Defense Ministry: to change the way state orders are managed and strengthen the private sector’s role in defense. Without this, simply increasing the military budget will not have any effect at all.
Currently, the system for managing state defense orders includes, in addition to the Armed Forces’ Weaponry Service that controls 80% of all spending, at least five other various organizations. They are all pursuing their own institutional interests. As a result, state defense orders at best go only 40-50% filled. In April of this year, President Putin attempted to tighten control over defense orders and gave a presidential order to create the Federal Defense Order Service (FSOZ). The Service is headed by the former general director of Rosoboronexport, Andrei Belyanin. In the near future, Belyanin will present his proposals for reforming the arms purchasing system at Russia’s military agencies. As the new head of the FSOZ admitted recently at a closed briefing, his agency is now working in an information vacuum. Practically every branch of the Ministry of Defense is withholding its accounts from the Service.
The second logical direction reform could take is to strengthen market mechanisms at Russian defense plants. At present, the companies of Russian military-industrial complex look like dwarves compared to the Western arms giants. Russia’s biggest defense company, Sukhoi, sell $1-1.5 billion in military hardware a year. On the Defense News list of the world’s biggest arms manufacturers, Sukhoi has never gotten above 28th place. Sukhoi not only falls behind Lockheed Martin and Boeing with military sales of $25 billion a year, but also behind almost all of its European competitors. Other Russian companies are faring even worse. Most of them cannot even make it into the Top 100.
Nonetheless, even these rankings should be considered a success. The fact of the matter is that all these companies have been completely locked out of the state military order system. Sales growth at Russia’s biggest defense companies (around 25% last year to $5.7 billion) was almost 100% due to increased exports. Among Russia’s biggest companies, only one had a larger share of state rather than export orders: the Mil Moscow Helicopter Plant. Its sales totaled $41 million, a ridiculously low figure for Russia’s largest helicopter manufacturer.

Helping the private entrepreneur

While at least some sort of reform is underway in the state defense order system, in the defense industry as a whole reform stopped long ago. Since March, the Russian government has not had a clear-cut policy for defense industry development. Yet almost all private defense companies do have a clear strategy. Over the past several years, the majority of factories engaged in mass production that have been purchased by private owners have turned from mere factories into full-fledged, vertically integrated corporations with their own engineering divisions. An excellent example of this trend is Irkut, based on a former Sukhoi plant, the Irkutsk Aviation Production Union (IAPU). In the six years since privatization, Irkut has managed to become one of the most successful companies in the Russian defense industry. The company’s new management, headed by General Director Alexei Fedorov who bought the controlling stake in the IAPU, quickly realized that there was no future in merely developing the enterprise in Irkutsk as a typical factory. For this reason, the Irkut Corporation back in the late 1990s acquired a controlling stake in the Russian Avionics Design Bureau specializing in the modernization of aviation technology. To forge a strong engineering link in the production chain, Irkut also acquired the Beriev Aircraft Company. At present, Irkut controls approximately 10% of all Russian arms exports with $500 million in orders. This is almost twice what the state corporation MiG can boast.
The Kazan Helicopter Plant is another private aviation company. With export orders from India, Egypt, Columbia, and Malaysia, Kazan has earned more than a billion dollars over the last eight years. At the same time, Kazan has not only mastered mass production of the Mi-17 and Mi-171 helicopters based on the tried-and-true Mi-8, but has also got to work on a completely new class of light helicopters, the Ansat and Aktai. All this, while the company has had almost no income from state orders.
There are also examples of successful private companies in shipbuilding. Last year the IST Group announced the founding of the Baltic United Shipbuilding Company (BOSK) based on the Baltic Plant. This company just recently successfully completed a contract with India to the tune of $900 million for three frigates, far advanced of any currently in the Russian Navy’s fleet. Without the companies that belong to BOSK, it will be impossible to build a single cruiser, destroyer, frigate, or atomic icebreaker. Nikolai Dobrinov, Vice-President of IST, says that when organizing the holding, the group’s directors strove to create this very situation on the market, when the state would have no choice but to place orders for new destroyers with BOSK.
Despite these success stories, the private sector in the Russian defense industry is still very small, only 20-25% of all sales. However, it is expanding rapidly and if nothing gets in the way, in five to seven years it will produce more than all the state arms companies combined.
State companies lost their Soviet lead by the end of the 1990s. It is already obvious that Russia basically lost the race against the US in military aviation. Russia is five years behind the US in terms of weaponry, five to ten years behind in terms of on-board systems, and ten to fifteen years behind in engines. State companies’ chances of making up for lost time with well established Soviet brands are shrinking with each passing year. However, Russia’s private companies are more than capable of catching up with the Americans. Irkut, which recently outbid Boeing in Malaysia, is more than enough proof of this. Yet without large state orders, Irkut will never become a company comparable to Boeing or Lockheed Martin, as the export market is not enough. If private companies were to operate at full capacity thanks to state orders, the way they do in Europe and the US, Russia would not have to worry about falling behind new technologies from the US and Europe, or even worse from China and Saudi Arabia.

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