The ever increasing costliness of defense equipment, the limited defense budgets, the concerns about employment levels, and the importance of industrial competitiveness in a global economy have led governments to leverage their imports of major weapon systems so as to yield benefits for their domestic economies. Offsets are one way to achieve these benefits. Such programs are often an essential part of a weapons procurement and allow the purchasing government to build public support for large expenditures of public funds. It is difficult to accurately measure the impact of offsets on the overall U.S. economy and on specific industry sectors. Military equipment is sold to foreign governments either by DOD through the FMS program or by defense contractors as direct commercial sales. These sales are accompanied by offset agreements that are established between U.S. defense contractors and purchasing governments. Although the U.S. government is a party to FMS agreements and issues licenses for technology transfers as needed, it is not a party to offset agreements and assumes no liability pursuant to the agreements. In the past, contractors had to absorb the costs of offset implementation against their negotiated profit margins. In 1992, however, DOD recognized that contractors incurred such costs by allowing their recovery under FMS contracts. Today, U.S. defense contractors may recover administrative costs incurred to implement their offset agreements under certain circumstances by charging such costs to the purchasing foreign government through the FMS contracts. Figure 1 illustrates the U.S. government’s “hands-off” policy on offsets and the offset relationships between a U.S. contractor and a country purchasing FMS. Offset agreements ordinarily specify the level of offset required, normally expressed as a percentage of the sales contract, and the types of activities that are eligible for offset credits. Negotiating an offset credit is an important part of implementing offset agreements because countries can encourage companies to undertake highly desirable offset activities by granting additional offset credit through multipliers. For example, a country may grant an offset credit for advanced technology or training activities based on what the country would have paid to procure or develop the training or technology itself. Countries may also offer large multipliers to encourage desired activities. Offset agreements contain a wide spectrum of activities that U.S. contractors agree to undertake to satisfy their obligations. Offset agreements tend to be specific in stating requirements and ways they are to be satisfied. Offset activities can be grouped into the following categories: coproduction and subcontracting related to defense items, technology transfers, in-country procurements, marketing assistance, financial assistance, and investments or joint ventures. Activities can fall into more than one category. For example, coproduction activity may also include the transfer of technology needed to improve production processes. As another example, a contractor can buy carpet and display it prominently in its executive lobby—a combination of in-country procurement and marketing assistance activities. In addition, there are other activities that do not fit within any of these categories. Coproduction tied directly to a weapons sale, subcontracting for defense-related products, and technology transferred as part of those arrangements, or separately, are transactions commonly found in the agreements we reviewed. Procurements of goods and services not related to the weapon system sales—indirect offset activities—were also frequently used. Coproduction occurs when defense companies located in offset countries receive contracts to assemble, build, or produce articles for the weapon system sale. Subcontracting occurs when a U.S. contractor procures defense-related components and subsystems for export from suppliers in countries where the contractor has offset obligations. Foreign subcontracts are either competed within the purchasing country or directed to an entity within that country. Regardless, per the agreements, U.S. contractors normally insist that the foreign companies meet certain contract standards for price, quality, and delivery to become qualified subcontractors. One U.S. contractor stated that foreign companies must meet the same contract standards as those used to select qualified U.S. subcontractors. Placing contracts overseas has resulted in additional contractors who are qualified to participate in weapon system development and production. However, the long-term supplier relationships that develop may result in reduced business opportunities for some U.S. firms. In the transactions we reviewed, coproduction and subcontracting activities ranged from 2.5 percent to 66.7 percent of the total offset obligation. The following examples describe coproduction and subcontracting activities. A U.S. contractor used two foreign defense companies to assemble an aircraft and produce some of its components and parts. Together, the U.S. contractor and foreign country determined that these particular components and parts were compatible with the foreign companies’ manufacturing processes and concluded they could be produced at a lower cost by the foreign companies than by the U.S. contractor. These activities equated to about 8.8 percent of the total offset obligation. According to the contractor, although the contractor did not solicit any U.S. companies to compete for the contract, it determined that the two foreign companies were competitive in their price, quality, and delivery. An Asian government, per the offset agreement, specified that it would select industry participants to manufacture airframe spares. This would allow all four of the Asian country’s aerospace companies to participate and achieve a proportionate share of the spares manufacture. U.S. contractors have established longer term relationships covering foreign firm participation in future sales of the weapon system and beyond their commitment in the purchasing country. In many cases, the foreign subcontractor will become a longer term supplier to the U.S. contractor for that item being produced. For example, an American defense contractor subcontracted a European defense company to assemble the tail section for a particular aircraft system sold worldwide. The manufacturing know-how was transferred to the company through a Department of State approved manufacturing license. In another illustration, a U.S. contractor subcontracted with a European company to manufacture test sets for a weapon system sold worldwide. Technology transfer is widely used to fulfill offset obligations and often accompanies coproduction and subcontract activities. It, however, is also used in areas unrelated to defense procurements. From the contractors’ perspective, technology transfers are often a relatively inexpensive way to earn offset credit because, in some cases, the contractors already possess the technology the foreign government desires. In most cases, the value of the technology transfer is negotiated between the U.S. contractor and the foreign government. The negotiated value of the technology is often based on the contractor’s prior investment in research and development, the market value of the technology, or the cost to the foreign government for developing the technology itself. Multiples of the negotiated value are also used, depending on the value the foreign government places on certain types of technology. For example, in one European country, the multiplier for this activity varied between 1 and 20, depending on the benefits received by that country’s industries. Recognizing the difficulty in determining the value of technology transfer, an Asian country and a U.S. contractor agreed to negotiate in good faith the mutually acceptable offset credit amount based on such factors as the market value, the license fees and royalties appropriate for such technology, the costs to transfer the technology, the sale or benefits resulting from the transfer, or the development costs of the technology. Many of the purchasing countries prefer projects that require technology transfers because the transfers generally provide manufacturing skills and technical assistance that can be used to help the economic development within the countries. For example, a European government wanted to develop an in-country capability by using indigenous labor that would perform flightline and special repair activity maintenance. Thus, a U.S. defense contractor provided one of the country’s defense companies a comprehensive technology transfer and training program that permitted the foreign company to train its country’s Air Force personnel to operate, maintain, and repair a weapon system in accordance with appropriate U.S. military and manufacturer standards. The State Department permitted this technology to be transferred by approving the technical assistance and manufacturing license agreements between the two parties. The U.S. contractor received an offset credit when the training program was established, and it expects to earn future credit once the European company trains other countries with this technology. In another example, an Asian government, per the offset agreement, indicated a strong desire to infuse technology into the country’s business in order to increase its commercial business capabilities. To satisfy this desire, a U.S. contractor provided an Asian commercial company with technology and training in the area of commercial component manufacture. In-country procurement is an indirect offset activity that entails purchases of goods and services not related to the foreign weapon system sale. In addition to the U.S. contractors making purchases, they also employ other parties such as major subcontractors, suppliers, and foreign entities to help meet their offset obligations. In a few cases, U.S. contractors advocated a foreign firm’s product to DOD or suppliers. Suppliers will often purchase items from foreign countries in which a U.S. contractor has an offset obligation in an effort to strengthen relationships with the prime contractor or to establish new relationships with other customers that will eventually lead to future contracts. According to U.S. contractors, some of these items are purchased because of need and at competitive prices, others mainly to help satisfy an offset obligation. Contractors often encourage their suppliers to participate in satisfying their offset obligations. For example, one U.S. defense contractor uses its supplier rating or performance evaluation system to encourage participation. The system measures factors such as the affordability, the quality, and the responsiveness (including offset cooperation as a subfactor) of the supplier and the supplier’s goods. Depending on the overall rating, a supplier may receive an increased percentage of additional work from the contractor or recognition from other customers. Another contractor holds periodic conferences or places a clause within purchase orders as a means to inform suppliers of its offset obligations with foreign countries.