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Oboronprom CEO Andrey Reus: We Now Compete With The World’s Best

Oboronoprom, Russia’s leading defense contractor and part of the Rostekhnologii (Russian Technologies) state corporation, will be 10 years old this year. Interfax-AVN has spoken to its director-general, Andrey Reus, about the company's achievements and plans.

REUS: First of all, let us recall the circumstances in which our corporation was set up, and the Russian industrial policy at the time. I was actually involved in drawing up that policy when I served as deputy minister for industry and energy in 2004-2007.

Throughout the 1990s there was a clear lack of attention on the part of the Russian government to the development of high-tech industries, such as machine-building. The so-called “free-marketeers” believed that the best industrial policy for Russia would be not to have any such policy. But there were also many people who realized that there can be no growth without a proper industrial policy. That applies not just to Russia but to any other country such as France, the United States, etc.

I think that President Vladimir Putin put an end to these debates back in 2004 when he ordered our ministry and other ministries to develop an industrial policy strategy. That strategy included individual industrial programs, including the program of reforms in the defense industry. The program introduced the policy of integration in several industrial sectors.

The government also introduced several other mechanisms of fostering growth in the machine-building sector. These included subsidized interest rates, because the machine-building sector is not as profitable as the oil and gas industry and cannot afford to pay the same rates on bank loans. There were also measures to support exports, reduce import tariffs on industrial equipment which is not made in Russia, provide state guarantees, and other policies aimed at giving the industry some breathing space and enabling it to achieve the objectives set by the government.

After my appointment as director-general of Oboronprom in 2007 I made the full use of all these new instruments to support the Russian helicopter industry and the aircraft engine makers, especially during the world economic crisis.

Q: It is well known that the Russian defense industry went though a very difficult period in the 1990s. What helped it to overcome that crisis?

REUS: It kept itself afloat mainly through exports, especially to China and India. In Soviet times MoD procurement contracts accounted for almost 100 per cent of many of our companies’ revenues. So when that revenue stream dried up almost overnight, those companies were facing bankruptcy.

Q: Is it true that Russian helicopters are in such great demand that the manufacturers are fully booked?

REUS: That is correct, the Russian helicopter industry is working flat out, there is no spare capacity. As of this moment we have about 18bn dollars worth of confirmed orders for helicopter deliveries. That includes very large and long-term MoD contracts, which account for about 30 per cent of our output. The remaining 70 per cent is non-MoD orders, including foreign customers.

The Russian helicopter industry is in rude health. The Vertolety Rossii (Russian Helicopters) holding company is now the world’s third-largest maker of helicopters, in dollar terms. As recently as eight years ago we were not even seen as a major player on the world market.

Q: The strategic objective set before Oboronprom was to become a diversified corporation. To what extent has that objective been met?

A: Let me begin by saying that the strategy of merging Russian defense companies into large integrated corporations has proved entirely justified. Oboronprom divisions include the Vertolety Rossii holding company, which owns almost all of Russia’s helicopter industry assets, and the United Engine Corporation (ODK), which owns all the main Russian manufacturers of gas turbine engines.

We have become a major global player. Our output and sales are growing at a rapid pace, and we have a very aggressive export policy. In the helicopter industry we are now competing with such global giants as Sikorsky, Eurocopter, Bell, AgustaWestland, and Boeing. But in the engine industry there is still a lot of work to be done before we become competitive with the likes of General Electric, Pratt & Whitney, Safran and Rolls-Royce.

In the early days of ODK there was a distinct lack of unity within the corporation. We have now overcome that problem; everyone has come to realize the value of intellectual, financial and manufacturing synergies. Some of our largest projects, such as the development of the new PD-14 family of aircraft engines, involve the Ufa Motor Company, Saturn (Rybinsk), Aviadvigatel and PMZ (Perm), and Salyut (Moscow); the latter company is already working in close cooperation with ODK.

Another driver of our success is the adoption of modern manufacturing and business strategies, and the use of best international practice. I am not saying that we have achieved a 100 per cent success rate in that area, but we already have a lot of managers at every level who have adopted new ways of thinking. That process is going on at a very rapid pace, and Oboronprom is one of the leaders in this area.

The new methods and strategies we are adopting include lean manufacturing, the gate system of organizing our projects and programs, and forging long-term relations with our suppliers. Vertolety Rossii and ODK have signed a 10-year contract for engine deliveries. We have also signed 3-5 year contracts with most of our suppliers. This demonstrates that we have a clear growth strategy and a clear plan for the next several years.

Another major new area is unmanned aerial vehicles. This is a very promising market. We are working in cooperation with Israel’s IAI. We believe that making UAVs and making helicopters are complementary lines of business.

Q: Is there a danger of the industry's centralization in the form of massive holding companies stifling competition, which is, as we all know, the engine of progress?

REUS: Some of my colleagues sometimes voice similar concerns. But the relations which existed until recently between our separate engine and helicopter makers were not real competition. These companies were not so much competing as squabbling and fighting for limited state funding.

Besides, there are now only five or six major players on the world market for helicopters and aircraft engines. Russian companies must compete on that global market as opposed to competing with each other.

Q: Can you give us a roundup of key Oboronprom economic indicators for 2011? Have you managed to overcome the effects of the world economic crisis?

REUS: We continued to grow throughout that crisis because there is a lot of demand for our products. But government support, including subsidized interest rates and government guarantees, has also played a positive role.

Our 2011 figures are very good. The corporation’s output reached 230bn roubles, which represents a 26 per cent growth compared to 2010. That is a very impressive result.

Q: How much of Oboronprom’s business depends on exports?

REUS: About half of our output is destined for exports. But in the helicopter segment the share of domestic contracts has increased substantially, thanks in large part to MoD procurement contracts.

We are quite happy with the current fifty-fifty split between exports and domestic contracts; the export market is very important to us. What is more, we have ambitious expansion plans. We are not limiting ourselves to setting up jointly run service and maintenance centers abroad; we actually want to build manufacturing facilities abroad. Negotiations are already under way.

Q: After a long pause the Russian armed forces have finally resumed large weapons procurement programs. Do you think this will help your exports?

REUS: I am sure of it. It is well known that as soon as a new helicopter model enters service with the Russian armed forces, demand for that model on the world market immediately starts to pick up. Conversely, when we offer foreign customers something that is not used by Russia’s own armed forces, they start wondering why the Russian MoD is not buying that model. There is a direct link here.

Q: It has been announced that Vertolety Rossii plans an IPO for later this year. When exactly might that happen?

REUS: We will launch an IPO when the market is right for it. Last year we decided against an IPO because the market started to fall sharply, and it kept falling almost every day. We therefore decided that the price we could get for our shares was not attractive enough. Our goal is not just to sell a stake in Vertolety Rossii. The goal is to attract the necessary investment and use it to become more competitive. In the end that will increase our market share.

To all intents and purposes, Vertolety Rossii is already operating as an open, publicly traded company. That is a matter of principle for us.

Q: Will there be an IPO by ODK as well?

REUS: That is certainly a possibility; an eventual IPO is part of the ODK strategy. I believe that every respectable company should be "IPO-able". That is a mark of its maturity as a business, and a sign of trust in that business.

Q: What is your situation regarding MoD procurement contracts? Have all the contracts for this year been already signed?

REUS: Last year we signed all the MoD contracts we expected to sign, for both helicopters and engines. In the helicopters segment we have already signed contracts up until 2018-2020.

The MoD has placed orders for almost the entire Vertolety Rossii product range, including the Mi-8/17 family, the Mi-35M, and the new Ka-52 Alligator and Mi-28N Night Hunter attack helicopters.

I have no doubt that our new models, including Ansat, Ka-226T, Ka-62 and Mi-34S1, will also find their niche in the Russian armed forces.

The trend for signing long-term contracts is a very positive development for the Russian machine-building industry. We need these long-term contracts to achieve the necessary profit margins. I believe that the margins on defense contracts should be higher so that the industry could develop.

Q: Can you tell us about the progress on the contract with the United States for the delivery of 21 Mi-17 helicopters to Afghanistan?

REUS: The first batch of nine helicopters has already been delivered. It is a very important contract for us, so we give it our full attention.

The Americans certainly cannot be accused of not supporting American companies; they work hard to support their own industry and their own corporations. So the fact that they have preferred to buy Russian helicopters for this contract suggests that our products are irreplaceable in many important ways.

Q: What is the current geography of Oboronprom’s export contracts?

REUS: Our products are in service in more than 100 countries. We are now in the active phase of cooperation with about 40 countries. We are regaining some of the markets which were considered lost to us. We are also expanding our presence in some parts of the world.

The markets of India and China are a priority for us. These two countries are our strategic partners.

We are winning new markets as well. Sales of our helicopters in Latin America are growing at a very impressive pace.

Q: You have described India as a strategic partner. What are the chances of your Ka-226T model winning the Indian contract for 197 multirole helicopters?

REUS: We are in a very good position to win that contract. We have invested a lot into that new model. We took out a loan from Vneshekonombank in order to bring the Ka-226T to mass production status. This is an excellent helicopter, and I have no doubt that it has clear advantages over its competitors. But the choice is for our Indian partners to make.

Q: Has it been decided what kind of helicopters will be used with the new Mistral helicopter carriers? Will there be a special carrier-based version? Will there have to be any major design changes to the existing models?

REUS: The Ka-52 Alligator model has been chosen as the main helicopter to serve with the Mistral carriers. The decision had already been made. There are no technical problems to prevent these helicopters from being adapted for service with the Mistral.

Q: You have visited almost every single engine making division of Oboronprom since the beginning of 2012. Does that mean that ODK will be at the top of your list of priorities this year?

REUS: I have had working trips to helicopter divisions as well. I always visit our manufacturing facilities as part of a large team at the beginning of every year in order to assess the situation on the ground and discuss all the topical issues. During these trips I also represent the Union of Russian Machine-Builders, since I am a member of the Bureau of the organization’s Central Council.

It is true, however, that our engine division is very high on the list of my priorities. This year we are scheduled to complete the consolidation of the group. We have already completed some restructuring measures. For example, we have already completed the formation of separate divisions for power plant engines, helicopter engines and combat aviation engines. We have also reshuffled senior management; new managers have been appointed at Kuznetsov, MMP Chernyshev, PMZ and Star. We now have highly qualified specialists running our engine companies. We are also implementing a modernization program; we are launching new projects and new technologies.

Q: What is the state of your relations with Ukraine’s Motor Sich company? Are you discussing the possibility of the company becoming part of ODK?

REUS: We are very tightly integrated with Motor Sich. We have signed a number of contracts, including one five-year contract. That has given our Ukrainian partners a clear idea of what engines we are going to buy from them, and how many.

Right now we are not discussing the acquisition of any shares in Motor Sich, but nothing is being ruled out.

Q: Can you tell us about the project to develop a new engine for the fifth-generation fighter aircraft? Who will be the lead developer?

REUS: We have determined the list of companies to be involved in the project to develop a new engine for the fifth-generation fighter (PAK FA), as well as the new PD-14 engine family. We have also appointed the lead designer for the project; he is also the deputy chief designer of ODK. The schedule of the project has been approved, and the first installments of budget funding have already been disbursed. We should have the first working prototype in 2016.

The entire corporation is involved in developing the new PD-14 engine and the engine for the PAK FA program. We have already achieved some progress and we are confident of a successful outcome.

We are also developing an engine for high-speed helicopters; these helicopters are an important part of our strategy.

Q: Are there any problems with the program to produce engines for the Sukhoi Superjet 100 aircraft?

REUS: The project is on schedule. We are going to deliver 48 engines this year, as agreed with OAK (United Aircraft Corporation).

The program is high on our list of priorities, even though it is not very advantageous to us in terms of its economics and finances. We are going to argue that the project needs to be subsidized. That is usual international practice: achieving an acceptable unit cost of a new engine requires some help from the government.

Q: Many Russian companies are working closely with Western counterparts on promising joint projects. Is that true of Oboronprom as well?

REUS: International cooperation is very high on the list of our priorities. We have long-term relations with France's Safran, including its Snecma division (on the SaM146) and the Turbomeca division (on engines for the Ka-226T and Ka-62 helicopters). We are also developing cooperation with Finmeccanica and its helicopter division, AgustaWestland, as well as with Avio and other companies.

Speaking about local in-country production, to me this means the ability to produce components and finished products not only for the domestic market but for the international market as well. This is a matter of principle. As a result of launching local production we essentially become equal partners with foreign companies, we become an international player.

Oboronprom aims to make products which can be marketed all over the world. That is why we are working to obtain international certification for our products, manufacturing facilities, materials, design bureaus, etc. That will enable us to work with foreign partners as second and third-level component suppliers. That is a strategic area of our business which we are going to develop.

Interfax AVN