A Profile of the Australian Defence Industry

A Proﬁ le of the Australian Defence Industry

Helping align defence industry, defence industry policy, and defence strategic planning

November 2004

COMMISSIONED BY:

■ The Australian Industry Group Defence Council;

■ The Australian Industry Defence Network;

■ The Department of Defence;

■ The Department of Foreign Affairs and Trade;

■ The Department of State and Regional Development (NSW);

■ The Department of State Development and Innovation (QLD);

■ The Defence Unit in the Department of Trade and Economic Development (SA);

■ The Department of Innovation, Industry and Regional Development (VIC);

■ The Department of Industry and Resources (WA) © ACIL Tasman Pty Ltd This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Permission for any more extensive reproduction must be obtained from Kelly Milne at ACIL Tasman on (03) 9600 3144. Reliance and Disclaimer The professional analysis and advice in this report has been prepared by ACIL Tasman for the exclusive use of the party or parties to whom it is addressed (the addressee) and for the purposes specified in it. This report is supplied in good faith and reflects the knowledge, expertise and experience of the consultants involved. The report must not be published, quoted or disseminated to any other party without ACIL Tasman’s prior written consent. ACIL Tasman accepts no responsibility whatsoever for any loss occasioned by any person acting or refraining from action as a result of reliance on the report, other than the addressee. In conducting the analysis in this report ACIL Tasman has endeavoured to use what it considers is the best information available at the date of publication, including information supplied by the addressee. Unless stated otherwise, ACIL Tasman does not warrant the accuracy of any forecast or prediction in the report. Although ACIL Tasman exercises reasonable care when making forecasts or predictions, factors in the process, such as future market behaviour, are inherently uncertain and cannot be forecast or predicted reliably. ACIL Tasman shall not be liable in respect of any claim arising out of the failure of a client investment to perform to the advantage of the client or to the advantage of the client to the degree suggested or assumed in any advice or forecast given by ACIL Tasman.

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Bob Wylie Telephone (02) 6240 8055 Mobile 0404 822 325 Email [email protected] A Profile of the Australian Defence Industry

Foreword

This Study of Australian defence industry undertaken by ACIL Tasman examines the role of Australian defence industry in supplying and supporting Australia’s defence capabilities. As ACIL Tasman shows in this Study, private sector enterprises – large and small - play critical roles in the provision and development of Australian defence capabilities. The viability and success of the industry is itself, an important defence capability. Defence is a specialised area that calls for a close partnering relationship between the public and private sectors. It is fitting, therefore, that this Study is the result of a cooperative effort bringing together sponsors from industry and government agencies both at the Federal and State levels. The Study shows the importance of ongoing assessment of, and improvements to, the relationships between the defence industry, government and defence agencies. In particular, the Study identifies a number of areas for Defence authorities and industry to explore possible improvements in contracting arrangements and it also points to the benefits of building better linkages between business and the Defence Science and Technology Organisation (DSTO). The Study confirms the impact on defence industry of the shortage of skills across a range of operational and managerial occupations. Skill shortages are already having widespread effect across industry making this an area of concern. One fundamental area impacting on all areas of the defence industry is that of contracting. Since completing this Study the CEO of the Defence Materiel Organisation (DMO) has indicated to Defence industry a desire to make substantial changes to the template for undertaking major project activity with Defence - ASDEFCON. Those changes are principally aimed at ensuring that contractors meet agreed work schedules so that major capabilities can be acquired on time, on budget, and to the required capability, quality and safety standards.

While industry supports that goal, it is keen to ensure that contracting changes do not result in inequitable transfer of risk to industry. For this reason, representatives of the DMO Executive and the National Executive of the Australian Industry Group met in August and September 2004 specifically to discuss the proposed schedule management changes to the ASDEFCON (Strategic Materiel) template. In those meetings, industry expressed its views

Foreword xi A Profile of the Australian Defence Industry

on how risk could be shared between itself and Defence and how the parties could move towards a more cooperative and open contracting environment while achieving better contracting outcomes for all concerned.

This area, like the many raised in the Study, illustrates the importance of close and open dialogue between industry and Defence authorities in seeking to further improve the effectiveness of the role played by industry in maintaining and developing Australian defence capabilities.

Paul Salteri

Chairman Australian Industry Group Defence Industry Council

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Contents

Glossary vii Foreword xi Executive summary xiii Recommendations xxi 1 Introduction 1 1.1 The Defence Strategic Industry Sector Plans 1 1.2 The Profile and the Sector Plans 2 1.3 The Study 3 1.4 The Profile Structure 3 1.5 Framing The Profile 4 1.5.1 Defining defence industry 4 1.5.2 A Defence capability-based framework 4 1.5.3 Defence strategic planning requirements 5 1.5.4 Communicating Defence strategic planning requirements 6 1.6 Shaping the Study 7 2 The Structure and Performance of the Australian Defence Industry 8 2.1 The Scale of Defence Industry 8 2.2 Function of Defence Industry 9 2.2.1 The service component of Defence business 9 2.3 The Location of Defence Industry 10 2.4 The Defence Business Environment 12 2.4.1 The profitability of the defence industry 12 2.4.2 Sources of finance 15 2.4.3 Defence business constraints 16 2.4.4 Role of government industry programs 18 3 Supply and Support of Defence Capability 20 3.1 Supply and Support of Defence Information Capability 21 3.1.1 The national electronics industry base 22 3.1.2 Electronics software and systems integration 23 3.1.3 Supply and support of current defence information capability 24 3.1.4 Supply and support of the future force 27 3.2 Supply and Support of Navy Ships, Boats and Submarines 29 3.2.1 The shipbuilding and repair industry base 29 3.2.2 Supply and support of maritime capability 30 3.2.3 Supply and support of the future force 33

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3.3 Supply and Support of Army Land Transport 35 3.3.1 The land transport industry base 35 3.3.2 Supply and support of future field vehicles 38 3.4 Supply and Support of ADF Munitions 39 3.4.1 The munitions industry base 39 3.4.2 Precision and guided weapons 41 3.4.3 Supply and support of future munitions 42 3.5 Supply and Support of Defence Aviation Capabilities 42 3.5.1 The aerospace industry base 43 3.5.2 Supply and support of future aerospace assets 46 4 Managing Defence Demand 50 4.1 Defence demand management 50 4.2 Managing Defence Project Risk 51 4.2.1 The capability system life cycle 52 4.3 Defence Contracts and the Australian Industry Involvement Program 53 4.3.1 Linking preparedness and industry support 54 4.3.2 The Australian Industry Involvement Program 54 4.3.3 Defence industry flexibility and the cost of doing defence business 57 4.4 Managing Competition to Develop Industry 59 4.5 Modifying the Project-By-Project Business Model and Defence- Industry Partnering 60 4.5.1 Evolutionary acquisition and spiral development 62 4.6 Coordinating demand management 64 5 Defence Industry Enablers 66 5.1 Exports by Defence-Related Industries 66 5.1.1 Exports as a defence industry enabler 66 5.1.2 The pattern of Australian defence-related exports 68 5.1.3 Australian Defence exporters 72 5.1.4 Australian Defence export controls 74 5.2 Access to Overseas IP and Technology 75 5.2.1 Access to US intellectual property: US policy and processes 76 5.3 Research, Development and Innovation 81 5.3.1 Defence R&D in Australian industry 81 5.3.2 Innovation in the defence industry 86 5.3.3 Defence R&D and the national R&D Base 87 5.4 Skills Development 91 5.4.1 Training arrangements 91 5.4.2 Defence specific-skills 92

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6 Conclusion 96 A The Capability Development Advisory Forum A-1 B The Profile Data B-1 C Estimating the Size of the Australian Defence Industry C-1 D Industry Performance D-1 E Access to US Intellectual Property: US Policy E-1 F Exports by Region and Category F-1 G Research and Development G-1 H Recruitment of Skilled Personnel: Sources H-1

Boxes, figures, tables and charts Box 1 Network Enabled Operations 21 Box 2 Guided Missile Frigate Progressive Upgrade 32 Box 3 Bushmaster 36 Box 4 Airborne Surveillance for Land Operations 47 Box 5 GKN Aerospace Engineering Services 48 Box 6 Exporting the Australian Minesweeping System 67 Box 7 Impact of US Export Controls 77 Box 8 National ICT Australia Ltd 90 Box 9 Employer Incentives under the New Apprenticeships Scheme 94

Figure 1 Manufacturing sector performance (Operating Profit Margin) 13 Figure 2 Services sector performance (Operating Profit Margin) 14 Figure 3 Exports by firm size 74 Figure 4 Technology readiness levels 82 Figure B1 Size distribution of respondents B-3

Table 1 Defence business profitability 12 Table 2 Defence industry profit margins 13 Table 3 Survey respondent profitability by industry 15 Table 4 Sources of finance and their importance 16 Table 5 Defence business impediments 17 Table 6 Skill shortages 18 Table 7 Importance of industry assistance programs 19 Table 8 Defence industry support programs 55 Table 9 Service exports 71 Table 10 export constraints 72 Table 11 Business arrangements for export 73

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Table 12 Application for foreign government export licences 76 Table 13 Focus of innovation 86 Table 14 Ranking IP sources 87 Table 15 Protecting IP 87 Table 16 Major areas of Defence related R & D 89 Table C1 Assumed firm size and response rate C-1 Table C2 Estimate of defence industry size C-1 Table D1 Industry performance, manufacturing D-1 Table D2 Industry performance, services D-1 Table F1 Exports by destination and category, 1999 F-1 Table F2 Exports by destination and category, 2000 F-1 Table F3 Exports by destination and category, 2001 F-1 Table G1 National R&D expenditure G-1 Table G2 Defence R&D expenditure G-1 Table H1 Senior management recruitment H-1 Table H2 Professional recruitment H-1 Table H3 Tradespeople recruitment H-1

Chart 1 Location of Defence business units 11 Chart 2 Exports of Defence industry-related goods by region by year 70

vi A Profile of the Australian Defence Industry

Glossary

The Glossary explains the terms used in this publication. The explanations are not intended to be technical definitions of the terms.

ABS Australian Bureau of Statistics Acquisition Purchasing, leasing or other ways by which the Defence Materiel Organisation procures a materiel capability or system for use by the Australian Defence Force. Acquisition phase The period in the lifecycle of a materiel capability or system when it is acquired. ADF Australian Defence Force AHECC Australian Harmonised Export Commodity Classification — an internationally standardised list of products used by the Australian Bureau of Statistics to classify export statistics. AIDN Australian Industry Defence Network AIG Australian Industry Group ASPI Australian Strategic Policy Institute, established in 2000 by the Government to provide fresh ideas on Australia’s defence and strategic policy choices on an independent, non-partisan basis. ANAO Australian National Audit Office ANZSIC Australian New Zealand Standard Industry Classification – an internationally standardised list of industries used by the Australian Bureau of Statistics to classify industry statistics. Australian Industry A mechanism by which Defence uses its procurement leverage to engage Involvement Australian and New Zealand companies to develop, enhance and sustain Australian Defence Force capabilities. Availability A measure of the proportion of time a materiel capability or system is available for operational use versus total time. Capability An operational outcome or effect that users of equipment need to achieve.

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Capability definition The period in the lifecycle of an Australian Defence Force materiel phase capability when the initial need is identified and performance requirements defined. Capability CDAF: A forum announced in June 1998 by the then Minister for Development Advisory Defence Industry, Science and Personnel to encourage, early in the Forum defence capability development process, two-way communication between industry and Defence about technology trends and specific capability proposals. Capability Manager The Australian Defence Force end-user of a materiel capability. Capability Maturity CMMI: A model of world’s best practice in development and integration Model Integrated of electronic systems which covers Process management, Project Management, Systems and Software Engineering, Integrated Teaming Management, Acquisition Management and Support functions. Commercial off the COTS: Commercial equipment, electronic hardware or software used for shelf military purposes without adaptation. Continuous Continuous improvement involves working towards more effective and improvement efficient materiel capability management. Contract management A process for managing the rights and obligations of parties to a contract, for example quality, performance, reporting, delivery schedule and payment. Defence Capability A ten-year forward plan of Australian Defence Force Major Capital Plan Equipment capability assets to be acquired. Defence Company A contract management and performance measurement tool used by Scorecard Defence to formalise its corporate knowledge of a contractor’s performance. Defence Materiel DMO: One of the enabling elements of the Australian Defence Organisation Organisation responsible for acquisition and in-service support of defence materiel. Defence Science and DSTO: That element of the Defence Organisation responsible for giving Technology Defence professional, impartial, and informed advice about the Organisation application of science and technology that best meets Australia’s security needs. Defence White Paper An abbreviation of the formal title of “Defence 2000 — Our Future Defence Force” which explains the Government’s strategic defence policy for the next decade.

Glossary viii A Profile of the Australian Defence Industry

DIIREC Defence Industry Investment Recognition Scheme — sub-set of the Australian Industry Involvement Program which recognises investment by overseas companies in local defence industry capacity. Disposal phase The disposal phase is the period in the lifecycle of a materiel capability or system when action is taken to dispose of it efficiently, effectively and safely. End-users The Australian Defence Force Element Group that deploys a materiel capability or system. Equipment Means all materiel capability or systems, except consumable. May be qualified by referring to items as Major or Minor Capital Equipment. Force Element Group The group of people in Navy, Army or Air Force who use the capability or system acquired. In-service support The period in the lifecycle of a materiel capability or system when it is phase operated, supported, maintained, modified, upgraded or improved. JDAM-ER Joint Direct Attack Munition-Extended Range: an iron bomb converted to an air-launched stand-off weapon by the addition of a guidance system and wings. Lifecycle The lifecycle of a materiel capability covers the period from its initial inception, through to ultimate disposal and includes need and requirements definition, acquisition, in-service support and. Logistics A management discipline that covers all facets of ensuring that an Australian Defence Force capability or system is supported and kept in a state of readiness for its intended use. Major capital Strategically important Defence materiel with an acquisition cost of $20 equipment million or more. Materiel Australian Defence Force capability assets, including their logistic support. Military off the shelf MOTS: Military hardware or software developed overseas and used by the Australian Defence Force without adaptation. Minor capital Strategically less important Defence materiel with an acquisition cost of equipment less than $20 million. Munitions Weapons and their ammunition, including missiles

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Network enabled Network enabled operations aim to give ADF commanders ‘decision operations superiority’ over an adversary by providing ADF commanders with a common and enhanced battlespace awareness and enabling them to use that awareness to deliver maximum combat effect. NICTA National ICT Australia Ltd: A centre of excellence established in 2002 to boost Australia’s long term strategic research in information and communication technology Precision and Guided PGM: ammunition, missiles, or underwater weapons with smart munitions technology that allows their delivery to a target with high rates of accuracy. Requirements phase The period in the materiel capability or system lifecycle where the requirements of that capability or system are determined. Services Navy, Army and Air force. SIDA Strategic Industry Development Activities — a sub-set of the Australian Industry Involvement Program which provides for Defence recognition of investment by companies in strategically important industry capacity outside specific projects. SMEs Small and medium enterprises Technology Readiness TRLs: Standardised descriptions of technology readiness used by the Levels defence scientific community to explain the technological risk inherent in proposed solutions to particular defence capability requirements. Through Life Support A whole of life management methodology that takes an integrated approach to all aspects of supportability and readiness of a materiel capability or system. Whole of life approach The integration of materiel capability and system acquisition, in-service support and disposal services. Whole of life costs Total costs over the materiel life cycle. Also referred to as lifecycle costs.

Glossary x A Profile of the Australian Defence Industry

Executive summary

The Profile of Australia’s Defence Industry was commissioned by a partnership of industry organisations and federal and state government departments.1 The Profile examines the state of Australia’s defence industry, its role in supplying present defence capabilities and its capacity to meet future defence requirements. For the purposes of this project, Australia’s defence industry consists of Australian-based manufacturing and service sector businesses that are engaged (or that could be engaged) in the supply, support and development of defence capabilities. Like other studies, the Profile pays particular attention to the role of the defence electronics industry, the naval shipbuilding and repair industry, the construction of special purpose vehicles, the munitions industry and the aerospace industry. The Profile places greater emphasis on distinguishing between industry’s capacity to support the present force and action needed to supply and support the future force. Australian industry’s capacity to develop, supply and support defence capabilities is critically influenced by Defence and by government. Regardless of whether a defence industry participant has a direct commercial relationship with Defence or whether it has a role in a supply chain, it operates in an environment that is strongly influenced by Defence policy and procedures, by variations in defence force preparedness and by changes in strategic directions. The Profile is particularly focussed on the ability of the defence industry to respond to emerging requirements in the face of changing expenditure priorities, the variability of preparedness and the evolution of defence strategic planning. Defence industry responsiveness is influenced by exports, access to overseas intellectual property, domestic R&D and access to skilled people. The effective management of these ‘enablers’ is a key element both in the competitiveness and sustainability of the defence industry itself and in the broader context of the maintenance and development of Australia’s national defence capabilities.

1 The Defence Council of the Australian Industry Group; The Australian Industry Defence Network; The Department of Defence; The Department of Foreign Affairs and Trade; The Department of State and Regional Development (NSW); The Department of State Development and Innovation (QLD); The Defence Unit in the Department of Trade and Economic Development (SA); The Department of Innovation, Industry and Regional Development (VIC) and the Department of Industry and Resources (WA).

Executive summary xiii A Profile of the Australian Defence Industry

By publishing the rolling Defence Capability Plan and other guidance, Defence provides a framework for industry planning. The utility of this framework was recently enhanced by the Government’s decision to endorse strategic industry sector plans for defence electronics systems and defence aerospace. The Profile complements this guidance by helping decision makers in Government and industry gauge the need for action to encourage defence industry to develop in accordance with evolving Defence requirements.

Structure, Performance and Operating Environment

The Profile describes the industry in terms of its size, location, profitability and operating environment. The data underpinning this description has limitations which should be addressed in future studies.

Size

The available data suggests that the Australian defence industry comprises between 200 and 300 core companies who employed an estimated 13,000 people and generated some $4.7 billion turnover in 2002-03. Of these, the largest ten companies generated over $3 billion from defence and other business. As prime contractors, these large companies marshal the resources of innumerable sub-contractors (an estimated 1300 in the ANZAC ship project alone). Estimates of the number of these sub-contractors permanently engaged in defence business ranged from a low of 200-300 to a high of 500 companies. In this range, the number of sub-contractors dedicated solely to supply of specialised military equipment like sonars, mobile military communication equipment or surface wave radar is likely to be closer to 200-300. A much larger number of sub-contractors have long term contracts for the supply of less specialised equipment like the air conditioning, pumps and electrical equipment used by the ANZAC ships: At any one time 500 or more companies could hold such long term contracts.

Location

The defence industry appears to be distributed in rough proportion to population and business activity generally. Against this, supplying and supporting those units of the Australian Defence Force located in Northern

Executive summary xiv A Profile of the Australian Defence Industry

Australia readily explains the disproportionately large concentrations of industry in the Northern Territory and Central and Northern Queensland. On the manufacturing side, concentrations in Victoria and NSW appear to match the general geographical pattern for this sector.

Profitability

The data suggests, and anecdotal information tends to confirm, that overall defence industry profitability is broadly in line with that of the general manufacturing and service sectors in which they are embedded. There does, however, appear to be some concentrations of poorer profitability - particularly among prime contractors for larger more complex electronics projects. The central position of these projects and companies in the defence industry means that overall the industry is not particularly robust in terms of its ability to meet future Defence needs on time and to cost.

Operating Environment

Defence suppliers expressed strong concerns about the transaction costs associated with defence business in general and the cost of tendering in particular. SMEs were also concerned about the availability and cost of professional indemnity insurance. A recurring theme is the shortage of suitably skilled labour. This ranges across managerial, professional and trade occupations. Skill shortages are most acute in relation to trades. There appears to be a comparatively high level of responsiveness to government programs among the defence industry. Federal and State/Territory programs seem to have above average take-up compared to the broader economy.

Supplying and supporting present and future forces

The profile assessed industry’s capacity to supply and support: • Defence information capability; • Naval ships, boats and submarines; • Army land-based manoeuvre; • Defence munitions; and • Defence aviation.

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Defence information capability

Defence information capability, which encompasses everything from commercial business systems to the integration of platforms, sensors and weapons, is of overriding importance in the competition for military advantage. Over the next ten years, therefore, Defence will spend more on electronic systems, both stand alone and embedded in other platforms, than it will spend on aircraft, weapons and munitions, vehicles, and ships and submarines.

The local electronics industry will need to increase dramatically in both scale and scope in order to supply and support the electronic systems foreshadowed in the Defence Capability Plan 2004-14. The profile suggests, however, that the strategically vital task of integrating electronics systems is not particularly profitable. Hence local system houses like RLM and ADACEL Technologies have left the Australian defence industry in the last two years.

The conventional defence procurement model is unlikely to give local electronics companies sufficient incentive to extend their existing investment in skilled people and sophisticated processes to the extent required to meet future defence information capability requirements.

Navy ships and submarines

The Defence Capability Plan 2004-14 provides for the concurrent construction of overseas-designed air warfare destroyers and amphibious support ships. These programs will drive a restructuring of the ownership and capacity of the naval shipbuilding industry. Their timing will make the next shipbuilding cycle shorter and make expenditure peak more sharply compared to the previous cycle. The ANZAC ship and COLLINS Class submarine programs have established local industry capacity to build the air warfare destroyers to demanding naval construction standards. The ANZAC ship and FFG Guided missile frigate programs demonstrate how local through-life support can be enhanced by investing in the detailed ‘Australianisation’ of overseas designs. Australia maximises self reliant in-service support when local naval architects have sufficient intellectual property to assume design authority for the ships built here. Local supply and support of current naval combatants has established a substantial Australian capacity to integrate electronic systems in the maritime environment. The main challenge confronting Australia’s naval shipbuilders will be extending this existing capacity in time to integrate the more demanding electronic systems that define the capability of both air warfare destroyers and amphibious support ships.

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Army land transport

Defence imports armoured vehicles and operates a mix of locally built and imported field vehicles and trailers. Defence relies on a mix of in-house arrangements and readily available commercial resources to repair, maintain and adapt this inventory.

Defence’s decision to acquire a military-off-the-shelf replacement for the current inventory of field vehicles and trailers makes good strategic and economic sense. Australian industry has ample capacity to repair, maintain and adapt such vehicles. Developing local industry’s capacity to integrate the vehicles and their cargoes into Defence systems for command, control, communication and intelligence would facilitate Army participation in network enabled operations.

Defence munitions

Defence buys ballistic munitions from ADI but imports precision and guided munitions (PGM). The latter involve certain very sensitive technologies which the US and other countries will only release to Australia on a government-to- government basis. Defence maintains such PGM in-house or returns them to the original equipment manufacturers. The Joint Direct Attack Munition (Extended Range) developed by the Defence Science and Technology Organisation (DSTO) and Hawker de Havilland offers a potentially attractive synthesis of ballistic munition and precision stand-off weapons. In addition, participation in international collaborative programs like the Enhanced Sea Sparrow missile improves Australia’s prospects for achieving self-reliant supply and support of precision weapons cost effectively.

Military aviation

Defence will continue looking to the Australian aircraft industry to repair, maintain and do limited upgrade of the fixed and rotary wing aircraft operated by the ADF. The aerospace sector plan pointed out that, by taking advantage of emerging opportunities to rationalise its aircraft inventory and by moving away from project-by-project contracting for support, Defence can create powerful incentives for the currently fragmented industry to adopt a more viable structure.

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Aligning Defence Industry Development with Future Defence Requirements

The Profile identifies managing defence demand and fostering defence industry enablers as the two main levers by which the future development of defence industry capacity can be aligned with defence strategic planning requirements.

Managing Defence Demand

Where Defence is the sole customer for an industry, it is the management of defence demand, rather than a free market, that will determine the health and capacity of that industry. The profile analysed the management of project risk, the linking of contracts and preparedness, competition policy, and partnering as specific aspects of managing defence demand so as to align defence industry capacity and defence strategic planning requirements. The competition for military advantage leads Defence to demand leading edge solutions to its information capability requirements. How Defence and industry identify and manage the resulting technology risk will determine the health of that element of the defence electronics industry responsible for supplying and integrating software-intensive systems. The Profile advocates taking advantage of recent defence procurement reforms to develop the commercial mechanisms needed to share project risk effectively. Contracts and the contracting process are critical links between defence industry capacity and defence strategic planning requirements. In procuring, for example, the Hawk Lead-in fighter and new patrol boats, Defence has begun incorporating in-service support and acquisition in long term contracts administered by a dedicated System Project Office that manages a project through the full capability life cycle. These innovations provide a basic linkage between industry capacity and the preparedness element of defence strategic planning. Logical extensions of this basic linkage advocated by the Profile include: • Widening the metrics of the Defence Company Scorecard to include a company’s contribution to achievement of specified ADF preparedness targets; • More explicit linkage of Australian Industry Involvement objectives to ADF preparedness targets. The Profile finds, however, that the cost of doing defence business attenuates the above linkage between industry capacity and strategic planning by compromising defence industry’s ability to adjust to changing defence requirements.

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Such flexibility is critical if defence industry is to align with defence strategic planning requirements: The ability of SMEs to enter or leave the market on a contract by contract basis and the ability of larger firms to reallocate resources by building diversified defence and non-defence business portfolios is more important than the actual size of the industry at any particular time. The Profile therefore reiterates long standing calls for a concerted effort by defence and industry to reduce defence business transaction costs The Profile reaffirms the importance of appropriately managed competition in creating incentives for companies to innovate and contain costs. Within this framework, the Profile builds on certain aspects of the defence industry sector plans in advocating refinements in the way industry and Defence manage competition for defence contracts.

Defence industry enablers

The Profile identifies a number of defence industry enablers that help industry meet requirements for the supply, support and development of defence capabilities.

Exports Exports of defence-related goods and services can offset the limitations of the Australian defence market by underwriting scale economies and development of domestic expertise that improves the competitiveness of the domestic industry and its effectiveness in supplying domestic requirements. The profile finds that defence industry participants export vigorously – mainly to the US.

Access to imported technology

Companies play a key role in importing technology not available from Australian sources at acceptable cost and risk. The Profile finds that a large proportion of Australian defence businesses are importers of intellectual property – particularly from the US. The Government’s strategic guidance has reaffirmed the fundamental importance to Australia of continued access to advanced US military technology. The Profile highlights the strategic and commercial importance of developing more efficient and predictable ways of obtaining US technology within the framework of stringent US export controls.

Executive summary xix A Profile of the Australian Defence Industry

Research and innovation

The ABS estimates that in 2000-01 Defence accounted for a relatively modest 3.5% of total national R&D activity in that year. Commonwealth government agencies accounted two thirds of total Defence R&D, business generated one third and the higher education sector generated 1%. While the predominance of public funding of R&D for Australian defence purposes is likely to continue, the Profile finds considerable scope for industry to increase its role through greater collaboration and partnering with publicly funded defence researchers.

Developing skills

The defence industry’s capacity to deliver defence projects on time and cost is being adversely affected by widespread skill shortages across all broad occupational groups. The Profile draws attention to opportunities for industry and Commonwealth and State government agencies to address current and emerging skill shortages.

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Recommendations

The report’s thirteen recommendations can be grouped into the following categories: • Defence demand management; • Innovation and project risk; • Defence business processes; and • Commercial viability of defence suppliers.

Category One: Demand Management

The report’s recommendations concerning defence demand management constitute a major agenda for industry engagement of defence. The recommendations in this category follow.

Recommendation 6 (Section 4.4, page 60)

Defence uses competition to create incentives and opportunities for companies to innovate and contain costs. Defence demand does not always generate sufficient predictable work to sustain the investment by companies needed to meet defence strategic planning requirements under the conventional procurement model of open and effective competition. Where Defence demand can only sustain a monopsonist-monopolist market structure, industry should consult the Departments of Defence and of Finance and Administration about drawing on the logic and principles underpinning the Agreement of Competition Principles concluded by the Commonwealth and State/Territory Governments. Such a departure from established government procurement principles would have substantial implications for Defence force structure development and preparedness management. The Defence Capability Advisory Forum is appropriately constituted to ensure the more specialist work required is undertaken with due regard to defence strategic planning requirements.

Recommendation 7 (Section 4.5, page 62)

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• linking separate projects strategically; and • establishing and managing Defence–industry partnerships for undertaking selected, strategically linked Defence projects. The Defence Capability Advisory Forum is appropriately constituted to guide the work of the Defence Contracting Consultative Forum in pursuing an initiative along the above lines.

Recommendation 8 (Section 4.5.1, page 64) The extent to which defence industry capacity is aligned with defence strategic planning requirements will increasingly depend on how Defence manages the procurement of defence information capability, either embedded or stand alone. The business model being used for Phase Five enhancements of the Jindalee Over the Horizon radar demonstrates how evolutionary acquisition and spiral development principles in long term contracts can be applied in the Australian environment. Industry should consult Defence about extending the business model for JORN Phase 5 enhancements to other defence information capability developments foreshadowed in the Defence Capability Plan 2004-14. The Capability Development Advisory Forum is appropriately constituted to oversight such an initiative.

Recommendation 9 (Section 4.6 page65)

The actions recommended in this Profile to align defence industry capacity with defence strategic planning requirements were developed in parallel with initiatives to implement the sector plans for defence electronics and defence aerospace. Implementation of recommendations flowing from, respectively, the Profile and the sector plans needs to be coordinated. Industry should consult Defence with a view to obtaining Ministerial agreement to broadening the ambit of the proposed Defence Industry Ministerial Council to include oversight of: • action to align defence industry capacity with defence strategic planning requirements in accordance with the recommendations in this Profile; and • initiatives to implement the recommendations in the strategic industry sector plans for Defence Electronic Systems and Defence Aerospace.

Category Two: Innovation and Risk

The report’s recommendations about defence demand management are supported by the following additional recommendations concerning access to technology, innovation by defence industry and managing defence project risk.

Recommendation 1 (Section 4.2.1, page 53)

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When they are tendering for projects, companies have a stronger incentive to understate technical and other aspects of project risk. This is particularly the case for complex software intensive projects. Greater use of funded project definition studies in the pre-tender phase of projects would help both customer and supplier identify and manage project risk. Such an approach would help manage the risk inherent in the large number of information capability projects foreshadowed in the Defence Capability Plan 2004-14. Industry should consult Defence about developing principles and procedures for augmenting and extending the use of funded project definition studies in the pre-tender stages of capability development proposals. The Capability Development Advisory Forum is appropriately constituted to oversight the development of such principles and procedures.

Recommendation 11 (Section 5.2.1 page 80)

Australian defence industry is currently owned by a diverse mix of local and overseas interests. Australian strategic and commercial interests are best served by preserving such diversity. In order to do so without prejudicing Australian access to US technology, industry should consult Defence about establishing a joint Defence-industry understanding of • the detailed governance principles and procedures that the US Government requires foreign-owned companies to institute if they are domiciled in the US and involved in supply and support of the US military; • action required by Defence and Industry to align Australian defence industrial security arrangements with the governance principles and procedures the US imposes on non-US companies supplying and supporting the US military; and • the balance of costs and benefits, in terms of Australian strategic and commercial interests, of making such enhanced defence industrial security arrangements a precondition for local companies’ involvement in future Australian projects requiring access to controlled US technology (for example, the Joint Strike Fighter, Soldier Combat System, Air warfare destroyer and amphibious support ships. The Capability Development Advisory Forum is appropriately constituted to facilitate the above industry-Defence consultation.

Recommendation 12 (Section 5.3.3, page 90)

Recommendations xxiii A Profile of the Australian Defence Industry

• criteria for access to, and arrangements for administration of, the augmented Capability and Technology Demonstrator (CTD) program, using the Joint Direct Attack Munition-Extended Range project as a case study; • the criteria for eligibility for seed funding pre-CTD application and for activity funding post-CTD application; • drawing on commercial experience with joint ventures in developing principles for the guidance of DSTO and industry in managing defence developmental projects on the basis of an equitable sharing of risk and reward; and • the scope for linking commercial R&D in support of Defence information capability to wider national initiatives (including the establishment of the national centre of excellence on information and communication technology) to develop information and communication technologies.

The Capability Development Advisory Forum is appropriately constituted to facilitate such consultation.

Category Three: Defence Business Processes

The report made the following two recommendations about defence business processes.

Recommendation 2 (Section 4.3.1, page 54)

In order to link development of defence industry capacity to defence strategic planning requirements, contractor performance needs to be linked to preparedness. Defence should consult industry about linking Defence strategic planning to defence industry capacity through: • appropriate provisions in contracts, drawing on experience with recent contracts that focus more on capability outcomes than project outputs (for example, the Hawk Lead In fighter and the Replacement Patrol Boat Programs); and • inclusion of preparedness planning objectives in the Defence Company Scorecard program. The Capability Development Advisory Forum is appropriately constituted to facilitate and oversight such consultation.

Recommendation 3 (Section 4.3.2, page 56)

Recommendations xxiv A Profile of the Australian Defence Industry

• using such indicators to inform proposals for: – Australianisation of designs for the air warfare destroyers and amphibious support ships; and – encouraging shortlisted tenderers for Army’s field vehicle and trailers to involve local companies in adapting military off the shelf vehicles for network enabled operations in the Australian environment. The Capability Development Advisory Forum is appropriately constituted to oversight the reinvigoration of the AII program along the above lines.

Category Four: Supplier Commercial Viability

The following recommendations in the report are about improving companies’ capacity to supply and support defence on a commercially viable basis.

Recommendation 4 (Section 4.3.3, page 57)

Reducing the cost of tendering would improve defence industry profitability and would give Defence better value for money. The potential gains in these areas are sufficient to warrant Defence and industry making a concerted effort to reduce the cost of tendering by: • reviewing the fixed costs associated with defence tendering; and • exploring the scope for adjusting defence management of lower value/lower risk contracts with a view to securing better alignment of tender costs and tender value/risk. Defence and industry have previously used the Defence Contracting Consultative Forum to develop revised contracting principles and related documentation. The DCF is well suited to reviewing the cost of tendering along the above lines.

Recommendation 5 (Section 4.3.3, page 58)

Small and medium defence suppliers, like other small and medium enterprises (SMEs) in the Australian economy, are reporting difficulty in obtaining appropriate professional indemnity insurance. If SMEs are unable to indemnify themselves, the ability of defence industry to provide innovative solutions to defence requirements, to accommodate shifts in defence spending and to share project risk is compromised. Defence industry groups should develop a more coordinated approach to improve the availability of appropriate professional indemnity insurance for SMEs involved in supplying and supporting Defence.

Recommendations xxv A Profile of the Australian Defence Industry

Recommendation 10 (Section 5.1.4 page 75)

Defence-related exports contribute to the commercial viability of many actual and potential defence suppliers. Hence Industry should consult State/Territory and Commonwealth agencies, as appropriate, about: • the efficiency and effectiveness of defence export assistance having regard to responses to the Defence Industry Survey; • obtaining a better understanding of the characteristics of defence exporters with particular reference to SMEs with a view to informing support by both State/Territory and Commonwealth agencies; • identifying additional opportunities for export of defence industry related goods and services as specified in the US Defense Federal Acquisition Regulations and other US legislation consequential upon signature of the Free Trade Agreement and • Defence resuming publication of defence export control statistics in the interests of maintaining a transparent, predictable export control regime. The Defence Exporters Council is appropriately constituted to facilitate engagement by industry with Defence, and Commonwealth and State/Territory export facilitation agencies along the above lines.

Recommendation 13 (Section 5.4.2, page 95)

A shortage of skilled personnel can prejudice the ability of companies to deliver projects on time and to cost. Industry Associations, Commonwealth training agencies and their State/Territory counterparts should develop a coordinated approach to meeting future defence industry requirements for adequately trained managers, professionals and associate professionals and tradespeople. In formulating such an approach, industry and training agencies should have particular regard to the requirements of: • naval shipbuilding and repair; and • military systems integration. Because the availability of an appropriately trained workforce is so important to industry’s contribution to defence capability development, such an initiative should be coordinated through the Capability Development Advisory Forum.

Recommendations xxvi A Profile of the Australian Defence Industry

1 Introduction

In 2003, The Defence Council of the Australian Industry Group; The Australian Industry Defence Network; The Department of Defence; The Department of Foreign Affairs and Trade; The Department of State and Regional Development (NSW); The Department of State Development and Innovation (QLD); The Defence Unit in the Department of Trade and Economic Development (SA); The Department of Innovation, Industry and Regional Development (VIC) and the Department of Industry and Resources (WA) agreed to commission a study of the Australian Defence Industry. The aim of the study was “to enable Australian industry to work effectively with the government and government agencies in aligning the defence industry and defence industry policy with the requirements of strategic planning.”2 To this end the study constructed a profile of the Australian defence industry and assessed the current and projected capabilities of the industry to supply domestic and export markets. The profile is designed to be updated periodically and is based on: • a framework geared to defence strategic planning and which shapes the collection of empirical data; and • a data base which permits manipulation of the data it contains and which can be updated periodically. 3 By encompassing the defence industry as a whole, the profile complements and builds on selected aspects of the defence strategic industry sector plans which Defence initiated in 2002-03.

1.1 The Defence Strategic Industry Sector Plans

In the Defence White Paper the Government indicated that “We must take a strategic approach to our defence industry base, and not regard its capabilities as simply a by-product of procurement decisions.”4 The Government subsequently announced in October 2001 that it would adopt a more strategic industry policy approach, key features of which were to include: • defining the key industry capabilities that it requires and develop long-term strategies to sustain them,

2 Profiling the Australian Defence Industry : Project Specification, Australian Industry Group, February 2003 3 Ibid. 4 Defence 200: Our Future Defence Force, page 98, para 9.1

Introduction 1 A Profile of the Australian Defence Industry

• changing the way Defence manages its demand, linking individual acquisitions to the sustainability of key industry capabilities within defence industry sectors, • changing Defence’s competition policy arrangements, and • adopting new accountability and transparency measures in support of the two tiered approach to ensure continued value for money outcomes.5 In order to realise this strategic approach, the then Minister for Defence, in his Keynote Address to the Defence and Industry Conference 2002, announced that Defence would work with industry to develop strategic industry sector plans. Defence subsequently released draft plans for: • naval ship-building and repair (released for discussion, pending Government consideration, in September 2002); • defence aerospace (released for public comment, pending submission to Government, in June 2003); • defence electronics (also released for public comment, pending submission to Government, in June 2003).

1.2 The Profile and the Sector Plans

Of the above draft plans, those for aerospace and defence electronics were endorsed by Government in June 2004. The plan for naval shipbuilding and repair (NSR) was overtaken by the rescheduling in the 2004-14 Defence Capability Plan of the air warfare destroyer and amphibious support ship programs by the way forward for the NSR sector announced by the Government in May 2004 (see Section 3.2.3 below). The sector plans contain valuable information about the nature and scale of defence demand. Demand-side information in the sector plans was subsequently updated with release of the current Defence Capability Plan 2004-14. The profile does not duplicate this information. Instead the profile uses it as a point of departure for analysis of industry’s capacity to supply and support specific elements of the future force and to inform action required to align industry capacity with future planning requirements (see Section 3 below). Several defence business policy themes were common to all the published draft sector plans. Of these overarching themes, this study picks up those relating to identifying and managing project risk and managing defence demand to foster defence industry capacity (see Section 4 below).

5 The best public statement of this policy is in the Government’s defence policy statement released for the 2001 election. See www.liberal.org.au for “Strengthening Australia's Defences”, Part 6 ‘A Strategic Defence industry’, page 44.

Introduction 2 A Profile of the Australian Defence Industry

1.3 The Study

The study consists of : • This profile which in turn comprises: – a description of the framework of the profile; – an analysis of activities like exports, access to overseas intellectual property, domestic research and development and training that enable local companies to meet Defence requirements; – an assessment of the capacity of specific industry sectors to supply and support the various elements of defence capability; – synopses of the Defence strategic industry sector plans; and • A separate data base and an associated compact disk containing the data generated in the course of the study and analysing the methodologies underlying the profile. The study used statistical data derived from: • sector level statistics extracted by the Australian Bureau of Statistics for the latest available year (mainly 2001-02); and • export data extracted by Defence from the Customs EXIT data base for the three years to 2001-02; and • the Defence Industry Survey of actual and potential suppliers conducted in January and February 2004. The study also drew heavily on: • broad knowledge of defence industry policy as it relates to defence strategic planning provided by ACIL Tasman; • sector-specific information gained in the course of one-on-one discussions with industry participants; • issue-specific information gained through follow-up discussions with individual respondents to the Defence Industry Survey; and • policy guidance provided by the Defence Science and Technology Organisation and other Defence elements.

1.4 The Profile Structure

The Profile is divided into the following sections: • Section 2, which describes the scale, function, location and operating environment of defence industry; • Section 3, which analyses supply and support by specific industry sectors of particular elements of the current and likely future Defence Force; • Section 4, which summarises defence demand management as the single most important determinant of industry’s capacity to support defence;

Introduction 3 A Profile of the Australian Defence Industry

• Section 5, which analyses exports, access to overseas intellectual property, domestic R&D, risk management and skills development that further enable Australian defence industry to meet defence requirements; and • Section 6, which draws out the main conclusions of the study.

1.5 Framing The Profile

This sub-section: • defines ‘defence industry’; • explains the concept of defence capability shaping the study; and • summarises the processes by which Defence communicates strategic planning requirements to industry.

1.5.1 Defining defence industry

As used in this profile, the term ‘defence industry’ denotes those Australian industries that are actually or potentially involved in supplying Australian Defence Force capability and which are influenced by Defence business policies or purchasing decisions. Implicit in this definition are some important judgements about the ambit of defence industry. This definition includes selected defence-oriented elements of the manufacturing sector (including shipbuilding, aerospace, automotive, chemicals, electrical and electronic equipment, other fabricated metal products and machinery and equipment). The definition excludes from the defence industry profile those industries supplying goods or services which, while perhaps critical to ADF functionality (eg petroleum, oil and lubricants; civil roads, harbours and airports; commercial information technology), are not significantly affected by Defence policy or purchasing. The definition includes, in addition to selected elements of the technical and business services sector, service providers who now provide garrison support and other services under the Defence Commercial Support Program (initiated in the early 1990s).

1.5.2 A Defence capability-based framework

‘Defence capability’ is the focus of the profile. This focus derives from the objective of aligning development of defence industry capacity and defence strategic planning requirements. ‘Defence capability’ is the power to achieve a desired operational effect in a nominated environment (for example land, sea or air) within a specified time and to sustain that effect for a designated period. Defence capability results from developing a force structure appropriately prepared for operations.

Introduction 4 A Profile of the Australian Defence Industry

1.5.3 Defence strategic planning requirements

The strategic planning requirements to which the defence industry profile is aligned are those relating to adjustment of military capability: • in the longer term, via changes in the force structure generated by the defence capability development process; and • in the shorter term, via adjustment of the preparedness of the current force. Accordingly, the aim of the defence industry profile is to inform the development and application of defence industry policy as an adjunct to: • Defence’s long term force structure development; and • Defence’s short term preparedness management.

Supplying defence force structure

The Defence Force Structure denotes the combination of personnel, equipment, facilities and military doctrine required to conduct operations effectively. Force structure is relatively static in the short term but changes over the medium to longer term. The evolution of defence force structure is managed through the defence capability development process6. This process is a key defence planning activity. Ensuring those involved in, and responsible for, defence capability development are appropriately informed about Australian industry’s capacity is a key objective of the study and the profile.

Supporting defence preparedness

Preparedness is the more flexible and dynamic element of defence capability in the short term. In principle, Defence capability derives from linking preparedness to the various components of force structure (which include not only materiel but also people, organisations and facilities). ‘Preparedness’ is a combination of ‘readiness’ and ‘sustainability’. Readiness is the ability of a military force (for example, naval surface combatants) to undertake specified operations within a designated time. The defence industry profile seeks to help decision makers understand Australian industry’s capacity to support the readiness of the Defence force structure by, for example, upgrading the ANZAC frigates’ capacity to defend themselves against anti-ship missiles.

6 The principles and procedures underpinning the defence capability development process are described in detail in the Capability Systems Life Cycle Management Manual 2002, Department of Defence, December 2002.

Introduction 5 A Profile of the Australian Defence Industry

Sustainability is the ability of a capability output to continue conducting operations for a specific period. The defence industry profile is about helping decision makers understand Australian industry’s contribution to the capacity of individual Defence capability outputs to sustain operations through, for example: • supply of specialised stores like ammunition; • provision of services like repair and maintenance; and • provision of services like garrison support which release military personnel for core combat tasks. Defence is developing a detailed preparedness management framework within the context of Defence’s annual outcome/output budget planning process. The framework is intended to enable Defence to advise Government about the state of preparedness of all the ADF’s operating force elements, having regard to strategic guidance and available budget resources. While the framework is still evolving, it has potentially important implications for defence industry policy. As the Australian Strategic Policy Institute (ASPI) has explained: • Navy preparedness is based on the availability of ships and their crew to undertake a mission and is currently measured in terms of Unit Ready Days (URD); • with the exception of Army Aviation, Army preparedness is measured by the availability of trained personnel and equipment for each capability output, qualitative assessments of which are published in the annual defence report; and • Air Force and Army Aviation measure preparedness of individual capability outputs in terms of number of flying hours.7

1.5.4 Communicating Defence strategic planning requirements

Defence procurement processes are based on a capability systems life cycle involving requirements, acquisition, in-service and disposal phases.8 Within this framework, Defence communicates its strategic planning requirements to industry by: • in the requirements phase of the capability life cycle, developing and publishing the rolling Defence Capability Plan and other investment planning documents to implement the military strategy outlined in the Government’s broad strategic guidance;

7 See for example The Cost of Defence: ASPI Defence Budget Brief 2003-04, page 33 8 See Capability Systems Life Cycle Management Manual, op cit, para 1.16.

Introduction 6 A Profile of the Australian Defence Industry

• in the acquisition phase of the capability life cycle, tendering and contracting for supply of platforms and systems that underpin individual capability developments; and • in the in-service support phase of the capability life cycle, promulgating the Chief of the Defence Force’s Preparedness Directive for the ADF as a whole and from which are derived Preparedness Objectives for individual capability outputs specified in the annual Defence budgets (and reported on in the Defence Annual Report). Defence-industry dialogue can best influence defence strategic planning in the pre-competitive/pre-acquisition phase of the capability life cycle. Conversely, defence industry capacity is most directly influenced by the contracts Defence concludes with companies in the acquisition and in-service support phases of the capability life cycle.

The key focus of such pre-competition Defence-industry dialogue is the Defence Capability Development Advisory Forum (CDAF) and associated working groups - see Appendix A. The Profile therefore proposes the CDAF as the primary vehicle for progressing recommendations for improving the alignment of defence industry capacity and defence strategic planning requirements. How the CDAF functions in these terms seems likely to be influenced by the establishment of the Defence–Industry Ministerial Council announced by the Minister Assisting the Minister for Defence on 22 June 2004 (see Section 4.6).

1.6 Shaping the Study

The above Defence capability-based framework determined the thrust of the study. The framework differentiates this study from previous studies of defence major capital equipment projects sponsored by the Australian Industry Group and other stakeholders and which addressed the regional and national economic benefits flowing from such projects.9 The framework also shaped the collection of statistical and other data for the study see Appendix B for an overview of these arrangements.

9 See “Impact of Major Defence Projects: A case study of the ANZAC Ship Project” and “Impact of Major Defence Projects: A case study of the Minehunter Coastal Project” by Tasman Asia Pacific published in respectively, February 2000 and January 2002.

Introduction 7 A Profile of the Australian Defence Industry

2 The Structure and Performance of the Australian Defence Industry

This section analyses the structure and performance of the Australian defence industry in terms of: • Scale; • Function; • Location; and • The Business Environment.

2.1 The Scale of Defence Industry

Defence industry comprises a relatively stable ‘core’ of large, medium and small companies who devote all or part of their capacity to defence or defence- related business on a long term basis. This core is supplemented by a large number of mainly small and medium sized companies who enter or leave the defence market on a contract-by-contract basis. Estimating the size of such a fluid element of the Australian economy poses important methodological challenges. Estimates of the size of the Defence industry used in this study are based on responses to the Defence Industry Survey. The methodology and assumptions used to estimate the size of the defence industry on this basis are explained in Appendix C. Using this methodology, ACIL Tasman estimated that the Australian defence industry employed some 13,000 people and generated some $4.7 billion turnover in 2002-03. Limitations in the survey data mean that this estimate should be treated cautiously and is probably conservative. The largest ten companies in the industry generated a defence-related turnover of over $3 billion. Most of these companies are prime contractors for the supply of defence capital equipment but service providers constitute a large and growing minority (see below). Prime contractors play a key role in marshalling the resources of numerous sub-contractors (an estimated 1300 in the ANZAC ship project alone). Extrapolating the Defence Industry Survey data in order to estimate the number of SMEs permanently involved in the defence industry requires some important assumptions. As indicated in Appendix C, a very conservative estimate of the number of such SMEs is 200-250. State Government officials have suggested that the true number is probably twice that.

The Structure and Performance of the Australian Defence Industry 8 A Profile of the Australian Defence Industry

ACIL Tasman has not attempted to make a definitive estimate of the number of SMEs in the defence industry. Arguably, the more important point is that the size of the defence industry depends on the business in hand and how it is managed. The flexibility of sub-contractors in entering and leaving the Australian defence market helps the defence industry as whole adjust to inevitable shifts in defence expenditure among different defence capabilities; and between short term preparedness and long term force structure development.

2.2 Function of Defence Industry

The Australian manufacturing sector hosts companies responsible for manufacturing the electronic hardware used in Defence information capability. This sector also hosts companies involved in the construction, repair and modification of Navy vessels, Army vehicles, munitions for all three services, and Defence aviation assets. The nature and scale of supply and support by the manufacturing sector for each of these Defence capability groupings is analysed in greater detail in Section 3. Responses to the Defence Industry Survey indicate that manufacturing and construction accounts for just over 50% of all sales by actual and potential suppliers. This probably understates the very substantial value of the services embedded in defence platforms, systems, stores and consumables. Defence is also a major buyer of services in their own right.

2.2.1 The service component of Defence business

Manufacturing remains the predominant activity of the three largest defence suppliers (ADI, Tenix and BAE Systems). All three of these companies include in their defence business portfolio, however, such commercially significant service elements as: • warehousing, maintenance and distribution of explosive ordnance in the case of ADI; • Albury-Wodonga Military Area logistic and garrison support services in the case of Tenix; and • Woomera Support Services, Riverina Garrison Support and the ADF Basic Flying Training School in the case of BAE Systems. Under the Commercial Support Program and related initiatives like the Defence Efficiency Review, Defence has contracted out a broad range of non- combat related services with a view to concentrating military personnel on core combat and combat-related tasks. Non-core activities out-sourced on this basis include, for example:

The Structure and Performance of the Australian Defence Industry 9 A Profile of the Australian Defence Industry

• garrison support for high-readiness units like 1 Brigade in Darwin and 3 Brigade in Townsville; • provision of port services like tugs and lightering required by Australian Navy ships here and abroad; • operation and maintenance of mission-critical facilities like the naval communication facilities at North West Cape, Canberra and Darwin; and • operation of the Australian Defence Force Basic Flying Training School. Consequently, for example, the defence business part of the Spotless Group and SERCO Sodexho Defence Services together employed 5500 people and generated a total turnover of $380 million in providing garrison support for ADF units throughout Australia. In other cases, Defence has retained in- house those services required to enable units to deploy for operations (for example operational level maintenance for aircraft) but now relies on contractors for deeper maintenance. For example, QANTAS Defence Systems employs over 400 people and generated some $137 million turnover in undertaking deeper maintenance of a range of fixed and rotary wing aircraft for the ADF. Defence also relies increasingly on contractors for operation and support of mission-critical command, control and communication services. Boeing Australia, for example, employed some 1500 people and generated a turnover of some $222 million by, among other things, managing and maintaining a network of defence communication stations throughout Australia. Defence is beginning to look to contractors for the provision of a capability rather than a defined number of, say, platforms or systems. For example, in replacing Navy patrol boats, Defence specified the operational outcomes it required in terms of performance (measured in terms of, eg, sea state) and rate of effort (measured in terms of, eg, ship days). The contract to replace the patrol boats was won by a consortium of AUSTAL and Defence Maritime Services who will determine the number and characteristics of the vessels involved and the level of through life support required to generate these operational outcomes.

2.3 The Location of Defence Industry

Participants in the Defence Industry Survey were asked to indicate the location of the business units actually or potentially supplying or supporting Defence. The responses are displayed in Chart 1. These figures should be treated as indicative rather than definitive: Future surveys will need to give greater attention to the state-based composition of the sample.

The Structure and Performance of the Australian Defence Industry 10 A Profile of the Australian Defence Industry

The available data suggests that 26% of defence business units are located in NSW and 17% in Victoria. These states have long hosted defence manufacturing hubs, in many cases focused on what were once government- owned dockyards and factories. Firms locating close to military customers kept at high levels of readiness account for many of 20% of total defence business units located in QLD and nearly all the 3% of such units located in NT. The 5% of defence business units located in the ACT are mainly there to market to the Defence Materiel Organisation but the ACT also hosts some specialised electronics firms. South Australia accounts for 9% of all defence business units, many of whom are relatively small electronics firms clustering around DSTO’s Electronic Surveillance and Research Laboratory (ESRL) located near Adelaide. The home porting of Navy ships in WA sustains most of the 9% of defence industry units located there while the 1% of such units located in Tasmania includes niche suppliers of products like specialised marine buoys.

Chart 1 Location of Defence business units

Defence Business Unit Distribution, 2003

Western Australia ACT

New South Wales

Victoria Northern Territory

Overseas Tasmania South Australia Queensland

Data source: Defence Industry survey

What is now DSTO’s Electronics and Surveillance Research Laboratory (ESRL) near Adelaide dates from support for rocket programs conducted at the Woomera Rocket range in the 1950s. This relatively large concentration of electronics expertise, the tendency of knowledge intensive industries to cluster and to be less scale intensive than manufacturing accounts for the disproportionately large number of relatively small scale defence electronics suppliers in South Australia. Hence, for example, Daronmont Technologies is based in Melbourne but has chosen to locate its engineering office near ESRL in order to facilitate liaison with ESRL personnel involved in surface wave radar development.

The Structure and Performance of the Australian Defence Industry 11 A Profile of the Australian Defence Industry

The location of defence industry will also be affected by the balance Defence strikes between, on one hand, seeking to reduce overheads through centralised support arrangements and, on the other hand, seeking to improve preparedness by encouraging support providers to co-locate close to their customers. The choices Defence makes could affect, for example, the quality of NT-industry support for 1 Brigade in Darwin and the viability of the Bandiana workshops in the Albury-Wodonga military area.

2.4 The Defence Business Environment

The profile addresses the defence business environment in terms of: • Profitability of defence and defence-related business; • Sources of finance; • Defence business constraints; • Government programs; and • The outlook for Defence business.

2.4.1 The profitability of the defence industry

To help gauge the health of the defence industry, Defence Industry Survey respondents were asked about the profitability of their business (both defence and non-defence) in the three years 2000-2003. Over 80% of survey respondents indicated they generated a profit in their total overall business in each of the three years to 2002-03 – see Table 1.

Table 1 Defence business profitability

Year Total Loss Broke Even Profit

2000-01 104 11 10 83 2001-02 105 11 12 82 2002-03 106 12 10 84 Source: Defence Industry Survey

These results need to be interpreted cautiously: • A large proportion of the larger, overseas owned prime contractors declined to answer questions about their profitability. • One-on-one discussions indicate that several of these companies have incurred losses over the last three years (see below). • The figures for companies indicating a loss in Table 1 exclude these and other non-respondents. This suggests that the survey-based data about profitability is biased toward locally owned SMEs (who were much less inhibited in responding to this aspect of the survey). .

The Structure and Performance of the Australian Defence Industry 12 A Profile of the Australian Defence Industry

Recognising the above qualifications, the Defence Industry Survey suggests that, following the hiatus in Defence business leading up to publication of the Defence White Paper in December 200010, Defence suppliers have begun returning to profitability. (see Table 2). Of those that indicated a profit overall, some 63% indicated an operating profit margin in the 0-9% range in each of the three years to 2002-03. The balance indicated a profit margin over 10% in each of the same three years.

Table 2 Defence industry profit margins

Year Total Made Broke Made a Profit (Margin) Respondents Loss Even 1-3% 4-6% 7-9% 10%+

2000-01 104 11 10 24 11 20 28 2001-02 105 11 12 15 15 24 28 2002-03 106 12 10 17 16 20 31 Data source: Defence Industry Survey

Care is needed in comparing levels of profitability indicated by respondents to the Defence Industry Survey and overall industry profits estimated by the ABS using tax-based data. The above profitability levels are broadly consistent with the 3.7% operating profit recorded by the machinery and equipment manufacturing sector overall (see Figure 1) and the 5.7% recorded by the relevant service industry sectors (see Figure 2).

Figure 1 Manufacturing sector performance (Operating Profit Margin)

Telecommunication, broadcasting and transceiving equipment mfg

Professional and scientific equipment mfg n.e.c.

Photographic and optical good mfg

Aircraft mfg

Shipbuilding

Automotive component mfg n.e.c.

Motor vehicle body mfg

Motor vehicle mfg

Electronic equipment mfg

Photographic and scientific equipment mfg

Other transport equipment mfg

Motor vehicle and part mfg

Machinery and equipment mfg

024681012 %

Data source: ABS Special data service

10 This hiatus was analysed in detail in the draft Defence Electronic Sector Plan: See Section 3.4: Scheduling of capital acquisition projects, pages 19-23.

The Structure and Performance of the Australian Defence Industry 13 A Profile of the Australian Defence Industry

Figure 2 Services sector performance (Operating Profit Margin)

Business Management Services Computer Consultancy Services Computer Maintenance Services Information Storage and Retrieval Services Technical Services n.e.c. Consulting Engineering Services Surveying Services

02468101214 %

Data source: ABS special data service

Twelve firms account for 80% of Defence expenditure on military systems integration in Australia.11 In order to gauge the extent of any bias in the above analysis of defence industry survey data, this study took advantage of the fact that these 12 major defence electronics suppliers also participated in the defence industry survey. In the course of developing the Defence Electronic Sector Plan, these firms were asked about their rate of return on capital or on assets employed as an indication of their profitability. Of the seven major defence electronics suppliers that agreed to provide this information, only two indicated returns that exceeded their cost of capital.

Profit on defence sales

In order to gauge the health of the defence industry, participants in the Defence Industry Survey were also asked to indicate the profitability of the business conducted either with Defence or with Defence prime contractors over the last three years. Of those respondents doing defence business, some 77% indicated they made a profit in doing so. Of these, the proportion of defence service providers generating a profit of 10% or more was much higher than the proportion of defence manufacturers who generated this level of profit (see Table 3).

11 Defence Electronics Systems Sector Strategic Plan”, Defence Materiel Organisation, February 2004, pages 38-39.

The Structure and Performance of the Australian Defence Industry 14 A Profile of the Australian Defence Industry

Table 3 Survey respondent profitability by industry

Business Total 0-3% 4-6% 7-9% 10%+

Computing services 4 2 2 Engineering services 3 1 2 Integration 9 2 1 4 2 Maintenance 33 5 8 5 15 Manufacturing 1 1 Other support services 13 2 2 4 5 Platforms 9 1 2 4 2 Spares 29 5 9 15 Systems 23 2 5 6 10 Technical services n.e.c. 6 2 2 2 Data source: Defence Industry survey

Looking ahead, 76% of Defence Industry Survey respondents expected general business opportunities to increase over the next three years while 63% expected defence business opportunities to do so.

Losses on defence business

The circumstances of the 10-11% of Defence Industry Survey respondents who indicated a loss over the last three years is an important indicator of the health of the defence industry. Closer examination of this data did not, however, reveal any particular trends in terms of size of company or category of defence business. One-on-one discussions tend to corroborate the conclusion in the Defence Electronic Sector Plan that there is considerable variation in profitability across Defence projects with the larger, more complex projects accounting for the majority of losses incurred.12 This issue is discussed in more detail in Section 3.1.4.

2.4.2 Sources of finance

Defence Industry Survey participants were asked to indicate the importance of various sources of finance for their total business (both defence and non- defence). The responses are summarised in Table 4. The overwhelming majority of respondents are self-financed, with nearly half the sample relying on owner contributions and over 68% relying on retained profit. Banks are the next most important source of finance while seven respondents (equivalent to 6% of the sample) relied on the sale of equity.

12 Ibid, page 39

The Structure and Performance of the Australian Defence Industry 15 A Profile of the Australian Defence Industry

Table 4 Sources of finance and their importance

Finance Source Critical High Moderate Low/Minor Nil

Owner contribution 26 10 13 3 2 Retained profit 32 29 12 6 Equity sale 3 4 3 3 3 Parent company funding 11 9 7 2 3 Bank loan 18 16 18 8 1 Other debt finance 5 6 6 7 1 Venture capital 3 2 Equipment leases 1 Customer prepayments 1 Loan from related entity 1 Other – unspecified 1 Data source: Defence Industry Survey

Venture capitalists invest in high risk companies offering prospects of commensurately high returns – either from ultimate listing of the company concerned or from sale of the technology concerned: Only three respondents (equivalent to 2.7% of the sample) relied on the venture capital market.

2.4.3 Defence business constraints

Defence Industry Survey participants were asked to indicate the importance of various constraints on, or disincentives to, doing defence business including: • the cost of tendering; • the availability of finance ; • the availability of insurance; and • the availability of people with suitable skills. The responses to questions about tendering, finance and insurance are set out in Table 5.

The Structure and Performance of the Australian Defence Industry 16 A Profile of the Australian Defence Industry

Table 5 Defence business impediments

Defence Barrier Total Critical High Moderate Minor Nil

Tendering 90 3 30 32 22 3 Financing 81 7 14 23 36 1 Insuring 76 7 23 15 28 3 Lack of contacts 1 1 Contractors 1 1 Quality accreditation 3 1 2 Security clearance 1 1

Respondent Supplied Responses Complexity 1 1 Opportunity cost of cancelled 1 1 programs International travel to visit the o/s 1 1 primes Cost of finding defence contracts 1 1 Other – Filling forms 1 1 Delayed decisions 1 1 Other – Relationship management 1 1 Other – unspecified 1 1 Other – establishing network 1 1 Data source: Defence Industry Survey

Cost of tendering

Overall, nearly 37% of Defence Industry Survey respondents regarded the cost of tendering as either highly important or critical constraint on doing defence business. The distribution of respondents holding this view is skewed markedly toward SMEs. Defence industry has long been concerned about the cost of defence tendering. The then Industry Commission analysed the cost of defence tendering in its 1994 report on Defence Procurement13. In that report, the Commission quoted a 1993 survey indicating that: • tendering for purchases of around $1 million costs firms 2-5%, tapering to 1-3% for major acquisitions; • below the $1million figure, tendering costs grew disproportionately, to around 10% for projects worth around $10,000.14 This tended to be corroborated in analysis of the cost of tendering as a proportion of project value undertaken by ACIL Tasman in 2002 for the Defence Electronic Systems Sector Plan. ACIL Tasman conducted a small survey of military system integration firms for that Plan. This survey suggested that successful tenderers incurred costs equivalent to 4.5% of the cost of

13 Report No 41 “Defence Procurement”, Industry Commission, August 1994, Chapter 7 14 Ibid, page 92.

The Structure and Performance of the Australian Defence Industry 17 A Profile of the Australian Defence Industry

projects costing less than $10 million15. This point is analysed further in Section 4.3.3.

The availability of insurance

As Table 5 indicates, well over one third of Defence Industry Survey respondents stated that the cost and even the availability of professional indemnity insurance was a major constraint on their willingness or ability to do defence business. A disproportionately large number of SMEs made this point. This issue is analysed in greater detail in Section 4.3.3.

The availability of skilled people

Defence Industry Survey participants were asked to indicate the extent to which their business had been constrained by shortages of skilled personnel. The responses are summarised in Table 6.

Table 6 Skill shortages

Occupational Group Total Critical High Moderate Low Nil

Senior manager 62 2 9 14 9 28 Professional 72 3 12 27 11 19 Associate professionals 62 1 6 23 11 21 Trades 69 16 13 17 4 19 Data source: Defence Industry Survey

Of the respondents answering this question, 40% had been significantly16 constrained by a shortage of senior managers, 58% by a shortage of professional staff, 48% by a shortage of associate professional staff, and 67% had been significantly constrained by a shortage of tradespeople. Defence industry is probably not alone in the Australian economy in facing skill shortages of this magnitude. As this is a major defence policy issue, however, possible responses to this constraint on doing defence business are canvassed in Section 5.4 below.

2.4.4 Role of government industry programs

Survey participants were asked to rank the importance to their overall (defence and non-defence) business of Commonwealth and state government programs for assisting industry. Their responses are summarised in Table 7.

15 Defence Electronic Systems Sector Plan: op cit page 32 16 “significantly” subsumes “critical”, “high” or “moderate” distinctions in answers to the survey question.

The Structure and Performance of the Australian Defence Industry 18 A Profile of the Australian Defence Industry

Table 7 Importance of industry assistance programs

Industry Support Program Total Critical High Moderate Low/Minor

R & D concession 39 2 19 9 9 Export assistance 23 8 7 8 Preferential purchasing 10 2 2 6 Industry extension 16 3 6 7 Concessional rates/utilities 11 1 5 5

Respondent Supplied Responses Exhibition display subsidies 2 2 R & D grant 2 1 1 Ship building bounty 1 1 Ausindustry/Tradex 1 1 Data source: Defence Industry Survey

Of those respondents indicating that they benefited from such programs, the great majority (over 75%) nominated Commonwealth R&D concessions as being significant, followed by export assistance (67%), and state-based industry extension programs (57%). Within the limits of what is a small sample of companies answering this question, the responses suggest a high take up of government assistance and a commensurately high level of influence by governments on the defence business environment.

The Structure and Performance of the Australian Defence Industry 19 A Profile of the Australian Defence Industry

3 Supply and Support of Defence Capability

As indicated in Section 1, the defence industry profile is intended to help align industry capacity with adjustment of military capability via: • adjustment of the preparedness of the current force in the short to medium term; and • changes in the force structure generated by the defence capability development process in the medium to long term. To this end, Australian industry’s capacity to supply and support the current force and, by extension, the future force is analysed in this section of the report. The analysis is based on associating defence capability outputs with the industries that host the companies supplying and supporting them as follows: • Defence information capability (see below); • Naval ships, boats and submarines; • Army land-based manoeuvre; • Defence munitions (comprising supply and support of munitions for navy, army and air force capability outcomes); and • Defence aviation (comprising navy aviation, army aviation and selected air capability outputs). The above industry categories align closely with the industry categories used in the annual Defence Capability Plan (DCP). This study makes a clearer distinction, however, between supply of defence force structure and support of defence preparedness. To this end the analysis focuses on: • the capability outputs involved; • the associated industry base, comprising: – the host industry sector; – the defence industry element of that sector; • industry capacity to supply and support: – the current force; – the future force; and • issues for Defence and for defence industry. In accordance with the definition of defence industry used in this profile, the above industry categories exclude, for example, the footwear, clothing and

Supply and Support of Defence Capability 20 A Profile of the Australian Defence Industry

medical stores procured under the Army minors program.17 Nor do they include the industries that supply and support a large number of diverse items which, like Army gap crossing equipment, are supplied and supported by the general manufacturing industry base.

3.1 Supply and Support of Defence Information Capability

The Defence White Paper noted that “Effective use of information is at the heart of Australia’s defence capability”18 and focussed on information capabilities as a separate capability grouping. The term ‘network-enabled operations’ denotes the application of information capability to warfare. The Defence Capability Plan 2004-14 reflects Defence investment in the transition from ‘platform-centric’ operations to ‘network-enabled operations’ - see Box 1

Box 1 Network Enabled Operations

“Network-Enabled Operations derive their power from effectively linking different elements of the organisation to conduct warfare more effectively. Network-Enabled Operations treat platforms as ‘nodes’ of a network. Since all elements of the network are securely connected, they can collect, share, and access information. This shared information is used to create a common, real time battlespace ‘picture’ across all components and all Services, which in turn allows a greater level of situational awareness, coordination, and offensive potential than is currently the case”19

The ADF’s current information capability is primarily ‘platform-centric’ but with some elements required for network–enabled operations. It comprises: • the embedded systems that define the functionality of all ADF platforms; • stand alone information capability systems, including: – capabilities for intelligence; – tactical, operational and strategic communication capabilities;

17 This is, nevertheless, substantial business: See Defence Forward Procurement Plans for Minor Capital Equipment 2003-2008, Defence, June 2003 18 Defence 2000: op cit page 94 para 8.78 19 Force 2020, Chief of the Defence Force, Canberra, 2002, page 19

Supply and Support of Defence Capability 21 A Profile of the Australian Defence Industry

– information warfare; – command and headquarters systems; and • logistics management and business information systems. The electronic systems underpinning Defence information capability, whether embedded or stand alone, generally operates defence-specific software. Supply and support of defence-specific software often entails levels of skill and degrees of process sophistication not normally found in commercial applications of information technology. By contrast, Defence uses logistics management and business information systems that are adapted directly from commercial products.20 Against this background, the following section analyses: • the characteristics of the national electronics industry base that hosts the companies supplying and supporting defence information capability; • the capacity of that base and more specialised companies to supply and support current defence information capability; and • the likely capacity of that base to supply and support future development of defence information capability outlined in the Defence Capability Plan 2004-14.

3.1.1 The national electronics industry base

The following description of the national electronics industry base focuses on those elements that manufacture hardware and develop software.

Electronics hardware

The local companies responsible for supply and support of electronics hardware are concentrated in: • ANZSIC Group 283 (Photographic and scientific equipment manufacturing) and • ANZSIC Group 284(Electronic equipment manufacturing). In 2000-01, manufacture of photographic and scientific equipment sustained 1421 management units (98.7% employed less than 100 persons each), employed some 14,570 people and generated $2.8 billion income. Manufacturers in ANZSIC 283 earned an operating profit margin of 10.7% in 2000-01. This compares to the 3.7% margin generated by machinery and equipment manufacturing overall.

20 This description is based on Defence 2000 page 95 paras 8.84-8.87.

Supply and Support of Defence Capability 22 A Profile of the Australian Defence Industry

In 2000-01, manufacture of electronic equipment sustained 805 management units (95.5% of which employed less than 100 persons each), employed 22134 people and generated an income of $5.3 billion. Those 36 electronic equipment manufacturers each employing 100 or more people generated 72% of total ANZSIC 284 income. Profits generated by electronic equipment manufacture are relatively modest – in 2000-01 the overall operating profit margin for ANZSIC 284 was 5.9%, close to the 3.7% achieved by machinery and equipment manufacturing overall. Australia as a whole is a large net importer of goods incorporating information and communication technology. The Department of Communication, Information Technology and the Arts estimates that the nation’s deficit on trade in ICT goods was running at some $10 billion in 2001-02. Defence is, similarly, a large importer of electronic products (many of which come embedded in imported platforms like aircraft). Within these limits, however, in 2000-01, exports of ICT hardware accounted for about 4.3% of the sector’s total income. This result included impressive performance in niche areas, driven in part by spin-off from Defence-related development and production (see below).

3.1.2 Electronics software and systems integration

The services generated by the companies embedded in ANZSIC Group 783 (computer services) are fundamental to Defence information capability. ANZSIC Group 783 comprises: • ANZSIC class 7831 (data processing services), which includes such basic functions as data entry, processing and tabulating services; • ANZSIC class 7832 (information storage and retrieval services), which includes non-library information storage and retrieval services; • ANZSIC 7833 (computer maintenance services), which includes the maintenance and repair of computer hardware; and • ANZSIC 7834 (computer consultancy services), which includes computer systems analysis, computer programming and specialised software production. Of these, ANZSIC classes 7833 and 7834 are of most direct importance to the supply and support of defence information capability. In 2000-01, computer maintenance services (ANZSIC 7833) generated $1.2 billion worth of operating income with a profit margin of 5% (compared to, say, the 6% profit margin recorded by consulting engineering services). In the same year, by contrast, computer consultancy services (ANZSIC 7834) generated over $15 billion worth of operating income with a relatively modest

Supply and Support of Defence Capability 23 A Profile of the Australian Defence Industry

profit margin of 3%. This was only slightly higher than the 2% profit margin recorded by firms providing information storage and retrieval services and less than the 5% recorded by firms in the computer maintenance business. Taken together, the computer services of most direct relevance to Defence generated an income of over $16 billion in 2000-01. This dwarfs Defence’s peak annual expenditure of $2.5 billion on electronic systems expected later this decade21.

Innovation in the national electronics industry base

In 2000-01 national expenditure on R&D in information, computing and communication sciences was a relatively modest $1.6 billion, of which: • nearly 80% was generated by business; • 11.4% was generated by the Commonwealth; • 7% was generated by higher education; and • 1.8% was generated by the state/territory governments. The Government has responded to concern about the adequacy of this level of R&D expenditure with a series of initiatives. These initiatives are analysed in greater detail in Section 5.3: Defence Industry Enablers - Research, Development and Innovation.

3.1.3 Supply and support of current defence information capability

The above national electronics industry base hosts numerous companies that supply and support a spectrum of current defence information capability requirements. This spectrum includes: • business management and logistic information systems similar or identical to those systems in commercial use; • design and manufacture of electronic products (for example sonars) specialised for military applications; • integrating specialised military electronics products into major operational systems (for example, a ship’s combat system, an air defence system or an area surveillance system); and • increasingly, linking the above operational systems on a theatre-wide basis.

Logistic and business systems for the current force

Defence takes advantage of the rapid uptake of information technology in the wider Australian economy by adapting commercial information systems to

21 See DCP 2004-14, page 8

Supply and Support of Defence Capability 24 A Profile of the Australian Defence Industry

meet defence requirements for more efficient and effective logistic support. For example, as part of its Supply System Redevelopment Project, Defence engaged MINCOM to adapt for defence logistic management purposes software the company had developed to facilitate management of mining and similar asset intensive businesses. Sale of the MINCOM software to Defence helped the company to sell a similar product and associated services to the Canadian Defence organisation, in turn encouraging the company to invest in further development of the product.

Supply and support of electronics hardware for the current force

For a broad range of electronic products, the ADF’s requirements are essentially the same as those of Australia’s friends and allies. Such electronic products – designated “military-off-the-shelf” – are traded relatively freely within the limits of strategic trade controls. Australian industry has limited presence in the MOTS market. The importance of Australian access to this category of products developed overseas is discussed below in Section 5.2: Access to Overseas Intellectual Property. In specific areas, however, Australian Defence demand has supported the development of niche technologies in Australian industry. A key feature of such development has been initial technology development by DSTO, licensing of the technology so developed to industry, after which industry assumes responsibility for production and marketing. Niche technologies supplied and supported by Australian industry on this basis include: • electronic warfare systems, for example – the NULKA active missile decoy system (developed by DSTO in collaboration with the US Navy, produced by what is now BAE Systems in partnership with the US company SIPPICAN, and in service with the Australian, US and Canadian navies); – the Starlight computer network security system (developed by DSTO, licensed to Tenix Defence, with over 4500 units in service with Commonwealth agencies as well as in Canada, the US, the UK and New Zealand). • mobile military communications; • niche capabilities in radar, for example such over-the-horizon radar technologies as: – sky wave radar developed by DSTO and licensed to Lockheed Martin Australia and Tenix; and – surface wave radar being developed by DSTO and Daronmont;

Supply and Support of Defence Capability 25 A Profile of the Australian Defence Industry

• underwater acoustic technologies, including sensors and communications, supplied by, among others, Thales Underwater Systems; and • innovative solutions to particular Australian requirements, for example: – accurate maritime survey data (Laser Airborne Depth Sounder developed by DSTO and Tenix LADS Corporation); and – mine countermeasures (Australian minesweeping system developed by DSTO and ADI Ltd). The capacity of Australian companies to supply and support niche solutions to specific Australian requirements along the above lines is underpinned by substantial public sector research – mainly that of the Defence Science and Technology Organisation. This Defence R&D base is analysed in greater detail in Section 5.3.1: Defence R&D in Australian Industry.

System Integration for the current force

Commercial arrangements for the integration of electronics systems for the current force demonstrate the importance to Defence of local industry’s ability to synthesise both local and overseas technology in meeting defence requirements. According to the Defence Electronics Systems Sector Plan, some 12 companies account for 80% of Defence’s expenditure on electronic systems integration and, hence, comprise the core Australian-based capacity to integrate military systems at the secondary level. These large firms are supported by some 30 smaller firms.22 Of these major firms, three are Australian owned, about eight are subsidiaries of US firms and the balance are owned by West-European firms. The implications of this pattern of ownership for Australia’s access to overseas, particularly US information and communication technology is analysed in greater detail in Section 5.2.1: Access to US Intellectual Property. Taken overall, the above companies have demonstrated a variable capacity to meet Defence demand for systems integration. On one hand, the companies have demonstrated a capacity to undertake systems-intensive projects like the ANZAC ships and Minehunter Coastal Projects successfully. In addition, the difficulties encountered by industry in developing combat system for the COLLINS Class have eclipsed Australian industry’s achievements in developing the complex, mission critical vessel operating system.

22 See Defence Electronic Systems Sector Plan, op cit page 35.

Supply and Support of Defence Capability 26 A Profile of the Australian Defence Industry

On the other hand, the companies – or their overseas parents – have had well publicised difficulty in undertaking the system integration involved in, for example: • High Frequency Modernisation (JP2043) • Jindalee Operational Radar Network (JP 2025); and • Upgrade of P-3C Orion Maritime Patrol Aircraft (Air 5276). The profitability of Australian-based systems integrators was analysed in Section 2.4.1: The Profitability of Defence Industry. The pattern of R&D by defence electronics and other elements of the defence industry are analysed in greater detail in Section 5.3.3: Defence R&D and the National R&D Base. Overall, the record of supplying existing systems, the profitability of current suppliers and the nature and scale of investment in systems-related knowledge suggests that meeting current defence requirements defines the outer envelope of the capacity the existing systems integration industry. At issue is the incentive for local system integrators to invest in the skills, processes and tools required to meet future defence requirements in this key area.

3.1.4 Supply and support of the future force

According to the Defence Capability Plan 2004-2014, annual expenditure on future stand-alone information capability projects will peak at some $700 million by 2009-10. This annual expenditure will be driven by such projects as, for example: • Military satellite communications (JP2008) $480m-$650m • ADF joint command support (JP 2030) $200m-$300m • Defence wide area communications (JP2047) $250m-$350m • Land battlespace communication system (JP2072) $550m-$700m • Maritime command/information management (Sea 1442) $280m-$400m The Defence Capability Plan 2004-14 also estimates the amount of electronic systems work embedded in major maritime, land and air projects. If this estimate of the cost of future embedded systems is added to the above estimate of the cost of future stand-alone systems, Defence’s total annual expenditure on electronic systems will peak at some $2.5 billion in 2011-12. This annual expenditure on electronics will be driven by, in addition to the stand-alone projects already mentioned, such system intensive projects as:

Supply and Support of Defence Capability 27 A Profile of the Australian Defence Industry

• P3-C Orion enhancements (Air 5276) $365m-$520m • New aerospace combat capability (Air 6000) $11500m-$15500m • Soldier combat system (Land 125) $$740m-$1020m • Collins class improvements (Sea 1439) $600m-$$800m • Air warfare destroyer (Sea 4000) $4500m-$6000m • The amphibious support ships 23. $700m-$900m

Responding to the Defence electronics challenge

The nature and scale of the skills, processes and tools required to undertake these tasks constitute a substantial increment above those required to supply and support the ADF’s current information capability. Adhering to a ‘business as usual’ approach is most unlikely to secure the requisite increment of industry capability in the time frame stipulated in the Defence Capability Plan.

Mandatory Industry Capability Tests

Developing the capacity of Australian industry to participate successfully in systems integration of this nature and on this scale would require concerted effort by both policy and commercial stakeholders. In an important chapter entitled “Lifting the capability bar”,24 the Defence Electronics Sector Plan canvassed, as one such initiative, the idea of mandatory industry capability tests based on application of the Capability Maturity Model Integrated (CMMI). The above analysis reaffirms the merits of such tests, subject to some qualifications discussed below.

Sufficient continuity of work

In one-on-one consultations in the course of this study, Industry representatives stressed that industry capability tests like CMMI were no substitute for actual experience. They also indicated that, without corresponding adjustments to the way Defence does electronic business, imposition of mandatory electronic industry capability tests along the above lines will lead to CMMI “box ticking”. Companies need an enduring incentive to embed such skills, processes and tools in their business. Industry stressed such incentives will require sufficient continuity of work and imply a degree of specialisation to sustain the business case.

23 These ships will have a major command, control, communications and intelligence function 24 Defence Electronic Systems Sector Plan, op cit page 69-71.

Supply and Support of Defence Capability 28 A Profile of the Australian Defence Industry

In response to similar concerns, the Defence Electronic Industry Sector Plan recommended linking, within a competitive business framework, projects into strategic work packages where they: • derive from common core technologies; • are applied in a common operating environment or as a common operating system across multiple platform types or environments; • will benefit from specialisation and learning-by-doing; and • can be expected to find a natural fit with industry if tendered as a package.25 This issue is analysed in greater detail in Section 4.5.

3.2 Supply and Support of Navy Ships, Boats and Submarines

Supply and support of navy aviation and navy munitions are discussed in subsequent sections of the profile. This sub-section of the profile focuses on supply and support of: • major surface combatant operations; • patrol boat operations; • submarine operations; • afloat support; • mine warfare operations; • amphibious lift operations; • hydrographic/oceanographic operations. The above capabilities involve an inventory of over 50 major ships26 all of which were built or refitted in Australia in a 15 year surge of naval construction activity involving 5 different companies in 5 different locations.

3.2.1 The shipbuilding and repair industry base

The companies that supply and support the above navy capability outputs are embedded in that segment of the Australian shipbuilding sector concentrating on construction of vessels over 50 tonnes (ANZSIC 2821). In 2000-01, according to the ABS, the 108 business in this sector employed over 6000 people and generated over $1.4 billion worth of income. Ownership of

25 Ibid, page 87 26 The current Navy output structure and associated platforms are described in Defence Portfolio Budget Statements 2003-04, pages 61-70

Supply and Support of Defence Capability 29 A Profile of the Australian Defence Industry

shipbuilding is relatively concentrated, with the nine shipbuilders that employ over 200 people accounting for some 87% of the sector’s income.

Naval ship building and repair

Naval shipbuilding and repair dominates this industry sector: Of these nine companies, the three involved in supply and support of surface combatants, mine warfare vessels and submarines (ADI, ASC and Tenix) employed, between them, some 56% of the ship building sector’s total workforce. In addition, the two companies involved in repair/refit of, respectively, the amphibious ships (Forgacs) and the hydrographic ships (NQEA) employed, in total, a further 15% of the sector’s total workforce.

Ferries and, to a lesser extent, patrol boats dominate Australia’s maritime exports – mostly to South East Asia. While such exports reduce the exposure of Australian shipbuilders to cyclical variations in Australian defence demand, they are lumpy and correspondingly volatile: After reaching $321.9 million in 1999-00, they fell to $8.8 million the next year, rising to $83.9 million in 2001- 02. This was equivalent to 6% of total income of the shipbuilding sector in that year. Despite this overall volatility, exports have fostered new entrants to the Australian naval shipbuilding market. For example: • in 2000, following the ADF’s highly successful use of an INCAT catamaran ferry to support UN operations in East Timor, the US Navy and US Marine Corps leased high speed aluminium ferries from both AUSTAL and INCAT for test and evaluation as fast logistic support ships; • in 2003 AUSTAL Ships drew on its experience in designing and building high speed aluminium ferries and patrol boats for the export market to win a $350m-$450m contract to replace the Navy’s ageing Fremantle class patrol boats; • in 2004, the US Navy selected an AUSTAL-designed aluminium trimaran derived from a fast ferry being built by AUSTAL as one of two shortlisted candidates for its littoral combat ship program (which entails building 60 vessels over 15 years at an estimated cost of $US14 billion).

3.2.2 Supply and support of maritime capability

This sub-section analyses industry’s role in: • supplying the present inventory of naval ships; • supporting the preparedness of the present navy.

Supply and Support of Defence Capability 30 A Profile of the Australian Defence Industry

Supplying the present force

In the present inventory, the surface combatants, submarines, mine warfare and oceanographic ships were all built to overseas designs which were adapted here to suit Australian circumstances. This can entail substantial innovation: In 2001-02, Australia spent nearly $27 million on research and development in maritime engineering. Of this total, some $7.6 million (28%) was for defence purposes.

This represented nearly 3% of Australia’s total expenditure on defence-related R&D in that year and was incurred by primarily business, followed by the universities. Such local R&D was vital in, for example, developing the anechoic tiles optimised for the COLLINS class submarines and their operating environment.

Over last 15 years, and with the limited exception of the ANZAC ships (see below), Australia has not exported any naval combatants. This suggests that, while reliance on overseas IP does not of itself preclude exports, the need to pay royalties and to negotiate marketing rights erodes the international competitiveness of Australian builders. The upshot has been that, with the exception of the ANZAC ship program discussed below, Australian naval combatant builders have been confined to the local defence market. Australia has had only limited success in offsetting the volatility of local demand by emulating the European practice of international collaboration in the construction of naval combatants. Tenix built the ANZAC ships to meet joint Australia and New Zealand requirements but Australian attempts to initiate analogous programs with Malaysia (offshore patrol combatants) and Thailand (mine hunter vessels) were unsuccessful. Local construction of larger overseas designed vessels is a major commercial undertaking with substantial implications for regional economic activity. For example, the ANZAC ship project is estimated to have involved over 1300 companies (over 90% of which were SMEs) in Australia and New Zealand. Companies in Victoria (where the ships were assembled) received over 75% of the value of Australian subcontracts.27 Australia has employed both overseas and local companies to supply, integrate and upgrade the electronics systems that define the functionality of naval combatants. Overseas companies supplied the COLLINS class combat system. On the other hand, for example, SAAB Australia adapted Scandinavian technology for the ANZAC ship combat data system. Similarly, ADI supplies and supports:

27 “Impact of Major Defence Projects: A Case Study of the ANZAC Ship Project”, February 2000, Tasman Asia Pacific Pty Ltd, page vi.

Supply and Support of Defence Capability 31 A Profile of the Australian Defence Industry

• the ship operating system by which the COLLINS Class is managed (as distinct from the combat system which integrates and controls the COLLINS class weapons and sensors – see below) • the Australian Distributed Architecture Combat System (ADACS) which is at the heart of the FFG upgrade project (see Box 2).

Box 2 Guided Missile Frigate Progressive Upgrade

Project SEA 1390 aims to restore the military competitiveness of the Navy’s guided missile frigates through upgrade of their air defence, anti-submarine and anti-surface warfare capabilities. At the heart of the upgrade is the Australian Distributed Architecture Combat System (ADACS). Systems already tested and integrated with ADACS include the electronics surveillance system, automatic radar detection and tracking system, underwater warfare system and on-board training system.

Supporting the current force

Australian companies that build ships for Navy are then better placed to keep those ships ready for operations. Hence, for example, after building the German-designed ANZAC ships, a Tenix-SAAB consortium is now upgrading their anti-ship missile defence and other capabilities at an estimated cost of $174 million. Similarly, after building the Swedish designed COLLINS Class submarines the Australian Submarine Corporation has been awarded a contract to improve (with the support of the US-based General Dynamics/Electric Boat Corporation) the submarines’ reliability and sustainability and to repair and maintain them for the next 25 years. Responsive support by local companies located close to the home ports of the ships they serve helps Navy force element commanders meet the levels of preparedness specified by the Chief of Navy28. Defence spends some $100 million per year maintaining surface ships and submarines home ported at Fleet Base East (NSW), Fleet Base West (WA) and elsewhere. In addition to repair and maintenance, however, industry provides a range of other services that enable Navy to operate more cost-effectively. For example, under Navy’s Port Services and Support Craft contract, Defence Maritime Services provides tug and mooring services, target towing, deep sea range

28 Navy preparedness is specified by the Chief of the Defence Force (CDF) in a preparedness directive to, and an associated organisational performance agreement with, the Chief of Navy. The latter in turn negotiates with Navy output managers output-specific Directed Levels of Capability which are reflected in performance targets published in pages 61-70 of the 2003-04 Defence Portfolio Budget Statements.

Supply and Support of Defence Capability 32 A Profile of the Australian Defence Industry

support, integrated logistic support management and planning (including provision of spares, fuel and consumables), explosive stores transfer and waste management (including oil spill containment). DMS will also organise local support for the Armidale Class patrol boats which will be home ported at Darwin and Cairns and which make extensive use of commercial-off-the-shelf equipment like diesel engines and radars.

3.2.3 Supply and support of the future force

According to the 2004 Defence Capability Plan, the Government will look to the local shipbuilding industry for supply and support of some $8billion worth of air warfare destroyers, amphibious support ships, and underway replenishment ships over the next 10-15 years. While this is a large, technologically diverse program by Australian standards, it is smaller than the construction program that drove the previous naval ship building cycle. Within these limits, however, the program is likely to drive another surge in naval ship building activity focussed primarily on construction of: • the three overseas designed air warfare destroyers built to naval standards at an estimated project cost of $4.5billion-$6billion; • the two overseas designed amphibious support ships built largely to commercial classification standards at an estimated project cost of $1.5billion-$2billion. Expenditure on the air warfare destroyers and amphibious support ships is likely to be compressed into a shorter time frame and to peak more sharply than occurred in the previous cycle. There are three main issues: • access to the intellectual property, including designs, needed to maximise local in-service support; • industry capacity to handle the systems integration task; and • the availability of skills in the compressed timeframe involved.

Intellectual Property

The Commonwealth, ASC and KOCKUMS have only recently concluded protracted negotiations about ownership of COLLINS submarine IP. This illustrates the commercial and strategic importance of the terms and conditions under which Australia has access to the intellectual property inherent in the overseas designs built locally. Australia has a range of options for local adaptation of overseas designs for the AWD and amphibious support ships, ranging from build-to-print to assumption of full design authority. The latter is required if local companies are to undertake refit programs comparable to, for example, the FFG Progressive Upgrade (SEA 1390).

Supply and Support of Defence Capability 33 A Profile of the Australian Defence Industry

On 27 May 2004 the Ministers for Defence and for Finance and Administration announced a series of decision by the Government about the future of naval ship building and repair.29 The ministers announced, among other matters, that the Government plans to: • issue tenders for the air warfare destroyers later in 2004 and identify the preferred tenderer by early 2005; and • issue tenders for the amphibious support ships in early 2005 and identify the preferred tenderer by late 2005. The degree to which designs for the above ships are Australianised will determine the range and quality of local in-service support. This is a specific application of the principles underpinning the reinvigoration of the Australian Industry Involvement Program recommended in Section 4.3.2 below.

Systems integration

The USN, for example, operates a large quantity and range of specialised naval combatants. The RAN by contrast, must use a limited number of multi- mission assets in undertaking a diverse range of operational missions. In these circumstances, and in order to provide the requisite level of air defence and interoperability with other ADF elements, the AWD will require a level of systems integration much more complex than that undertaken by Australian industry to date. The amphibious support ships will also serve as the command post for joint operations in a network-enabled environment and will therefore involve a commensurately high level of system integration. As indicated in Section 3.1, the level of systems integration capability required to undertake these projects will challenge the Australian electronics industry and will require access to sensitive US command, control and communication technology. This issue is pursued in greater detail in Section 5.2.1.

Skills

Supply and support of current and future maritime forces is likely to require a spectrum of skills: • supply of the air warfare destroyers and refit of the existing naval surface combatants and submarines will require the more specialised fabrication skills fostered in the previous naval ship building cycle; • local construction of the large amphibious support ships and other support vessels, while requiring substantial investment in the requisite facilities, can

29 See Minister for Defence media release “Naval Shipbuilding: Moving Forward, Thursday 27 May 2004

Supply and Support of Defence Capability 34 A Profile of the Australian Defence Industry

draw more readily on the skills available in the general engineering base; and • supply and support of the patrol boats and similar smaller vessels can leverage off the internationally competitive base of fast ferry construction. As indicated in Section 2.4.3, respondents to the Defence Industry Survey drew attention to the shortage of skills they experienced over the past three years. Continuation of this shortage during concurrent construction of the AWD and amphibious support ships and on-going support of the fleet could entail significant cost and schedule risks for the above construction program. Possible action to mitigate the impact of any such shortages on the air warfare destroyer and amphibious support ship programs is discussed in Section 5.4.2.

3.3 Supply and Support of Army Land Transport

Army’s manoeuvre capability is based on a combination of land transport, airlift and amphibious support ships, operation of which is managed by a series of command and control assets operating at tactical and theatre levels. This section focuses on supply and support of the armoured vehicles and field vehicles and trailers underpinning Army’s capability for mechanised operations, combat support operations, operational logistic support and motorised infantry operations.30 Defence uses the term ‘Land 5000’ to denote efforts to develop these separate but related capabilities on a holistic basis within the framework of network centric warfare. Land 5000 identifies the cluster of programs and projects through which concepts of network enabled warfare will be applied to the land battle. Land 5000 entails using superior target acquisition capability and superior networking of both direct and indirect firepower assets to deliver more effective firepower more efficiently than is presently the case.

3.3.1 The land transport industry base

The companies that support the preparedness of the Army’s armoured vehicles are embedded in ANZSIC 2869 - Industrial machinery & equipment (n.e.c.). This is a residual manufacturing industry category that is too diverse to permit useful analysis at the sector level. Analysis of industry capacity to supply and support these assets is therefore based on discussions with the companies concerned. The Australian motor vehicle and part manufacturing industry (ANZSIC Group 281) fosters the basic mechanical engineering and metal fabricating

30 Army capability outputs and associated platforms are described in Defence Portfolio Budget Statements 2003-04, op cit, pages 77-89.

Supply and Support of Defence Capability 35 A Profile of the Australian Defence Industry

capacity required to supply and support the Army’s field vehicle and trailer fleet and specialised vehicles like Bushmaster and the high speed engineering vehicle produced by ADI – see Box 3. Motor vehicle and part manufacturing is a major component of the Australian manufacturing industry base.

Box 3 Bushmaster

Bushmaster maximises use of commercial-off-the-shelf components within a welded steel monocoque hull designed to provide ballistic and mine protection. Commercial components include Caterpillar 3126 6 cylinder turbocharged diesel engine, ZF Ecomat G2 fully automatic transmission, Arvin Meritor/Timoney 4000 series independent suspension axle system and dual circuit Meritor air operated disk brakes.

In 2000-01, the industry comprised over 1500 management units, employed nearly 63,000 people and generated an income of $23.8 billion.31 Total annual expenditure by Army s on the materiel component of its capability for mechanised operations, combat support, operational logistic support and motorised infantry operations is less than 3% of this income. Within the overall motor vehicle and parts manufacturing sector, the following sub-sectors are more directly relevant to supply and support of Army field vehicles and trailers: • Motor vehicle body manufacturing (ANZSIC Class 2812 - which in 2000- 01 accounted for 6% of the automobile industry’s total income, employed nearly 16% of its workforce and accounted for 39% of the total number of management units in the industry.32); and • Automotive component manufacturing nec (ANZSIC Class 2819 - which in 2000-01comprised over 844 manufacturers, generated 18.5% of the total income of the motor vehicle and part manufacturing industry and accounted for nearly 39% of the industry’s total employment). The Bushmaster and M113 upgrade projects illustrate how ADI and Tenix drew on the automotive industry base in supplying and supporting Army special purpose vehicles. While this base is relatively large, diverse and dynamic, Australian companies developing specialised military vehicles need to invest in substantial technical development and incur significant technical risk. In 2000-01, the national expenditure on research and development in the automotive engineering field totalled $365.4 million, of which 0.42% was attributed to Defence applications. This would include R&D in support of such programs as ADI’s Bushmaster and high speed engineering vehicle projects and Tenix’ rebuild of the MII3 armoured personnel carriers.

31 ABS special data service, October 2003 32 Ibid

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Supply and support of the present land transport inventory

With the exception of the Bushmaster and high speed engineering vehicles (which ADI produces at its Bendigo facility), all of Army’s armoured vehicles are imported. This pattern is likely to continue in future, with Defence replacing Army’s existing Leopard tanks with Abrams tanks procured from the US Defense Department under Foreign Military Sales Arrangements.

In these circumstances, the defence industry policy issue is the capacity of local industry to repair, maintain and adapt imported armoured vehicles.

The 2003-04 Defence Budget provides for expenditure of a total $393.4m on the preparedness of the Army’s armoured vehicles. This includes: • deeper maintenance and refit of both the Leopard tank and M113 by Tenix Land Division at the Vehicle Rebuild Line in the Bandiana workshops (part of the Albury Wodonga Military Area); and • assembly and deeper maintenance of the ASLAV General Dynamics Land Systems–Australia (GDLS-A), who build turrets for Australian and overseas light armoured vehicles in Adelaide. In March 2004 the Government announced that it will buy 59 M1A1 ABRAMS tanks through US Government Foreign Military Sales arrangements to replace the Army’s Leopard tanks at an estimated project cost of $550 million. Defence has yet to announce arrangements for in-service support of the ABRAMS tanks. In December 2003, Defence awarded Tenix Toll Defence Logistics (a joint venture by Tenix Defence Pty Ltd and Toll Holdings Ltd) a contract worth up to $920 million for the provision of Defence’s national warehousing and distribution services and the maintenance of selected land materiel and electronic equipment under the Defence Integrated Distribution System (DIDS). These developments give Defence several options for supplying and supporting the present inventory of Army vehicles, including: • use of Army’s in-house resources (In Darwin, for example, 1Brigade maintains its field vehicles using a mix of in-house resources and local truck distributors); • in-service support by the prime contractor supplying the equipment (for example, GDLS-A repairs and maintains the ASLAV in Darwin so as to maximise the availability of 1 Brigade’s vehicles); • repair of vehicles by Tenix Toll under DIDS auspices; and • repatriation of the vehicles to Bandiana or a similar centralised facility for deeper maintenance33.

33 In choosing in-service support options, commanders responsible for individual Army outputs will increasingly take into account the Preparedness Directive issued by the CDF to

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In high mobility war, access to hardened vehicles like Bushmaster broadens the range of tactical options has available to the land commander. ADI has recently begun low-rate initial production of the Bushmaster. While Defence and ADI have yet to announce arrangements for in-service support of the vehicle, the high proportion of COTS components facilitate commercial support arrangements.

3.3.2 Supply and support of future field vehicles

Project Overlander (Land 121) amalgamates the ADF’s entire requirement for field vehicles and trailers into a single project to facilitate acquisition of a common family of vehicles which can be supported more cheaply and efficiently. It entails acquisition of some 700 vehicles per year for 10 years, spread across some 19 variants at an estimated project cost of $1.5 billion. The Australian economy is road transport intensive: In 2002 a total of 284,00034 light, medium and heavy trucks and buses were sold on the Australian domestic truck market. Of these, only 3000 (1.03%) were manufactured or assembled in Australia, indicating that the production volume is insufficient to sustain economically viable production in Australia. Overseas manufacturers of military field vehicles have production lines that can produce vehicles at the rate of tens of thousands per year, with ample spare capacity to provide for Australian Defence requirements. Defence has therefore decided to acquire a family of military-off-the-shelf vehicles. In response, local defence suppliers (for example Tenix Defence, ADI, GDLS-A) have teamed with overseas truck builders. In these circumstances, local industry involvement in supply and support of the FV&T fleet is likely to focus on support for: • the readiness of the FV&T fleet in terms of its configuration for the wide variety of tasks it is required to undertake and its compatibility with Network Enabled Operations/Land 5000; and • the sustainability of FV&T operations, primarily vehicle repair and maintenance – perhaps utilising commercial vehicle support networks. This is a specific aspect of the reinvigorated Australian industry involvement program recommended in Section 4.3.2.

the Chief of Army and reflected in Army output-specific performance targets published in pages 72-89 of the 2003-04 Defence PBS. 34 Figures supplied by ABS

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3.4 Supply and Support of ADF Munitions

Weapon Systems comprise ballistic weapons and munitions, insensitive munitions and precision and guided munitions. Ballistic weapons technology is relatively mature, with innovations like insensitive munitions affecting the logistics of storage and handling weapons rather than their lethality. The greater ballistic efficiency and effectiveness of precision weapons can improve ADF tactical flexibility and operational efficiency. Australia stands to take advantage of substantial investments by the US and other nations in precision weapon technology.

Advanced guided missiles are increasingly using software based technology to integrate and interpret data from a variety of sensors enabling them to self- sense and discriminate among potential targets. Such missiles are also becoming more autonomous and independent of the launch platform, with the requisite programming being fed directly into the missile itself, rather than into, for example, an aircraft combat data system. Guided missile software can be upgraded in response to, for example, the development and deployment of countermeasures or to exploit improved sensors. It needs to modified to render missiles suitable for Australian circumstances, including, integration into Australian platforms.

3.4.1 The munitions industry base

Light infantry operations, special forces operations, and combat support operations require ballistic munitions (ie small arms, artillery and associated ammunition), production of is located in ANZSIC Class 2769 (Fabricated metal products). Production of the explosive and propellant components of ammunition for Army, Navy and Air Force are both are located in ANZSIC Class 2541 (Explosives). ADI is the only local producer of small arms, larger calibre ordnance, and ammunition used in generating Navy, Army and Air Force capability outcomes. The precision and guided munitions used by the ADF are imported, serviced in-house, and returned to OEMs for deeper maintenance. Confidentiality constraints preclude release of ABS data about munitions production. The following analysis is therefore based on discussions with ADI and Defence personnel.

Munitions for the current force

ADI Ltd currently produces the Army small arms, artillery and associated ammunition at, respectively, its Small Arms Factory Lithgow, Bendigo precision engineering facility and Benalla ammunition filling facility. ADI also

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manages production of propellant and explosive required for ammunition at the Mulwala explosive facility, owned by the Commonwealth. These facilities also manufacture significant elements of the ballistic munitions used by Navy (for example 5” gun ammunition and associated ordnance) and Air Force (for example iron bombs). Following a decision by Government to retain an indigenous capacity to produce ballistic weapons and associated munitions (including propellants and high explosives) the Commonwealth concluded the following agreements with ADI: • the Strategic Agreement for Munitions Supply (SAMS), signed by the Commonwealth and ADI on 9 July 1998, for the supply of munitions to the ADF until 2015, with options for further extensions; • the Mulwala Agreement, which was originally negotiated in 1993, covers the lease of the Mulwala facility by ADI for the provision of propellant and high explosives for use at Benalla. It was re-negotiated in 1999, and parallels the duration of SAMS. On 9 July 2001 the Government announced that it would upgrade Mulwala’s capacity for the manufacture of propellant and high explosives. ADI manufactures overseas designed rifles, machine guns and artillery. This meets the strategic requirement for a responsive local support of these weapons, including adaptation to changing ADF requirements. For example, ADI has modified the Austrian-designed Steyr rifle extensively to render it suitable for the Australian operating environment and to enable it to use local ammunition satisfactorily.

Supply of Ballistic Munitions

There is surplus capacity to produce high explosives at the Mulwala facility which can produce the ADF’s annual requirement for high explosive in two months. Exports are important in exercising the balance of Mulwala’s capacity. Benalla supplies the ADF’s annual munitions demand on a single shift production basis. The base level munitions production capability maintained at Benalla is intended to maintain a cadre of skills as a basis for future expansion if necessary. Under the SAMS Agreement Defence and ADI share the benefits (including reduced costs) of increased production of ballistic munitions. ADI Lithgow can produce more than 10,000 Steyr rifles per annum, but the ADF has no current requirement for new weapons and therefore current production at Lithgow (whole of factory) is well under capacity. The next major small arms related project for the ADF is Land 91 Phase 6 Small Arms Life of Type Extension, for which the Year of Decision is 2006/07 and which is worth an estimated $30.0m - $50.0m.

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3.4.2 Precision and guided weapons

Precision and Guided Munitions (PGM) encompass a broad spectrum of capabilities. This spectrum provides important options for both Defence and industry in investing in local capacity for the supply and support of the ADF. At the high capability/high cost end of the spectrum are, for example, imported PGMs like Harpoon. The US will only release to Australia the software required to manage Harpoon on a government-to-government basis. DSTO and the Joint Ammunition Logistics Agency (JALO) are the normal repositories for such highly restricted technology as Australia requires to program the weapon for operations. Defence routinely maintains Harpoon and similar weapons in-house and periodically returns them to the Original Equipment Manufacturer (OEM) for deeper maintenance. In normal circumstances, OEMs require approximately 18 months to two years to complete such deeper maintenance of ADF missiles and to return them to Australia. Modified ballistic weapons like the Joint Direct Attack Munition – Extended Range (JDAM-ER) represent the lower capability/lower cost end of the PGM spectrum. The JDAM-ER technology was pioneered by DSTO who licensed it to Hawker de Havilland. The latter is developing JDAM-ER for both Australian and selected overseas markets – see Section 5.3.1. JDAM-ER converts a conventional MK 82 iron bomb into an air launched stand-off weapon by the addition of a cheap, reliable GPS-based internal guidance system linked to: • removable tail fins which provide directional control; and • a strap-on wing kit which enables the munition to glide unaided from point of release to target. The Evolved Sea Sparrow Missile represents a mid-point of the PGM capability spectrum. Australia is a member of the NATO Sea Sparrow Consortium35 and is participating in the engineering development and manufacturing phases of the Evolved Sea Sparrow Program. BAE Systems Australia and other Australian companies are involved in development of, for example, the missile’s guidance section, thrust vector controller, and certain control surfaces and fins for the total program.

35 The ESSM Consortium comprises Australia, Canada, Denmark, Greece, The Netherlands, Norway, Spain, Turkey and the U.S..

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3.4.3 Supply and support of future munitions

The technology of precision weapons is changing rapidly, driven by wider information capability developments, including fusion of intelligence and surveillance data. The interaction between precision weapons, launch platforms and command and control systems constitute another aspect of technological uncertainty. While successful acquisition, integration and operation of precision weapons is therefore a key aspect of the ADF’s knowledge edge, it is also expensive and characterised by high technical risk. In these circumstances: • the ESSM project demonstrates that, by coordinating very closely, Defence and Australian companies can participate in international missile development programs and, through targeted industry involvement, provide components and expertise to the international market; and • the JDAM-ER program demonstrates how Defence and industry can reinforce Australian self reliance by developing cost effective solutions to ADF requirements for PGM and maintaining the capacity to produce such weapons on a commercially viable basis. In the Australian PGM inventory, locally produced JDAM-ER and collaboratively developed ESSM complement highly capable but expensive and strictly controlled weapons like Harpoon. Taken together, these weapons represent a portfolio of PGMs. The portfolio covers not only diverse domestic and overseas sources of supply but also a range of capabilities. In defence industry profile terms, the key point is that ADF preparedness is enhanced by access to both locally supplied and imported PGMs covering a spectrum of capabilities. The JDAM-ER model is therefore explored further in Section 5.3.

3.5 Supply and Support of Defence Aviation Capabilities

This sub-section addresses industry support of the platform element of ADF capabilities for: • Naval aviation operations; • Army aviation operations; • Air combat operations; • Maritime patrol; and • Airlift.

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These capability outputs involve an inventory of some 155 rotary wing aircraft, 132 fast jet aircraft, and an additional 86 fixed wing aircraft for maritime patrol and airlift36.

3.5.1 The aerospace industry base

The companies that supply and support of the ADF’s fixed and rotary wing assets are all embedded in aircraft manufacturing (ANZSIC Class 2824) which includes aircraft engine building and repair, airframe building and repair, avionics equipment repair, guided missile manufacturing and helicopter manufacture/repair. According to the ABS, in 2000-01 aircraft manufacturing comprised 376 management units which employed a total of 5849 people and generated a total income of $951.2 million. Ownership of aircraft manufacturing is relatively dispersed. Of the above 376 management units in the sector, 97% employed less than 100 people in 2000- 01. In that year, and at the other end of the spectrum, there were: • four aircraft manufacturers employing 100-199 people; • three aircraft manufacturers employing 200-499 people; and • three aircraft manufacturers employing 500-999 people. Australia is an aircraft importer but the local aerospace industry competes vigorously in overseas markets: In each of the three years to 2000-01, annual export of aerospace goods averaged some $A470 million. This constitutes the largest single category of defence–related exports by Australian companies and was equivalent to about 40% of all such exports in each of those years. In 2000-01, aerospace exports were equivalent to 55% of the sector’s total income. In each of the three years to 2000-01, North America typically accounted for round 40% of Australia’s total aerospace exports. The Pacific was usually the next largest destination, followed by Western Europe. Hawker de Havilland fabricates airframe components for sale to Boeing and other aircraft control surfaces for sale to Boeing, Lockheed and Airbus. The latter incorporate these components into civil and military aircraft sold world- wide. In addition, according to the EXIT data base, Australia also exports - largely to South East Asia and to the South West Pacific – a large volume of aircraft engines, avionics and aircraft mechanical systems. As few of these items are manufactured in Australia, and most are imported, refurbished and then re-exported, these exports warranted closer examination.

36 See Defence Budget 2003-04, op cit, pages 62-63 for a description of Navy aviation capabilities, pages 81-82 for a description of Army aviation capabilities and pages 95-100 for a description of Air Force capability outputs.

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In recording such exports in the EXIT data base, exporters estimate the market value of the component concerned and then add the value of the labour and materials involved in maintaining, repairing or refurbishing that component. This process means that information in the EXIT data base is at best a crude proxy for the very extensive service component of the value of aerospace exports. The services so exported enable Hawker Pacific and similar companies to sustain a more comprehensive capacity to repair and maintain comparable components for ADF aircraft more cost effectively than would otherwise be the case.

Supply and support of existing aviation assets

The ADF operates some 20 different aircraft types supplied by 11 different Original Equipment Manufacturers out of 5 different countries. Until very recently, Defence has supported these aircraft through a mix of in-house and commercial arrangements, with the latter involving numerous different contracts let to many different companies. As the draft aerospace sector plan indicated, this has inhibited long term industry planning and reduced the incentive for overseas companies to commit to doing business in Australia over the long term.

Commercial support arrangements

Defence began modifying this business pattern with procurement of the Hawk lead-in fighter from BAE Systems Australia (a subsidiary of the UK BAE Systems PLC) which employs 2500 people in a broad range of aerospace and systems business. The Hawk program involved: • Defence awarding BAE Systems a contract for the supply and long term support of the Hawk lead in fighter; • BAE Systems developing the infrastructure required to assemble the aircraft at RAAF Williamtown (the aircraft home base); • Transfer of the BAE facilities and personnel used in the acquisition phase to the through-life support function once the aircraft were delivered. Defence spends about $1 billion per year on in-service support of ADF aircraft through a combination of overseas, in-house and local commercial arrangements. Of this, about 65% is incurred in Australia, with an increasing proportion of this local expenditure on in-service support accounted for by commercial arrangements. For example: • Boeing Australia (a subsidiary of the US Boeing Company which employs 1500 people) now operates the F111 weapons support facility; • Australian Aerospace Ltd (a subsidiary of the European EADS Consortium which employs 275 people) is responsible for maintenance and

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logistic support of the RAAF Caribou fleet and, in future, of the armed reconnaissance helicopters procured at an estimated project cost of $1.64 billion under Project Air 87; and • QANTAS Defence Services Pty Ltd (a subsidiary of QANTAS Pty Ltd which employs 446 people) supports the B707 Tanker aircraft and will provide similar support for the Boeing 737-700 aircraft being modified at an estimated cost of $3.6 billion for airborne early warning and control operations.37

Modifying defence aircraft

Maintaining the readiness of ADF aircraft can entail major software and system enhancements, original systems development work, major structural enhancements and major life extensions. Defence expenditure on this work is expected to rise from about $500 million per year currently to peak at over $800 million in 2007-08. Upgrade of the F/A-18 aircraft accounts for over half this expenditure, followed by expenditure on upgrade of the Black Hawk and Seahawk helicopters and on C130H transport aircraft and P-3 Orion maritime patrol aircraft. Because most such enhancements/life extensions require access to OEM intellectual property, they are generally done overseas. Hence, for example, Boeing is modifying the airframes of the Boeing 737-700 aircraft for the airborne early warning and control project (AIR 5077) in the US. About 10% of the expenditure involved is incurred in Australia – mainly on incorporating modifications.

Aerospace R&D

Local supply and support is facilitated by a relatively modest R&D program: In 2001-02, Australia spent some $96 million on aerospace engineering research. Of this total, some 13% was for defence purposes. Aerospace engineering accounted for just 4.4% of the $275 million Australia spent on total R&D for defence purposes in 2001-02. Defence accounted for the great bulk of this expenditure. R&D to support the readiness of ADF aircraft is undertaken by the Defence Science and Technology Organisation (DSTO) and involves programs like, for example, F/A-18 fatigue life testing. Such programs are tending to blur the boundaries between public and private sector research. For example:

37 These arrangements are integral to the ability of ADF commanders to meet levels of aviation preparedness specified in Directed Levels of Capability promulgated by their respective Service Chiefs and reflected in performance targets published in the 2002-03 Defence PBS.

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• in 1997, DSTO awarded Aerostructures Group a contract to provide on- going professional engineering support for the DSTO aircraft structural integrity program; • Aerostructures Group was also required to compete for comparable commercial work, using specialist DSTO facilities on a commercial basis; • Aerostructures Group now employs 65 full time staff, provides DSTO some 20 technical specialists per year and, in addition, services the USAF and USN.38 In the course of supporting ADF aircraft readiness, DSTO has created internationally competitive intellectual property. For example, gearboxes are the most complex and highly stressed part of helicopter transmission systems: • DSTO developed vibration-based fault detection and diagnostic techniques for helicopter gearboxes; • DSTO licensed this technology to Chadwick-Helmuth which supplies the vibration analysis systems used by 85% of the world’s helicopters, including those operated by the ADF.

3.5.2 Supply and support of future aerospace assets

The outlook for defence aerospace is likely to be shaped by: • the impact of uninhabited aerial vehicles on the ADF aircraft inventory; and • how Defence acquires new aircraft for the ADF and how it manages the expiry of existing individual TLS contracts.

Uninhabited aerial vehicles

The introduction of uninhabited aerial vehicles is an important source of innovation for the Australian aerospace industry. At the strategic end of the capability scale is the study and purchase of long endurance unmanned aerial vehicles Global Hawke program (Air 7000 Phase 1). At the tactical end of the scale are, for example, the Aerosonde UAVs deployed to the Solomon Islands in July 2003 to conduct surveillance of remote areas and coastlines in support of multi-national assistance to the Solomon Island Government – see Box 4.

38 Source: DSTO

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Box 4 Airborne Surveillance for Land Operations

The Defence Capability Plan 2004-14 provides for the acquisition at an estimated cost of $100million-$150 million of a tactical unmanned aerial vehicle (TUAV) system capable of providing airborne surveillance, reconnaissance, and target acquisition to support land operations (JP 129 Phase 2). Year of decision is 2003-04, for in service in the 2008-2010 time frame.

Leveraging future aircraft procurement

The nature and commercial viability of future arrangements for support of ADF aircraft will depend importantly on how Defence acquires new aircraft for the ADF and how it manages the expiration of existing individual TLS contracts. Of the new acquisitions in prospect, management of the following projects will be critical to the viability of the proposed aerospace business model and to the future of the sector as a whole: • AIR 6000 (Replacement air combat capability); • AIR 7000 (Replacement maritime patrol capability: • AIR 8000 (Replacement fixed wing airlift capability); and • AIR 9000 (Replacement helicopter capability).

AIR 6000

The Australian Government has spent $150 million to buy into the System Development and Demonstration Phase of the Lockheed Martin F-35 Joint Strike Fighter. To date, some 12 Australian companies have won contracts with Lockheed Martin to supply, for example, precision machined structural wing components for the JSF over the next ten years and components for the prototype F-136 engine. These successes are potentially significant commercially and technologically. For example, in May 2004 Lockheed Martin announced the engagement of GKN Aerospace Engineering Services (see Box 5) to reduce the weight of the JSF airframe. This work has directly facilitated GKN’s involvement in comparable work for Northrop Grumman.

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Box 5 GKN Aerospace Engineering Services

GKN Aerospace Engineering Services is located in Port Melbourne. It is a wholly owned unit of GKN Plc based in the UK. It employs about 100 specialist engineers, of whom at least 30 are working on the JSF program. Through its membership of the Aerospace Engineering Services Global Network, GJK Aerospace Engineering Services also contributes airframe engineering services to, for example, the Airbus project.

Defence and industry will need to make additional sustained effort, however, to establish in Australian industry the capacity to support the aircraft and its systems in Australian service. In particular, and as the discussion of the Wedgetail project in Section 5.2.1 indicates, obtaining the US export licenses required to establish in-country support capacity will require concerted effort by both Defence and commercial stakeholders.

AIR 7000 and AIR 8000

The estimated cost of upgrading the Long Range Maritime Patrol aircraft (AIR 5276) is $365million-$520 million, mainly for avionics, sensors, information systems, simulators and systems engineering. This program, like the JP 2062 (Strategic Unmanned Aerial Vehicle Project) is system intensive. Engineering substantive supply and support by Australian industry of these aircraft will require Defence and industry to obtain the requisite US export licenses and to maximise the leverage on the overseas suppliers involved.

AIR 9000

The ADF currently operates a mixed fleet of Kiowa, Iroquois, Black Hawk, Seahawk, Sea King, Super Sea Sprite and Chinook helicopters. AIR 9000 subsumes discrete projects involving acquisition of Additional Troop Lift capacity and upgrades of, respectively, Black Hawk, Seahawk and Chinook helicopters. At a strategic level, Defence sees the outcome of the additional troop lift helicopter competition (AIR 9000 Phase 2) as the first step in developing a relationship with an Australian commercial entity capable of supplying the ADF’s helicopter needs and of providing cost-effective TLS and upgrade capabilities over longer term. Defence will also look to Australian industry for supply and support of aircraft systems, avionics, aircraft structures, simulators, aircraft propulsion and training aids. Australian companies will need to make substantial investments to meet these requirements.

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Australian Industry Involvement in Future Aerospace Project

Initiatives along the above lines would entail a modified approach to competition. This is discussed in greater detail in Section 4.5. Achieving satisfactory project outcomes would be facilitated by realignment of the Australian Industry Involvement Program along the lines recommended in Section 4.3.2.

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4 Managing Defence Demand

This section of the profile analyses : • the concept of defence demand management as a means of aligning defence industry capacity and defence strategic planning requirements; • specific applications of defence demand management, to include risk management, linking contracts to preparedness, and competition policy.

4.1 Defence demand management

Defence is a monopsonist in the market for supply and support of, for example: • Naval surface combatants and submarines; • ballistic and guided weapons and associated munitions; • military fixed and rotary wing aircraft; and • specialised electronic systems for, say, collecting and managing data collected by sensors, command and control, electronic warfare, and the collection and distribution of intelligence. In such markets, what business Defence does and how it does that business drives defence industry capacity decisively. While the existence of Defence’s monopsonist market power has long been recognised by both Government and industry, the 1997 Report of the Defence Efficiency Review39 made, arguably, the first reference in the Australian defence industry policy context to the active use of defence demand to develop defence industry capabilities: “Experience in the UK is that demand manipulation generally is sufficient to retain capabilities and it is our view that it should be here also. The alternative is to designate industrial capabilities or technologies, which equates to telling companies how to do their business (instead we should specify outputs and leave it to them to determine which technologies they need and how to get them)….A guide to which general areas of technology seem most likely to be needed is as far as we should go” 40

Since publication of the Defence Efficiency Review, the concept of ‘defence demand management’ has become more widely used. For example, the Defence Aerospace Sector Plan states: “Although significant changes are underway, acquisition and procurement policy has not kept pace with the transition to an increasing reliance on

39 “Future Directions for the Management of Australia’s Defence: Report of the Defence Efficiency Review”, March 1997, page 33-34. 40 Ibid, page 34

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industry. Defence as a monopsonist customer for major military equipment and in-service support, plays a major role in shaping the industry base; it is defence demand, if employed strategically, rather than a free market that will determine the extent and depth of future capabilities within the defence aerospace industry’.41 Against this background, the Profile discusses the following issues as sub-sets of demand management: • identifying and sharing Defence project risk; • defence contracts, preparedness and Australian industry involvement; • competition policy; • modifying the project-by-project business model; and Coordinating development and application of demand management principles.

4.2 Managing Defence Project Risk

How Defence and its suppliers identify and manage project risk has major implications for the health and sustainability of defence industry. This is a recurring theme: Both the Aerospace and Electronic sector plans highlighted the need to manage technical and other risk inherent in procuring the advanced platforms and systems required to meet defence capability requirements.42 According to the recent Defence White Paper, the “information technology revolution” could revolutionise the conduct of war.43 For defence industry profile purposes, the application of information technology to military requirements is the single most important aspect of defence project risk. The need to manage this aspect of defence project risk is widely recognised. Hence, for example, Defence has developed specialised guidance and standardised terms and conditions for the acquisition of high-risk software intensive systems, including the acquisition of major platforms.44 In addition, Defence procurement processes already provide for consultation with industry with a view to better identifying and managing project risk. None of these initiatives, however, provide sufficient guidance for either the Defence customer or industry supplier to decide how defence and industry can most appropriately share defence project risk.

41 The Australian Defence Aerospace Sector Strategic Plan, June 2003, page 69, para 4.22 42 See Chapter 8 entitled “Managing Risk” on page 97 of the Electronics Sector plan; see section also entitled “Managing Risk” in Chapter 4, page 80 of the Aerospace Sector Plan. 43 White Paper, op cit page 56 para 6.44. 44 See discussion of Australian Defence Contract (Strategic Materiel) in the Defence Materiel Guide, June 2002, page 25.

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4.2.1 The capability system life cycle

Defence procurement principles recognise that as the cost of corrective action in developing a capability increases exponentially as the life cycle progresses, a dollar invested during the requirements phase can save thousands later. More specifically: “Industry involvement in the requirements Phase will encourage their participation in the key process of trading-off capability, costs and schedule and result in a requirement which is better tuned to industrial and technological reality. Industry’s improved understanding of the capability requirement can reduce the number of iterations required to reach a satisfactory proposal, saving industry and Defence both time and money. “Teamwork with industry will also encourage a combined Defence and industry approach to risk reduction before Second Pass (Project) Approval which should mean that the Acquisition Phase can proceed more quickly and with confidence that targets will be met.”45

Mr Malcolm Kinnaird AO echoed this theme in his Defence Procurement Review 2003. The Government has accepted the recommendation by Mr Kinnaird that, among other defence procurement reforms, Government should mandate (and revise the Cabinet rules to enforce) a rigorous two pass system for new defence capital equipment acquisition. The revised procedures envisaged by Kinnaird included greater emphasis in project expenditure on analysis and project definition before proceeding to tender. Kinnaird suggested that, in the case of complex projects, an investment of up to 10%- 15% of project funds should generate commensurate return in terms of greater certainty of costs and a better understanding of risk in the acquisition phase.46 The Soldier Combat System illustrates both customer and supplier need to collaborate closely in identifying, sharing and managing the risk inherent in evolving requirements and long term technological development. Such risk management typically requires companies to invest in a combination of: • access to overseas intellectual property; • research related to the capability in question, typically in collaboration with DSTO; and • in-house development of technology offering promising solutions to defence capability requirements. As the Defence Electronic Systems Sector Plan has already argued, creating sufficient incentive for companies to make the above investments will require a concerted effort by Defence and industry to develop and promulgate the requisite principles and procedures. The existing provisions of the Capability Systems Life Cycle Management Manual provide a satisfactory procedural framework within which to develop such principles and procedures.

45 Ibid, paras 3.59-3.60. 46 Defence Procurement Review 2003; Malcolm Kinnaird et al, August 2003, pages 11-20.

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The Defence Electronic Systems Sector Plan canvassed several options for funding direct industry engagement in the preparation of the Capability Requirement Business Case within this framework.47 Defence already funds project definition studies with a view to refining capability development proposals prior to seeking tenders. In funding the developing of concepts and designs for the innovative Littoral Combat Ship, however, the US Navy went further in funding a series of commercial studies, the intellectual property from which it was free to use in subsequent procurement activity. These principles and procedures warrant closer examination.

Recommendation 1

4.3 Defence Contracts and the Australian Industry Involvement Program

This sub-section analyses: • the link between defence contracts, preparedness planning and industry support; • Defence industry capacity development through the Australian Industry Involvement Program; and • the link between defence industry flexibility and cost of doing defence business.

47 See Defence Electronic Systems Sector Plan, op cit page 103.

Managing Defence Demand 53 A Profile of the Australian Defence Industry

4.3.1 Linking preparedness and industry support

Contracts provide the primary linkage between industry and defence preparedness planning. Relevant contracts include those for in-service support of defence platforms and systems, garrison support of military units, and IT and other support for Defence Corporate Services. In addition, Defence is also tending to include provision for in-service support in contracts for the acquisition of platforms and systems. For example: • under its contract for supply of the Hawke Lead-In fighter, BAE (Australia) will also provide in-service support; • the contract between Defence and the AUSTAL/DMS consortium for the new patrol boats incorporate preparedness targets. Contract-based linkages between, on one hand, defence industry capacity and, on the other hand, defence preparedness could be reinforced by inclusion of support for preparedness in the Defence Company Scorecard System through which Defence monitors and reports on company performance. The Company Scorecard is a contract management and performance measurement tool through which Defence formalises its corporate knowledge of a contractor’s performance and encourages better performance through active dialogue between the contractor and Defence.48

Recommendation 2

In order to link development of defence industry capacity to defence strategic planning requirements, contractor performance needs to be linked to preparedness. Defence should consult industry about linking Defence strategic planning to defence industry capacity through: • appropriate provisions in contracts, drawing on experience with recent contracts that focus more on defence capability outcomes than acquisition project outputs (for example, the Hawk Lead In fighter and the Replacement Patrol Boat Programs); and • inclusion of preparedness planning objectives in the Defence Company Scorecard program. The Capability Development Advisory Forum is appropriately constituted to facilitate and oversight such consultation.

4.3.2 The Australian Industry Involvement Program

The Australian Industry Involvement (AII) Program was created in 1986 to encourage suppliers to establish the local capacity to support that equipment.

48 Doing Business with Defence, June 2002, page 18.

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Defence requires tenderers to propose how they intend to maximise domestic involvement in each procurement worth $5million or more. • The major component of AII is local content which is defined as the value added (ie the contract price less imported content less any duties) by Australian and New Zealand industry under the contract. • Companies can also boost their AII by transferring defence-related skills, technology and infrastructure to Australia through Strategic Industry Development Activities (SIDAs). • The Defence Industry Investment Recognition Scheme (DIIREC) also recognises for AII purposes the investment by overseas companies which develop and sustain local industry capabilities outside specific defence contracts.49 Defence Industry Survey participants were asked to rank the importance to their defence business of AII, SIDAs and the DIIREC. The responses are summarised at Table 8.

Table 8 Defence industry support programs

Defence Program Total Critical High Moderate Low/Minor

Australian Industry Involvement Program 24 1 9 7 7 Strategic Industry Development Activities 15 4 7 4 Defence Industry Investment Recognition 12 3 2 7 Scheme Data source: Defence Industry Survey

SIDAs are relevant to the larger defence industry suppliers, of whom 11 considered the program of moderate to high importance. This suggests a fairly high take up of this program. The DIIREC scheme applies to overseas firms, five of whom considered it of moderate to high importance. Considering the importance of off-shore ownership of Australian defence industry, this suggests a modest take up by overseas primes of the scheme. Less than one quarter of the Defence Industry Survey respondents answered the AII question. Of those that did so, only ten (or 9% of the total survey sample) regarded AII as either critical or of high importance. This warrants closer examination. Defence negotiates AII with the prime contractors responsible for supply of major capital equipment. It is probable that, as work flows down the supply chain via sub-contracts, the AII provisions in the prime contract become less visible to the sub-contractors involved.

49 Doing Business with Defence, June 2002, page 12

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That said, however, defining AII in terms of local content focuses industry activity on inputs rather than outcomes: Measures of AII performance focus on local content in the prime contract for defence capital equipment rather than on the efficacy of through life support of the equipment resulting from the AII. This suggests that AII requirements in Defence tenders, AII provisions in defence contracts, and AII outcomes in terms of Defence preparedness should be linked more clearly. The Australian National Audit Office (ANAO) reached a similar conclusion in its June 2003 review of the AII Program. The ANAO noted that the AII program lacked both quantitative and qualitative performance measures.50 Defence agreed with the ANAO recommendation that “Defence report its performance in achieving the Government’s Australian Industry Involvement Program objectives against key performance indicators derived from agreed outputs and outcomes for the Program.”51.Defence is steadily refining its preparedness management framework. The availability of such a framework to defence and industry decision makers seems likely to facilitate development of AII performance indicators.

Recommendation 3

The Australian Industry Involvement (AII) program remains a key lever for helping align defence industry capacity with defence strategic planning requirements. Industry should consult Defence about: • developing key performance indicators for the AII program based on Defence preparedness objectives; and • using such indicators to inform proposals for: – Australianisation of designs for the air warfare destroyers and amphibious support ships; and – encouraging shortlisted tenderers for Army’s field vehicle and trailers to involve local companies in adapting military off the shelf vehicles for network enabled operations in the Australian environment. The Capability Development Advisory Forum is appropriately constituted to oversight the reinvigoration of the AII program along the above lines.

50 Audit Report No. 46 2002-03 “Australian Industry Involvement Program”, June 2003, page 5 para 17. 51 Ibid, page 16 para 2.19

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4.3.3 Defence industry flexibility and the cost of doing defence business

This sub-section analyses the adverse impact on defence industry flexibility of the cost of the following aspects of defence business: • tendering; and • insurance.

The cost of tendering

SMEs account for a large proportion of Defence minor capital equipment and related small purchases. By contrast, the larger companies will be prime contractors or major sub-contractors for defence major capital equipment projects. Tendering costs for larger projects are a lower proportion of the total cost of these projects.This helps account for SME’s stronger concern about the cost of tendering relative to larger firms. In addition, SMEs are typically more specialised than larger companies. Such specialisation allows SMEs far less scope than larger, more diversified companies to reallocate staff among a portfolio of different projects. This leaves SMEs more exposed to the costs inherent in holding bid teams together while awaiting the outcome of Defence tender evaluations. Since the 1994 report by the Industry Commission, Defence has modified its contracting arrangements and now differentiates between high risk, software intensive projects; high value, medium risk projects; high value, low risk projects and simple procurements.52 The above analysis suggests that the benefits of recent changes in tender procedures and documentation have not flowed through in the form of reduced costs of tendering.

Recommendation 4

Reducing the cost of tendering would improve defence industry profitability, give Defence better value for money and improve the responsiveness of the defence industry base. The potential gains in these areas are sufficient to warrant Defence and industry making a concerted effort to reduce the cost of tendering by: • reviewing the fixed costs associated with defence tendering; and • exploring the scope for adjusting defence management of lower value/lower risk contracts with a view to securing better alignment of tender costs and tender value/risk. Defence and industry have previously used the Defence Contracting Consultative Forum to develop revised contracting principles and related documentation. The DCF is well suited to reviewing the cost of tendering along the above lines.

52 See Defence Materiel Guide, June 2002, page 25

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Access to professional indemnity

Defence requires the companies with whom it contracts to obtain appropriate professional indemnity. This requirement is incorporated in transactions between Defence and its prime contractors. The latter flow the requirement down the supply chain to sub-contractors, many of whom are SMEs.

As noted in Section 2.4.3, the Defence Industry Survey indicated that a disproportionately large number of SMEs found the cost of professional indemnity insurance a major constrain on their willingness to do defence business. Follow-up conversation with respondents indicated that, while those SMEs involved in production-to-print or maintenance were not so constrained, those involved in ab-initio design or the production of mission- related software were particularly adversely affected. Discussions with survey respondents suggest that these difficulties are a sub-set of the wider problem of professional indemnity being investigated by the Senate Economics Legislation Committee in the course of its inquiry into the Treasury Legislation Amendment (Professional Standards) Bill 200353. Like AIDN and the AIG, Australian Business Limited (ABL) consults Defence about business issues of concern to its members. Following consultation with Defence contracting policy personnel in September 2003, ABL is arranging a series of workshops for selected defence companies with the Insurance Council of Australia, professional indemnity insurers and brokers. The aim is to ensure all parties understand the nature of defence business, the range of risks involved and how suppliers are best advised to approach insurers.

Recommendation 5

53 See for example submission from Professions Australia of 12 March 2004

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4.4 Managing Competition to Develop Industry

Commonwealth purchasing policy uses competition to create incentives and opportunities for both innovation and cost containment. In its defence policy statement for the 2001 election, however, the Government flagged the need to modify Defence’s current procurement approach, based on an open competition model, in dealings with ‘tier 1’ companies.54 All three published sector plans canvassed the deficiencies of the open competition model of business as a means of sustaining critical capabilities.

For example, in discussing competition for through life support of defence aircraft, the Defence Aerospace Sector plan stated that: ‘the open competition approach has led to a lack of continuity in workload for the major players, giving rise to over-capacity and poor returns within some defence aerospace sub- sectors. More importantly, this, in turn, has created a fragmentation of key industry capabilities and skill sets. Uncertainty over future defence workload has created a situation where companies are often unwilling to invest in new capability, including state-of-the-art equipment, research and development and a costly, highly skilled workforce."55

The NSR sector plan concluded that Defence’s future demand over the period 2002-03 to 2016-17 was insufficient to sustain more than one entity for the construction of Navy’s major surface ships. It concluded that at least the main shipbuilding activity (as opposed to the activity feeding into it) was a natural monopoly, that significant concentration of this activity was inevitable, and that, in order to capture an equitable share of the potential benefits, the Government should influence the consolidation process by: • clearly specifying its requirements in terms of capability, sustainment of skills, value for money, access to world wide technology preferred contracting framework and corporate governance arrangements; and • letting industry determine how best to meet these requirements through a structured and transparent process of engagement.56 This conclusion was widely contested at the time. It was since overtaken by the Government’s announcement in May 2004 that “Given the significant increase in NSR sector expenditure resulting from the Defence Capability Review, a competitive model is the preferred approach for contracting in the NSR sector with intervention by Government only in exceptional circumstances.”57

54 “Strengthening Australia’s defences”, op cit, page 47. 55 Aerospace sector plan, op cit, page 66, para 4.16 56 NSR sector plan, op cit, page 109 57 Minister for Defence media release on 27 May 2004 re naval ship building, op cit.

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What is important for present purposes, however, is the discussion of the competition principles that might guide the Government in achieving value for money in those areas of defence business where defence demand is insufficient to sustain the conventional model of competitive procurement. The NSR competition principles, which were derived from the Agreement of Competition Policy Principles concluded by the Commonwealth and State/Territory Governments, are set out in pages 103-106 of the NSR sector plan. The electronics sector plan provided a similar analysis in its discussion of avoiding monopolist behaviour by prime contractors for through life support of ADF aircraft assets – see pages 106-114. The same principles would seem relevant to, for example, supply and support of Army’s armoured vehicles following completion of the current cycle of rebuild activity. This goes to the core of the Government’s procurement principles and related concepts of best value for money. As such it is a matter not only for Defence but also for the Department of Finance and Administration.

Recommendation 6

4.5 Modifying the Project-By-Project Business Model and Defence-Industry Partnering

All three sector plans advocated a greater consolidation of the packages of work offered by Defence with a view to encouraging industry to invest in more capable skills and infrastructure. In the case of military system integration, for example, the Defence Electronic Systems sector plan noted that “firms will require more assured continuity of work than they currently enjoy in order to

Managing Defence Demand 60 A Profile of the Australian Defence Industry

secure returns on their investments and to minimise the disruption of ‘ramp ups’ and ‘ramp downs’…”58 Similarly, in discussing through-life support of ADF aircraft, the Defence Aerospace sector plan indicated that “If critical industry capabilities are to be sustained in country, a new approach to Defence procurement is needed. This new approach would involve the development and contracting to industry of long term, through life support packages, including major upgrades where appropriate..”59. As the Defence Electronics Systems sector plan pointed out, however, bundling defence work into strategically linked packages would have major implications for both Defence customer and industry supplier. It would, for example, concentrate commercial opportunities into significantly fewer tenders and would diminish Defence’s scope to manoeuvre in the market post- contract. The White Paper recognised that partnering will become commonplace for significant defence procurements.60 The NSR Plan developed this notion extensively and explored the alliance contracting and other formal business arrangements required to manage a relationship between Defence and a sole source supplier of naval combatants (and supporter of submarines) in considerable detail. The relevance of these arrangements was reaffirmed in the Government’s recent announcement of the way forward for naval ship building: “Tenderers for the AWD contract will be asked to bid on the basis of an alliance relationship with the Commonwealth. An alliance contract will reflect all of the key commercial principles that will govern the relationship and will rely on providing incentives to the parties to minimise costs.”61 The Defence Aerospace sector plan foreshadowed similar sorts of arrangements, noting that the prospect of greater commonality of platforms combined with long term commercial partnerships (which could last 20 years or for life of type) among industry partners and between Defence and the industry will: • create the volume and predictability of business required for sustainable investment in capabilities critical to local support; • reduce the cost of ownership for Defence; and

58 Electronics sector plan, op cit, page 85 59 Aerospace sector plan op cit page 70, para 4.24 60 White Paper, op cit, page 106 61 Minister for Defence media release 27 May 2004, op cit, page 1

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• increase Defence leverage on overseas original equipment manufacturers to include internationally competitive Australian companies in global supply chains. Accordingly, the Defence Aerospace sector plan devoted a chapter to principles and practices that might be used to manage long term partnerships on a mutually beneficial basis. 62 Such an approach would also have potentially important implications for wider Government procurement policies, for which the Department of Finance and Administration is responsible.

Recommendation 7

Competition remains a key instrument for containing costs and stimulating innovation but .project-by-project competition does not always create sufficient incentive for companies to invest in the capacity required to meet Defence strategic planning requirements. Defence can create stronger incentives for companies to make such investments by linking projects strategically and inviting companies to compete for the resulting “bundles” on the basis that Defence and the winner form a long term partnership. Industry should consult the Departments of Defence and of Finance and Administration about agreed principles for: • linking separate projects strategically; and • establishing and managing Defence–industry partnerships for undertaking selected, strategically linked Defence projects. The Defence Capability Advisory Forum is appropriately constituted to guide the work of the Defence Contracting Consultative Forum in pursuing an initiative along the above lines.

4.5.1 Evolutionary acquisition and spiral development

Spiral development is a program for mitigating risk prior to major investment in production. Evolutionary acquisition through long term contracts enables defence capabilities to be upgraded in a planned way from the delivery of a specified initial capability to eventual achievement of a full capability. Evolutionary acquisition and spiral development are closely related processes. Under long term contracts and subject to appropriate project management and a particularly close relationship between all stakeholders, evolutionary acquisition and spiral development: • enable both the Defence customer and the supplier to learn from experience with the initial capability and its subsequent increments; • reduce the risk inherent in introducing major technological improvements in a single step;

62 Aerospace sector plan, op cit, pages 99-118.

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• enable a capability to incorporate evolving technology as it becomes available; and • help avoid acquisition of obsolescent items by avoiding early commitment to the final capability system. Importantly, neither spiral development nor evolutionary acquisition precludes use of competition to contain costs or to stimulate innovation. In the case of system intensive development, the strategic level innovation is in the integration of subsidiary systems and components. It is at this level that long term relationships between defence customer and prime supplier are the most economically efficient way of fostering knowledge and harvesting learning. Conversely, as subsidiary systems and electronic components become increasingly ‘commodified’, open and effective competition arrangements are more likely to yield best value for money. The US makes extensive use of evolutionary acquisition and spiral development processes. For example, the AEGIS combat system which Australia will procure for the air warfare destroyers are currently in their seventh phase of development over a 30 year period. In Australia Defence is already experimenting with this approach. For example, Defence is planning to award companies involved in development of the Jindalee Over-the-Horizon Radar Network and related projects an additional long-term contract for enhancement of JORN (JP2025 Phase 5). The enhancements relate to signal processing, algorithm improvements, data fusion/integration and distribution, and man-machine interface improvements and will be undertaken in close collaboration with DSTO in a facility built by Defence for the purpose. Taken together these JORN enhancements constitute a program of spiral development and risk minimisation in which the long term contract program underpins the company’s investment in specialisation and learning. Over the next decade and beyond, Defence plans to integrate progressively the separate components of information capability into a comprehensive information network which will underpin network-enabled operations. In principle, this network will comprise: • a sensor grid (which collates real time information from every kind of sensor to create a shared picture of the battlefield); • a command and control grid (which will allocate targets and decide manoeuvre on the basis of the shared picture of the battlefield compiled from the sensor grid and other sources); and

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• an engagement grid which will execute the decision of the command and control grid using whichever Army, Navy or Air force ‘shooter’ is best equipped and located to deal with the designated target.63 The limited application of spiral development and evolutionary acquisition arrangements in the Australian context have, to date, been applied to stand- alone defence electronic systems. In future, however, such arrangements are likely to become increasingly important as less systems-intensive projects (for example Army field vehicles and trailers) are viewed in terms of their role in network-enabled operations rather than as platforms in their own right.

Recommendation 8 Industry’s capacity to supply and support individual platforms and systems will remain important for the foreseeable future. Defence strategic planning requirements, however, will place increasingly more emphasis on industry’s capacity to optimise individual defence capability outputs for network enabled operations. The extent to which defence industry builds on existing capacity while remaining aligned with evolving defence strategic planning requirements will increasingly depend on how Defence manages the procurement of defence information capability, either embedded or stand alone. The business model being used for Phase Five enhancements of the Jindalee Over the Horizon radar demonstrates how evolutionary acquisition and spiral development principles in long term contracts can be applied in the Australian environment. Industry should consult Defence about extending the business model for JORN Phase 5 enhancements to other defence information capability developments foreshadowed in the Defence Capability Plan 2004-14. The Capability Development Advisory Forum is appropriately constituted to oversight such an initiative.

4.6 Coordinating demand management

In June 2004, the Minister Assisting the Minister for Defence announced that Cabinet had agreed to implement the Defence Electronic Systems Sector Strategic Plan and the Defence Aerospace Sector Strategic Plan. In making this announcement, the Hon Mal Brough MP also indicated that Defence is to develop more detailed arrangements to implement the sector plans over July- September 200464. To this end he called for “revised consultative arrangements and working groups that acknowledge the new reforms in Defence procurement.”65 These arrangements will include a Ministerial

63 Ibid 64 Speech to the Defence and Industry Conference 2004 by the HON Mal Brough MP, 22 June 2004, page 1 65 Ibid

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Council to oversight more focussed work on demand management, capability fore-sighting, and capacity building.66 The work by ACIL Tasman and others required to prepare this Profile of defence industry has necessarily paralleled development of the initiatives announced by Mr Brough. This Profile advocates maximum use of established Defence and industry consultative arrangements in general, and of the Capability Development Advisory Forum (CDAF) in particular. At issue, therefore, is the relationship between: • on one hand, the work foreshadowed by Mr Brough on demand management, capability fore-sighting and capacity building by the Ministerial Council and associated working groups; and • on the other hand, the role of the CDAF in pursuing the recommendations concerning demand management in Section 4 above and concerning defence industry enablers in Section 5 below. ACIL Tasman was advised that terms of reference for the above Ministerial Council and associated sector plan working groups are still being finalised. Preliminary discussions suggest, however, that actions required to implement the recommendations of, respectively the sector plans and the Profile are mutually reinforcing with: • the sector plans drilling down to the requirements of specific sub sectors (eg mobile military communications and electronic warfare) and projects (eg AIR 9000 and other aerospace projects); and • the Profile addressing demand management and other industry capacity development themes that include those canvassed in the aerospace and electronic sector plans but go further to include other defence industry sectors. Recommendation 9 The actions recommended in this Profile to align defence industry capacity with defence strategic planning requirements were developed in parallel with initiatives to implement the sector plans for defence electronics and defence aerospace. Implementation of recommendations flowing from, respectively, the Profile and the sector plans needs to be coordinated. Industry should consult Defence with a view to obtaining Ministerial agreement to broadening the ambit of the proposed Defence Industry Ministerial Council to include oversight of: • action to align defence industry capacity with defence strategic planning requirements in accordance with the recommendations in this Profile; and • initiatives to implement the recommendations in the strategic industry sector plans for Defence Electronic Systems and Defence Aerospace.

66 Ibid.

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5 Defence Industry Enablers

The previous section of the profile canvassed how defence demand might be managed with a view to fostering high priority defence industry capabilities. This section of the profile analyses how the following factors can complement and reinforce demand management in reinforcing companies’ incentive to invest in the capacity to supply defence force structure and support defence preparedness more effectively: • exports; • access to overseas IP and technology; • domestic R&D; and • access to skilled personnel.

5.1 Exports by Defence-Related Industries

This section of the profile: • explains the term “defence industry-related exports” and why such exports are included in the defence industry profile; • analyses the pattern of Australian defence industry-related exports; • describes the characteristics of Australian defence exporters; and • analyses the impact of Australian defence export controls.

5.1.1 Exports as a defence industry enabler

The term “defence industry-related exports” denotes exports of those goods and services the production of which exercises Australian industry capacity either directly or indirectly relevant to supply and support of defence capability. As such, defence industry-related exports encompass more than military goods like infantry weapons and ammunition. For reasons explained in Section 3 of this profile, such exports also encompass overseas sales of, for example: • fast ferries; • special purpose vehicles; • civil aerospace components; and • a broad range of services related to engineering and information and computing. Annual defence expenditure on individual capabilities can vary considerably and this volatility can leave defence suppliers exposed to considerable commercial pressure. Hence by exporting goods and services comparable to

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those consumed by Defence, companies can offset the volatility inherent in defence business and sustain defence-related capacity on a more commercially viable basis than otherwise. Within this general framework, however, defence industry-related exports advance more specific defence industry policy objectives discussed in the following paragraphs. Production of consumable items like munitions can be scale intensive. In these cases exports can result in lower prices for defence and better returns for the supplier. A case in point is the export of propellant produced for the ADF by ADI at the Mulwala explosive factory. Both Defence and ADI benefit from ADI’s propellant exports: • ADI obtains more revenue than it would secure from servicing the Australian defence market alone; and • Defence has access to a domestic ammunition supplier (including a capacity to surge production in a defence emergency) more cheaply and efficiently than otherwise. Development of innovative solutions to defence requirements can entail substantial commercial risks. This is particularly the case where Defence demand is limited relative to the cost of developing the product concerned and of subsequently keeping it competitive in military terms. The Australian Minesweeping System illustrates how exports can create an incentive for both Defence and the company involved to invest in further development of the product concerned – see Box 6.

Box 6 Exporting the Australian Minesweeping System

Australia has a compelling interest in ensuring that its sea lanes and those of its neighbours are adequately protected from anti-shipping mines. DSTO developed the Australian Minesweeping system (AMASS) to counter modern mines. In 1992 ADI purchased the license to manufacture AMASS and has since sold some $50 million worth of the systems, of which some $40 million was to overseas customers. Under the 1996 Mine Warfare Industry Alliance between the two parties, ADI invests in on-going research, development and marketing of the systems while DSTO reinvests significant royalty revenues to further develop the system.

In other cases, exports involving technology with dual civil and military applications can enable companies to meet defence requirements far more cost effectively than would otherwise be the case. For example, what is now Thales Underwater Systems sells solid, thin-line towed sonar arrays for marine geophysical survey work which were an adaptation of arrays developed in early collaboration with DSTO for anti-submarine warfare. In this case, the ADF has access to a world class domestic sonar capacity which has sold more than 700 kms of towed arrays for petroleum exploration worth $320 million (which dwarfs ADF usage).

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Successful exports can foster efficiencies that companies can exploit in competing for Australian defence contracts. Hence, for example, exports of patrol boats (based on the Bay Class vessels operated by the Australian Customs Service) enabled AUSTAL to minimise workforce learning and other ramp-up costs in producing the new Armidale patrol boats for Navy. Sales to the ADF are normally a precondition for Australian sales to overseas military customers. AUSTAL’s participation in US Navy’s littoral combat ship program and that Navy’s trialling of CEA Technology’s active phased array radar are encouraging indications of Australian companies looking to global markets from the outset. Should this activity result in overseas sales, Australian defence customers have access to tested innovations and proven suppliers. Finally, exports can enable a company to sustain a local capacity to meet latent defence demand. Exports by Hawker de Havilland of F/A-18 airframe components to Boeing (and also of aircraft control surfaces to Airbus) are a good example. In this case, the company does not sell to Defence directly and is entirely dependent on overseas demand for its products. Such exports sustain an option for Defence to access a proven domestic source of such components should the need arise.

5.1.2 The pattern of Australian defence-related exports

As explained in greater detail in the accompanying technical volume, the basic tool for analysing the export of goods is the Australian Harmonised Export Commodity Classification (AHECC). All exporters are required to classify individual goods exported by AHECC and to record the value of exports so classified in the Customs EXIT data base. Access to the EXIT data base is confined to appropriately authorised Commonwealth personnel. Accordingly, the staff of the Defence Trade Control and Compliance Section (DTCC) of the Department of agreed to extract specified AHECC data and provide it to ACIL Tasman for the study. The results of this analysis are shown in Appendix F. No comparable system exists in Australia to record the export of services. The ABS uses quarterly surveys to estimate the nature, scale and destination of service exports and publishes the results in the ABS catalogue Number 5368: “International Trade in Goods and Services, Australia”. As explained in the technical volume accompanying this report, this data proved too coarse for defence industry profile purposes. Hence the profile relies on service export data gathered through the Defence Industry Survey.

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The export of defence goods and of defence-related goods

Defence’s DTCC staff interrogated the EXIT data base to obtain the value of exports for 1999-00, 2000-01 and 2001-02 classified by AHECC and by country of destination. The AHECC so nominated included not only military goods but also defence industry–related exports, the production of which could exercise industry capacity broadly relevant to supply and support of the ADF.

Defence industry–related exports involves a large number of transactions worth, in total, over $2.9 billion in the three years to 2001-02 (and worth over $1 billion in 2001-02 alone). These exports are classified by region by year in Chart 2 below.

North America (predominantly USA) is by far the largest single buyer of Australia’s defence industry-related exports, accounting for 28% of the total of such exports for the three years to 2000-02. The next largest buyer was the South Pacific (predominantly NZ), accounting for 17% of the total, followed by South East Asia (which accounted for 16.4%). In the three years to 2001-02, aerospace products constituted the largest single product category sold to North America, accounting for 42% of the $828.5 million worth of defence industry-related exports to that region. Aerospace products also constituted the largest single category of defence industry related exports in the three years to 2000-02, accounting for nearly 44% of the $2.9 billion of total exports of defence industry related goods in that period. Aerospace products also dominated sales to the South Pacific, accounting for about 54% of the $499.1 million worth of defence industry-related exports there in the three years to 2001-02. On the other hand, sales of maritime products dominated sales to South East Asia in the three years to 2001-02, accounting for nearly 39% of the $480.4 million worth of defence industry- related sales to that region.

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Chart 2 Exports of Defence industry-related goods by region by year

900 800 700 2001 600 2000 500 1999 m 400$ 300 200 100 -

a ic a e a st a ia ic s ia ia e ic t in p ic a ic s if e s s p fr rc h o r E r A c r A A o a r e e a to t r A t C u m le m th P S th s u n E d A r t u a E A n A d o f o E n r in i th N ra S r te t M r c th te s a o ir u s a L N A o e E d S W n a s ip h S

Data source: ACIL Tasman, based on data supplied by DTCC

After aerospace products, those incorporating information technology constituted the second largest category of defence industry-related exports – accounting for about 35.5% of such exports in the three years to 2001-02. While North America was the largest single buyer of IT-based exports (accounting for nearly 23% in the three years to 2001-02), Africa was the next biggest buyer (accounting for nearly 16% in the same period), followed by South East Asia (12.3%), South Asia (12.1%) and the South Pacific (10.7%). Defence industry-related exports are volatile. For example, aerospace exports to North America totalled $234.3 million in 1999-00, fell to $25.9 million in 2000-01 and rose to $277.5 million in 2001-02. Similarly, for example, overall exports of maritime products totalled a robust $321.9 million in 1999-00, fell to $8.8 million the next year, before rising to $83.9 million in 2001-02. This volatility suggests that, with the exception of certain niche products (see below), defence industry related exports are unlikely to supplant domestic defence demand as the main driver of defence industry capacity for the foreseeable future.

Exports of defence industry-related services

Of those Defence Industry Survey respondents that had exported in the last three years, 47% had exported services worth in total $185 million in 2000-01; $287 million in 2001-02; and $292 million in 2002-03 – see Table 9.

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Respondents indicated that, on average, services accounted for about one quarter of their total exports in each of the last three years. On this basis, an indicative estimate for total exports of defence industry-related goods and services is $1.6 billion in 1999-00; $750 million in 2000-01; and $1.25 billion in 2001-02.

Table 9 Service exports

Companies reporting Total export Average service service exports revenue ($m) exports per company ($m)

2000-01 23 185 8.042 2001-02 22 287.2 13.056 2002-03 24 292 12.162 Data source: Defence Industry Survey

The US-Australia Free Trade Agreement

Because of the importance of the United States as a buyer of Australian defence industry-related exports, the study assessed the implications of the US- Australian Free Trade Agreement (FTA) provisionally negotiated by the US and Australian Governments in March 2004. In effect, both Governments have agreed to remove their respective defence procurement from the ambit of the FTA67. In addition, the US Government has expressly removed from the ambit of the FTA the US Merchant Marine Act 1920 (U.S. Code 883: The Jones Act)68 which prohibits US imports of foreign ships. This does not mean that the US DoD (and related organisations like the US Coast Guard) are precluded from purchasing from Australian companies. It does mean, however, that conclusion of the FTA would not effect existing US policy and legal provisions relevant to Australian defence exports. This is not to say that the FTA is irrelevant for defence industry profile purposes. The US Defense Federal Acquisition Regulations (DFARS) make standing provision for US procurement duty free of a specified range of non- military and non-strategic products from countries with whom the US has concluded a free trade agreement69. In addition, the US will waive the current 50% tariff imposed on in-voyage repairs under 19 USC 1466 (Equipment and

67 See FTA Chapter 15 Annex A page 3 for Australian exemptions and page 7 for US exemptions. 68 See Free Trade Agreement, Annex 2-A, Section A page 2-10 which expressly removes the Jones Act from FTA Article 2.2 (re national treatment) and FTA Article 2.9 (Import and Export Restrictions). 69 See DFARS Sub Part 225-401-70: the products so listed include, for example, certain transport equipment and related consumables, pumps and compressors, training aids and devices and general purpose ADPE, software, supplies and support equipment.

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repair of vessels), in turn enhancing opportunities for companies based in Fremantle and Darwin to do such business with the US Navy.

Exports to Latin America

The Defence Industry Survey included, at the instigation of the Department of Foreign Affairs, questions designed to gauge interest in a Latin America export initiative. Of those who answered this question: • 6% already exported to Latin America; • some 21% had considered exporting there; • 6% had encountered problems in doing so; and • 18% indicated they would support a Latin American defence export initiative.

5.1.3 Australian Defence exporters

Overseas markets constitute an important adjunct to the Australian market for actual and potential defence suppliers: 44% of Defence Industry Survey respondents indicated that they had exported goods and/or services (both defence and non-defence) over the three years to 2002-03. Survey participants were also asked about constraints on their ability to export. Responses to this question are summarised in Table 10.

Table 10 export constraints

Export Constraint Total Critical Significant Somewhat Unaffected

Competition from overseas suppliers 58 11 22 17 8 Priority for Australian customers 40 4 8 13 15 Lack of information 48 6 12 21 9 Foreign government policies 47 9 15 19 4

Respondent supplied answers Commercial constraints 32 6 19 7 Local content preference 1 1 Transport costs 1 1 Cost of international business 1 1 Growth capital 1 1 Change in market requirement 1 1 Australian competition 1 1 Australian dollar 1 1 Data source: Defence Industry Survey

Of those respondents who exported, 38% indicated that competition from overseas suppliers was a significant constraint on their ability to export but only 19% indicated that such competition was a critical constraint. This suggests that,

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within their respective niche markets, Australian companies are fairly competitive internationally. Defence and AUSTRADE officials work actively with companies both directly and through the Defence Export Council to identify export opportunities and to pursue them on a coordinated basis. Despite this support, 38% of exporters indicated that they were constrained by a lack of information. Foreign government policies constituted a significant or critical constraint on the ability of 51% of respondents to export. Follow-up discussions suggest that the policies concerned have much in common with, for example, the Australian Industry Involvement Program. Survey participants were also asked to indicate the extent to which they used various commercial arrangements to export goods and services. The arrangements specified and the associated responses are indicated in Table 11.

Table 11 Business arrangements for export

Export Arrangement Total Often Sometimes Rarely Never

Agent 49 16 17 11 5 One off direct 55 13 32 10 Repeat to regular 54 30 14 9 1 Long term contract 42 15 9 10 8 Supply chain 31 10 5 5 11 Transfer within group 32 7 8 3 14 Data source: Defence Industry Survey

The prevalence of sales to regular customers, sales under long term contracts and sales within a supply chain suggests that exports are an important and durable element of the business strategy of the 44% of respondents selling overseas.

SMEs and Exports

Responses to the Defence Industry Survey suggests that the smaller companies populating Australia’s defence industry derive a much larger proportion of their income from exports than do the larger companies in that industry – see Figure 3. This result is counter to the conventional wisdom that successful exports require a commitment of resources of a nature and on a scale that is only practicable for larger companies. It warrants closer examination by industry, and agencies with export related responsibilities in both Commonwealth and State/Territory governments.

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Figure 3 Exports by firm size d

e 1.2 t r o

p 1 x E t

u 0.8 p t u 0.6 O f o 0.4 n o i t r 0.2 o p o r 0 P 0 100 200 300 400 500 Employment (Pax)

Data source: Defence Industry Survey

5.1.4 Australian Defence export controls

The Australian government, in concert with Australia’s friends and allies, controls the export of military goods, non-military lethal goods and strategically sensitive goods with dual civil and military applications. Such controlled goods are a sub-set of the defence industry-related exports discussed above. In 2000-0170, the total value of Australian exports so controlled comprised: • $37 million worth of military goods, over 67% of which went to the USA; • $9 million worth of non-military lethal goods, of which over 72% went to South East Asia and the South West Pacific; • $555 million worth of dual use exports, mainly to New Zealand (30%), ASEAN (24%) and North America (22%). The commercial significance of military goods exported to the US should not be overstated: Such exports include numerous ADF goods (for example, guided munitions) returned to US-based original equipment manufacturers for maintenance, repair and refit.

70 This is the latest available data which was published by Defence in February 2002. Responsibility for defence export controls has been transferred the Defence Materiel Organisation to the Strategy Group in the Defence Department: see www.defence.gov.au/strategy and follow the prompts for export controls

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The Defence Industry Survey suggests that Australian defence export controls affect the commercial activities of relatively few companies: Respondents indicated that just over 7% of the value of their exports required Australian Government export licenses. The Australian government is broadening the range of goods subject to such controls and/or administering the controls more stringently as part of an international effort to counter terrorism and the spread of weapons of mass destruction. Australian agreement to introduce controls on the export of services in return for greater access to US intellectual property (see Section 5.2.1 below) would entail a major expansion of the current export control regime. Suppliers of defence and defence–related goods and services have a strong interest in ensuring that, in administering Australia’s defence export controls, Defence and other Government agencies continue to balance politico-strategic constraints and commercial imperatives in a transparent way.

Recommendation 10

5.2 Access to Overseas IP and Technology

The 2000 Defence White Paper reaffirmed previous guidance that Australia’s access to many important overseas technologies renders complete defence

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industrial self sufficiency neither realistic nor necessary.71 Australian companies play a key role in obtaining overseas intellectual property and using it in the supply of Australian defence force structure and the support of Australian defence preparedness. Well over 40% of respondents to the Defence Industry Survey indicated that in the last three years they had imported intellectual property, technology, goods or services. Of those that did import such items, some 29% frequently applied for foreign government export licenses themselves, while 52% relied on overseas suppliers to do so on their behalf – see Table 12.

Table 12 Application for foreign government export licences

Self obtained permission Supplier obtained permission

Never 26 12 Rarely 9 15 Sometimes 7 15 Often 7 10 Data source: Defence Industry Survey

5.2.1 Access to US intellectual property: US policy and processes

In its Defence White Paper, the Government noted that “The kind of ADF that we need is not achievable without the technology access provided by the US alliance.”72 The US Government manages release of military technology to other countries so as to protect US security interests and to advance US foreign and defence policy objectives. The policy and legal framework for these controls is summarised at Appendix E. For the purposes of the present study, it is helpful to distinguish between: • US exports of unclassified military hardware (including components and finished goods) which, while not prejudicing US military superiority, do engage US security or foreign policy interests; – for example, shoulder fired missiles or munitions access to which could facilitate, say, terrorist operations; and • US exports of more sensitive technology (which may be either classified or unclassified) export of which the US controls primarily to protect the combat superiority of US forces. It is US controls on export of the latter, more sensitive technology that is of prime concern in the present context. Particularly relevant here is the general requirement for US defence exporters to obtain an export licence from the

71 Defence 2000: op cit page 99 paras 9.6 -9.7. 72 Defence 2000: op cit page 35 para 5.9

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State Department's Office of Defense Trade Controls (DTC) for each stage of an international defence sale, including marketing, industry discussions, placing a bid, and the export itself. In addition, when technical data is to be transferred, or defence services are involved, DTC approval is required for a Technical Assistance Agreement which the Australian and US companies are required to sign jointly. These requirements, which can take 2-3 months to approve, can obviously make marketing by US companies to potential Australian defence customers a protracted affair. More importantly for defence industry profile purposes, however, is the impact of such requirements on the transaction costs incurred by US companies seeking to team with Australian companies in supplying US- origin systems to meet Australian defence requirements. Having crossed this threshold and on receipt of US licensed technology, the Australian importer becomes responsible for custody of that technology throughout its life. The importer must obtain prior written US Government approval before re-exporting, reselling or otherwise disposing of the material and guaranteeing to protect that technology from access by unauthorised third parties. This can impact directly on the governance of the companies concerned – see Box 2.

Box 7 Impact of US Export Controls

The Victorian Civil and Administrative Appeals Tribunal (VCAT) granted Boeing Australia an exemption to the Equal Opportunity Act enabling the company to require foreign nationals it employs to wear different identification and to restrict their computer and technology access:

“Boeing told VCAT the exemption was necessary because the US State Department required that it not “transfer technical advice, defence articles, or furnish defence services to any person who is not an ‘Australian national’ or US person. The company could lose its American export market for up to three years if it refused to meet these conditions..”73

Access to US Intellectual Property: ITAR Exemptions

In 2000, in an attempt to streamline these requirements, the Australian and UK Governments accepted an invitation by the then Clinton Administration to negotiate an exemption from US export licenses otherwise required for a range of unclassified but sensitive US defence technology. The invitation was part of that Administration’s Defense Trade Security Initiative. The proposed exemptions, which essentially parallelled those already enjoyed by Canadian

73 The Age Friday, March 5, 2004, page 1

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companies, encompassed unclassified hardware, technical information and services like R&D. Australia’s existing export controls do not cover a number of fundamental US requirements including: • the export of sensitive technical information by intangible means (ie, by e- mail, facsimile, telephone or direct personal communication); • the internal transfer (within Australia) of goods or information from one company to another; • the export of defence related services. The US sought an agreement addressing these issues for all US defence articles, and not just for ITAR exempt material. The US also sought the enactment of Australian legislation to control intangible transfers as a prerequisite for an ITAR exemption.74 As Boeing Australia’s experience illustrates, any such agreement could have significant implications for the governance of the companies concerned, including: • the nationality of the company’s owners and employees; • the cost of compartmentalising workforce and management; • the additional overheads required to establish credible arrangements to administer intangible transfer controls and to manage service exports. Accordingly, Australia secured US agreement to the voluntary accession to the ITAR exemptions by those individual Australian companies that judged that the benefits of such exemptions outweighed the costs they incurred in obtaining them. Under the proposed agreement, Defence undertook to review and accredit the technology security arrangements instituted by those Australian companies wishing to obtain ITAR exemptions. Defence envisaged using the established Australian Defence Industrial Security Arrangements as a starting point for such accreditation. Following referral by the US Administration to the US Congress for endorsement in mid-2003, however, the proposed agreement was strongly opposed by the US House of Representatives (the US Senate is reportedly more supportive). In a committee report, the House of Representatives drew attention to the potential importance of the precedent set by the Australian (and UK) agreement and criticised the lack of clarity in the Australian agreement about:

74 See page 7 of the Industry Handout distributed on 7 October 2002 by Defence’s Director, US Export Control Systems, Mr Steve Hyland and entitled “International Traffic in Arms Regulations (ITAR) Exemption”.

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• the US Government’s right to obtain prior written consent for third party transfer and access; • the domestic legal framework underpinning the Australian government’s commitments; • Australia’s willingness to enact the new laws and regulations to meet the above fundamental US requirements. 75 In addition to engaging Australian commercial interests, this issue also engages Australian strategic interests.

Access to US Intellectual Property: Defence project implications

In a performance audit of management of the Wedgetail Airborne Early Warning and Control Project, the Auditor General noted that a lack of US Government export licenses for some of the project’s advanced technology had precluded local industry gaining contracts worth some $44 million in such areas as: • design and development of Wedgetail sensors, mission systems, communication systems, electronic warfare systems electronic support systems and tactical intelligence sub-systems; • system integration tasks sufficient to enable local industry to support Wedgetail systems and associated test and support systems; • full through life support of AEW&C, including software and systems integration, a through life test and evaluation capability, and operational and logistic support.76 Elsewhere in the same report the Auditor General noted that similar constraints imposed by DTC had limited Defence’s ability to verify and validate certain hardware, software, technical documentation/data, and know how as part of the project’s test and evaluation program.77 For defence industry profile purposes, the main significance of the Boeing Australia experience and the Wedgetail experience lies in: • the implications for the governance of Australian companies owned by third country nationals and the need to distinguish between ownership and unauthorised third party access; and • the scope for the Australian Government to conclude project-specific Technical Assistance Agreements and related understandings with the US

75 “US Weapons Technology at Risk: the State Department Proposal to Relax Arms Export Controls to Other Countries” Report by US House of Representatives Committee on International Relations, May 1 2004, page 28. 76 Audit Report No. 32 2003-04, ‘Wedgetail’ Airborne Early Warning and Control Aircraft: Project Management”, February 2004, page 44 77 Ibid, page 58.

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State Department with a view to establishing umbrella arrangements that facilitate access by Australian companies to US technology on a case-by- case basis. The US Defence community itself allows non-US ownership of strategically sensitive companies provided those companies can demonstrate that their governance enables them to protect US strategic interests by quarantining management from ownership. For example, the UK-based Nautronix Plc owns: • Nautronix Pty Ltd based in Fremantle, Western Australia, who is responsible for the development of sensitive undersea communications technology for both Australian and US defence applications; and • Nautronix MariPro located in California whose core business is supply and support of undersea ranges for the US Navy.78 From a US Government perspective, however, Nautronix Maripro is managed and staffed by US citizens to the same extent as, and is subject to exactly the same legal and policy constraints as, a fully US-owned and US-controlled company. This sort of arrangement is indicative of the governance the US is likely to require as a pre-condition for release of controlled technology to Australian-domiciled companies owned by third parties.

Recommendation 11

78 See www.nautronix.com/maripro/maripro_company

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5.3 Research, Development and Innovation

This section of the profile addresses: • different models by which Australian industry contributes to defence R&D; • innovation in defence industry; and • Defence R&D in the national R&D base.

5.3.1 Defence R&D in Australian industry

The study identified three defence R&D business models for defence industry profile purposes: • company-led R&D; • Government-led R&D; and • the shared public-private R&D. These three models are best discussed in terms of the nine standardised technology readiness levels used by the defence scientific community to explain the technological risk inherent in particular proposals. These levels are illustrated in Figure 4 below.

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Figure 4 Technology readiness levels

High Risk Low Risk for for Product Launch Product Launch P R O 8 9 D System System qualified qualified U through through C test & mission demonstration operation T I TECHNOLOGY 6 Prototype O READINESS Prototype System demonstration Prototype N LEVELS in in TRLs relevant operational environment environment

4 5 Component Component validation validation in in Laboratory operational environment environment

1 2 3 Basic Technology Active principles concept R&D Capability and Technology observed and/or Proof Demonstrator (CTD) and application of reported formulated Concept

Concept Concept Full Scale Engineering Development Production Definition Demonstration

Technology Development Product Development

Data source: DSTO

The company-led R&D model

The Metal Storm (MS) weapon technology is one of the few military technology innovations identified during the study which Australian private interests took from Technology Readiness Levels (TRLs) 2/3 to TRLs 5/6. The technology, which was first demonstrated in the early 1990s, involves electronic ignition and sequential firing of multiple stacked bullets in a single barrel. In theory, the technology enables accurately controlled firing of millions of rounds per second. Metal Storm has concluded research and development agreements with the US Defense Advanced Research Projects Agency (DARPA) and the Defence Science and Technology Organisation (DSTO).

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Of prime interest for defence industry profile purposes is DSTO’s use of the Capability and Technology Demonstrator (CTD) program to develop the Metal Storm technology.

The Capability and Technology Demonstrator (CTD) program

A CTD is a project that demonstrates how well established technology may be operationally exploited to enhance defence capability in a previously unexplored manner. The CTD Program was established in 1997 and is managed by DSTO on behalf of Defence as a whole. The CTD Program: • focuses on technology-driven capability; • aims to provide opportunities to demonstrate how advanced technology can enhance defence capability in priority areas; • allows Defence and industry to share risks and rewards in exploring useful technology developments. Because resources are limited, CTDs must be sponsored by a Defence element with a defence capability development function and compete for funding in the financial year in which they are nominated. They should be able to demonstrate capability within about three years of acceptance and CTDs typically cost less than $4million all up. Responses to the Defence Industry Survey suggest, however, that to date the CTD program has made little impact on commercial decision making. Only nine companies considered the CTD program either moderately or highly important. This is probably because of the modest size of the program. In each of the last three years Defence has spent some $12-15 million p.a on CTDs. Since the program’s inception in 1997, some 31 technology demonstrations have been undertaken, of which 11 have been completed to date.79 DSTO advises that, of the demonstrations so completed, about one quarter have led to use of the technology in defence applications: For example, the hyper-acoustic communications link developed by Nautronix was incorporated in Navy’s low-probability-of-intercept sonar program. Defence is providing extensive assistance to help Hawker de Havilland develop the Joint Direct Attack Munition-Extended Range. In addition to CTD funding, this assistance includes access to the DSTO wind tunnel and flight testing by Air Force’s Aeronautical Research and Development Unit, the total value of which is worth an estimated $5million-$6million. This warrants closer examination as an example of how public and private interests can share the cost and risk of defence R&D.

79 DSTO advice.

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More generally, companies – particularly SMEs - can have difficulty funding the development of technology to the point at which it is sufficiently mature to be a candidate for the CTD program. In addition, SMEs can have major difficulty maintaining a team in anticipation of a successful CTD application while Defence evaluates that application. Accordingly, the Government has announced80that it will provide: • seed money to help bridge the gap between company efforts and CTD requirements; and • modest funding of CTD-related activity pending the outcome of Defence consideration of the application. These funds are not yet available and the criteria for assessing eligibility not yet established.

The Government-led R&D model

The risk inherent in development of new solutions to Defence requirements has in the past led DSTO to extend initial research (TRLs 1-3 in Figure 4) through to the product development (TRLs 6/7). DSTO then licensed the developmental technology to a company which assumed responsibility for taking the technology to production and marketing it (TRLs 8-9 in Figure 4). Prominent examples of such Government-led innovation in the defence area include: • Jindalee over-the-horizon radar network • Laser airborne depth sounding System • Nulka anti-ship missile decoy system. The above government-led R&D model has shielded Australian companies from much – but by no means all – of the risk inherent in military-specific technology development. Its disadvantage, however, is that opportunities for harnessing commercial resources for technology development come late, thereby increasing the cost to Defence. A case in point is development of the JDAM-ER stand-off weapon already mentioned. Much DSTO development had focussed on maximising the glide range of the weapon. In exploring the international market for such a weapon, however, Hawker de Havilland found greater customer interest in the simplicity, cheapness and ruggedness of the JDAM-ER test vehicle. Earlier DSTO-industry partnering might have positioned the weapon for a broader market, obviated much nugatory research by DSTO and given Air Force the option to procure a stand-off weapon more cheaply and earlier than otherwise.

80 Speech by the Hon Mal Brough MP to the Defence and Industry Conference on 22 June 2004.

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DSTO now places less emphasis than previously on its role as technology developer and places greater emphasis on provision of technology advice in support of the defence capability development process. Hence, in future, DSTO’s role in technology development is likely to be confined increasingly to concept definition/demonstration with limited involvement in full scale engineering development (TRLs1-5 in Figure 4). In these circumstances, the nature and scale of locally developed solutions to defence capability requirements will depend heavily on how effectively DSTO and industry collaborate in moving from component validation in laboratory and operational environments through to trialling a system prototype in an operational environment (TRLs 5-7 in Figure 4). The study therefore investigated scope for concurrent, public-private R&D in the defence area.

The shared public-private R&D model

Defence technology is changing rapidly in areas like information capability. In these circumstances, DSTO and companies are tending to share costs and risks from the outset by forming project-specific alliances and technology specific research agreements across the interface between the public and private sectors. DSTO advises that these arrangements for public/private risk sharing are likely to become increasingly prevalent in the concept demonstration stage (TRLs 2- 3 in Figure 4). In principle, the seed money and the augmented CTD program announced by the HON Mal Brough and the Chief Defence Scientist on 22 June 2004 will help companies participate in these arrangements. Clearly, however, such funding will remain modest relative to the resources required to take a defence technology from concept (TRLs 2-3) to prototype (TRLs 8-9). Such funding is most unlikely to ever be a viable substitute for the prospect of earning substantial profit as an incentive for companies to invest in defence-oriented R&D. The proper basis for seed funding and augmentation of the CTD program is therefore not generalised subsidies but risk identification and risk management. At issue is the appropriate commercial arrangements between DSTO and companies to do business on this basis. Economic theory suggests that each party to a commercial joint venture contributes to a shared development up to the point at which the marginal costs they incur equal the benefits they expect to gain in terms of shared risks and commercial rewards. These principles might usefully inform development of the mechanisms foreshadowed by the Chief Defence Scientist to facilitate early involvement of industry in Defence R&D. One potentially

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important mechanism is the Defence Science Access Network (DSAN) announced on 22 June 2004 and intended to help align DSTO priorities and programs with industry research capabilities. Related issues are canvassed in the following discussion of innovation in defence industry.

5.3.2 Innovation in the defence industry

Participants in the Defence Industry Survey were asked about their strategies for innovation. Responses are summarised in Table 13 below.

Table 13 Focus of innovation

Total Critical High Moderate Low Nil

New or changed products 93 16 39 24 10 4 New or changed processes 83 7 30 18 21 7 Revised financial 78 5 12 20 29 12 arrangements Revised organisation or 92 7 29 32 19 5 personnel structures Upgrading employee skills 92 15 38 29 7 3 Revising relations with 97 16 37 31 10 3 customers, distributors or suppliers

Respondent supplied answers Lobbying 2 2 New customers 1 1 Introduction of new 1 1 processes maturity model Data source: Defence Industry Survey

Most respondents (59%) focussed on new products, while 45% focussed on new processes. Competition for defence business remains a strong incentive for companies to invest in new product development while the need to increase profits motivates companies to improve their processes. Defence Industry Survey participants were also asked about the relative importance of various sources of intellectual property. The results are summarised in Table 14 below.

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Table 14 Ranking IP sources

IP Source Total Critical High Moderate Low Nil

Purchase of IP from Australia 43 4 5 9 13 12 Purchase of IP from overseas 41 2 8 8 12 11 Supply of IP from parent 39 4 13 6 4 12 In house R & D 81 25 23 17 11 5 Collaborative research 55 2 13 20 12 8 arrangements Acquisition/merger 35 1 4 8 7 15 Registered Australian IP 1 1 Data source: Defence Industry Survey

Of those developing either new products or new processes: • most (some 62%) relied primarily on in-house resources; • 64% considered collaborative research arrangements important; • 44% relied heavily on their parent company for IP; and • 44% relied significantly on buying overseas IP. The incentives for companies to innovate in these terms depends importantly on their individual assessment that they can appropriate sufficient of the benefits accruing from successful innovation to justify the initial investment. Participants in the Defence Industry Survey were therefore asked how they protected their intellectual property. The responses are summarised in Table 15.

Table 15 Protecting IP

Method Total Critical High Moderate Low Nil

Patent/Legal 67 9 18 11 18 11 Secrecy 75 14 29 16 11 5 Speed to market 76 13 32 17 7 6 Commonwealth own IP for work done 1 1 Mandatory inspection process 1 1 Data source: Defence Industry Survey

The great majority (nearly 82%) of those survey respondents undertaking R&D relied primarily on speed to market to exploit the competitive advantage so obtained. A significant majority (79%) relied on secrecy to do so, while 57% relied on patents.

5.3.3 Defence R&D and the national R&D Base

The ABS has developed the Australian Standard Research Classification (ASRC) to facilitate the measurement and analysis of research and

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experimental development undertaken in Australia in both public and private sectors. The ASRC classifies R&D by: • type of activity (ie basic research, strategic basic research, applied research and experimental development); • research fields, courses and disciplines, that is the nature of the R&D being examined; and • socio-economic objective (SEO - ie the purpose of the R&D as perceived by the data provider). The ABS defines Defence as a SEO.

National R&D for defence purposes

The ABS estimates that in 2000-01, the value of total R&D attributed to the defence socio-economic objective was $361 million, equivalent to a relatively modest 3.5% of total national R&D activity in that year. Of this $361 million Defence R&D, the ABS estimates that: • 66.1% was generated by the Commonwealth; • 32.7% was generated by business; and • 1.2% was generated by the higher education sector (mainly the universities).81 No Defence R&D was generated by the state governments or private non- profit organisations. Defence officials have suggested that the above ABS estimates seem to understate Australia’s total defence R&D effort although no better national- level data is presently available. While total national expenditure on defence R&D remains to be estimated definitively, it is generally agreed that the proportion of defence R&D accounted for by Government is twice that accounted for by business. This is the converse of the relative proportions of total national R&D accounted by government and business. In 2000-01: • 47% of gross expenditure on R&D (GERD) was expended in the business sector; • 27% in the higher education sector; • 23% in the government sector; and • 3% in the private non-profit sector. The distribution of Defence R&D by research discipline is summarised in Table 16 below.

81 ABS Catalogue 8112.0 “Research and Experimental Development, all sector summary, 2000- 01, page 12

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Table 16 Major areas of Defence related R & D Materials Engineering 28.2% Classical Physics 12.2% IT n.e.c. 11.1% Mechanics and Industrial Engineering 9.5% Computation Theory and Mathematics 7.0% Other Engineering and Technology 5.2% Aerospace Engineering 4.4% Other Chemical Sciences 4.3% Organic Chemistry 3.4% Maritime Engineering 2.8% Electrical and Electronic Engineering 2.6% Communications Technologies 2.2% Other Physical Sciences 2.0% Other 5.1% Data source: ABS special data service

The data suggests that materials engineering research accounts for nearly a third of total defence R&D. This dwarfs R&D attributed to, for example, the strategically vital information, computing and communication sciences, which in total accounted for about 23%. Similarly, mechanical and industrial engineering accounts for 9.5% of total defence research while defence-related electrical and electronic engineering accounts for nearly 3% of such research. Most (53%) of the respondents to the Defence Industry Survey concentrated their R&D expenditure (both defence and non-defence) on engineering (which on average accounted for 69% of these companies’ overall R&D expenditure). One quarter of the respondents spent on average 58% of their R&D on information, computing, and communication sciences.

R&D in support of Defence Information capability

Section 3.1 summarises the information capability developments dominating the Defence Capability Plan. The software required to integrate military systems tends to be more complex and to require more rigorous validation than corresponding commercial applications. That said, Defence stands to benefit from the national initiatives to lift Australian ICT standards. The establishment of National ICT Australia (NICTA) Ltd is a potentially important link between Defence ICT developments and wider national developments. NICTA is the national ICT Centre of Excellence. In May 2004 the Government announced a $251 million extension of funding for NICTA– see Box 8.

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Box 8 National ICT Australia Ltd

• NICTA was established in 2002 as a centre of excellence to boost Australia’s long term strategic research in information and communication technology; • The Australian Government will give NICTA $380 million over ten years from 2001-02; • NICTA currently has 12 operational research programs with nearly 140 researchers;

• The goal is 300 researchers and up to 100 PhD students82.

NICTA is already working with Defence on software-related research. Current examples include: • dynamic planning optimisation and learning under constraints with DSTO (the research agreement for which enables NICTA to apply the IP so developed to non-defence applications like bushfire fighting); and • machine translation technology for use in uninhabited aerial vehicles (with DSTO); and • contact with Defence officials in the Defence Materiel Organisation responsible for software engineering. The Australian Defence Information and Electronics Systems Association (ADEISA) includes representatives of both Defence and industry with responsibility for electronic systems development and integration. It is well placed to take the lead in canvassing NICTA-Defence interest in broadening the above contact to include Defence suppliers within a commercial framework: Companies will only invest in R&D if they judge it is the most cost-effective way either to obtain what they want or to obtain sustainable competitive advantage.

Recommendation 12

R&D arrangements that gave industry a stronger incentive to share technology risk would increase the cost-effectiveness of defence R&D overall. In order to improve the cost effectiveness of R&D for Defence purposes, industry should consult Defence about: • criteria for access to, and arrangements for administration of, the augmented Capability and Technology Demonstrator program, using the Joint Direct Attack Munition- Extended Range project as a case study; • the criteria for eligibility for seed funding pre-CTD application and for activity funding post-CTD application; • drawing on commercial experience with joint ventures in developing principles for the guidance of DSTO and industry in managing defence developmental projects on the basis of an equitable sharing of risk and reward; and

82 see media release “Developing Australia’s ICT research capability”, 11 May 2004, at www.dcita.gov.au

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• the scope for linking commercial R&D in support of Defence information capability to wider national initiatives (Including the establishment of the national centre of excellence on information and communication technology) to develop information and communication technologies. The Capability Development Advisory Forum is appropriately constituted to facilitate such consultation.

5.4 Skills Development

Shortages of appropriately skilled people identified in the Defence Industry Survey (see Section 2.4.3) stand to exacerbate cost and schedule risk across the full spectrum of defence projects and substantially impede alignment of defence industry capacity with defence strategic planning requirements. This section considers: • the overall pattern of training in Australian industry; and • the development of Defence-specific skills.

5.4.1 Training arrangements

In 2001-02, according to the ABS, 81% of all Australian employers provided some training for their employees – up from 61% in 1997.83 The trend in companies actually or potentially involved in supply and support of Defence capability is likely to have been similar. The ABS differentiates between formal structured training arrangements (often involving an external training provider) and unstructured training on-the-job. The Defence Industry Survey retained the same distinction. ABS data suggests that, nationally, larger employers were more likely than smaller employers to provide structured training to their employees. Nationally, in 2001-02, according to the ABS: • 98% of businesses employing100 or more people provided structured training; • 70% of businesses employing 20-99 employees provided structured training; • 39% of businesses employing less than 20 employees provided structured training.

83 ABS Catalogue 6362.0 “Employer Training Expenditure and Practices, Australia”, April 2003, page 1.

Defence Industry Enablers 91 A Profile of the Australian Defence Industry

Responses to the Defence Industry Survey suggest a similar pattern for the small, medium and large companies actually or potentially involved in supply and support of Defence capability. Detailed responses are set out in Appendix H. Different industries obviously have different needs for specialised skills and qualifications, leading to substantial variation of structured training provision across industries. In 2001-02, for example, 87% of employers classified to electricity, gas and water supply provided structured training compared to 34% of employers classified to manufacturing and 17% of employers classified to transport and storage. The Defence Industry Survey suggests that the great majority (78%) of respondents relied on unstructured in-house training for senior managers, with 60% relying on structured training provided by external providers. This pattern was repeated across the full spectrum of managerial, professional and trade skills, with: • nearly 80% relying on unstructured training for professional staff and 69% using external training providers running formal courses; and • 84% relying on unstructured training for tradespeople and 77% using external training providers.

External training providers

ABS data suggests that during 2001-02, of all those businesses providing structured training, 92 % used external trainers to do so. This pattern of overwhelming reliance on external training providers was the same whatever the size of the business involved. Within this framework, most businesses used private training providers (40% in 2001-02), compared to 36% using public institutes of technical and further education (TAFE). The available data suggests, however, that service providers (for example those providing technical or computer services) were much more inclined to use private training providers or professional associations, with only 11% using TAFEs. On the other hand, the Defence Industry Survey suggests that companies actually or potentially involved in supply and support of Defence capability relied on TAFE for 20% of their structured training (followed closely by universities for 17%) and 19% relied on private training providers.

5.4.2 Defence specific-skills

The survey responses suggest that, of those companies doing defence business, defence-specific knowledge and skills are more important for professional staff

Defence Industry Enablers 92 A Profile of the Australian Defence Industry

than for either senior managers or tradespeople. On the other hand, respondents estimated that, on average, over 11 months was required to train senior managers to the requisite degree of defence-specific skill, compared to 8 months for professionals and 5 months for both associate professionals and tradespeople. Against this background, the following section outlines action to address shortages in defence industry requirements for: • tradespeople; and • professionals and associate professionals.

Meeting Defence industry requirements for tradespeople

As indicated in Section 2.4.3, a shortage of tradespeople significantly affected 67% of Defence Industry Survey respondents. The shortages of tradespeople experienced by respondents to the Defence Industry Survey is a sub-set of a national trend which has already prompted a series of initiatives by the Commonwealth Education, Science and Training portfolio supported by the Australian National Training Authority and State Government training agencies. The Commonwealth introduced New Apprenticeships in 1998. They combine practical work with structured training to give a nationally recognised qualification. According to the Department of Education, Science and Training, the scheme has attracted over 1,341, 500 new apprentices in more than 1500 nationally recognised qualifications since 1998.84 The Australian Government provides a range of incentives for employers to take on New Apprentices – see Box 9. The scheme also provides for ‘User Choice’ arrangements which enable the employer to choose either public or private training providers, negotiate the timing, location and nature of the training to be provided; and purchase flexible training over and above what is publicly funded.

84 Department of Education, Science and Training: Budget Information 2004 At A Glance, page 7

Defence Industry Enablers 93 A Profile of the Australian Defence Industry

Box 9 Employer Incentives under the New Apprenticeships Scheme

• The standard range of incentives include subsidies worth up to $4,400 per place; • The scheme provides additional $1,100 incentive for companies to train people to understand, apply and manage enabling technologies considered vital for innovation; • In 2004-05, the Australian Government will spend over $725.5 million on New Apprenticeships;

• 406,900 people are currently training under the scheme.85

On 6 April 2004, the Minister for Education, Science and Training announced a National Skills Shortages Strategy86 to address skills shortages through, among other initiatives: • working in partnership with key industries such as engineering, energy and utilities, process-based manufacturing and light manufacturing; • making traditional trade training more flexible by, for example, shortening apprenticeships and introducing specialised apprenticeship pathways in selected sectors; • addressing skill shortages on a regional basis; and • improving the quality and usefulness of labour market forecasting.

Meeting Defence industry requirements for professionals and associate professionals

As indicated in Section 2.4.3, shortages of professionals and associate professionals have adversely affected over half the respondent to the Defence Industry Survey. The analysis in Section 3.1.4 of Australian industry’s capacity to supply and support future defence information capability suggests that such shortages will be particularly acute in the defence electronics industry in general and particularly in the systems integration component of that industry. The Defence Electronic Systems Sector Plan reached a similar conclusion and went on to recommend that, as a first step, Defence and industry establish a course for both industry and Defence personnel in project management, systems and software engineering for systems integration.87 This Defence proposal paralleled national initiatives to foster information and communications capacity in Australia. These initiatives included:

85 Ibid 86 See www.dest.gov.au/ministers/nelson/april_04 87 Defence Electronics Sector Plan, op cit, page 133

Defence Industry Enablers 94 A Profile of the Australian Defence Industry

• merging the IT Skills Hub and the IT&T Industry Training Advisory Board in August 2003 to create a single, united body responsible for developing ICT skills across the entire education and training spectrum from secondary schools and TAFE to higher education and industry certification88. • the establishment in June 2004 of a software quality accreditation working party to examine existing levels of accreditation of software developers, the extent to which such accreditation boosts sales and the cost of accreditation – particularly for SMEs89; and • the establishment of NICTA with a strategic level training as well research focus. As pointed out in Section 3.1.3, the software skills required for military systems integration are highly specialised. That said, initiatives to develop the capacity of Australia’s defence electronics industry cannot be considered in isolation from the above national ICT initiatives. NICTA is a potentially key link between software development (and associated training) for military systems and comparable commercial activity. In addition, as the experience of the South Australian and Queensland Governments in fostering tertiary-level Defence electronics and aerospace training shows, the State and Territory Governments can mobilise extensive training resources through universities in their respective jurisdictions.

Recommendation 13

A shortage of skilled personnel can prejudice the ability of companies to deliver projects on time and to cost. Industry Associations, Commonwealth training agencies and their State/Territory counterparts should develop a coordinated approach to meeting future defence industry requirements for adequately trained managers, professionals and associate professionals and tradespeople. In formulating such an approach, industry and training agencies should have particular regard to the requirements of: • Naval shipbuilding and repair; and • Military systems integration. Because the availability of an appropriately trained workforce is so important to industry’s contribution to defence capability development, such an initiative should be coordinated through the Capability Development Advisory Forum.

88 See media release “Leading a united agenda for ICT skills”, 13 August 2003, www.itskillshub.com.au 89 see media release “Taking ICT into the future”, 8 June 2004, at www.dcita.gov.au

Defence Industry Enablers 95 A Profile of the Australian Defence Industry

6 Conclusion

This profile of Australian defence industry highlights the diversity and flexibility of the companies involved in supplying and supporting Defence. At one end of the spectrum of such supply and support, the profile identifies a broad range of products procurement of which is well suited to established defence business models based on open and effective competition. These products include both those specialised for military applications and others little changed from those in normal commercial use. The analysis suggests that this end of the defence industry spectrum is healthy in the sense that the firms involved are sufficiently profitable and have sufficient incentive to invest in the capacity needed to meet defence requirements. Midway across the defence industry spectrum are companies producing a range of tangible military assets like navy ships, armoured and other vehicles specialised for military use, and products ranging from ammunition to radar and communication hardware. These tangible assets typically have long military lives and are based on relatively stable production technologies. Current defence business models have derived from arrangements for procurement of this category of goods and services. This is an area where: • Defence typically enjoys a broad range of local and overseas supply options; and • Defence industry policy stands to benefit from wider defence progress in preparedness planning. Based on Defence Industry Survey responses, the overall record of companies delivering projects on time and to cost and companies’ success in exporting niche products, it is reasonable to conclude that companies involved this category of business are reasonably healthy. Companies supplying and supporting defence information capabilities occupy the other end of the defence industry spectrum. The military advantage the ADF gains from effective use of information technology derives increasingly from intangible assets based on ideas, innovation, and rapid changes on both demand and supply sides of the defence market. What Defence buys and how it does so exerts a decisive influence on the capacity of companies operating in the information capability end of the defence industry spectrum. At this end of the spectrum, however, both defence customer and commercial supplier are poorly served by procurement arrangements derived from acquisition of long lived, physical equipment that

Conclusion 96 A Profile of the Australian Defence Industry

has reasonably predictable life cycles and that can be valued in a technical, deterministic paradigm. The model by which Defence procures military-specialised information and communication technology and integrates related systems needs to accommodate the characteristics of knowledge-intensive innovation. Innovation in the development of tangible military assets tends to be linear and based on research push and market demand pull. By contrast, innovation in military systems integration depends much more on how effectively specific institutions – be they government laboratories, companies or universities – interact in a collective system of knowledge creation and use that has both domestic and overseas dimensions90 Against this background, that element of the defence industry supplying and supporting defence information capability seems poorly prepared to build on existing capacity and to supply the information systems foreshadowed in the Defence Capability Plan 2004-14. ACIL Tasman gained the overall impression that, with some important exceptions, Australian companies involved in the supply and support of defence information capability have limited incentive to invest in the capacity of the nature and on a scale that accords with Defence requirements. Defence industry survey data about the profitability of the firms involved in supplying and supporting defence information capability is inconclusive. Previous surveys undertaken for the draft electronics sector plan and subsequent one-on-one discussions for this study suggest, however, that: • company-based R&D is narrowly focussed relative to the spread of embedded and stand alone systems canvassed in the DCP; and • networking by government laboratories, companies and universities via cooperative research centres, research agreements and research alliances is thin relative to Capability Plan requirements in this area. Electronic systems already define the functionality of individual defence capabilities. This trend will increase as Defence progressively networks all capabilities in order to gain military advantage. Such progressive networking means that deficient commercial incentives to invest in the capacity to supply and support information capability stand to undermine the health of the rest of the defence industry. Rectifying these deficiencies will require Defence and industry to strike the appropriate balance between access to overseas – particularly US – technology in this area and investment in developing indigenous intellectual property.

90 See Industry Commission Report Number 44 “Research and Development”, May 1995, Volume 1 page 66 for more detailed discussion of this issue.

Conclusion 97 A Profile of the Australian Defence Industry

Excessive reliance on overseas intellectual property and innovation will lead to the ‘dumbing down’ of Australia’s capability in this area, thereby reducing Australia’s strategic and commercial options. A goal of self-sufficiency in information capability is neither realistic nor necessary for Australia. For the foreseeable future, Australian-based subsidiaries of US firms will remain key means by which Australia obtains US technology of critical strategic and commercial importance. Australian access to this technology is highly conditional, however, and the Seasprite helicopter program demonstrates that relying on overseas systems houses does not guarantee satisfactory outcomes. Hence such access as we have does not obviate the need to maintain a local capacity to integrate systems - both locally developed and imported – in configurations suited to Australian requirements. The record to date suggests that fostering such capacity will require a concerted effort by Defence and the companies involved. This study suggests that such an initiative will entail building on and extending existing Defence industry consultative arrangements to: • develop more flexible arrangements for collaboration between DSTO and industry that do not prejudice the former’s key role in advising Defence about the relative technical and scientific merits of competing solutions to Defence requirements; • develop arrangements between Defence and industry for identifying and sharing technical risk that are consistent with the needs of knowledge- based innovation; • take full advantage of wider national initiatives to foster Australian capabilities in information and communication technologies. Careful coordination of disparate initiatives is required for defence-industry consultation along the above lines to be cost-effective in terms of aligning defence industry capacity and defence strategic planning requirements. Achieving such coordination is likely to require Ministerial authority. The Defence–Industry Ministerial Council proposed on 22 June 2004 by the Minister Assisting the Minister for Defence would seem an appropriate forum through which to coordinate action to align defence industry development and defence strategic planning requirements.

Conclusion 98 A Profile of the Australian Defence Industry

A The Capability Development Advisory Forum

The CDAF was established in June 199891 with the objective of: • providing a forum for early industry access to, and feedback on, Defence capability development issues; • maximising Australian industry participation in, and understanding of, the development of major new ADF concepts and capabilities; and • exposing through-life support issues and Australian industry capability at an early stage in the capability development process.92 The CDAF is co-chaired by the Head, Capability Development Division and a senior representative of the defence industry. It functions as a steering group oversighting the workings and activities of individual members or combined Defence/industry Working Groups. These Groups, which date from the inception of the CDAF in 1998, currently include: • the Aerospace Environmental Working Group • the Maritime Environmental Working Group; • the Land Systems Environmental Working Group; and • the Australian Defence Information and Electronic Systems Association (which in 2001 subsumed the original Command, Control Communications and Intelligence Systems Research Forum established under CDAF in 1998).

91 See Defence and Industry Strategic Policy Statement, Minister for Defence Industry, Science and Personnel, June 1998, page 12. 92 Information provided by Australian Business Ltd who, together with the Australian Industry Group and the Australian Industry Defence Network, are core members of the CDAF.

The Capability Development Advisory Forum A-1 A Profile of the Australian Defence Industry

B The Profile Data

Collecting empirical data within the above framework involved two stages: • the initial stage concentrated on identifying sources of, and extracting, aggregate industry data; and • the second stage concentrated on obtaining and aggregating company- specific information.

B.1 Obtaining aggregate data

The first, top-down, stage of data gathering focused on the relevant industry base, national R&D activity and exports. It entailed: • identifying the Australian New Zealand Standard Industry Classification (ANZSIC) within which the companies supplying and supporting defence capability are embedded and then engaging the Australian Bureau of Statistics (ABS) to extract: – selected economic indicators to establish structure and performance benchmarks at sector-level93; and – trends in the provision of training to establish training benchmarks at sector-level;94 • using the Australian Standard Research Classifications (ASRC) to identify research activity by government, business and universities classified to Defence and then engaging the ABS to extract the relevant expenditure to establish R&D performance benchmarks;95 • identifying those Australian Harmonised Export Commodity Classifications (AHECC) that capture defence- and defence-related exports and then engaging Defence to extract the relevant export statistics from the Customs EXIT data base to establish benchmarks for export performance. The detailed specifications of the data extracted on the above basis are described in the separate technical volume accompanying this report. These specifications, and the arrangements for obtaining and analysing the data so specified constitute an important starting point in profile development. They will, however, need substantial refinement and development in future studies.

93 See AUSSTATS data cube 8140.0.55.002 94 The starting point here is “Employer Training Expenditure and Practices, Australia”, ABS Catalogue No 6362.0 95 The starting point here is the series “Research and Experimental Development, all sector summary, Australia”, ABS Catalogue No 8112.0

The Profile Data B-1 A Profile of the Australian Defence Industry

B.2 Obtaining company data

The second, bottom-up stage of data gathering entailed a survey of companies actually or potentially involved in the supply and support of Defence capability. This initiative is designated the Defence Industry Survey in this report.

The questionnaire and other aspects of the Defence Industry Survey are also described in the separate technical volume accompanying this report. The deficiencies in certain aspects of the survey data are pointed out in related areas of this report and need to be addressed in future studies.

B.2.1 The Defence Industry Survey

Defence Industry Survey participants were questioned about: • the nature and scale of, respectively, their overall business and their defence business; • research, development, innovation and competitiveness; • exports; and • employment and skills. The survey generated 112 useable responses. The distribution of respondents according to the size of company (as indicated by number of employees) is illustrated in Figure B1 below.

The Profile Data B-2 A Profile of the Australian Defence Industry

Figure B1 Size distribution of respondents

40 35

s 30 m r i

f 25 f o 20 r e b 15 m u

N 10 5 0

0 0 0 0 0 0 0 0 e 2 5 0 5 0 0 0 0 r 1 1 2 3 5 0 o 1 M Number of employees

Data source: Defence Industry Survey

While the survey is a necessary element of efforts to obtain company data, it is by no means sufficient: For example, some companies declined to provide information about their profitability (see Section 2.4.1). Future surveys will need to refine the sample of companies approached. In order to construct a robust profile in these circumstances, the study supplemented the survey with numerous one-on-one discussions with individual defence suppliers and survey respondents.

The Profile Data B-3 A Profile of the Australian Defence Industry

C Estimating the Size of the Australian Defence Industry

ACIL Tasman developed a simple methodology for extrapolating responses to the Defence Industry Survey in order to estimate the size of the defence industry as a whole. An important feature of the methodology was recognition that a single extrapolation of all survey responses would distort the estimate. Accordingly, ACIL Tasman assumed different response rates for different company sizes. This recognised the additional effort invested in obtaining responses from the larger defence operators. This method, in turn, provided two methods for adjusting the assumptions to ensure that the results were reasonable: • the definition of the company size; and • the response rate for each company size. The assumptions used are set out in Table C1.

Table C1 Assumed firm size and response rate

Firm size Min. Employees Max Employees Percentage Responded to Survey

Small 20 30% Medium 21 50 60% Large 51 90% Data source: ACIL Tasman

On this basis, defence industry employed an estimated 13,000 people and generated some $4.7 billion turnover in 2002-03 – see Table C2.

Table C2 Estimate of defence industry size

Firm Size Firms Industry Turnover Industry Employment

($m) Small 132 $2,518.51 540 Medium 51 $173.55 832 Large 26 $2,293.46 11,241

Estimating the Size of the Australian Defence Industry C-1 A Profile of the Australian Defence Industry

D Industry Performance

The following data underpins discussion of: • Defence industry profitability at section 2.4.1; • Defence information capability and the national electronics industry base at section 3.1.1; • supply and support of naval vessels at section 3.2.1; • supply and support of army land transport at section 3.3.1; and • supply and support of military aviation at section 3.5.1.

Table D1 Industry performance, manufacturing Sales and Employment service Sales and Earnings at end of income service before June - including income - Earnings interest and Management Employment Relative rent, leasing Relative before tax - Relative units at 30 at end of Standard and hiring Standard interest and Standard Operating Return on net Long term ANZSIC June June Errors income ($ Errors tax ($ Errors profit margin worth debt to equity code Description (Number) (Number) (a) (Percent) (a) Millions) (Percent) (b) Millions) (Percent) (Percent) (Percent) (Percent) 28 Machinery and equipment mfg 10032 202170 1.1 50644.9 0.6 2312.6 3.3 3.7 14.9 56.1 281 Motor vehicle and part mfg 1539 62661 1.9 23764.3 0.6 724.2 7.2 2.3 12 40 282 Other transport equipment mfg 1275 22465 3 4042.4 1.7 225.2 10.8 4.9 16.8 74 283 Photographic and scientific equipment mfg 1421 14570 4.5 2843.2 1.8 325.9 4.9 10.7 35.7 79.4 284 Electronic equipment mfg 805 22134 2.9 5318.9 2.3 355.8 7.8 5.9 13.8 33.7 2811 Motor vehicle mfg 45 23243 0.6 16322.6 0.1 222.2 0.2 0.9 5.1 29.7 2812 Motor vehicle body mfg 602 9908 4.2 1433.5 3.7 45.9 18.7 2.5 21.7 106.8 2819 Automotive component mfg n.e.c. 844 24424 4.6 4395.3 3.1 394.5 13.1 7.4 28 64.5 2821 Shipbuilding 108 6079 3.3 1410 1.8 92.7 3.2 6.1 15 73.9 2824 Aircraft mfg 376 5849 10.1 951.2 6.2 72.5 31.8 6.6 25.5 99.6 2831 Photographic and optical good mfg 86 3368 7.6 1268.3 2.8 129.8 3 9.5 42.5 122 2839 Professional and scientific equipment mfg n.e.c. 356 4548 9.8 836.1 7.6 93.2 11.6 10.3 23.7 64.3 2842 Telecommunication, broadcasting and transceiving equipment mfg 161 9114 5 2471.3 2.8 124.5 20.5 4.4 15.9 38.1 Data source: ABS Special data service

Table D2 Industry performance, services

7832 7823 7829 Information 7833 7834 7822 Consulting Technical Storage and Computer Computer 7855 Business Surveying Engineering Services Retrieval Maintenance Consultancy Management Services Services n.e.c. Services Services Services Services

Labour costs $m 604 3,367 849 81 326 5,403 5,084 Wages and salaries $m 541 2,975 745 73 299 4,878 4,486 Total operating income $m 1,418 11,198 2,556 218 1,218 15,042 15,593 Total operating expenses $m 1,314 10,523 2,420 214 1,154 14,559 13,784 Operating profit before tax $m 105 675 137 4 64 483 1,809

Profit margin 7652 5 312 (=OPBT*100 / income) EBIT $m 124 760 156 6 67 553 2,361 Data source: Special data service

Industry Performance D-1 A Profile of the Australian Defence Industry

E Access to US Intellectual Property: US Policy

The US manages release of military technology to other countries so as to protect and advance its security interests in general and its foreign and defence policies in particular. The legal and policy authority for these controls is based on: • the Arms Export Control Act; • Executive Order 12958 setting out US Government policy for the protection of classified national security information; • National Security Decision Memorandum (NSDM) 119 promulgating US National disclosure policy. The US Arms Export Control Act prohibits the sale or lease of defence articles and defence services unless the recipient: • agrees not to transfer title or possession; • will not permit the article or service to be used for purposes other than for those specified; and • agrees to provide substantially the same degree of security as the US. Executive Order 12958 prohibits the dissemination of classified US information outside the Executive Branch of the US Government unless: • access to that information is required by trustworthy parties to accomplish a lawful and authorised US government purpose; and • the originator of the classified information agrees to release the classified information outside the Executive Branch. NSDM-119 stipulates that classified military information is a national security asset which must be: • conserved and protected; and • shared with foreign governments only where the US obtains a clearly defined advantage in terms of US foreign policy or military security. NSDM-119 further stipulates that release of classified military information is: • subject to assessment of the recipient’s capability and intent to protect the information; and • limited to that necessary to satisfy the US Government objective. The US Government establishes a foreign Government’s intent to protect US classified military information by the negotiation of a bilateral General Security of Military Information Agreement. This agreement and the associated

Access to US Intellectual Property: US Policy E-1 A Profile of the Australian Defence Industry

Industrial Security Annex provide for on-site security surveys by US Government agencies. The surveys are intended to: • determine whether the recipient is able to protect US classified military information in a manner that is substantially equivalent to the protection afforded it by the US; and • help determine classification eligibility levels, formulate special disclosure policies for individual nations, evaluate requests for exception to the National Disclosure Policy. Australia has a long-standing General Security of Military Information Agreement (including the associated Industrial Security Annex) with the US.

Access to US Intellectual Property: US Policy E-2 A Profile of the Australian Defence Industry

F Exports by Region and Category

The following data underpins the discussion of defence industry related exports by region in section 5.1.2.

Table F1 Exports by destination and category, 1999 Region Air combat and strike Field vehicles & trailer Infantry Information Maritime Grand Total Africa$ 24,387,075.85 $ 1,645,012.26 $ 12,137,742.01 $ 3,662,475.06 $ 16,889,298.33 $ 58,721,603.51 Antarctic$ 200,000.00 $ 200,000.00 China$ 1,724,711.24 $ 5,154,610.29 $ 1,415,844.38 $ 13,049,046.90 $ 21,344,212.81 Eastern Europe$ 306,400.36 $ 312,626.94 $ 619,027.30 Latin America$ 681,226.61 $ 262,803.23 $ 1,851,879.51 $ 375,904.71 $ 3,171,814.06 Middle East$ 8,461,897.91 $ 1,136,733.00 $ 1,266,554.04 $ 5,956,011.08 $ 16,821,196.03 North America$ 234,277,563.03 $ 1,389,105.88 $ 20,077,069.83 $ 67,609,938.26 $ 19,030.00 $ 323,372,707.01 North Asia$ 19,569,793.81 $ 12,060.00 $ 4,635,156.41 $ 9,614,871.18 $ 42,249.83 $ 33,874,131.24 Pacific$ 184,270,352.98 $ 7,379,091.42 $ 15,399,523.73 $ 30,382,374.79 $ 76,373,562.04 $ 313,804,904.96 Ships and Aircraft Stores$ 4,885.72 $ 43,056,305.00 $ 43,061,190.72 South Asia$ 777,641.64 $ 1,340,389.69 $ 56,450.59 $ 31,631,229.67 $ 35,390.00 $ 33,841,101.59 South East Asia$ 78,238,518.28 $ 2,627,405.56 $ 8,020,024.29 $ 42,777,754.21 $ 145,014,639.80 $ 276,678,342.16 Western Europe$ 105,440,191.59 $ 927,880.00 $ 5,570,756.59 $ 12,989,770.43 $ 40,449,746.13 $ 165,378,344.74 ZOCA A$ 23,690.73 $ 2,820.00 $ 2,975.00 $ 29,485.73 Grand Total $ 658,359,064.04 $ 21,875,091.34 $ 70,438,707.11 $ 218,364,978.24 $ 321,880,221.14 $ 1,290,918,061.87 Data source: ACIL Tasman based on DTCC data

Table F2 Exports by destination and category, 2000 Region Air combat and strike Field vehicles & trailer Infantry Information Maritime Grand Total Africa$ 7,563,514.00 $ 670,292.00 $ 1,473,158.51 $ 8,787,352.28 $ 69,800.00 $ 18,564,116.79 China$ 43,417.14 $ 210,533.44 $ 12,597,679.39 $ 12,851,629.97 Eastern Europe$ 153,000.00 $ 234,338.71 $ 387,338.71 Latin America$ 32,191.88 $ 725,000.00 $ 48,639.00 $ 95,719,811.96 $ 25,908.59 $ 96,551,551.43 Middle East$ 334,738.96 $ 20,000.00 $ 807,605.25 $ 3,628,309.38 $ 4,790,653.59 North America$ 25,908,327.07 $ 45,136.00 $ 6,129,431.07 $ 85,223,739.42 $ 306,410.04 $ 117,613,043.60 North Asia$ 255,797.13 $ 445,000.00 $ 1,389,785.30 $ 19,353,262.71 $ 6,900.00 $ 21,450,745.14 Pacific$ 7,652,972.25 $ 795,325.00 $ 2,794,477.99 $ 70,991,425.60 $ 156,602.00 $ 82,390,802.84 South Asia$ 57,267.49 $ 93,829,742.49 $ 17,860.00 $ 93,904,869.99 South East Asia$ 16,109,586.20 $ 1,041,256.89 $ 1,714,743.00 $ 47,365,311.28 $ 7,779,791.00 $ 74,010,688.38 Western Europe$ 42,128,323.55 $ 10,000.00 $ 2,024,146.08 $ 35,758,704.14 $ 439,739.63 $ 80,360,913.41 ZOCA A$ 11,181.00 $ 49,751.71 $ 437,292.00 $ 498,224.71 Grand Total $ 100,250,316.68 $ 3,752,009.89 $ 16,642,271.36 $ 473,926,969.37 $ 8,803,011.26 $ 603,374,578.57 Data source: ACIL Tasman based on DTCC data

Table F3 Exports by destination and category, 2001 Sum of AUD Area Region Air combat and strike Field vehicles & trailer Infantry Information Maritime Grand Total Africa$ 5,967,151.43 $ 4,413,988.00 $ 308,631.82 $ 153,267,308.79 $ 97,948.00 $ 164,055,028.05 Antarctic$ 2,600,000.00 $ 2,600,000.00 China$ 9,402,054.77 $ 162,069.99 $ 321,090.16 $ 29,581,377.12 $ 10,844,389.60 $ 50,310,981.64 Eastern Europe$ 224,171.79 $ 373,647.90 $ 25,000.00 $ 622,819.69 Latin America$ 939,161.45 $ 3,655.07 $ 415,120.82 $ 1,357,937.34 Middle East$ 6,303,852.17 $ 11,762,473.91 $ 299,722.78 $ 1,589,567.09 $ 4,073,694.61 $ 24,029,310.57 North America$ 277,462,479.57 $ 1,574,749.40 $ 25,370,059.76 $ 82,773,057.84 $ 311,834.77 $ 387,492,181.34 North Asia$ 4,427,193.12 $ 3,502,301.41 $ 13,968,723.26 $ 40,713.00 $ 21,938,930.80 Pacific$ 79,779,046.70 $ 3,422,592.00 $ 7,910,390.70 $ 9,735,930.14 $ 2,067,813.00 $ 102,915,772.54 Ships and Aircraft Stores$ 170.00 $ 991.00 $ 34,748.00 $ 33,778,099.65 $ 33,814,008.65 South Asia$ 6,983,921.11 $ 21,715.00 $ 590,942.96 $ 7,596,579.07 South East Asia$ 50,378,736.22 $ 2,461,333.00 $ 6,377,428.78 $ 37,855,272.22 $ 32,636,683.94 $ 129,709,454.15 Western Europe$ 78,615,004.80 $ 835,924.98 $ 13,262,576.67 $ 16,669,548.79 $ 36,784.31 $ 109,419,839.55 ZOCA A$ 8,807.00 $ 3,794.35 $ 12,601.35 Grand Total $ 523,091,750.12 $ 24,654,846.28 $ 57,356,848.16 $ 346,859,039.27 $ 83,912,960.88 $ 1,035,875,444.72 Data source: ACIL Tasman based on DTCC data

Exports by Region and Category F-1 A Profile of the Australian Defence Industry

G Research and Development

The following data underpins the discussion of R & D at section 5.3.

Table G1 National R&D expenditure $ '000

Sum of Total R&D Body Field Name Business Comm Govt Higher Ed Private non profit State Govt Grand Total Agricultural, Vetinary and Environmental Sciences $152,336.69 $233,953.47 $204,513.22 $510.00 $539,309.04 $1,130,622.43 Architecture, Urban Environment and Building $7,103.34 $1,810.82 $21,833.69 $1,655.35 $32,403.19 Behavioural and Cognitive Sciences $2,191.18 $6,974.10 $87,750.96 $467.60 $2,934.87 $100,318.72 Biological Sciences $126,709.58 $153,267.99 $324,509.31 $74,217.00 $106,519.08 $785,222.96 Chemical Sciences $172,338.42 $88,408.58 $127,196.20 $2,628.05 $6,889.26 $397,460.52 Commerce, Management, Tourism and Services $28,308.21 $2,626.41 $110,953.64 $4,281.91 $146,170.17 Earth Sciences $50,688.85 $181,490.20 $94,619.08 $33,627.78 $360,425.91 Economics $2,723.84 $47,884.59 $66,841.99 $131.12 $2,954.20 $120,535.73 Education $1,491.32 $762.42 $86,649.25 $14,240.64 $8,616.92 $111,760.55 Engineering and technology $2,680,408.83 $359,356.66 $309,069.60 $332.80 $25,404.65 $3,374,572.53 History and Archaeology $0.00 $499.93 $56,524.35 $2,278.18 $59,302.46 Information, Computing and Communication Sciences $1,307,216.54 $187,019.01 $113,136.22 $2,655.24 $29,783.93 $1,639,810.95 Journalism, Librarianship and Curatorial Studies $0.00 $64.82 $10,183.68 $301.21 $10,549.70 Language and Culture $19.20 $146.60 $55,842.11 $357.14 $56,365.05 Law, Justice and Law Enforcement $0.00 $12,501.85 $49,073.44 $149.80 $10,181.16 $71,906.24 Mathematical Sciences $15,358.87 $22,918.40 $59,392.81 $1,123.83 $2,211.83 $101,005.74 Medical and Health Sciences $297,152.35 $25,474.45 $667,715.67 $160,894.94 $157,189.64 $1,308,427.06 Philosophy and Religion $28.80 $21,562.28 $66.40 $10.98 $21,668.46 Physical Sciences $51,416.29 $92,465.01 $112,024.53 $616.59 $792.43 $257,314.86 Policy and Political Science $0.00 $502.98 $44,400.22 $286.70 $1,889.28 $47,079.18 Studies in Human Society $184.54 $6,592.79 $93,671.80 $671.06 $5,078.69 $106,198.88 The Arts $223.20 $73.30 $57,100.21 $0.00 $1,304.96 $58,701.67 Grand Total $4,895,900.04 $1,424,794.39 $2,774,564.27 $258,991.78 $943,572.49 $10,297,822.97

Data source: ABS Special data service

Table G2 Defence R&D expenditure $'000

Sum of Defence R & D Body Field Name Business Comm Govt Higher Ed Private non profit State Govt Grand Total Agricultural, Vetinary and Environmental Sciences $0.00 $126.03 $2.13 $0.00 $128.16 Architecture, Urban Environment and Building $0.00 $0.00 $0.00 $0.00 Behavioural and Cognitive Sciences $0.00 $4,682.94 $32.00 $0.00 $4,714.94 Biological Sciences $0.00 $66.13 $98.52 $0.00 $164.65 Chemical Sciences $44.60 $21,275.80 $5.37 $0.00 $21,325.77 Commerce, Management, Tourism and Services $0.00 $2.46 $13.59 $16.05 Earth Sciences $0.00 $118.57 $3.92 $122.49 Economics $0.00 $2.24 $0.27 $0.00 $2.51 Education $0.00 $0.00 $0.00 $0.00 $0.00 Engineering and technology $21,687.70 $130,911.22 $2,219.22 $0.00 $154,818.13 History and Archaeology $0.00 $0.00 $0.40 $0.40 Information, Computing and Communication Sciences $9,960.40 $42,602.87 $837.85 $0.00 $53,401.13 Journalism, Librarianship and Curatorial Studies $0.00 $0.00 $0.00 $0.00 Language and Culture $0.00 $0.00 $0.00 $0.00 Law, Justice and Law Enforcement $0.00 $0.00 $0.65 $0.00 $0.65 Mathematical Sciences $0.00 $48.30 $346.88 $0.00 $0.00 $395.18 Medical and Health Sciences $149.40 $106.31 $26.21 $0.00 $281.92 Philosophy and Religion $0.00 $0.00 $0.00 $0.00 Physical Sciences $124.60 $38,722.21 $689.63 $0.00 $39,536.45 Policy and Political Science $0.00 $0.00 $78.71 $0.00 $78.71 Studies in Human Society $0.00 $0.00 $2.92 $0.00 $2.92 The Arts $0.00 $0.00 $4.57 $0.00 $4.57 Grand Total $31,966.70 $238,665.10 $4,362.84 $0.00 $0.00 $274,994.64 Data source: ABS Special data service

Research and Development G-1 A Profile of the Australian Defence Industry

H Recruitment of Skilled Personnel: Sources

The following data underpins the discussion of sources of skilled personnel in Section 5.4.

Table H1 Senior management recruitment Recruit Source Total Critical High Moderate Low Nil Australian recruitment 100 27 59 12 1 1 Overseas recruitment 66 2 4 12 37 11 Intra-company transfers within Australia 64 2 15 15 14 18 Intra-company transfers from Overseas 50 6 7 18 19 Structured training 78 5 16 26 22 9 Unstructured training 90 12 31 27 16 4 Overseas Training 11 Structured Inhouse Training 11 On the job mentoring and development 11 Data source: Defence Industry Survey

Table H2 Professional recruitment Recruit Source Total Critical High Moderate Low Nil Australian recruitment 97 29 55 8 4 1 Overseas recruitment 66 2 5 13 37 9 Intra-company transfers within Australia 63 2 11 16 16 18 Intra-company transfers from Overseas 52 5 6 21 20 Structured training 84 7 21 30 20 6 Unstructured training 84 9 30 28 14 3 Overseas Training 22 Structured Inhouse Training 11 On the job mentoring and development 11 Data source: Defence Industry Survey

Table H3 Tradespeople recruitment Recruit Source Total Critical High Moderate Low Nil Australian recruitment 81 26 45 5 2 3 Overseas recruitment 45 2 7 4 21 11 Intra-company transfers within Australia 45 2 5 8 13 17 Intra-company transfers from Overseas 33 1 1 3 10 18 Structured training 64 10 17 22 9 6 Unstructured training 70 13 13 33 7 4 Overseas Training 11 Structured Inhouse Training 11 Data source: Defence Industry Survey

Recruitment of Skilled Personnel: Sources H-1 AIG3159