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Oboronprom CEO Andrey Reus: We Have Consolidated Everything We Could

Oboronprom CEO talks about the Russian helicopter and engine industry

In recent years Russian helicopter and engine makers have been increasing their sales on the domestic and international market. Kommersant correspondent Ivan Safranov has spoken to the CEO of the Oboronprom corporation, ANDREY REUS, about the company's relations with the Russian MoD and its strategy on the international market.

Q: The ongoing trend in the Russian defense industry is for separate defense contractors to be merged into holding companies. Oboronprom is one example of such a holding company. Did you support the idea right from the start?

A: I was directly involved in the development of these consolidation strategies back in 2004-2007, when I served as the deputy industry and energy minister in charge of the machine-building sector, including the defense industry. We developed and implemented that consolidation strategy as part of the Russian government's decision to launch a completely new industrial policy. Up until that moment the predominant view in the government was that the best industrial policy would be not to have any such policy.

Q: Was that the right way forward for the machine-building industry?

A: Beyond any doubt. Over the past five years at Oboronprom I have come to believe that financial, organizational and political instruments have played a decisive role in the renaissance of the Russian machine-building sector. For example, the club of the world's leading makers of helicopters has long included five internationally recognized players: Sikorsky, AgustaWestland, Eurocopter, Bell и Boeing. Now that club also includes Vertolety Rossii (Russian Helicopters). As recently as in the early 2000 the Russian makers of helicopters were not even seen as an important player on the global market. We just had a few separate manufacturers who were barely keeping themselves afloat and whose output was miniscule. Russian companies accounted for only 3 per cent of the world output; they were making about 80 helicopters a year. They were seen as minnows.

Our foreign competitors were in a much better position to win the customer. These companies took shape after World War II and by the time the Soviet Union broke up they had already become major international players. The same applies to the engine industry; our own ODK (United Engine Corporation) has yet to become a serious competitor to such giants as General Electric, Pratt&Whitney, Safran, and Rolls-Royce. So in order to catch up with the world leaders we needed to move quickly to consolidate our intellectual, manufacturing, financial and human resources. We needed to merge them into a company which is worthy of becoming a member of the elite international club. We have now formed such a company. In a space of just eight years we have become the world’s third-largest maker of helicopters, in dollar terms. Vertolety Rossii controls about 14 per cent of the market; the company has won recognition as a serious international competitor. I believe the success of our helicopter industry proves that the overall government policy for the machine-building sector is delivering the results and we must press ahead with it.

Q: But can such an environment still remain competitive?

A: Our example shows that it is difficult but possible. I think that such a competitive environment is indispensible if we want to build a successful company capable of delivering competitive new products, new technologies and a good service. The concentration of intellectual resources and expertise we have achieved has enabled that company to keep up with the world trends.

Q: So you do not believe that by merging separate companies into giant holdings we are stifling competition within the Russian industry and thereby stifling growth?

A: That is utter nonsense! In this day and age competition in the machine-building sector has shifted to the global level. All the leading global players in the aerospace industry, the helicopter industry and the engine industry almost always represent one country and one company. Meanwhile, our opponents say we must have several competing companies within the Russian industry. What would be the point? None of these separate smaller companies would be strong enough to become a world leader, and in the end they would be taken over by one of the global giants. Industry consolidation alone has given as a 15 per cent boost in efficiency thanks to various synergies.

Q: That was achieved by industry consolidation alone?

A: Well, of course, we were very lucky with the helicopter industry: we already had very talented designers and engineers. Thanks to their projects which were already in the pipeline we have managed to achieve rapid progress in a very short time. But now we have the resources to design completely new products. We have consolidated all the resources we could in order to achieve our goal. There was no other way of becoming a global player. It was the only way, and we did what was necessary.

Q: There is a debate going on about whether the Russian companies should see the domestic or the international market as a priority. How much of Oboronprom’s business depends on exports?

A: The domestic Russian market is becoming increasingly important for us. A few years ago exports accounted for 70 per cent of our output; the remaining 30 per cent was domestic contracts. Now the proportion is fifty-fifty.

Our domestic business is growing thanks to large and long-term MoD contracts, some of which run up until 2020. Domestic defense procurement now accounts for up to 30 per cent of our output. But we are determined to remain a global player. That is a mark of quality: if a company’s products are in demand on the global market it means that the company has the trust and confidence of the consumers. On the whole, Vertolety Rossii has shown rapid growth in the past few years. In 2011 we made 265 helicopters; the target for 2012 is 300.

Q: Is that a realistic target?

A: It is of course very ambitious. But we know how to achieve it and we have the necessary resources. By 2015 we plan to increase our output to 400 helicopters.

Q: Several weeks ago the MoD announced a contract for light helicopters. Judging from the terms of the contract and from the list of requirements, your own Ansat and Ka-226T models have a slim chance of winning; the contract will probably go to a foreign competitor. What is your opinion on that?

A: I think it is bad news when the government awards contracts to a direct competitor of its own national champion. Vertolety Rossii has the necessary technologies and products in this segment, including the Ansat and the Ka-226T. We have offered these products to the MoD. We keep the situation with the mass production of these models high on the list of our priorities. We are ready to work hard so as to be able to supply large batches of these helicopters not only to the MoD but also to other customers. Let me also add this: international practice in terms of the relations between the armed forces and the defense industry suggests that R&D should be part of defense procurement programs and contracts.

Q: What is the current state of the Ka-226 program?

A: The Ka-226 is already being mass-produced and supplied to customers. There is also the Ka-226T model, which will soon enter mass production. We have taken out an investment loan from Vneshekonombank; we have focused our engineering and manufacturing resources to speed up this program. We have equipped this helicopter with the Arrius engine imported from France. That is why it is very important for us to win the Indian contract for 197 light helicopters. One of the direct competitors of the Ka-226T for the Indian contract is a helicopter made by Eurocopter (the AS-550 Fennec - Kommersant), and that is exactly the model the Russian MoD wants to buy.

Q: What are Russia's chances of winning the Indian contract?

A: I think they are very good. Our product (the Ka-226T - Kommersant) meets all the requirements listed by the Indians.

Q: Are you still planning to set up a joint venture with Eurocopter?

A: We have discussed various joint projects with Eurocopter, but none of them has been given the go-ahead owing to differences in our two companies’ strategies. Nevertheless, we want to forge cooperation with the world leaders in those segments which can make us stronger. Setting up a joint venture is a complicated process. For example, setting up such a venture with AgustaWestland took us two and a half years of preparations. We are launching production of the AW 139 model later this year; it will be followed by the AW 119. These two models will account for only a small proportion of our output, but it is important for us to forge partnership with one of the world leaders. We are training our staff to the best international business standards; we are also adopting best practice in manufacturing and after-sale service. Of course, we are going to pursue other local in-country production projects. But our priority is the global market, so these localization projects are important as a way of becoming more competitive internationally.

Q: Let us talk about the Russian defense procurement contracts. Last year you signed your first batch of large long-term contracts with the MoD. How many Ka-52 helicopters will the MoD buy?

A: About 140.

Q: Were there any problems during the negotiations?

A: Negotiations with the customers are always tough. Very often the most contentious issue is the profit margin. Machine-building is not the kind of industry in which suppliers enjoy exorbitant profit margins. Our own profit margins should be higher than they are now so as to enable us to develop and invest in new products. But the terms of the contract for the Ka-52 helicopters we have signed with the MoD are acceptable. It was important for us to secure a long-term commitment. Signing a five or seven-year contract with the MoD enables us to sign long-term contracts with our own suppliers. That is a much more preferable economic model, which produces a much more predictable price formula. And if the formula is predictable, we are in a much better position to stay on budget.

Q: What contracts are you planning to sign with the MoD in 2012?

A: We are now preparing several engine contracts in addition to helicopter contracts. We are now transitioning to long-term engine contracts, just as we have transitioned to long-term helicopter contracts. This year we are making much better progress than in 2011. We are also discussing an additional contract for Mi-35 helicopters. We plan to deliver about a thousand helicopters in total to the MoD by 2020.

Q: The industry is now working on the fifth-generation fighter program, the PAK FA. Who will be the main designer of the engine for the new fighter?

A: The ODK corporation consists of several divisions. A while ago we set up the power plant engines division; late last year we completed the formation of the helicopter engines division and of the combat aviation engines division. That latter division is in charge of the project to develop the engine for the PAK FA program. The main design bureau in charge of the project is the Lyulka Bureau. But the project is a cooperative effort by the entire ODK; it involves our operations in Ufa, Rybinsk and Moscow. The Salyut company, which to all intents and purposes has already become part of ODK, also plays a major role in the project.

Q: Have there been any complains from Sukhoi Civilian Aircraft (GSS) about the engines for the SSJ-100 jet?

A: Every aircraft maker always has some complains about the engines. ODK is working very closely with GSS on this issue. There have been some problems; for example, certification of the SaM146 engine took longer than expected. But that is the kind of problem every new product faces. We have now agreed a schedule which details when exactly the engines will be supplied for each individual aircraft.

I have to say that the SaM146 program is not very attractive to us financially. That is why we are arguing that it needs to be subsidized. This is normal international practice. Achieving the required unit cost for a new engine requires some help from the government. The government is already providing a bit of help, but it takes a long time for a new product to be launched and to break even.

Q: How long will it take for the product to reach the break-even point?

A: Based on the initial contract for the SaM146 which we have now, it will take seven years.

Q: The government is now drafting a decree under which Salyut will become one of the divisions of ODK. The document is almost ready for signing. Do you have any plans to make Ukraine’s Motor Sich part of ODK as well?

A: We are working with Motor Sich based on five-year contracts. We have several joint programs, including engines for the Mi-26 helicopter. Are we interested in Motor Sich as a company? Yes we are. But at this moment we are not in any acquisition talks, although we considered this option a while ago.

Q: Why did you decide against buying Motor Sich?

A: It was mainly about the price. We are not interested in acquisitions for the sake of acquisitions.

Q: What is the state of the NK-93 engine program?

A: ODK strategies are based on the market situation. If we see that there is real demand for some product, we are going to supply it. We have not managed to identify any real demand for the NK-93. OAK has no plans of using it for its current or future aircraft. The NK-93 was designed an alternative to the main PS-90A engine for the Il-96-T and Tu-330 aircraft. But there are no plans to launch mass production of those two aircraft.

I believe that the solutions developed as part of the NK-93 program can be used in other future engines for medium and heavy passenger and transport aircraft, as well as military transports. But in this particular case ODK is merely a component supplier, so our decisions will be based on the requirements of the aircraft makers.

Q: Is consolidation the right way forward for the engine industry as well?

A: I think the answer to this question is obvious. We have already consolidated the intellectual and manufacturing resources of the Russian engine industry. Our engine makers have stopped fighting each other; instead they are now competing on the global markets. ODK has already launched a central engineering center which brings together all the engineering talent from across the holding company. It has also determined the list of the main projects which will keep Russia competitive on the global markets over the next 40-50 years. These projects include the PD-14 family of engines, the engine for the PAK FA program, a high-speed helicopter engine, and a gas turbine power plant for small scale power generation. The Russian industrial policy aims to foster innovation and to support such projects, which makes our job much easier. ODK aims to become one of the five world leaders in its segment by 2020.

Q: Is the government providing enough support to your companies?

A: Government support was crucial for many companies. Ten of our operations were on the verge of bankruptcy. But thanks to such industrial policy instruments as direct investment, subsidized interest rates, government guarantees on bank loans, etc, we have managed to overcome the crisis and to begin retooling and modernizing our manufacturing facilities. Almost all of our breakthrough projects, such as the PD-14, the future high-speed helicopter, and the engine for the PAK FA program, receive some government financing. Some 400 million roubles has been allocated for the high-speed helicopter project, 2.5 billion roubles for the Mi-38 project, 652m roubles for the Ka-62 project, and 14bn roubles for the PD-14 project.

Q: What is the current situation with the American contract for the delivery of 21 Mi-17V5 helicopters to Afghansistan? How many helicopters have already been delivered?

A: Deliveries are on schedule; nine helicopters have already been delivered to the customer. This contract is a signal for the business community, a certificate of recognition of the excellent quality of our product.

Q: What kind of reputation have Russian helicopters earned themselves in India? Is the customer happy?

A: If the customer is not happy he stops buying. Also, people sometimes say that one can sell anything at all to India or China. That is not so! Our Indian and Chinese partners are very particular about the hardware and weaponry they buy. On the whole, it would be no exaggeration to say that India and China are our strategic partners. We are now working on a contract signed by Rosoboronexport for the delivery of 80 Mi-17V5 helicopters to India. We are bidding for another Indian contract with our Ka-226T helicopter. Finally, we have a helicopter service joint venture and a plant which assembles engines under license.

Q: Which countries are the most important partners for Russia, now and in the future?

A: India has always been an important partner. After a certain pause we are once again increasing deliveries to China. We have always supplied large batches of engines to them, and sales continue to grow. We expect that in 2012 sales to that country will reach 2bn dollars.

Q: What exactly are they buying?

A: The latest deliveries were under a contract for 32 Mi-171E helicopters. We also supply the Ka-32A11VS to both China and India.

Q: What is the situation in Latin America?

A: Latin America is a very important market for us. We have fought for it for a long time. We are now supplying Mi-35M helicopters to that region under a contract signed by Rosoboronexport. Vertolety Rossii has also begun to sell civilian helicopters such as the Mi-8/17 and Ka-32A11VS to Latin America. It helps that Brazil has introduced the “open skies” policy, including over the big cities. China and India are now studying that option as well.  Helicopters are becoming more widely used, which opens up new opportunities for us.

Q: What about the Southeast Asian market?

A: Vietnam is a priority for us in that part of the world.

Q: What are the prospects for setting up a joint venture with China?

A: We are studying Chinese proposals to launch joint production of popular helicopter models in China. We are discussing joint development and manufacturing of a new heavy helicopter. We are also building a helicopter service center in Qingdao Province; the project is nearing completion. Speaking about our plans to build an international network of service centers, I would like to say that we are transitioning to a new business model in terms of customer service. The success of our products depends not only on the merits of those products themselves but also on the quality of the post-sale service we provide for them. That is why we are learning to build our business model based on the entire life cycle of the product.

Q: Have there been any talks with Saudi Arabia?

A: We have not sold any civilian products to that country. As far as I know, Rosoboronexport has been in talks with Saudi Arabia about a possible contract for military helicopters.

Q: The government has allocated about 3 trillion roubles to support the Russian defense industry. What will be your share of that pie?

A: Some 10bn roubles of government funding will be spent in 2012 on various Oboronprom programs. In the 2013-2015 period we plan to receive about 40bn roubles.

Q: Do you take out bank loans?

A: We have to. State-owned banks charge us 7-10 per cent interest on rouble loans and 8-12 per cent on hard currency loans. To compare, our competitors in the United States, Britain, Germany and France pay 2-4 per cent interest on long-term loans. In order to be able to compete we need the same kind of financial terms. When the price of money is so much higher in Russia compared to the world financial markets our machine-building industry loses out to foreign competitors.

Q: Will there be any further restructuring at Oboronprom in the coming months and years?

A: At the Vertolety Rossii division all the main restructuring measures were completed last year as part of preparations for an IPO. The division has adopted international accounting standards, and its Board of Directors now includes independent members. Even though we have decided to postpone the IPO, Vertolety Rossii is already operating as an open publicly traded company. As for ODK, I have already mentioned the formation of new divisions. Speaking of new lines of business, I would like to mention the unmanned aerial vehicles projects which we have launched using technologies supplied by Israel’s IAI. We believe the UAV market is very promising.

Q: What are the key financial indicators of Oboronprom for 2011?

A: Oboronprom made a 15bn rouble profit on revenues of 229bn roubles. Our engine making division broke even for the first time in 2011.

Q: And what are the targets for 2012?

A: We project a growth of at least 15 per cent. Our revenues target for 2015 is 500bn roubles, which includes both products and services. That is what I promised Vladimir Putin at the MAKS-2011 air show.

Q: What is the state of your relations with the rocket and space industry? The head of Roskosmos, Vladimir Popovkin, has been reported as saying that the Russian engine industry is in a crisis.

A: Space-related projects are one of ODK’s most reliable lines of business. Over the past two years Roskosmos has substantially increased its orders placed with our Samara operations. I think we have everything it takes to satisfy all the Roskosmos requirements.

Q: Do you want Oboronprom to take over other plans, such as the ones which make space rocket engines?

A: I can see the logic of such a step. We have a team of excellent crisis managers. Ten years ago Oboronprom was created as a kind of business incubator; it was tasked with taking over separate companies and consolidating them into an effective operation capable of competing on the global market. The example of Vertolety Rossii and ODK is a testament to our success. So we are not asking for more work, but if we are tasked with running these other plans we will cope with that task.

Andrey Reus

Personal file

Born May 10, 1960 in Chelyabinsk; graduated from the Economics faculty of the Moscow State University in 1983. Joined the Chelyabinsk Tractor Plant as an economist and was eventually promoted to deputy head of department. In 1991-1992 worked as a consultant at the Urals-Siberian regional center of economic, science and technical propaganda, and as deputy director of Set-1 (Network-1), a culture and education center. In 1994 appointed as head of the financial program at the Tolyatti office of the International Academy of Business and Banking; also worked as head of the Konsultant auditing firm. In 1998 moved to Moscow, where he was appointed as an advisor to deputy prime minister Viktor Khristenko, who also hails from Chelyabinsk. He was later promoted to deputy head of the Finance Ministry’s department for budgetary relations and then became head of the deputy prime minister’s secretariat. In 2004 appointed as deputy minister of industry and energy. On September 21, 2007 received his current appointment as Director-General (CEO) of Oboronprom. Holds a doctorate in Economic Sciences and several state awards, including the Medal of Honor, the Medal for Service to Fatherland IV Rank, and the Medal for Service to Fatherland II Rank.

Oboronprom

Company profile

The united industrial corporation Oboronprom was set up in 2002. It is a diversified industry and investment group, and part of the Rostekhnologii (Russian Technologies) state corporation. Its two main affiliates are Vertolety Rossii (Russian Helicopters), which controls 14 per cent of the world market for helicopters, and the United Engine Corporation (ODK), which controls 85 per cent of the Russian engine industry. Oboronprom has about 30 operations in Moscow, St Petersburg, Kazan, Perm, Ufa, Rostov-on-Don, Novosibirsk and other cities. It supplies a broad range of products and components to civilian and military customers in Russia and abroad. It also provides maintenance and repair services. Its shareholders are Rostekhnologii (58.31 per cent), Rosimushchestvo (27.82 per cent), RSK MiG (5.79 per cent), the Republic of Tatarstan (5.4 per cent), Rosoboronexport (2.22 per cent) and Rostvertol (0.45 per cent). The company’s Moscow head office employs 90 people. Oboronprom earned a 15bn rouble profit on revenues of 229bn roubles in 2011. It received 622bn roubles worth of confirmed orders in 2011.

Source: 
Kommersant newspaper
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