Direct vs. Indirect offsets
Direct offsets are products or services which the government (or a provider within the target country) will sell back to the defense contractor under the sales contract, concurrently with the primary purchase by the government from the contractor. A typical example would be a component, such as an aircraft window, which is manufactured in the target country and which can be incorporated into the contractor’s own products, such as complete aircraft, being sold in the primary sale. The value of the parts being supplied would offset some portion of the purchase price payable to the contractor. By contrast, “indirect offsets” are products or services desired by the government which the contractor does not itself produce. The contractor will nevertheless agree to source and deliver these offsets, as a condition to securing the primary sales contract.
Often indirect offsets are not readily available for delivery at or about the time of delivery of products to the government under the primary sales contract. In such cases, the sale will proceed, but the government will retain the offset obligations of the contractor under the contract which must be fulfilled sometime in the future. The government therefore carries an “offset credit.” To the extent of this offset credit, the government is an offset creditor and the contractor is an offset debtor.
Offset credits valuation and fulfilment
The particular type and kind of offset, or at least a fairly specific offset category, is stated in the sales contract. Through negotiation, the offset obligation is assigned a value, typically denominated in U.S. dollars. It is likely to be calculated as some percentage of the face value of the sales contract covering the products being sold by the contractor. It varies from country to country, product to product. It is likely to be anywhere from 30% of the value of the sales contract to as much as120%. Thus, for example, if a primary contract is for the sale of $100 million in actual contractor products, the offset credit might be $120 million; i.e., the contractor must supply designated goods and services having an “agreed” value of $120 million.
Satisfying a significant indirect offset credit can be a daunting task for the contractor. Certainly, incurring a $120 million offset obligation on only a $100 million sale would make no sense. But this anomaly is addressed through a mechanism of “multipliers.” That is, for purposes of crediting the offsets which the contractor provides, the government will assign different “multipliers” to the actual value of the designated goods. For example, the government may very much want to acquire mining equipment for its fledgling mining industry. While it may seek mining equipment having a hard value of $20 million, it might agree to a multiplier of 6x the actual cost of the equipment for offset purposes. Thus, the contractor can meet its full $120 million offset obligation with only $20 million worth of mining equipment, since 6x $20 million equates to $120 million and full satisfaction of the offset credit. In short, in this example, if the contractor wants to sell $100 million of aircraft, it must incur a mining equipment offset obligation of $120 million, but it can satisfy this obligation with only $20 million of equipment, given the 6x multiplier.