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President of Russia Dmitry Medvedev: Colleagues, we are meeting today to discuss the defence industry’s development. The idea of holding this meeting came up during discussion of a number of issues during the military exercises in Kaliningrad. Some of those who I met with then are present here today too. We agreed to meet and discuss the different issues, first publicly, and then behind closed doors. I will outline what I consider the most important issues we will be looking at today.

Today, I visited NPO Mashinostroyenia [Military and Industrial Corporation MIC Mashinostroyenia open joint-stock company]. This is certainly one of the defence industry leaders and its workers have much to be proud of. Our armed forces use the products they have designed and developed on their own and in cooperation with others. But this does not mean that all is well and that other defence industry companies are in just as good a situation. Even here, of course, they are not without problems. This is why we want to analyse today the situation in Russia’s defence industry and the prospects for its development, and also examine specific measures that I hope will make the sector more competitive and enable us to develop new arms and new-generation military equipment.

As I said, it was our work in Kaliningrad and the number of serious issues raised there that incited us to hold today’s meeting.

I will outline the biggest problems.

First, we all know that a lot of money has been invested in modernizing and developing the defence industry in recent years. But I think the results so far do not measure up to our expectations. Unfortunately, the policy of ‘patching the holes’ is still in place and, to be frank, the sector has not achieved the goal of upgrading its technology to the latest standards. This directly affects the quality of products delivered to our armed forces and to markets abroad. You are all well aware of this situation. One of the solutions to this problem is to adopt a targeted federal programme for developing the defence industry. We will discuss this.

The second matter is very important. The heads of the relevant state agencies and the company directors need to take measures to bring down the cost of the goods the sector produces. This is a question of survival. The cost of arms and equipment should be such that the armed forces can make batch purchases rather than buying one item at a time. Prices should also be attractive for our partners abroad. This is particularly important. Many of our military goods are losing their attractiveness. The costs are such that it makes less and less sense to buy them. Cost is a crucial factor for our competitiveness.

Bringing down the cost is a complicated issue. Visiting NPO Mashinostroyeniya before, I spoke with the director about the fact that there is this huge, old and unwieldy infrastructure that needs constant investment. It is not even so much a question of upgrading the production modules as keeping the infrastructure running, because this takes money and energy and has an impact on the products’ costs. We need to find solutions to this problem. We cannot explain either at home or abroad that our enterprises cover 150 or 200 hectares in area and that we need to keep all of this running, and this is why our costs are so high.

Third, we need to improve the laws regulating state defence procurement. Procurement orders have been increasing from year to year and this is good. Defence procurement has more than doubled over the last five years. But we need now to lay down very clear rules and regulations on planning and placing state defence procurement orders. We need a system that will function effectively, avoid ambiguity, and give us effective oversight of the tasks to be carried out. Moreover, we need to attain greater coordination between the relevant state agencies and we need to boost their discipline and responsibility. We need a stringent result-based approach that also covers quality and timely delivery of arms and equipment. And there should be no difference in this respect between deliveries for the export market and deliveries for our own needs, for building up our own defence capability.

Fourth, the state defence procurement programme invests considerable funds in producing sophisticated weapons. The situation in this area has improved substantially since the 1990s, when practically all work ground to a halt. We all remember those years. This is a crucial issue for our country’s defence capability. But priority should go to genuinely promising new models and not be wasted on simply clinging to old products or developing goods that might not ever get used. This is also something we encounter.

The worst thing is when money gets wasted on modernising what is already outdated or is set to become outdated in the next few years. We often try to tell ourselves that these are promising models and so on, but we need to take a wider view.

Research and development work sometimes lasts not years but decades. Of course, we are talking about very complex undertakings, but even so this is an unacceptably long time. For obvious reasons this situation suits those who placed the orders, and every year they shift the deadlines for work to be completed, while the developers are happy with the share they get out of it and keep the situation going year after year.

Fifth, the strategic outlines for the sector’s future development have already been set: structural reorganisation of the armed forces will be complete in two months time.

The next task is more complex – providing the armed forces with modern arms and equipment – and this will require a greater effort from the defence industry.

I will not make commonplace statements. You all realise that the situation in the defence industry has a direct bearing on the lives of our soldiers and officers, especially in combat situations, which unfortunately can arise even in circumstances in which we could not have foreseen such a turn of events. But how can we plan strategy and tactics if our arms are inferior? We have made it our goal to modernise our armed forces’ arms and equipment by 2012. We need to make serious progress in this area and then keep the development going.

Finally, another obvious issue is that the quality of the goods our defence industry produces is vital for our country’s competitiveness on the global arms market. We cannot on any account lose the ground we fought so hard to win. This would damage the reputation of our arms, and thus our entire country’s reputation. As it is, our reputation is still quite good and our arms are seen around the world as effective and exceptionally reliable. We need to keep it this way.

Let’s begin work.

Minister of Industry and Trade Viktor Khristenko: In my speech I will be concentrating on issues of quality, particularly because this is quite a complex problem as well as a comprehensive indicator that can be used to measure critical components of the manufacturing process.
It is impossible to realise existing advantages and create new competitive ones in Russia without improving our national competitiveness. With regards to the arms industry and manufacture of military and special technology, improving the quality and competitiveness of products requires concerted efforts and coordinated action at all levels of government. Obviously these actions should be underpinned by a set of measures with organisational, technical, regulatory, financial and economic aspects.

What’s important here is the stability of programme targets of state defence orders for arms and military and special equipment, adopting rational pricing policy approaches, ensuring a coherent regulatory and legal approach to our relations with those placing orders, the mandatory use of modern quality management methods, the adoption of digital technologies in product information support, and of course ensuring that the level of development of the industrial and technological base and staffing in the defence industry corresponds to present realities. Much has been done in this area in recent years, but it is equally obvious that much more remains to be done.
Production and industrial output in the defence industry are as follows: about 60 percent is military products. Of this a very significant amount, 35 percent, is for export. The dominant player in the defence industry is the aviation industry, which accounts for more than 35 percent of the total production of the industry.

If we look at the dynamics of production growth, the prospects here are very good. Despite the financial crisis, we can see a very positive trend in military production which reflects the active participation of the government in upgrading the army and helping the defence industry overcome the systemic crisis of the 90s. Of course this is important not only for growth but also for the quality of that growth.
Issues surrounding the quality of our military weapons and special equipment for both internal use and for export are a legitimate source of concern both for those within the state defence procurement order and for foreign buyers of military and special equipment.
(At this point the Minister discussed problems involved in the certification of a quality-control system and product certification.)

The implementation of the plan to create integrated structures within the defence industry continues. Today these structures account for more than 38 percent of the industry's production output. In 2010 this figure will reach 55 percent. I should remind you that one of the main goals, perhaps the main one, that the creation of integrated structures is expected to achieve is to maximise the concentration, capabilities and, most importantly, responsibility for the development of relevant sectors of production. These integrated structures should enable us to carry out corporate policies to optimise industrial production, and improve cost and quality management – in short, everything that affects the competitiveness of the defence industry.

The quality of military and special products at all stages of their product cycle, from the development of weapons, military and special equipment to after sales service, depends on many factors. The existing quality control system includes a system of civil (internal) control and a system of military (external) control by military representatives.

The main factors that ensure the quality and reliability of weapons and military equipment are directly related to the challenges defence contractors face when they drag their feet on improving the competitiveness of their products. For the most part, these problems have deep roots in the distant past. No elaborate analysis is required to show that the primary, basic and key issue is reequipping our enterprises so that they are based on modern technology in order to ensure that our weapons meet current needs and requirements of military technical cooperation. The justification for the immediate development and adoption of a range of strategic and policy documents is perfectly clear: wasted funds and obsolete technology create not only a real threat to the functioning of our enterprises, but also a real threat to security itself.

Since 2007, this package of programmes which includes more than a dozen federal technology related target programmes and, above all, an investment programme for the defence industry, has been implemented with significant, increased budgetary financing. We are already seeing some results but it is hard to expect radical solutions to problems that have been piling up for decades in just over two years, one of which was a crisis. Moreover, the bulk of funding for, let's say, the defence industry development programme is allocated for the period after 2010. We should bear in mind that the budgetary funding for various defence organisations is about 28 percent of the total volume, the rest of the funding comes from their own funds and borrowed funds.

In present conditions where the profitability of enterprises is reduced and the availability of loans has been considerably limited, this is not enough to ensure a fundamental revamping of obsolete facilities. In this situation, continued government support for technological programmes and those for the technological upgrading of defence industry enterprises, along with unconditionally preserving the budgetary funding and other means of support in the aftermath of the financial crisis are both urgently needed and important.

What suggestions exist regarding how to improve technological upgrading? While developing projects for the technological renewal of defence industry enterprises, we must have clear long-term development and production goals regarding weapons and military equipment, both as regards nomenclature and production volumes defined by the State Arms Programme for 2007–2015 (SAP) and comprehensive military defence cooperation plan. Along with this we must ensure consistency between the implementation of the SAP and federal target programmes in the defence industry, and in the first instance the target programme governing its development. In light of the current technological base implementing the SAP requires not only a profound modernisation of existing production facilities, but also the creation of new high-tech units. Actually, this whole set of measures represents one of the major challenges facing various integrated structures.

The situation in human resources is the second most important problem associated with the development of the defence industry and its increased competitiveness. I would like to draw your attention to that fact that the reduction of the number of employees working for defence industry enterprises corresponds with a steady long-term efficiency increase trend, including as a result of integration processes, optimisation of business operations of these organisations, implementation of advanced technologies and better labour organisation.

With regards to ensuring that the defence industry receives qualified personnel, we are acting in accordance with the approved strategy for creating a multi-tiered system of continuous education within the defence industry. The strategy includes measures to consolidate personnel in defence industry organisations, including young professionals, to develop fundamental departments and laboratories along the same lines as leading educational institutions of higher vocational education, and to work on implementing the state plan for training scientists, experts and workers for the defence industry. We are working on this together with the Ministry of Education. We are also creating a system of further vocational education within the [defence] industry.

(Mr Khristenko then talked about the system of standardisation in the defence industry, a subsystem of the national standardisation system.)

Military standardisation approaches are in harmony with general development trends governing the reform of technical regulation in Russia. This implies that via new regulatory and technical documents, the Ministry of Defence will change from making a detailed order according to a large number of different requirements, to only the essential requirements for service conditions and ensuring the combat effectiveness of products, designs and systems. Most importantly, this will attract all the technical, material and intellectual resources of our domestic industries, including civilian ones.

Obviously it is impossible to maintain a huge regulatory framework and, similarly, an industry that only fulfils the needs of the Ministry of Defence. It should be possible to move forward and address challenges regarding the development and production of weapons and military equipment on a commercial basis, enabling companies to find optimal solutions in the market for innovative and effective technical solutions. In addition, this approach would allow us to introduce advanced technologies and designs into our commercial products, which should improve the competitiveness of our defence enterprises in other markets and would positively impact on the performance of defence contracts.

The ministry has drawn up a programme of priority measures for improving the quality of military goods produced for state defence procurement needs and the export market, and has approved it with the relevant federal executive bodies, the Defence Ministry, the Federal Space Agency, and Rostechnology. The programme covers 2009–2010. Furthermore, a package of long-term quality control measures to be implemented starting in 2011 has also been drafted.

A council for coordinating quality control of arms and military equipment has been established and has started work. Alongside representatives of the relevant federal agencies, the council’s members include representatives of Russian Technologies and Rosoboronexport State Corporations, and also a number of the leading organisations specialising in arms improvement.

(The Minister went on to list the specific quality control measures to be implemented).

Finally, we are implementing a package of measures aimed at boosting personal responsibility. All of the problems we are examining today, whether cost management, quality control, or optimising existing capacity, are all company problems, corporate governance issues. In this respect, the integrated organisations that already cover a large share of defence industry production have a duty not just to implement these programmes but to monitor their results, and the state representatives in these corporations should have a part in this supervisory work too. These programmes should be coordinated as much as needed and as much as possible with the funding the state is able to allocate for industry modernisation and upgrading production facilities.

In this context, although it seems purely utilitarian in description, the final point is actually a key measure because it aims to make corporate governance more effective, and will also perhaps answer the question of whether state representatives can play an effective part on corporate boards, or whether effective independent managers would be better in this sector.

Dmitry Medvedev: Your proposals seem clear regarding quality control and human resources, but as far as cost management goes, what are the main steps you propose taking other than having the integrated organisations, which we are with varying degrees of success in the process of creating, work on this issue at the corporate level? What are the main outlines for action?

Viktor Khristenko: On the cost management issue there are several key problems that we first need to resolve. First of all are the price-setting rules and procedures that apply in the sector, the procedures followed, above all in coordination with customers, for setting different goods’ prices.

The second issue is important in that it affects costs and cost management, and this is the amount and stability of demand for particular goods. In your opening remarks you said that prices should be such that customers can place orders for whole batches. It is common economic sense that new models of a good produced in small lots cost several times more than the same goods produced in large number. Obviously, a clearer idea of the demand for particular goods and the deadlines for orders would create a much more transparent environment for setting prices and managing costs.

The final problem concerns the state of the defence sector companies themselves, above all the state of their basic assets. Obviously, given the state of equipment at most of our companies, it will be hard to bring down costs without first making significant capital investment. Not all companies are in the same situation in this respect. The picture is varied. There are some quite good examples of how programmes implemented in, say, military and civilian aviation, in coordination with the manufacturers, have given us the additional resource need to leapfrog straight to the latest production technology and considerably shrink the size of production facilities, thus bringing down companies’ overheads. This makes it possible to conclude long-term contracts at fixed prices with the Defence Ministry. The problem is that this is still the exception rather than the rule in the sector at the moment. But this is the direction we need to move in to ensure transparent price-setting for customers and enable producers to manage their costs.

Dmitry Medvedev: But in your view, where should the focus be in cost management efforts – at government level, in the ministries, in the integrated organisations, or at the level of the manufacturers themselves?

Viktor Khristenko: I am certain the focus should be on the integrated organisations. This is what we established them for. They are the ones who should be responsible for technological and cost-management decisions. I think that these organisations’ board members should make this a priority for the organisations’ executive bodies because the integrated organisations comprise two parts: there are the companies producing the actual main models, and there are the companies producing the various component parts. The former, as a rule, account for around 12–15 percent of a good’s total cost, while the latter, the component producers, account for the rest.

Today, however, the integrated organisations within Russian Technologies State Corporation are starting to draw in a large number of production assets in the components production sector too, and so we need to act immediately to set cost management targets for the entire production group, otherwise our efforts will not work. I do not think we can achieve results at government or any other level.

Dmitry Medvedev: That is clear. Thank you.

I give the floor to Deputy Defence Minister and Chief of Armament Mr Popovkin. Please give a brief report and then we will continue our work behind closed doors.

Deputy Defence Minister and Chief of Armament Vladimir Popovkin: One of the key tasks in the armed forces’ modernisation is to equip the newly formed units with the latest arms. I will examine the technical aspects of this issue.

Since the 1990s, there has been practically no replacement of old equipment in the armed forces and only minimal state defence procurement orders, and so arms were maintained for combat use mostly through repairs and partial modernisation. There were some individual orders for strategic arms and delivery systems, with the other arms simply being repaired as needed.

The defence procurement situation has undergone a turnaround over the last two years, and instead of placing orders for repair work we are now making batch purchases at company, battalion and squadron level.

Regarding increased funding for defence procurement, we have succeeded in optimising defence procurement by decreasing the share of orders for repair work, which now accounts for less than 16 percent. This is 20 percent lower than the figure originally planned. The resulting savings have enabled us to place orders this year for nine strategic missiles, six satellites, 43 fighter planes, 41 military helicopters, a coast guard ship, three Iskander missile launch systems and 13 Iskander missiles.

In 2010, the savings made by optimising the list of items for purchase, development of new models, and cutting back the amount of repair work will enable us to commission a mobile ground-based missile system, launch 11 satellites, more than double orders for ground-based installations for the GLONASS system’s users, purchase 17 fighter planes, 48 helicopters, five S-400 divisions, complete construction of two submarines, a corvette in series production, and launch construction of a further five warships.

But we are still not buying new arms and equipment fast enough to fully replace aging technology that can no longer be used. We are aware that successful implementation of our plans depends above all on the defence industry being able to develop and produce the necessary amounts of modern arms and equipment according to deadline.

But given the human resources, production, technology and financial problems the sector’s companies face, which the Minister of Industry spoke of just now, it will be difficult to achieve timely delivery of modern arms without fundamentally modernising the defence industry and setting it on an innovative development track. It is essential that, as the armed forces modernise, the defence industry also needs to shift its focus to developing and producing the priority modern arms and equipment that the armed forces need.