NATIONAL AUDIT OFFICE
REPORTBYTHE COMPTROLLERAND AUDITORGENERAL
Ministry of Defence: DefenceProcurement in the 1990s
ORDEREDBY THE HOUSEOF COMMONS TO BE PRINTED 13 MAY 1994
LONDON: HMSO 390 fB.15 NET MINISTRY OF DEFENCE: DEFENCE PROC”REMENT IN THE 199cls
This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.
John Bourn National Audit Office Comptroller and Auditor General 6 May 1994
The Comptroller and Auditor General is the head of the National Audit Office employing some 800 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies; and he has statutory authority to report to Parliamenton the economy,efficiency and effectiveness with which departments and other bodies have used their resources. MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Contents
Pages
Summary and conclusions 1
Part 1: Introduction 9
Part 2: The changing defence environment 11
Part 3: The application of competitive principles 16
Part 4: Transferring risk to contractors 24
Part 5: Other initiatives to minimise equipment costs 29
Annex
1 List of projects examined by the National Audit Office 35
2 List of companies and Trade Associations contacted by the National Audit Office 38
3 Comparison of United Kingdom and Overseas Procurement practices 39 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Summary and conclusions
Background and 1 The Ministry of Defence (the Department) currently spend nearly El0 billion Scope a year on equipment, stores and services. Their objective is to manage this programme, by open competition wherever possible, to ensure that operational requirements can be met within approved costs and timescales and with best value for money.’
2 During the 198Os, and in accordance with Government policy to promote competition, the Department adopted a number of initiatives to put their relationship with suppliers on a more commercial footing. Since these were introduced there have been changes in both the threat which the Armed Forces must meet and the market from which the Department must obtain their requirements.
3 The National Audit Office examined:
(a) the impact that changes in the defence environment are having on the Department’s ability to pursue the 1980s’ initiatives; (b) the continuing applicability of the particular initiatives introduced in the 1980s; the progress made by the Department in implementing them; and any enhancements which have been or could be made both to the existing initiatives and to procurement practices generally.
The impact of 4 The end of the Cold War and the changed political landscape in Eastern changes in the Europe, coupled with the growing diversity of threats faced by the United defence environment Kingdom, emphasise the need for our Armed Forces to be flexible and to have versatile equipment that is also interoperable with that of our allies. This poses a significant challenge to the Department.
5 The Department expect to continue to operate within tight budgets. The Chancellor of the Exchequer announced, in his budget speech on 30 November 1993, that new plans for reducing planned levels of defence expenditure (by !I260 million in 1994/95 and E520 million in 1995/96) “will be delivered, in part, by lower procurement and employment costs” (Hansard, 30 November 1993, Co1 928). He further announced that the Secretary of State for Defence had set in hand a major review of all aspects of the Department’s support activities. On 1 December 1993 the Secretary of State for Defence explained to the House of Commons Defence Committee that he was establishing a “Defence Costs Study” to look at ways of reducing spending on back-up services. Further to this, he announced in the House of Commons on 14 January 1994 (Hansard, 14 January 1994, Co1 342) that one of the studies which had been launched was concerned with procurement projects and practices.
1 The Department’s approach was set cut in “The Government’s Expenditure Plans 1992/W to 1994/95: Departmental Report by the Ministry of Defence” [Cm 1901 of February 1994) as follows: “The Department continues to seek best value for money in procurement, so our relationships with suppliers are based on a commercial approach. Open competition remains the basis of procurement policy wherever practicable.. ”
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6 Another difficulty faced by the Department is that, since the procurement of major equipment is a long term process (in 1992-93 over 80 per cent of the equipment budget was already committed as a result of contracts let in earlier years), they are constrained in their ability to shift the emphasis, should that be necessary, to procure equipment wholly suitable for the changed environment. Similar challenges to those facing the Department are also present in other countries. From a review of procurement practices adopted by 11 other countries the National Audit Office concluded that, relatively, and particularly in terms of the pursuit of competition, the Department was performing well. Furthermore, subject to a few exceptions (such as Producibility Enhancement Programmes used in the United States), there was little of significance to learn from other countries which would be of benefit to the Department. Details of the approach adopted and the results of this survey are in Annex 3.
7 The Department have responded to the changed strategic environment and associated reductions in funding by, in some cases, stretching the procurement cycle and in others by reducing production quantities or cancelling programmes altogether. An indication of the impact of the funding cuts is provided by the fact that of 37 projects examined by the National Audit Office, 14 had been delayed as a result of budgetary constraints, whilst 10 of 24 contractors contacted also commented on the adverse effect of delay on project costs.
8 The Department recognise the complexities involved in stretching the procurement cycle as well as the cost implications for the defence industry (and, ultimately, themselves) of putting decisions “on hold” whilst programmes and plans are re-appraised. Such delays can lead to industry putting project teams and expensive resources “on ice” in the hope that existing orders will be confirmed and/or new orders announced. It is the Department’s policy, wherever possible, to try and avoid changes in the procurement cycle which adversely affect the cost-effectiveness of the purchase, although variations in procurement quantities and project timescales will still need to be adopted to ensure that the programme remains in balance, both with military requirements and available resources.
9 As illustrated by employment levels, the changed strategic environment, together with industry’s consistent efforts to improve productivity, have also had an effect on the United Kingdom defence industry. The Department estimatethat the total numberof people employedin the British defence industry fell from 625,000 in 1985-86 to 560,000 in 1991-92 and provisionally estimate that there were 500,000 employed in 1992-93. In addition to shedding staff, companies have also sought to rationalise and/or merge with other companies, or to diversify away from defence work. These moves could have an important longer term impact on the maintenance of effective domestic competition in defence procurement. However, given the Department’s willingness to purchase from overseas where this will secure value for money, their competitive policy remains viable.
The continuing 10 In general, the initiatives introduced by the Department during the 1980s applicability of, have been successful particularly in promoting competition and remain and enhancements appropriate in the 1990s. The two key pillars of the commercial approach to, the 1980s' were a drive to increase the proportionof contracts let competitively and the initiatives placing of greater responsibility and risk for the delivery of goods with
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industry. The National Audit Office analysed the impact of these and other measures. This analysis showed that the Department have implemented all of the measures, some with significant impacts.
11 Competition, the key initiative of the 198Os, remains central to the Department’s procurement policy. It is difficult to quantify the overall benefits of competition but there are some examples which indicate the scale of savings achieved. The Department consider that competition has reduced the costs of procurement very significantly, possibly by over El billion per year, and is a major factor in improving the competitiveness of British industry, enabling it to win export orders worth in excess of g6 billion in 1993.
12 The Department have placed particular emphasis on arrangements such as prime contractorship; linking payments to milestone achievement; fixed and firm prices and liquidated damages. These have been designed to give more responsibility and incentives to contractors to deliver goods and services on time and to cost and to transfer risk to those best placed to deal with it.
13 The Department’s approach for non-competitive contracts is an initiative known as “No Acceptable Price, No Contract” (NAPNOC), which they believe will lead to greater use being made of target cost incentive contracting in the future. Through the NAPNOC initiative, the Department have wrought a major change in the culture of non-competitive contracting and now put commercial terms before operational timescales, if necessary. Under this initiative the Department’s aim is to place a contract only when a contract price, which reflects what it should cost an efficient contractor to carry out the work, has been agreed. NAPNOC, therefore, promotes early assessment of the degree of risk. 127 NAPNOC contracts have been placed so far with a total value of El.9 billion.
14 More broadly, the Department are now implementing wide ranging improvements to their contracts procedures. This follows an in-depth and wide-ranging review of contracting procedures by the Department which involved the Trade Associations, major defence contractors and major purchasers of commercial equipment. While no major weaknesses were revealed, practices are being sharpened and streamlined wherever possible.
15 The Department recognise that it is important that industry have some indication of future equipment plans if they are to focus their capital investment and research and development efforts. Efforts have been made to improve communications with industry through regular suppliers’ conferences, seminars, working groups and less formal meetings. Illustrative indications of possible trends in certain categories of defence procurement expenditure have also been made available to defence suppliers and in 1993 the Department published for the first time a consolidated list of approved staff targets and requirements.
16 However, against this background, projects have continued to experience cost variances. In their 16th Report (Session 1992-931, the Committee of Public Accounts recognised the progress but expressed concern that around one fifth of the projects, appearing in the 1991 Major Projects Statement suffered from cost increases of over 15 per cent. Whilst the 1993 Major Projects Report shows a slight reduction in the proportion of projects
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showing large cost increases, given the size of most equipment projects, this still involves many millions of pounds.
17 One of the key reasons for cost variances is specification changes which can undermine the disciplines imposed by competition and fixed/firm prices. The impact of specification changes is illustrated by the 1993 Major Projects Report where such changes have contributed to cost variances of El12 million (10 per cent of recorded cost variation). Similar cases arose in the sample of 37 projects examined for this study where 11 projects had been subject to significant specification changes. One project had experienced 193 specification changes valued at E9.3 million, an increase of more than 20 per cent on the original cost. Specification changes may, of course, arise for very good reasons but, given the importance of this topic the National Audit Office plan to undertake a separate review of the control of specification changes in the near future.
18 Overall the National Audit Office analysis was hampered by the fact that, for the 1980s’ initiatives, the Department had not always established full evaluative criteria against which the success of the initiatives could be measured. Consequently, the current Departmental drive to improve policy evaluation will need to ensure that, for any changes to existing initiatives, and as far as practicable for any new initiatives, suitable evaluative criteria are established from the outset although the National Audit Office recognise that isolating the impact of a single initiative can be a very complex process.
Placing contracts 19 Running competitions is resource intensive both for the Department and competitively industry. The Department will inevitably bear some of these costs through overhead recovery on other contracts. Indicatively, the average number of companies invited to tender, over some 13,000 competitions, was 6.4 per competition. However, this average conceals a wide variety of practices. The Department recognise the problem and also the difficulty of being seen to exclude bidders from Government work, and have initiated action to increase the duration of contracts, reduce the numbers both of competitions and tenderers invited and seek to establish through initial competition longer term relationships with suppliers governed by taut contractual conditions. This should serve to reduce the costs of competition to both industry and the Department. This is also important for the Department which needs to streamlinethe conduct of their businessin line with the progressive reduction in the number of directly employed staff.
20 The efforts to reduce the costs and maintain the rigour of procurement processes for both the Department and Industry by reducing the number of competitions and focusing invitations to tender upon reliable suppliers should not exclude new firms who are able to come forward with innovative ideas and practices. The Department have, therefore, since 1986 produced a fortnightly Bulletin detailing new contracts with a value in excess of E500,000 for most items. This Bulletin supplements other methods of informing potential bidders of opportunities, such as the regular formal and informal dialogue which takes place between Procurement Executive staff and suppliers of equipment. However, a recent survey carried out by the Department indicated that some 5 per cent by number (less than 10 per cent by value) of contracts above the Bulletin threshold were not being advertised because staff were not always implementing the Department’s
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own policy on the advertisement of contracts, with the risk that some potential new bidders were being overlooked. The defence industry informed the National Audit Office that, in their view, the threshold for including contracts in the Bulletin needed to be lowered to ensure that more contract opportunities were advertised.
21 There are 2,859 subscribers to the Bulletin (compared with a total of 8,000 companies registered with the Department on their contractors list) and the penetration of the Bulletin overseas is not particularly strong. It is, of course, up to companies themselves to seek opportunities to bid by subscribing to the Bulletin. Moreover, the Bulletin is not the only, or the main, means of informing potential bidders. Nevertheless some opportunities to attract competitive companies to the bidding process may be missed. The Department are aware of these, and other problems with the Bulletin identified in the main report, and have conducted a review of procedures with the aim of seeking improvements consistent with striking a better balance between minimising tender costs and maximising competition.
Transfer of risk to 22 The Department’s policy is to appoint a prime contractor wherever possible contractors to take responsibility for managing the entire project including managing the risks and making the necessary arrangements for the sub-contractors. This provides an incentive for them to complete the project to time, cost and technical performance and puts responsibility with the contractor for activities which they are usually best fitted to discharge.
23 Several issues arise here. The first concerns the choice between placing the contract with a fixed price [subject to defined input price increases) or with a firm price (where no inflation price increases will be paid). Firm prices are, in principle, preferable since both contracting parties know where they stand. However, a firm price spread over a long period may be hazardous for both the contractor [if inflation increases their costs more than anticipated) and the Department (if they have to pay extra to the contractor to offset inflationary risks that do not eventuate).
24 In negotiating contracts the Department do not consistently seek to identify comparative costs. Without assessing these it is more difficult for the Department to judge where the balance of advantage lies in individual cases. It will not always be sensible to carry out a detailed assessment because of the cost to industry and the Department of seeking bids on several different bases against the same requirement. It is not a simple question of asking a potential prime contractor to quote its risk premium. Qualitative issues which are more difficult to quantify also need to be taken into account. The Department would also need to assess the resource costs of managing contracts for the sub- contract items which would otherwise be Government Furnished Equipment and, even more important, to assess the risk that their failure to deliver even one of these equipments to the timescale agreed with the main contractor could lead to a substantial claim against the Department. Nevertheless, in some cases a more thorough assessment would put the Department in a stronger position when negotiating individual contracts and help to ensure that they commit scarce resources in the most cost effective way.
25 Contractors are incentivised to meet their delivery obligations by the prospect of payment on satisfactory completion, either of the finished
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articles, or tautly constructed achievement milestones. Additional incentives can be provided by including liquidated damages and current Departmental policy is that consideration must be given to the inclusion of liquidated damages provisions in contracts valued at more than El million - with the general presumption being that they are to be applied. Liquidated damages require the contractor to make compensation payments if equipment is delayed beyond the delivery date stipulated in the contract.
26 As with prime contractorship and firm prices, the inclusion of liquidated damages clauses leads to companies taking account of the prospective liability in their bids. On the Sea Owl project, the cost was El.4 million (5 per cent of contract value) whilst, on the Landing Platform for Helicopters, the cost was E2 million (1 per cent of contract value). Overall, this is another area where the Department do not routinely assess the costs included by contractors.
27 In general the Department has placed the contractual emphasis on risk transfer through mechanisms such as fixed/firm prices and prime contractorship, rather than risk sharing although, in some circumstances, the latter could be a better route to secure value for money. Risk sharing, which offers scope for savings where the risk is more difficult to quantify, can be achieved through the use of Target Cost Incentive Fee contracts. These are used by the Department for high value contracts where costs cannot be fully assessed at the outset. However, use of these contracts needs to be considered carefully since the sharing of risk on profit is balanced by the contractor’s ability to recover all of his actual costs up to the limit of the maximum price. Overall, in the three years ended 199’2./93, 10 per cent of contracts by value, were placed on this basis.
Other initiatives 28 There are always likely to be some contracts which cannot be placed competitively, although the National Audit Office noted that, between 1990 and 1992, contracts valued at E:277 million were let non-competitively because there was insufficient time to run a competition. It should be noted that the period covered by the survey was not necessarily typical as it includes the Gulf War. A more detailed breakdown of these contracts is not available. A more detailed analysis, which differentiated between those contracts let non-competitively for reasons of urgent operational need, and contracts let non-competitively because of avoidable delays in planning procurements, might permit the Department to identify ways in which non- competitive procurements could be further reduced.
29 To enhance the value for money obtained in cases where competitive procurement is still not practicable, the Department introduced the NAPNOC initiative in 1992 (paragraph 13). In the past, the Department’s performance in early pricing has been patchy and some improvement will be necessary if NAPNOC is not to lead to delays in placing contracts. For example, in the two years ended December 1992, only 60 per cent (by value) of contracts were priced at the outset with 8 per cent not priced until work was complete. Under NAPNOC, a longer term target has been set of 75 per cent of all non-competitive contracts to be priced at the outset, with the remainder to be priced by the time work is 25 per cent complete. This represents a challenging target, but progress has been encouraging with the first three quarters of 1993/94 showing 78 per cent by value priced at the outset.
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30 The Department also face problems in deriving reliable “should cost” data upon which to base judgements. This demands good production engineering and other information plus skilled judgement and experience. The challenge to the Department’s information systems and pricing staff is thus a steep one.
Other procurement 31 Given the budgetary pressures now facing many countries and the considerations increasing importance of interoperability, pressure to collaborate with allies or to buy proven “off-the-shelf” equipments is likely to grow.
32 Collaborative development, whilst usually cheaper for each participant than a national programme, can incur cost penalties due to worksharing arrangements agreed between partner nations. Cost reduction exercises on Eurofighter 2000 have shown that a rationalisation of worksharing with different ratios of work between partner nations would offer potential cost savings. In this case savings to the United Kingdom, of up to E2.5 million per aircraft (or E625 million on a buy of 250 aircraft) are being pursued. Departmental policy is to seek to avoid rigid workshare arrangements. In practice, this has proved very difficult and, instead, the Department has sought, whenever possible, to install competitive disciplines into collaborative procurements.
33 Overall, the option of countries collaborating to procure off-the-shelf, whereby the United Kingdom collaborates with other countries in the procurement of military equipment that has already been developed, is one of the best prospects for maximising value for money, as evidenced by the collaborative off-the-shelf purchase of AWACS aircraft with the French. Here, savings estimated at $24 million on procurement costs and at least $76 million on running costs, have or will accrue to the Department. However, at present, this approach is little used, mainly as a result of the difficulties in harmonising requirements with those of our allies and because “off-the-shelf” equipments do not exist for all our needs.
34 The Department have also introduced a number of initiatives and techniques which will enhance their ability to manage the procurement programme and achieve value for money. Technology Demonstrator Programmes are used to establish the maturity of new and emerging technologies and to reduce the risks associated with these before committing to full development. The results to date from these programmes have been encouraging, for example one programme to develop more efficient helicopter rotor designs is expected to produce savings of approximately E50 million over the life of the helicopter fleet.
35 The Department are also placing greater emphasis on reducing the life cycle costs of equipments by initiating drives to improve the consideration of reliability, in-Service maintainability and aspects of in-Service support (such as the level of contractor support) during procurement. Accordingly the Department have adopted the Integrated Logistics Support concept which ensures that through-life costs are given due weight in the decision- making process alongside purchase costs, timescales and performance from the outset of a project. Overall these measures hold out good prospects for reducing through-life support costs and allowing more of the risks associated with equipments to be passed to contractors. MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
38 In 1992 the United Kingdom was the second largest exporter of defence equipment in the world, winning orders worth E5.2 billion. As a result of these orders the Department estimate that they have saved 72340 million in reduced unit procurement costs due to contractors being able to spread their overheads over a wider base. More widely, exports are also a source of revenue to the Exchequer and help to preserve elements of the defence industry which, in turn, will help to preserve competition. In 1993 defence export orders totalled over !26 billion and the United Kingdom was, once again, the second largest exporter of defence equipment in the world. An analysis by the National Audit Office has shown that the Department considered exportability when drawing up specifications in 60 per cent of cases. Whilst the Department’s efforts to date are steps in the right direction, there is scope for them to undertake more detailed evaluations of export potential in future whilst balancing these with the needs of the United Kingdom’s Armed Forces.
Overall conclusion 37 The type of equipment required, the market from which it can be procured and the level of funding likely to be available have changed in recent years. These all pose a great challenge to the Department. Despite these changes the best prospects for the achievement of value for money lie in continuing with the competitive approach suitably modified by the comprehensive streamlining of contracts procedures the Department now have in hand and reinforced by the improved communications the Department have established with industry. The Department need to continue their energetic pursuit of the new initiatives outlined above which are already in train.
38 However, in some areas more remains to be done, particularly:
. the control of specification changes, a subject to which the National Audit Office plans to return; and . the need to assess the cost and benefit of reducing the threshold for the Contracts Bulletin and ensuring all valid contracts are included. 39 In the non-competitive sphere, the Department have, through the NAPNOC initiative, wrought a major change in the culture of non-competitive contracting and now put commercial terms before operational timescales if necessary. They are, however, faced with a difficult challenge to improve the quality of data availableon which to make “should cost” judgements. Finally, given the scope for securing savings by collaborating with allies when making large off-the-shelf purchases, the Department should continue their drive to ensure that opportunities for collaborative purchases are not missed.
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Part 1: Introduction
Background 1.4 In the past the Department have not sought to undertake any detailed evaluation of the 1.1 In 1993-94 the Ministry of Defence (the success of the various policies. However, Department) plans to spend E9.9 billion there is now a renewed drive to improve the (39 per cent of their total budget) on the quality of policy evaluation within the procurement of equipment, stores and Department. For this to succeed it is services. As a proportion of the overall important that suitable evaluative criteria are defence budget, procurement spending has established at the time an initiative is gradually fallen since 1985-86 when it introduced, something that was not always represented 46 per cent of the total budget. done for the 1980s’ initiatives. Consequently, Between 1985 and 1993 the overall defence the Department will need to ensure that, for budget fell by 14.5 per cent in real terms and any new initiatives, suitable criteria are is set to fall further. Against this background established at the outset, although the the 1993 Statement on the Defence Estimates National Audit Office recognise that isolating repeats the Department’s goal to ensure that the impact of a single initiative can be a very the Armed Forces “continue to have world- complex process. class equipment, providing capabilities appropriate to a broad spectrum of operational environments”. Scope of the National Audit Office examination 1.2 The Department aim to manage their equipment programme to meet approved 1.5 The National Audit Office examined: operational requirements whilst applying appropriate procurement policies and seeking . the impact that changes in the defence to obtain best value for money from the environment are having on the resources available. During the 1980s the Department’s ability to pursue the 1980s’ Department adopted a number of initiatives initiatives [Part 21; with the objective of setting their relationships with their suppliers on a more l the continuing applicability of the 1980s’ commercial footing. The main feature of this initiatives; the progress made by the was a drive to increase the proportion of Department in implementing them; and contracts let competitively, not just among any enhancements which have been or United Kingdom contractors but also by could be made both to existing initiatives inviting overseas bids, whilst seeking to bring and procurement practices generally market pressures to bear on the remaining (Parts 3-5). unavoidable non-competitive procurements. 1.6 The National Audit Office have undertaken The Department also sought to place greater four exercises: responsibility for the delivery of goods with industry to provide a better incentive to them . An examination of 37 projects (listed at to manage cost and programme risk. Annex 1) to assess the extent to which the initiatives have been implemented and 1.3 The drive to increase competition generally the effect they have had. served to reduce costs through the impact of market pressures. Figure 1 summarises ten of . To take account of the views of industry, the key initiatives introduced by the the National Audit Office entered into a Department during the 1980s and dialogue with three defence industry subsequently. The Figure also includes associations. Through these, the views of paragraph references to indicate where the 24 major defence contractors (listed at initiatives are considered in the main body of Annex 2) were canvassed. this Report.
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Figure 1: Key Initiatives Introduced by the Department
MeaSUre Objective RepOIl The 1980s’ initiatives Use of competitive Ta increasethe use of competitive tendering whilst reducing the tendering use Of cost plus type cordracts. 3.2-3.3
Encouragingsub- To maximise the extent of sub-contract competition to Secure contract competition keen prices. 3.28-3.29
Contracts Bulletin TOincrease industry visibility of contract and sub-contract opportunities.
New Suppliers To maintain a broad supplier base by encouragingComPardes to SerNce open business links with MOD. 3.10
Prime Contractorship Appointment of a single contractor with overall responsibility for co-ordinating the actions of sub-contractors. 4.2-4.5
lncentivising Setting performancecriteria. making contractors responsiblefor contracts achieving them and linking payment to demonstratedperformance. 4.16-4.18
Othsr Initiatives NAPNOC The application of competitive “should cost” principles to non-competitive contracts. 3.24-3.27
Reducingthe Costs Reducingcosts to bath the Depaltment and industry by reducing the of Competition number of competitions and tenderers, and increasing contract lengths. 3.13-3.17
Reliability and Placing greater emphasis on whole life costs of ownership by Maintainability contracting, at the outset, for reliability and maintainability of equipments. 5.19
Integrated Logistic A commitmentto place greater emphasis and funding on the support logistics aspect of a project during the initial procurement phase. 5.21 Source: National Audit Officeanalysis.
Figure 1 lists some of the measures introduced by the Department in the 1980s and more recently to encourage a commercial approach and to place greater emphasis on reducing through-life costs in defence procurement.
. Similar challenges to those facing the For instance, in countries where the Department are present in other countries. defence industry is largely state owned, Consequently, the National Audit Office competitive procurement receives far less also reviewed the approaches being emphasis. adopted in 11 other countries. The results . Finally, the National Audit Office have of this review ace recorded in various consulted the academic community, parts of the Report. Overall, however, the including Professor Ron Smith from National Audit Office concluded that, Birkbeck College, Professor Keith Hartley particularly in terms of the pursuit of from the University of York and David competition, the Department were Greenwood from Aberdeen University. performing well in comparison with other Specific inputs on the changing defence countries, (see Annex 3) although, it environment were commissioned from should be noted that, in some countries, Dr Neil Cooper. the procurement philosophy is different.
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Part 2: The changing defence environment
Introduction peace and stability. This encompasses the provision of support for NATO, the 2.1 Since the early 1980s the policy of the Western European Union and the United Government has been to promote the use of Nations. market forces across the whole range of public 2.4 Diverse threats have placed greater emphasis activities. In defence procurement this led to on United Kingdom forces having versatile the introduction of policies which sought to equipment that is also compatible with that of place the Department’s relationships with our allies. The importance and value of their suppliers on a more commercial footing. having equipment that is either standardised One of the key policies introduced was the or interoperable with that of our allies is greatly increased use of competition in the underlined by the recent Gulf conflict. procurement of defence equipment and services. 2.5 At the same time, the dissipation of the threat from the former Soviet countries has 2.2 Subsequent to the introduction of the 1980s’ increased expectations of a reduction in initiatives there have been fundamental defence procurement expenditure, the “Peace changes in the environment within which the Dividend”, and the level of defence United Kingdom’s Armed Forces must operate expenditure, as with other departments’ and the Department must purchase spending, is being determined against the equipment. This Part of the Report examines background of the Government’s objective to the nature of these changes, their implications reduce public expenditure as a share of Gross for defence procurement and the risks to value Domestic Product. The Department’s for money which the changes create. procurement strategy seeks to reconcile all of these expectations with the requirement of the Armed Forces. Changes in the strategic environment Budgetary considerations 2.3 Government defence policy, as set out in the 1993 Statement on the Defence Estimates, has 2.6 Between 1986-87 and 1992-93 expenditure three main strands: on equipment fell by over 24 per cent in real terms and is likely to reduce further in the l To ensure the protection and security of post-“Options for Change” restructuring of the the United Kingdom including provision Armed Forces. In addition, as with all of forces for the surveillance and policing Government departments, defence of territorial waters, providing defence for expenditure plans are reviewed annually as the dependent territories and providing part of the Public Expenditure Survey Round. support to the civil power, including the police in Northern Ireland. Nuclear forces 2.7 In his 1993 Autumn Budget Statement the underpin this strategy and provide the Chancellor of the Exchequer announced that ultimate guarantee of United Kingdom plans for reducing levels of defence security. expenditure (by f250 million in 1994-95 and E500 million in 1995-96) “will be delivered, . To insure against a major external threat in part, by lower procurement and to the United Kingdom and its allies, a employment costs” [Hansard, 30 November role discharged through membership of 1993, Co1 928). He further announced that the NATO. Secretary of State for Defence had set in hand . To contribute to promoting the United a major review of all aspects of the Kingdom’s wider security interests Department’s support activities. On 1 through the maintenance of international December 1993 the Secretary of State for
11 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1SWs
Defence explained to the House of Commons Figure 2: Changesin the defence budgets of Select Committee that he was establishing a selected NATOcountries “Defence Costs Study” to look at ways of Fall/(increase) reducing spending on back-up services. in proportionto Further to this, he announced in the House of COUlll~ % GOP % GOP GOPconsumed by Commons on 14 January 1994 (Hansard. 14 1985 1992 defence bud&?& 0,” January 1994, Co1 342) that one of the studies that had been launched was concerned with Belgium 3.0 1.6 1.2 Denmark 2.2 2.0 0.2 procurement projects and practices. FlallCe 4.0 3.4 0.6 Germany 3.2 2.4 0.8 2.8 In 1992-93, over 80 per cent of the equipment Greece 7.0 5.6 1.4 Italy 2.3 2.0 0.3 budget was already contractually committed Netherlands 3.1 2.4 0.7 as a result of contracts let in earlier years, Norway 3.1 3.3 ‘;:;I many of which relate to programmes designed Spain 2.4 1.7 Turkey 4.5 4.7 ‘$l for a different defence environment. UK 5.2 4.0 Consequently, in procuring equipment USA 6.5 5.3 1.2 suitable for the changed environment the Canada 2.2 2.0 0.2 Department are not only constrained by Source: TheMilitaw Balance 1993-94 budgetary pressures and uncertainties but by Figure 2 shows that the propoltion of GDPspent on defencehas the length of the procurement cycle. A good fallen acrw all countries listed except Norway and Turkey example is the Upholder submarine programme where the first approval occurred 2.10 NATO members have adopted different in 1979 but the last vessel will enter service in approaches to budget cuts with the majority 1994. As a result of changes in the threat, the choosing to make only limited changes to Department has now stated that it has no existing force structures and to meet the cuts operational justification for retaining these by reducing manpower, stretching V&WA. procurement programmes and reducing production quantities. A good example is the United States where budget cuts will see the Implications of the changed procurement budget fall by 59 per cent in real environment terms between 1985 and 1994. This has led to the curtailment of 100 procurement programmes and the stretching and reduction Reactions of Government of quantities for many others. 2.9 In 1990 the Department completed a fundamental review of the Armed Forces 2.11 In the United Kingdom, the reaction to the which was reflected in the 1992 Statement on lower defence budget has at least three the Defence Estimates under the title impacts. “Britain’s Defence for the 1990s”. This (i) Stretching of the procurement cycle by document contained a series of cuts planned delaying projects: 14 out of 37 projects for the defence budget which would require examinedby the NationalAudit Office(38 reductions both in manpower and per cent) had been delayed as a result of equipments. Figure 2 shows that a similar budgetary pressures. Such delays can pattern of cuts exists in most other NATO arise both before a project commences and countries. can also be imposed once a project has begun. An example of the potential costs of delay is provided by the Harrier TlO project. Here the Department recognised that, if they had accepted a delay of nine months, this would have resulted in the temporary closure of the contractors’ production facilities. If this had occurred the Department would have incurred up to s23 million additional expenditure to reactivate the facilities. In practice the programme was brought forward to avoid these costs. The incidence and cost of
12 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
delays was confirmed by 10 of the 24 (iii) Cancellation of programmes and contractors contacted, with one estimating withdrawal of equipment: the Department that delays had led to a 30 per cent have cancelled several programmes part increase in the development costs of one way through the project cycle in response project. The previous Chief of Defence to the changes in the threat. Examples Procurement acknowledged the costs of here are the Light Weight Sea Wolf missile delaying programmes when, in giving and the new Upholder Class submarines. evidence to the Committee of Public In the latter case four boats have been Accounts (11th Report, Session 1990-91), built, at an estimated cost of f9oo million, he confirmed that deferring expenditure with the last vessel entering service in may not be the best use of resources and, 1994 but, it has now been decided, they in the long run, could cost the taxpayer should be withdrawn from service in nmre money. This recognises the cost 1995. However, cancellation of sane implications for the defence industry and, programmes or disposals such as these are ultimately, the Department of putting inevitable as the Department reconcile decisions “on hold” whilst programmes earlier commitments with reduced and plans are reappraised. Such delays budgets reflecting the changed threat and can lead to industry putting project teams are usually considered to be preferable to and expensive resources “on ice” in the the option of stretching the procurement hope that existing orders will be cycle to accommodate more projects than confirmed and/or new orders announced. the Department can realistically afford. Ultimately, if those companies do win Reaction of industry future orders sane of these costs could well be passed on to the Department in 2.12 The reduction in defence budgets has also had the form of higher prices. Delays in an impact on the defence industry. A survey fielding new weapons systems can also of 30 major European defence contractors on lead to the Services having to use old and behalf of the European Commission (including uneconomic equipments. 11 British companies) showed that 27 of them perceived a significant threat to their future (ii) Reduction of production quantities: the profitability. Faced with this prospect 10 of Department have made significant the contractors were either seeking to merge reductions in the contracted production with another enterprise or were looking to quantities for several major weapons engage in more joint ventures with other systems where contracts had been let defence contractors, either in the United prior to the changes in the strategic Kingdom or overseas; eight were cutting back environment. This has led to savings in on their defence industry activities: and three terms of life cycle costs since less firms were converting military capacity to equipment ordered and used means less civilian use. expense. But the procurement unit cost of individual equipments has generally 2.13 As a result of reduced orders and industry’s increased as a result of production own efforts to improve productivity, the overheads, learning curve costs and estimated number of employees within the development costs being spread over a defence industry declined from 625,000 in smaller base. For example, on the Warrior 1985-86 to 560,000 in 1991-92. The project, a cut in production quantities Department estimate (provisionally] that by from 1,048 vehicles to 769 contributed to 1992-93 the figure had fallen to ~OO,OOO. an increase in the procurement unit cost of 14 per cent although, in the longer 2.14 These nmves also have implications for the term, net savings will accrue in terms of Department if they are reflected in a loss of in-Service support costs. The Department specific competences and skills within informed the National Audit Office that industry. This, industry argue, will adversely variations in procurement quantities and affect the Department’s ability to procure project timescales will still need to be domestically the range of products currently adopted to ensure that the programme available, in the future. However, the accords both with military requirements Department’s publicly stated policy (for and available resources. example in the Departmental Report by the Ministry of Defence, Government Expenditure plans 1993/94 - 1995/96, page 16, para 35) is
13 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
“to support open international competition issues will normally address a number of and buy equipment from overseas where this factors relevant to the health of the defence offers best value for money”. The exception to industries: this is the shipbuilding sector where current . the procurement strategy, including the government policy is to limit competition to extent of competition: domestic suppliers. . a description of the extent to which efforts 2.15 The National Audit Office found very few have been made to establish a common cases of procurement decisions being overtly approach with allies; influenced by a desire to maintain domestic . industrial considerations, including any capacity. Of 37 projects examined, in only significant effects on UK industry: and three cases was the maintenance of domestic capacity a consideration and, in two of these, . overseas sales prospects.” the contracts pre-date the Department’s public 2.17 Another feature of the changed industrial commitment to international competition. In environment is the incidence of mergers the remaining case (a Sonobuoys contract) the which, coupled with the main reason for restricting the choice to “internationalisation” of defence equipment, United Kingdom suppliers was the highly means that very few complex equipments are classified nature of target information with wholly manufactured in one country. For which the contract dealt. example, 11 per cent of the Challenger II tank is made overseas including the fire control 2.16 The primary duty of the Department, when computer, the primary sight and components taking procurement decisions, is to ensure for the gunnery sight: whilst the tracks, engine that value for money is achieved for the and transmission of the AS90 self propelled defence budget. The concern of industry is artillery vehicle are all made overseas. A that placement of an order overseas leads similar situation faces foreign governments. potentially to British firms going out of For example, the American F18 Fighter business and/or to loss of export orders. The incorporates a British ejector seat whilst 50 overall effect on the economy of an individual per cent of the components for the Swedish procurement decision is difficult to assess. In Gripen fighter are being manufactured general, though, the Government does not overseas (15 per cent in the United Kingdom). expect to secure any permanent gain to the Thus, in practice, it would be virtually economy by procuring a United Kingdom impossible to adopt a policy which aimed to good which offers less value for money for the retain the ability to wholly manufacture major purchaser than a procurement from overseas. equipments in any one country. To the extent that this happens, the Department loses potential efficiency gains, Prospects for competition and United Kingdom industry loses the stimulus of overseas competition. When 2.18 At the domestic level the reduction in the size taking procurement decisions the Department, of the market has already led to single therefore, do not, on the advice of the domestic suppliers in areas such as tanks, Treasury, seek to quantify the potential fighter aircraft, aero engines and nuclear economic implications when assessing submarines. As recorded in the National tenders from British and foreign contractors. Audit Office Report “Ministry of Defence: However, such factors are not overlooked. In Award of the Contract for the Landing their response to the Select Committee on Platform for Helicopters” (HC 864, Session Trade and Industry’s Third Report for 1992/93) similar problems could arise in parts 1992-93 on the British Aerospace Industry the of the shipbuilding sector. Government stated that “The MOD’s procedures already provide for consideration 2.19 However, despite the trend towards both to be given to industrial factors, both during domestic and international mergers and joint the annual Long-Term Costing exercise, which ventures, and the contraction in the United is informed by an analysis of the industrial Kingdom defence industrial base, there are, in impact of alternative measures, and when large measure, still good prospects for particular procurement decisions are being effective competition at the international taken. As the Department’s Supplementary level, for the foreseeable future. Moreover, the Memorandum to the Committee explained, possible appointment of prime contractors submissions to Ministers on procurement who are not the main platform builder but
14 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1WOs
integration specialists, such as IBM ASIC for the EHlOl helicopter, means that competition Key Points at prime contractor level should remain quite ~22 In the view of the National Audit Office the possible. following issues for value for money arise from changes in the defence environment: 2.20 Of the 37 projects examined by the National Audit Office, only 6 were won by overseas [i) The change in threat means that future companies and of these 5 were off-the-shelf equipments will need to be flexible and purchases. Overall the level of foreign interoperable with those fielded by our equipments procured, at between 9 and 10 per allies. This was underlined by cent of procurement expenditure, has experience in the Gulf. However, the remained static over the past four years. This Department are hampered in their ability compares with a figure of 10 per cent in to redirect the procurement programme Germany and 3 per cent in France, both of by the length of the procurement cycle which have similar size defence industries to which means that equipments designed the Unikd Kingdom, although countries such in the 1980s are still under development as Sweden and Holland, which have much and/or production today (paragraphs smaller domestic defence industries, both 2.4-2.5). procure 35 per cent of their defence (ii) The changed strategic environment and equipment overseas. There is no evidence that consequential decline in the defence the static level of United Kingdom overseas budget has led the Department to cancel purchasing implies any weakening of the programmes, withdraw equipment, Department’s resolve to consider overseas reduce production quantities and to bids on the basis set out in paragraph 2.14. It stretch existing programmes. The indicates the highly competitive nature of Department recognise that stretching British companies, an impression reinforced programmes is not usually cost effective by their success in highly competitive export and is to be avoided if at all possible. markets. However, they also acknowledge that some variations in procurement The Department’s relationship with indusm quantities and project timescales will 2.21 There has been considerable criticism in remain necessary to preserve a balanced recent years, from within the defence programme (paragraph Z.ll(i]]. industry, of the Department’s unwillingness to (iii) Prospects for international competition, provide details of their future plans. The in accordance with the Department’s Department’s policy is not to release full stated policy, remain good for the details of their annual long term costing, This foreseeable future. Experience over the is because it is designed for internal planning last few years shows 90 per cent of purposes and approval to commit expenditure procurement expenditure (including is subject to separate procedures and collaborative programmes) is spent with endorsement by Ministers as appropriate. British industry [paragraphs 2.14 and Providing details of the contents of the long 2.18-2.20). term costing would give a misleading impression as to the firmness of the Department’s plans. However, in the light of the changed environment, and the uncertainty which this brings, it is important that industry has some indication of future equipment plans if they are to focus their capital investment and research and development efforts. The Department have recognised this and taken steps to improve matters including holding regular Suppliers Conferences and publishing a consolidated list of extant staff targets. The Department are also considering ways of reinforcing existing guidance to industry on their future technological priorities.
15 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Part_ 3:-1 The application of competitive principles
Introduction been increasingly successful in achieving this objective. The use of competition has led to 3.1 This Part of the Report considers the large savings on s0me procurements. Department’s implementation of, and Extrapolating from a range of projects the potential enhancements to, their initiatives to Department estimate that overall savings apply competitive principles. It also examines resulting from competition will continue to the Department’s initiatives in the area of non- save in the order of El billion on the competitive procurement, the aim of which is equipment and spares budget each year. to ensure that value for money is achieved where the disciplines instilled by open 3.3 The extent of the Department’s achievement competition cannot be brought to bear. in obtaining competition is highlighted by a comparison with other countries. For example, in terms of the number of contracts, Competitive procurement the United Kingdom has consistently let sane 80 per cent competitively. The average 3.2 The key initiative introduced by the overseas, at around 70 per cent, is Department was that, wherever possible, significantly lower and only one of the contracts should be placed through countries surveyed (Australia1 has achieved a competition. Figure 3 shows that they have higher proportion.
Figure 3: Types of contract let by value 1981-82 to 1992-93
Per cent 100
80
60
40
20
0 81-82 83-84 65-86 87-88 89-90 91-92 92-93 Yeal
Cost Plus Non-Competitive IncentiveNon-Competitive Fixed Price Non-Competitive q Competitive
Source: Ministry of DefenceCompetition Statistics Figure 3 shows that a rising proportion of contracts are let competitively and that the proportion of cost-plus contracts has fallen significantly.
16 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
The selection of tenderers opportunities available. The Department have introduced two main measures to help 3.4 The Department maintain a list of companies achieve this, publication of a Contracts considered eligible to receive contracts in the Bulletin and the creation of the New form of a Defence Contractors List which Suppliers Service. Contracts Branches should use to draw up lists of tenderers. In 1992 the list, which then 3.8 The Contracts Bulletin, first produced in contained 11,500 contractors, was cleansed of 1986, is published fortnightly. This Bulletin inactive contractors (those not recejving supplements other methods of informing contracts for three years) and, following an potential bidders, such as the regular formal initial review, various improvements were and informal dialogue which takes place introduced. By 1993 there were sane 8,000 between Procurement Executive staff and companies registered on the list. The suppliers of equipment. In the two years to Department now undertake some financial the end of 1992, 782 contracts were placed checks on potential tenderers but tend to after being advertised in the Bulletin. The focus their attention on annual financial National Audit Office have reviewed the health checks for the 500 01‘ so major current systems and identified a number of companies on the list. reasons for the low number of contracts placed after being advertised: 3.5 For high value, technically complex and high risk contracts the Department is beginning to (i) For most items the threshold for inclusion make use of pm-contract award evaluation in the Bulletin is f500,OOO. Therefore, the teams tasked with examining the capabilities, Bulletin only covers 5 per cent of in terms of quality records and delivery contracts placed by number although this performance, of the shortlisted tenderers. The represents 80 per cent by value. The teams focus their efforts on evaluating the defence industry informed the National strengths and weaknesses of the tenderers in Audit Office that they would welcome a areas such as quality control systems, reduction in the threshold for the production capacity, and technical resources, inclusion of contract opportunities in the capabilities of key staff, control of sub- Bulletin. Reducing the threshold to contractors and financial status. f250,OOO would double the number of contracts advertised. However, the 3.6 Aside from the work of these teams, until Department would need to take account of recently, there was no formal Department- the resource implications of this. wide mechanism to learn and disseminate (ii) No reminders on the use of the Bulletin lessons from the past performance of had been issued to Contracts Branches for individual contractors, although, sane two years and no mechanism exists to systems were in place in individual areas. In ensure that all suitable opportunities are recent months a post has been established advertised. A recent study carried out by within the Procurement Executive with a view the Department indicated that scune 5 per to improving the dissemination of lessons cent by number [less than 10 per cent by learned. The Department is also seeking to value) of contracts over the threshold for increase the emphasis placed on Post Project inclusion in the Bulletin had been Evaluation and, in addition, are actively erroneously excluded over the past two considering the enhancement of the existing years with the risk that some potential vendor assessment system. new bidders were being overlooked. Broadening the supplier base (iii) At 2,859, the current number of subscribers to the Bulletin is relatively 3.7 As noted in Part 2 of the Report the number of low, especially when compared to the suppliers in sane sectors of the domestic number of companies on the Defence defence marketplace is falling, whilst there Contractors List. In particular, foreign has been no perceptible increase in overseas interest is poor, with the Bulletin having procurement. If the Department are to only 195 overseas subscribers of whom 13 continue to compete their requirements are the Department’s own Defence effectively, and implement their policy of Attaches (out of a total of 134). It is, of international competition, it is therefore course, up to companies themselves to important to ensure that potential players, seek opportunities to bid by subscribing to especially those overseas, are aware of the
17 MINISTRY OF DEFENCE:DEFENCE PROC”REMENT IN THE 1990s
the Bulletin. Moreover, the Bulletin is not new companies on the Defence Contractors the only, or the main, means of informing List should increase this figure further since, potential bidders. Nonetheless one reason at present, there is still a tendency to stick to for the limited penetration overseas could tried and tested names. be that the Bulletin is only published in English. Penetration of the Bulletin could Placing competitive contracts also be improved by ensuring that mcare of 3.11 One of the benefits of competition is that it the Department’s Defence AttachB’s can encourage tenderers to produce receive a copy. Further improvements in innovative and cost effective solutions to the coverage could be achieved by targeting Department’s requirements. On major &...a overseas Trade Associations since programmes this is likely to require bidders to ’ relatively few of them presently subscribe make trade-offs between specification and to the Bulletin, whilst provision of copies price in order to submit a tender likely to be to overseas defence ministries may also affordable to the Department. It is, therefore, help. At present only 10 subscribe. important that tenderers are aware of the 3.9 The Department has already taken scune steps relative importance which the Department to rectify some of the problems outlined attach to different aspects of the requirement above. The aim is to seek improvements and of the criteria against which tenders will consistent with striking a sensible balance be assessed. This information is also between minimising tendering costs and important if the Department themselves are to maximising competition. As part of this, be able to assess fully the merits of various greater emphasis has been placed on the bids. quality of tenderers’ marketing plans when the contract for the printing and sale of the 3.12 As industry have pointed out, and the Bulletin was recently re-let. In addition, the Department have accepted, the application of Department are considering sending a this principle has been patchy. For example, questionnaire to French contractors who do only 6 of the 37 projects examined by the not currently subscribe to the Bulletin, whilst National Audit Office contained their French counterparts are considering comprehensive tender assessment schemes. A making similar enquiries of United Kingdom good example is the recent contract for the contractors in connection with the French Landing Platform for Helicopters where the bulletin. The latter is to be particularly Department accept that they could have welcomed since at present British contractors provided more guidance on those areas where have complained about the lack of they were unwilling to accept relaxations in information on werseas bidding the specification. The Department are now opportunities. This is partly as a result of the renewing their drive to ensure that such fact that, compared to the United Kingdom, all information is published for all major other European countries, with the exception competitions. of Belgium, publish their bulletins less frequently and, without exception, with The costs of competition thresholdsfor inclusion which arehigher than 3.13 An analysisof the returnsto the Department’s in the United Kingdom. main Tender Boards showed that, across srxne 13,000 competitions, an average of 6.4 tenders 3.10 The New Suppliers Services (NSS) was were invited. Only half of the companies established in 1986 to encourage companies, invited, actually submitted bids. Within these at home and abroad, who wish to open or figures are a wide range of numbers of bids renew business links with the Department. requested and received. The NSS is currently undertaking a survey of companies who have approached them to try 3.14 Whilst competitions normally provide the to establish whether the service the branch best assurance of value for money in terms of offers has proved useful and if not to adapt it price, their administration can be resource to better meet industry’s needs. One of the intensive. For the Department the costs facts emerging from this survey is that, of include the compilation of tender documents, those companies who successfully pursue provision of advice to tenderers, evaluation of Defence Contractors List registration, 53 per tenders and the negotiation of the contract cent subsequently received an invitation to including any iterative tendering. For industry tender. A recent nmve to specifically identify the provision of detailed technical responses,
18 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
production of tenders and iterative tendering contracts the Department intend to use greater is also expensive although, of course,, bidding judgement, based on pre-defined criteria, to costs will always be incurred by a company, select tenderers for specific contracts. when entering any competition, irrespective Through these measures, the costs of of the entity seeking to purchase the goods or individual competitions should again be services. reduced.
3.15 There are no overall figures for the “cost” of Competing production competition to industry when bidding for 3.18 The Department normally retain the right to defence work. Estimates provided to the compete production separately where they National Audit Office by industry show have funded development. This area was bidding costs, for 24 different competitions, to identified in the 1980s as one where be between 0.04 and 5.8 per cent of the competition offered prospects for savings. In contract value. For the Department the practice this has not always been the case Contracts Branch input alone has been with difficulties sometimes encountered on estimated at 0.5 per cent of the contract value. even basic equipments. The main reason for Using the industry figures as a basis and this is the difficulty in passing adequate data assuming an average bidding cost of 3 per from the design rights holder to the second cent, this would give an annual cost of producer especially given that no two competition to industry, excluding costs manufacturers possess identical factories with incurred by companies who decide not to identical processes and workforce skills. The tender, of up to g400 million. Inevitably, some Department have recognised these problems of these costs will be passed back to the and are now, in general, looking to contract Department via overheads by those companies for design, development and production in a who are successful in winning future single package using option prices for contracts. production items established during the initial competition. 3.16 The Department have recognised the problem and, in December 1992, initiated a number of 3.19 The National Audit Office found that, for measures to alleviate these difficulties. Key those projects involving both development amongst these is a move to reduce the number and production, the most common approach of competitions. The Department are now was, indeed, to let contracts covering both seeking, where appropriate, to establish development and some element of production. through initial competition, longer term The letting of development and production relationships with suppliers governed by taut together has several advantages: contractual conditions. Examples of the application of such principles include: Provided that the initial competition is inviting tenders for longer duration effective, the Department can often obtain programmes; including option prices where a more competitive price for the whole future requirements are not clear; adding new package, something evident from one of requirements to existing contracts: and the the projects (Sea Owl radar) examined by aggregation of requirements into multi-year the National Audit Office. In this case the packages. These measures, which are Department estimated that savings could welcomed by industry, should reduce both be as high as EZ50,OOO on each production the number and the frequency of competitions unit. hence reducing costs for both industry and the By contracting for at least an initial Department. However, care will be needed to production quantity from the maintain bidding opportunities for both development contractor, the latter has an existing and new suppliers. incentive to minimise production costs for the tranche and ensure that a competitive 3.17 Allied to the reduction in the number of baseline price is established for future competitions is a drive to reduce the number tranches. of tenderers invited. On larger contracts the Department now intend to hold pre-qualifying Delays between project phases can be rounds in which bidders will be invited to minimised. Given the costs of delay demonstrate their capability to meet the identified in paragraph 2.11(i) this should requirement. Subsequently, a smaller number benefit the Department financially. will be invited to submit tenders. For smaller
19 MINISTRY OF DEFENCE:DEFENCE PROCUREMENT IN THE 1990s
However given their past experiences, the Department recognise the need to be careful to Key Points ensure that, when letting joint development 21 The National Audit Office consider that the and production contracts, overlap between following key points can be drawn out on the phases is minimised with production not Department’s use of competition: commencing until development has been shown to be successful. This can become (i) To improve the impact of the Contracts complicated by the fact that, under joint Bulletin the Department should assess development and production contracts, the the cost and benefits of reducing the final decision as to when to nmve to threshold from its current level to production often rests with the contractor. As increase the number of opportunities the Department also recognise, care is needed advertised. At the same time they should to ensure that a sufficiently broad range of continue with their drive to ensure that option quantities is established since, if this is all valid contracts are included and that not done, any changes to the quantity required the Bulletin is disseminated more will involve negotiations to adjust the contract widely, particularly abroad where Trade price in which the Department may not be in Associations and Defence Attach& can a strong position. play an important role (paragraphs 3.7-3.9). 3.20 Previously, the Department have sometimes (ii) The Department’s drive to ensure all split production quantities into several invitations to tender contain clear tender tranches and competed these separately. evaluation criteria and details of those However, with reduced quantities likely to be aspects of equipment performance to purchased in the future, splitting production which they attach greatest weight is into tranches is less likely to be cost effective. important. This should enable tenderers Again the Department recognise this, as to focus bids more clearly and assist the evidenced by one project examined by the Department in assessing the respective National Audit Office, where multiple merits of bids (paragraphs 3.11-3.12). production tranches were rejected because of economies of scale. Where separate (iii) Bidding costs to industry alone are production tranches are required the possibly as high as f400 million each Department now intend to encourage the year. Some cwts must inevitably be existing contractor to test its efficiency by passed back to the Department. The maximising the use made of “make in- measures proposed to reduce both the house/buy outside” comparisons at the sub- number and frequency of competitions contract level. This should bring some and the number of tenderers invited competitive incentives to bear on non- should be encouraged as they will help competitive procurements. to minimise costs but opportunities for both new and existing companies to bid for defence work must be maintained (paragraphs 3.13-3.17).
(iv) The Department are right to look to measures such as option pricing and make or buy comparisons when competing production would be difficult (paragraphs 3.18-3.20).
20 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Non-competitive procurement due to operational urgency. Nonetheless, the Department does not have a more detailed The extent of non-competitive procurement breakdown of this category of non-competitive procurement which, in total, represents 3.22 Between 1990 and 1992 the Department let purchases valued at f277 million. sane 33,000 contracts, worth f4 billion on a non-competitive basis. Figure 4 highlights the No Acceptable Price, No Contract (NAPNOC) main reasmxs for this. It shows that, in over 50 per cent of the cases, the Department were 3.23 It will never be possible for the Department to committed to a single source either because a compete all of their requirements. They have contractor had a unique capability or because therefore sought to identify an approach the Department had no rights to compete. This which transfers SOIIE of the competitive usually arises because the intellectual disciplines to non-competitive contracts. This property or design rights rest with a particular approach is known as “No Acceptable Price, contractor, for example, where the No Contract” or NAPNOC. Department has chosen to buy off-the-shelf to avoid development costs. In a further 31 per 3.24 NAPNOC is predicated on the fact that the cent a conscious decision was made to remain Department’s negotiating pusition is strongest with the original design team. In part, the before a contract is let. The initiative was latter reflects problems encountered in introduced in July 1992 with a f lo million competing production. In 7 per cent of cases threshold. In July 1993 the threshold was the reason for dispensing with competition reduced to El million which should bring was lack of time. Some of these cases relate to ZOO-300 contracts within the NAPNOC procurements made quickly to avoid cost discipline. This equates to sane 70 per cent of increases on other work whilst others relate to non-competitive contracts by value although urgent operational requirements. It should be only 5 per cent by number. The Department’s noted that the period covered by the survey is long term objective is to price 75 per cent, by not necessarily typical as it includes the Gulf value, of all non-competitive contracts at the War and the statistics for the first three outset, with the remainder to be priced by the quarters of 1993/94 show only 2.3 per cent by time work is 25 per cent complete. value of non-competitive contracts were let
Figure 4: Reasonsfor dispensing with competition 1990-92
No Rightsto Compet
Percentageby value
Source: Minishy of DefenceCompetition Statistics Figure4 shows that over half the caseswhere the Departmentdispensed with competition arose becausea supplier had a unique capability or the Departmenthad no rights to compete.
21 MINISTRY OF DEFENCE:DEFENCE PROC”REMENT IN THE 1990s
3.25 The Department have set challenging targets. Sub-contracts Between 1990 and 1992, an average of 50 per 3.28 In December 1992 the Department announced cent of contracts were priced at the outset and that they were abolishing the requirement for 61 per cent by the time a quarter of the work contractors to report the extent to which sub- was complete. Some 8 per cent of contracts contracts were let competitively. This reflects were still unpriced when all work was the limited value added by a process where complete. In the first 9 months of 1993194 78 there is already an assurance of value for per cent of new contracts (by value) were money given by competing the prime contract. priced at the outset. In total 127 contracts worth a total of El.9 billiun have now been 3.29 in non-competitive contracts no such priced on a NAPNOC basis. Thus, the assurance exists. In these cases, the Department appear on course towards their Department still intend to press for the long term objective of pricing 75 per cent of maximum level of sub-contract competition. non-competitive contracts at the outset However, rather than relying on earlier (paragraph 3.24 refers). The National Audit arrangements which had resulted in poor Office will continue to monitor progress on visibility and patchy management this initiative through their review of the information, the Department now intend to annual post costing statement. ensure greater visibility of contractors’ “make in-house or buy outside” plans. However, care 3.26 Under previous non-competitive arrangements will be needed since make-or-buy plans often the price was often established after work had change during the course of a contract. As commenced. In these cases the price tended to already noted in the context of competing reflect existing structures and methods and production (paragraph 3.20) these thus what the work was likely to cost the arrangements will form an important contractor. NAPNOC seeks to address this by safeguard to value for money by bringing providing an opportunity, through earlier competitive pressures to bear in the non- pricing, for the price to reflect what the work competitive arena. would cost in an efficient environment. The integrated pricing report, which will inform price negotiations in the future, will be based on the contractor’s own estimates, provided in the tender, but will, where practicable, take account of wider comparisons of industrial efficiency. Assessment of the latter will require accessible historical data to be held against which the Department can base “should cost” judgements.
3.27 In the past, cost data was maintained on 33 disparate databases. In the future, the utility of historical information will improve as more tenders, with the Department’s encouragement, include data in standard formats. This will allow more databases to be compiled although action will still be needed to ensure the comprehensiveness and accessibility of the databases. However, it will be a number of years before sufficient information is available to facilitate “should cost” judgements. Better access to historical data will facilitate the task of agreeing prices for new contracts but even then the Department will still be reliant on the skill and judgement of their experienced pricing staff.
22 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Key Points .30 The National Audit Office consider that the following key points can be drawn out on thl Department’s non-competitive and sub- contract procurement practices: (i) Over half of non-competitive contracts are placed because there is no alternative for the Department. For the remainder, the Department could analyse, in detail the justification for contracts being placed non-competitively, especially those where insufficient time is cited as the reason. This may help them to minimise non-competitive purchases even further in the future (paragraph 3.22). (ii] The Department’s past performance in early pricing, coupled with the reductior in the NAPNOC threshold from El0 million to El million and the impact of staff cuts, means that they will need to re-assess the priorities of their pricing staff if early pricing is to be achieved. Furthermore the information currently available for making “should cost” judgements is sparse, meaning that the Department’s initiative to collect data in standard formats will be crucial to the success of this initiative (paragraphs 3.24-3.27). (iii) Concentrating on “make in-house or buy outside” plans should enable the Department to secure, more directly, competitive pressures in the non- competitive arena, although care will be needed since make-or-buy plans often change during the course of a contract [paragraphs 3.28-3.291.
23 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Part 4: Transferring risk to contractors
Introduction the risks for the provision of civil works. Up to this point the project had experienced cost 4.1 One of the key thrusts of the 1980s’ initiatives overruns of flO0 million and schedule was to pass greater responsibility for delivery slippage of 5 years. Following the prime to industry by the transfer of cost and contractor’s appointment the problems have programme risk through the agreement of taut been considerably reduced indicating the contracts whether these were let on a benefits that can accrue from this approach. competitive or non-competitive basis. This Part of the Report considers the extent to 4.4 Contractors understandably seek to charge which the Department have been successful in extra when asked to bear the risks involved employing these initiatives and, given the with prime contractorship. However, the changes which have occurred in the defence Department do not routinely assess these costs environment, whether any refinements are when deciding upon their procurement now necessary. strategy for individual programmes. The National Audit Office have identified several examples of these costs. For example, on the Transfer of management UNITER communication system the Department paid f37 million (9 per cent of the responsibility contract value) for the introduction of prime contract arrangements and the supporting Prime conixactorship project management and co-ordination 4.2 Since the mid-1980s the Department’s policy activities. Since such data is not routinely has been, where possible, to appoint a single sought due to the costs to industry and the company or consortium, referred to as the Department associated with the requirement prime contractor, which has responsibility for to submit and evaluate bids on several bases, co-ordinating the actions of sub-contractors it has not been possible to assess the typical and integrating the individual components of extra paid by the Department for prime complex projects. From their analysis of contractorship, however the UNITER example projects the National Audit Office concluded does show that the sums involved can be that, by and large, the Department had been substantial. successful in achieving this aim. It is important to recognise that successful prime 4.5 The effect of obtaining information on the contracting means picking the projects where premium required by contractors for accepting it will work well. This requiresthe cultivation procurement risk is illustrated by the Trident of the necessary managerial and technical programme where, for the fourth submarine skills, discipline on both sides and a clear production order, having established the price understanding of where responsibility lies. required by the contractor for supply of the Whoever is responsible for managing the 2054 sonar system, the Department were able project it is important that the individuals to conclude that on the information available involved are held accountable for the at the time, the best value for money lay with successful completion of at least the current them carrying the risk themselves. stage of a project.
4.3 The projects reviewed by the National Audit Transfer of cost risk Office demonstrated the importance of prime contractorship arrangements by highlighting a Firm and fixed prices number of cases where problems arose 4.6 Wherever possible the Department seek to because a prime contractor was not appointed. agree firm or fixed prices. Firm prices pass the For instance, on the UNITER communication risk of both cost and inflation increases on to system, until a prime contractor was the contractor. For fixed price contracts the appointed in 1990, the Department had borne
24 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
supplier bears the cost risk only with the 4.11 Post tender negotiations and best and final Department making additional payments to offers are costly in resource terms for both the cover the costs of inflation which are Department and industry. There is also a risk calculated from individual cost indices, as with both techniques that, if they are used too stipulated in the contract. frequently by the Department contractors will simply build margins into their bids to allow 4.7 The best way of assessing these costs is to for subsequent iterations, although this is a request bids on both a fixed and firm price high risk strategy in a competitive situation. basis. In this area the Department routinely The Department’s internal Review of assess the bids and, in two cases (Harrier TlO Contracts Procedures recognised that both and the Landing Platform for Helicopters], techniques are acceptable but recommended this enabled them to reject the firm price bid that they are used sparingly and only in owing to the high level of contingency appropriate cases. The Department are included. updating its internal guidance to reflect this.
Iterative tendering Specification changes
4.8 When assessing tenders the Department must 4.12 To achieve value for money the Department make judgements about whether the offers must define its requirements adequately in they have received meet their requirements, mature and stable specifications. If this is not provide value for money and are affordable. In done specification changes can undermine the certain circumstances, the Department might discipline imposed by the transfer of cost risk engage in a process of iterative tendering with through the use of fixed or firm prices. the aim of securing improvements in the offers made. This process involves two 4.13 Eleven of the projects examined by the separate activities. National Audit Office had been subject to significant specification changes which had 4.9 The first is referred to as best and final offers. impacts for costs (in excess of 10 per cent) These are formal requests by the Department, and/or in-Service dates. One project, the to at least the two leading tenderers to submit Satellite Earth Terminal, had 193 specification a final offer. Best and final offers are used changes worth scune f9.3 million, an increase very selectively when, for example, a of more than 20 per cent on the original competition is closely contested and further contract value. clarification is required to select the winner. In the five years to March 1991, the last date 4.14 Further evidence of the adverse impact of to which data was collected, the Department specification changes is provided by the Major invited best and final offers from 798 Projects Report 1993. This shows that, on the tenderers on 302 contracts. Savings of Department’s 25 highest value programmes, El38 million were made equating to 7 per cent specification changes have resulted in cost of the original bid prices. increases of Over f110 million (10 per cent of the total cost escalation for the projects 4.10 The second activity is post tender negotiation, recorded). which is less formal and involves separate negotiations, normally with the leading Sharing of cost risks tenderer in a competition, without a re- 4.15 The approach adopted by most other submission of tenders. Post tender negotiation countries mirrors that of the United Kingdom is also used selectively and only where the with firm/fixed prices preferred for Department perceive that pre-contract production contracts where risk is more negotiation might give rise to improvements accurately definable. However, in a number of in the offered prices and/or in other terms. countries (including the United States, Over the five years to March 1991, 2877 Sweden, France and Holland] the preference contracts were let following post tender on higher risk development contracts is negotiations with an average of 5 tenderers moving towards greater risk sharing, at least involved in each case. Using this technique until that risk can be adequately defined. In the Department have achieved savings of 6 per the United States a study of 12 missile cent of the original tender prices, a total systems developed under fixed price contracts saving of f179 million, as well as other showed that 9 suffered from cost escalation of improved contract terms. more than 20 per cent as a result of
25 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
unforeseen technical difficulties. In these cases the Department of Defense bore part of Key Points the cost increases through specification 18 The National Audit Office consider that the changes. following key points can be drawn out on the Department’s arrangements for the transfer of 4.16 For their part the Department have recently management responsibility and cost risk: announced plans to nmve towards greater risk sharing for high risk development contracts. (i) The Department must understandably One way of doing this would be to make nmre expect tu pay a price for passing risk to use of target cost incentive fee arrangements. contractors in areas such as management, Under fixed or firm price arrangements any cost and inflation risks. The agreement of cost savings made by the contractor against such terms is often part of a package and the contract price are retained by him whilst before entering negotiations the he must also bear all cost overruns. With Department need to analyse what they target cost contracts, cost savings and are likely to pay for particular overruns are shared between the Department contractual terms. However, at present and the contractor although a ceiling is they do not consistently seek to quantify usually placed upon the amount which the these costs to assess whether the balance Department will pay. As part of these of advantage, in individual cases lies in arrangements the Department is given greater passing the risk or accepting the risk visibility of a contractor’s books and records internally. The benefits that can accrue than is usually the case with fixed or firm from such an evaluation are illustrated priced contracts. In the three years ended by the Trident programme (paragraphs 1xX-93,10 per cent of contracts by value, but 4.24.5). only 0.1 per cent by number were placed on [ii] Iterative tendering has achieved this basis, reflecting the Department’s current significant savings for the Department. guidance that only larger contracts are likely Its continued selective use is to be to benefit from the additional administrative encouraged (paragraphs 4.84.11). costs relating to such arrangements. (iii) One third of the projects examined by 4.17 Notwithstanding the above, the Department the National Audit Office included informed the National Audit Office that use of specification changes which had a Target Cost Incentive Fee contracts needed to significant impact on the contract price. be considered carefully since the sharing of These will affect the robustness of the risk on profit is balanced by the contractor’s initial price and reduce the incentive on ability to recover all of his actual costs, up to the contractor to perform efficiently. The the limit of the maximum price. Nevertheless, National Audit Office is planning a more the Department expects that as a result of the detailed review of this area (paragraphs NAPNOC initiative (paragraphs 3.24-3.27). 4.12-4.14). greater use will be made of target cost (iv) Greater risk sharing is appropriate at the incentive contracting in the future, since this earlier stages of high risk development initiative promotes an early assessment of the contracts especially where industry is degree of risk, enabling proposals for unlikely to be willing to bear all of the incentive fee bids to be sought where risks, 01‘where asking industry to bear appropriate. these risks would be unreasonable. The Department might have considered making more use of other incentive pricing arrangements, such as target cost/incentive fee contracts. With the advent of NAPNOC, the Department envisage an increase in their use in the future [paragraphs 4.15417).
26 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Transfer of performance risk familiar with the United Kingdom procurement approaches which can differ 4.19 In negotiating contracts the Department’s from practices overseas. Thus, foreign objective is to place responsibility for contractors can be reluctant to accept achievement of specified performance criteria United Kingdom terms and conditions in with the contractor. As part of this process the their totality. Nonetheless, the Department Department seek to establish monitoring and negotiate contracts as a package and, in payment arrangements which are linked to the cases where foreign contractors are contractor meeting these criteria and which, reluctant to accept certain United through contractual sanctions such as Kingdom terms, this forms just one aspect Liquidated Damages, provide the Department of the value for money factors taken into with sufficient assurances that industry will account when bids from the United deliver what was contracted for in the Kingdom and foreign suppliers are required time frame. In this connection the compared. liquidated damages clauses act as an incentive [ii) The Department are involved in several for the contractor and compensate the programmes which pose particular Department for losses they have suffered if, integration challenges, especially where for reasons within the contractor’s control, a one contractor is reliant either on another product or service is delivered late. Current contractor or the Department itself to Departmental guidance requires staff to enable it to fulfil its obligations. Such consider the inclusion of liquidated damages dependencies can undermine the clauses on all contracts with a value in excess effectiveness of contractual incentives. In of El million with the general presumption some cases, the National Audit Office being that they are to be applied. Such clauses found that the Department had may also be included in contracts below that acknowledged these complexities by, for threshold where appropriate. example, not including liquidated damages on the Action Data Improvement 4.20 From the projects examined by the National Programme due to the contractor’s Audit Office it was clear that the Department reliance on the Department for elements have been successful in including milestone of the work. This recognised the fact that, payment arrangements in virtually all even if the product was delayed by the contracts, whilst 21 out of 37 contracts contractor, there could also be delays in examined contained liquidated damages providing the equipment for which the clauses. This exercise also highlighted two Department was responsible. Thus, the aspects where the Department could focus effect of liquidated damages, for which more attention: the Department would have paid a (i) Two projects, E3 Airborne Early Warning premium in the contract price, would be Aircraft and Harrier TlO, included large nullified. elements of work placed in the United 4.21 Conversely, on projects such as the UNITER States. In both cases the Department faced communication system, the Earth Terminal difficulties agreeing milestone plans with Diversification and NAVSTAR navigation payment linked to achievement. For the system, liquidated damages clauses were Early Warning Aircraft, payments were included despite the existence of tasks for not formally linked to performance which the Department and/or other although, in this case, the contract did contractors were responsible. The Department allow for the withholding of payments in informed the National Audit Office that, in the event of lack of progress. Other recent these cases, the decision to include liquidated examples where the Department damages was taken because the Department encountered similar difficulties include believed that problems would not be the EHlOl prime contract and the encountered in delivering on time equipment procurement of the Harpoon missile from and facilities for which they were responsible. the United States. These and other related difficulties stem from the fact that overseas contractors are not always
27 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
In the event, on the UNITER programme there was a 5 year slippage on the works element Key Points which was outside the control of the systems 23 The National Audit Office consider that the contractor. This led to the effect of the following key points can be drawn out on the liquidated damages clause being nullified. Department’s arrangements for transferring performance risk to contractors: 4.22 As with prime contractorship and firm prices, contractors include extra costs in their bids to (i) The Department have been successful in cover liquidated damages. Here again the including incentives in contracts to Department do not routinely assess these encourage efficient contractor costs. However, occasional attempts at performance although some problems quantification have been made which have been experienced with persuading illustrate the cost to the Department. For overseas companies to accept standard example, on the Sea Owl programme, the United Kingdom procurement terms. In Department established that the amount future, the Department should place required by the contractor for the inclusion of increasing emphasis on ensuring that a liquidated damages clause was 5 per cent of such incentives are included in contracts the contract price and therefore decided to with foreign companies, something exclude the clause from the contract. On which should be helped by the another project [Landing Platform for increasingly fierce competition for Helicopters) one tenderer had included, in its defence orders (paragraph 4.20(i)). bid, a premium of f2 million (one per cent of (ii] Where projects involve complex linkages the bid price) to cover liquidated damages. and use government furnished equipment, 01‘ contractually bind the Department to providing facilities or information, the Department need to be sure of their ground when establishing contractual milestones, since the incentives could become less potent if a contractor can claim that failure to perform under the contract is due to the shortcomings of a third party (paragraph 4.2O(ii)). (iii) As with the transfer of management and cost risk, the transfer of performance risk through liquidated damages can lead to tenderers including extra costs in their bids. This is understandable given the role they are being asked to accept. However, the Department may end up paying an unduly large amount for this. Here again, the Department do not seek to quantify these costs and should consider doing so for all major procurements [paragraph 4.221. [iv) Current Departmental policy is a presumption in favour of including liquidated damages clauses in all contracts with a value in excess of El million. Given the problems of complex linkages, referred to in (ii) above, and the price which contractors may charge for including such clauses, the Department might wusidar whether such au all embracing policy is appropriate (paragraph 4.19-4.22).
28 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Part 5: Other initiatives to minimise equipment costs
5.1 Part 2 of this Report highlighted the pressures Alternative procurement routes likely to be exerted on the defence budget in coming years. This makes it important for the 5.2 There are four main procurement routes open Department to take all available steps to to the Department, although all four routes are reduce both initial procurement and unlikely to be available for every subsequent in-Service costs. This Part of the procurement. These are summarised in Report considers a number of initiatives, scum Figure 5. The choice of route can have a major new and some already in use, which could impact on procurement costs. However, cost reduce these costs. is not the only driver of procurement decisions and each route also has other advantages and disadvantages. These are examined in paragraphs 5.3-5.11.
Figure 5: Comparisonof main procurement routes ROute Advantages Oisadvantages National (1) Control over (1) Costs likely to be very development specifications. high for major platforms. (2) fZ;%$ over time (2) Developinga weapon from scratch as opposed to (3) Ability to impose UK buying off-the-shelf contractual practices. carries greater programme (4) Possibility of and cost risk. overseas sales. (3) Can lead to lack of commonality with NATO allies. Collaborative 151 Commonalitvwith Risk of compromising on development equipment ised by specifications. NATOallies. (5) Risk of project delays (61 Economiesan in- as a result of problems Service support. in partner countries. (7) Can lead to net (6) Difficulties in imposing inflow of technology UK contractual practice. from overseas. (7) Imposition of workshare (8) Owing to economiesof between partners can scale usually cheaper inflate costs. than national 63) May result in a net development. technology outflow from UK to other industrial - p.%tWS. Individual (9) Usually considerably (91 Equipment may not meet d-the-shelf cheaperthan funding requirement, leading to development. (101 Costly customisation (10) Equipmentis proven of equipment. when purchased. (11) As for (2) & (3) above. Collaborative (12) Owing to economies of (11) As for (4) (6) above. off-the-shelf scale usually cheaper (12) As for (9) & (10) above. than national off- the-shelf. (13) Canenhance inter- operability if equipment is used by allies. (14) .44;;;,3(73,@I& PI
Source: NAOresearch and analysis of projects. Figure5 shows that there is no single best method of procurementwith advantagesand disadvantagesassociated with all routes.
29 MINISTRY OF DEFENCE: DEFENCE PROC”REMENT IN THE 1990s
National and collaborative development 5.6 The management of a collaborative programme is ususlly undertaken by an 5.3 Pressure to reduce defence budgets in all international project office staffed by NATO countries has for many years cast secondees from each of the partner nations. doubt on the continuing ability of nations to An alternative is pilot nation status where one finance, on their own, the development of nation agrees to manage the programme on major equipments. To make nationally behalf of the others using its normal national developed equipment more affordable, one procedures while taking account of individual option the Department pursue is to encourage needs. An example of this approach is the M3 allies to buy British developed equipment off- Bridging project. The advantage of this the-shelf. Whilst this would permit all parties approach is that project management is to benefit from economies of scale, basing simpler than if several parties are involved. affordability calculations on the likelihood of future exports is a high risk strategy. 5.7 From their examination the National Audit Consequently, where off-the-shelf equipments Office found that United Kingdom staff are not readily available, the more likely route working in international project offices were will be collaborative development. in post for a shorter time than staff from other countries. The National Audit Office also 5.4 Whilst collaborative development can be noted that international project management cheaper than national development, since it has not been viewed as a special career skill allows sharing of non-recurring costs and by the Department. In France and Germany enhances interoperability, it also has certain project management in the collaborative field disadvantages. From an analysis of is regarded as a specialism. However, the collaborative projects such as Eurofighter Department consider that the different 2000, TRIGAT and EHlOl the National Audit approach they take towards staffing Office have noted the impact of these international project offices was not likely to problems in practice. For instance, on both impair programme management or result in Eurofighter 2000 and the Long Range TRIGAT United Kingdom personnel being any less missile programmes, recent rationalisations competent than their foreign counterparts. have shown how the original distribution of development work between partner nations on 5.6 Nonetheless, as part of a wider initiative, the the basis of a rigidly applied fixed percentage Department now regard management of workshare rather than price, had increased International Projects as a functional costs due to the complexity of the resultant competency and it is now included in the industrial structure. On Eurofighter 2000, Project Management Training Programme. The where the United Kingdom was obliged to “norm” for a tour length in a project office is accept rigid workshare arrangements at the now 4 years and in principle applies equally outset, studies have shown that a to international as well as national projects. rationalisation of worksharing with different ratios would offer potential cost savings of Individual and collaborative off-the-shelf some 7.7 per cent (Z2.5 million per plane for a purchasing buy of 250 aircraft i.e. f625 million). The United Kingdom is pursuing these savings. 5.9 Purchasing off-the-shelf (i.e. the procurement of equipment already developed and, often, 5.5 A further drawback arising from involving so in-Service elsewhere in the world) is many parties, both industrial and recognised by the Department as one of the governmental, is the risk that the operational best ways of reducing programme risk and requirement may become a compromise, costs and they endeavour to follow this route meaning that the solution eventually decided wherever practical. However, it carries the upon may not be the most cost effective. On risk that, in seeking to meet the specification, the other hand, such discussions can also costly changes will be made to the original serve to reduce any “gold plating” of the equipment. A recent example, the Tucano specification. Overall, the budgetary pressures aircraft, illustrates the extent to which off-the- on all NATO States ought to give affordability shelf or civil based equipments may, in some considerations a higher profile, which cases, be customised. On Tucano, a total of logically should lead to less rigid workshare ooo modifications were made meaning that allocation. the degree of commonality between the off-
30 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1SWs
the-shelf aircraft and the version purchased the future procurement plans of our allies was 22 per cent. The Department had been reaches those in a position to take positive aiming for 50 per cent commonality. action. Various staff in the Department, including Defence Attach& overseas, are 5.10 Many items purchased off-the-shelf by the aware of the procurement plans of other Department are produced by American countries and the Department have set up companies. For most countries buying from procedures to ensure that their knowledge is the United States, such items are purchased passed on to those who can act upon it. through the American Foreign Military Sales (FMS) system. However, the Department’s Key Points policy since the mid 1980s has been to adopt .l4 In the view of the National Audit Office the a case by case approach with a presumption following key points emerge from the against FMS and a preference for purchasing examination of procurement routes: direct from the manufacturer. This was the case in three projects examined [Harpoon, E3 (i) Budgetary pressures raise doubts about Airborne Early Warning Aircraft and the the “affordability” of major national Chinook helicopter Mid Life Update]. The development programmes. Whilst Department are currently reviewing their collaborative development is generally policy towards FM% cheaper, it carries with it significant risks, chief among which is the use of 5.11 The purchase of British or foreign equipment rigid workshare arrangements which may off-the-shelf in collaboration with other erode potential cost benefits. The countries who have a similar requirement, Department should continue to negotiate, carries with it many of the risks associated where possible, to avoid rigid workshare with collaborative development (with the arrangements. They may be helped in notable exception that workshare problems do this by the budgetary pressures now not usually arise) as well as some of the affecting all likely collaborative partners difficulties inherent in individual off-the-shelf [paragraphs 5.3-5.5). purchases such as the costs of customising the (ii) Off-the-shelf purchasing is generally a basic equipment. However, of the four cheaper option than funding procurement routes this probably offers the development. However, to ensure that Department the lowest price option, whilst, the benefits are maximised the for any off-the-shelf purchase, technical risk is Department must, whilst having due lower than if the Department, nationally or regard to the needs of the Armed Forces, collaboratively, develops the bquipment. minimise the extent to which equipment is customised (paragraph 5.9). 5.12 The benefits of collaborative off-the-shelf procurement are illustrated by one project (iii) Collaborative off-the-shelf procurement examined by the National Audit Office, the E3 probably offers the lowest cost option Airborne Early Warning Aircraft. Here, the and, as demonstrated by the E3 Airborne Department collaborated with the French Early Warning Aircraft, can give rise to government for a joint purchase of 12 aircraft significant savings. However, mainly of a type which was already in-Service in the because of the difficulties in aligning United States. As a result, both countries have requirements, it has been little used. The benefited from significant economies of scale Department should continue to ensure with savings on the purchase price amounting that opportunities fur this type of to $24 million and the Department estimating procurement are maximised by, for that at least a further $76 million will be example, ensuring that information saved on in-Service support. concerning the equipment requirements of other countries always reaches those 5.13 Despite the resultant savings the E3 Airborne in a position to act upon it (paragraphs Early Warning Aircraft is the only example of 5.10-5.13). collaborative off-the-shelf procurement being used for a major equipment. This is primarily because of difficulties in reaching agreement with allies over timescale and specifications. However, for such opportunities to be fully exploited it is important that information on
31 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Other initiatives and techniques 5.16 Given the need to minimise production costs, the National Audit Office welcomes the Technology Demonstrator Programmes importance the Department attaches to committing contractors to this aim from the 5.15 Past experience has shown that the greatest outset. This may be achieved in a number of risks to a project arise during its early stages. ways, for example by placing a package deal One way of reducing these is by using for both development and production (or Technology Demonstrator Programmes. These initial production contract), or obtaining programmes establish the maturity of new and guaranteed production options prices before emerging technologies prior to full placing a development contract. To assist in development. this drive the National Audit Office consider that, in certain cases the Department could 5.16 There ace a number of examples of the value make use of the concept of Producibility of such programmes. These range from the Enhancement Programmes. EAP prototype for Eurofighter 2000 to a number of smaller programmes which are generating continuing savings. A good example is BERP II (a programme to develop Reliability and maintainability more efficient rotor designs] which is 5.19 Two of the key drivers of the life cycle costs expected to produce savings of approximately ZOO million over the life of the helicopter of equipment are reliability and maintainability. In the late 1980s. the fleet, for an initial outlay of f6 million for Department initiated a drive to ensure that development. A second example is the ASCR both reliability and ease of maintenance were (a programme to reduce vibration on considered as part of the initial procurement helicopters) which recovered its full cost after contract. Thus, contractors are now required 10,000 flying hours. Given the potential for to meet reliability and maintainability targets savings from such programmes the National as part of their development and/or Audit Office intend to carry out a detailed production contracts. Given the importance of review of their use in the near future. reliability and maintainability for reducing equipment in-Service costs, the National Producibility Enhancement Programmes Audit Office are carrying out a separate study 5.17 Producibility Enhancement Programmes are on the issues raised and will report on their used in the United States to reduce both findings in 1994. production and life cycle costs. These involve techniques such as value engineering to reduce production costs and/or the in-Service In-Service support support costs of an equipment. A good example of their use has been on the United 5.20 In recent years the Department have States AMRAAM missile programme where introduced a number of initiatives relating to savings of $1.6 billion have been generated the in-Service support of equipment with the from an initial outlay of $300 million to help aim of getting better value for money. These finance more efficient production techniques. initiatives are beyond the scope of this study. Here, suitable proposals for enhancements However, where necessary, and in keeping were selected using a number of technical and with the Department’s whole life approach to cost criteria designed to ensure that only low- equipment procurement, in-Service support to-moderate risk candidates with the potential aspects, such as the level of contractor for significant savings were given serious support, are taken into account from the consideration. As a result, 25 individual earliest stages of a procurement project. The projects were selected and each progressed National Audit Office plan to return to the through a three-phase development, with the subject of in-Service support, in more detail, Department of Defense having the option to in the near future. terminate a project at the end of each phase. In the event none were terminated. A second tranche of proposals is currently under consideration which, it is estimated, will achieve potential savings of $530 million for an initial investment of 563 million.
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Integrated Logistics Support 5.24 Given the potential savings, the National Audit Office sought to assess the extent to 5.21 Another development in the area of in-Service which exportability is considered when the support costs is the Department’s adoption of Department draws up its specifications. This Integrated Logistics Support (ILS) for all analysis showed that exportability was procurement projects. This is a key initiative considered in 60 per cent of the cases aimed specifically at reducing equipment examined but that the extent and depth of ownership costs. ILS plays a major role in understanding varied. identifying trade-offs during the early stages of a project which, using the techniques of value engineering, is intended to reduce the The Private Finance Initiative in-Service support costs of an equipment. This is achieved by considering, at the design 5.25 The aim of the recently launched Private stage, through-life support aspects so that they Finance Initiative is to attract private sector are given due weight against performance, finance for infrastructure and other analogous cost ad Limascale. Cuupled with the drive in governmental projects, and to stimulate the areas of availability, reliability and innovation by a more flexible adaptation of maintainability, ILS should place the best financial and procurement practice to the Department in a stronger position by circumstances of the individual case. Within transferring more of the through-life support the Department, the Initiative might apply to risks to the contractor. innovative proposals from industry to undertake services or activities currently carried out in-house but, this aside, it will not Exportability affect the Department’s policy of competition for its requirements. The Department consider 5.22 In 1992 the United Kingdom was the second that there is no question of developments on largest exporter of defence equipment in the private finance undermining good world with new orders worth f5.2 billion procurement practice. (B.8 billion for equipment and the remainder for services and logistic support]. The United Kingdom retained this position in 1993 when export orders totalled over f6 billion. The Department’s own guidelines state that “it is important to obtain the views of industry on how best to enhance export potential”. However, some companies commented to the National Audit Office that, in practice, the Department is resistant to making any changes to the specifications for their own requirements with a view to enhancing export potential.
5.23 The decline in the size of production orders means that overhead rates charged to the Department are increasing. Against this the Director-General of Defence Contracts has estimated that, in 1992, the Department saved f340 million because exports of defence equipment lowered unit costs as a result of overheads being spread over a wider base. In a wider context, exports are also a source of revenue to the Exchequer and help to ensure the survival of particular companies in the defence industry which, in turn, can help to preserve competition.
33 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Key Points .26 The National Audit Office consider that the following key points can be drawn out on the Department’s measures to minimise equipment costs: (i) Technology Demonstrator Programmes offer good prospects both for reducing risks on selected development programmes and for establishing the maturity of emerging technologies. The National Audit Office plan to undertake a detailed review embracing this area in the near future (paragraphs 5.15-5.16). (ii) The National Audit Office welcome the Department’s efforts to minimise production costs. However, the National Audit Office consider that, in certain cases, use could be made of the concept of Producibility Enhancement Programmes (paragraphs 5.17-5.18). (iii) Exports offer the prospect of significant benefits not just to industry but also the Department, in terms of reduced unit costs. This is particularly important during a period of severe budgetary constraint. At present, consideration of exportability is patchy and the Department should take steps to encourage a more detailed evaluation whilst being careful to balance export needs with those of the United Kingdom Armed Forces (paragraphs 5.22-5.24).
34 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Annex 1: List of projects examined by the National Audit Office
.~~~. Project name Project Category Contracting Main Contract(s) Price Ibase cantract Competitwe/ description by value route (& Contractor(s)) date Non-competitive 1 ADIMP Improvement of cat. B 0 & P package D&P Firm price 1989 NOll,-competitive Type 42 CVS (Ferranti) (2) weapons commandand Controlsystem 2 Alternative Monitoring and Cat. 8 D & P package D&P Firm price 1389 UK competitive Earth control station for (Plessey) (1) Station Skynet military satellites 3 ASAAAM Shml range air to Cat. A D & P package D&P Fixed price 1992 International air missile @A@ competition 4 AS90 Self propelled Cat. 8 D & P package D&P Fixed price 1988 International howitzer to replace (VSEL) competition obsolete 105mm ABBOT and 155mm Ml09 howitzers 5 SR(SA) 902 Passive search cat.c Not yet decided Project Firm price 1992 UK competition sonobuoy for EHlOl fmtim (1) Electronics) 6 Chinook MLU Conversionof Mki Cat. B D 8. P package D&P Fixed price 1990 Non-competitive helicootersto the (Boeing) overseas purchase more keliable Mk2 (2) version 7 E3AEW Airborne early Cat.A Production (“on- Production Firm price 1987 International warning system the-shelf” system) (Boeing) competition, won by foreign bidder 8 EHlOl Anti-submarine Cat. A D & P package D&P Fixed price 1991 International helicopter (IBM ASIC) competition. won by foreign bidder 9 Eurofighter Fighter aircraft with Cat. A separate Development Maximum price 1988 Non-competitive 2000 offensive support development & (Eurofighter with budgetary (international capability production consaltium) elements consortium) 18 Goalkeeper Autonomous radar Cat. B Production & Production & Fixed price 1984 International ctws controlled gun-based installation installation competition. won close-in weapon (%ff-the-shelr -1st buy by foreign bidder system against system) missiles Production & Fixed price 1987 Non-competitive installation overseaspurchase -2nd buy 11 Harrier T10 Two seater trainer Cat. 8 D & P package D&P Maximum price 1992 Non-competitive for Harrier GR5!7 W) (2) 12 Hawk Single seataircraft cat. c 0 & P package Aircraft Fixed price 1971 UKcompetition with trainer, air to air and ground Wing replacementFixed price 1987 Non-competitive attackversions -1st buy 121 13 LPH Helicopter landing Cat. B D 8 P package D&P Fixed price 1993 UK competition platform (VSEL) (6) 14 MINX Bar mine system Project has activated from remote yet to be site endorsed 15 M3 Bridging Amphibious bridging cat. c separate Development Let by Germany. system that can be development & (Eisenwerke before UKjoined used as either a production phases Kaiserslauten) the project gap bridge or a ferry Production Fixed price 1994 International (not yet selected) competition
35 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Project name Project Category Contracting Main Contract(s) Price base contract Competitive/ description by value route (& Coctractor(s)) date Non-competitive
16 Navstar GPS Satellite based radio Cat. E D & P package D&P Firm price 1332 UK competition positioning and (GEC-Plessey) (1) navigation for fleet wide fitting in ships and submarinesversion 17 NVG Night vision goggles Cat. D D & P package D&P Firm price 1988 International for fixed wing (GECMarconi competition aircraft Avionics) 18 Rapier FSC Low level air defence Cat. A Full development 0 8 P Target cost 1983 Non-competitive system to give full & initial @AN incentive fee (2) day/night/poor production with maximum weather capability price 19 Replacement Replacementfor HMS Cat. D Purchaseof Purchase Firm price 1992 Non-competitive for Ice Endurance existing vessel (Rieber Shipping, cveneas purchase Patrol Vessel 20 Truck Utility Replacementof the Cat. B Production roff- Production Contract still International Light/Truck existing TUUfUM probable the-shelf” system) to be let comcetition Utility Medium (Land Rover) fleet to a military specification 21 Sea Dart LLF Replacementfuse for Cat. D D & P package D&P Development; 1990 UK competition Sea Dart missile We) firm price (4) operating on passive Production: infrared fixed price 22 Sea King Mk3 Sea air rescue cat. c D & P package D&P Firm price 1992 Non-competitive helicopter (Westland) (2) 23 Sea Owl Passive identification cat. c D & P package D&P Firm price 1985 UK competitive device for MK.8 (GECMarconi (4) Naval Lynx Avionics) 24 Sea Skua Helicopter launched Cat. B Full development/ Full development Target cost 1975 Competitive anti-ship missile initial production (BAe) contracts onwards (2) 25 Small Arms Computer range Cat. D Production (?ff- Production Firm price 1992 iniernational Trainer simulator for small the-shelr system) (Air Group Ltd.) competition, won awns training by UK bidder 26 Spearfish Replacementfor Cat. A Developmentand Developmentand Fixed price 1982 Based on compari- Tigerfish heavyweight initial production initial production son of US &UK torpedo (GECMarconi) options, not formal tenders 27 Swiftsure & Improvementsto Cat.A D & P package Sonar 2076 Firm price 1994 UK competitive Trafalgar submarine command and -accrcx. 50% Of (1) Class SSN tactical weapons toiil project by Update systems value (Ferranti) 28 Surface surlace to surface Cat. B Production roff- Production Fixed price 1984 International Launched anti-ship guided the-shelr system) -1st buy competition, won Harpoon missile by foreign bidder Production Fixed price 1990 Non-competitive -2nd buy overseas purchase 29 swm Improved guidance for Cat. D D & P package D&P Maximum price1989 Non-competitive the Swingfire anti- We) with target cost (2) tank guided weapon incentive fee system 30 TOWTI Thermal lmagerfor cat. c D & P package D&P Target cost 1388 Non-competitive TOW/LYNXroof sight We) incentivefee (5) 31 ;;xdi;~ Range Crew portable anti- Cat. A Full development Development Fixed price 1988 Non-competitive tank guided weapons (TRIGAT international system consortium) collaboration 32 Tucanc Two seater training Cat. B Production (“off- Production Firm price 1985 International aircraft the-shelf” system) (Shorts) competition 33 Type 23 Automatedcommand Cat. 8 D 8. P package D&P Fixed price 1983 UKcompetition Command system to process (Dowty-Sema) (1) System data from ship SenSclSfor cpera- ticnal purposes 34 UNITER Secure,survivable Cat. 8 D & P package stage 1 Fixed price 1983 UK competition integrated ground implementation (1) communicationsystem for the RAF stage 2 Fixed price 1986 Non-competitive implementation (2)
36 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Project name Project Category Contracting Main Contract(s) Price base COIltraCt Competilivel description by value route (& conIractor(s)) date Non-competitive
35 Vehicle with Light Armoured cat. c D & P package D&P Firm price 1991 UK competition Protection patrol vehicles (Courtaulds) (1) Kits 36 VLSMS Anti-tank scatterable cat. D Full development Development Fixed price 1992 International mine system with production (9Ae) competition options 37 Warrior Armoured fighting Cat. A Full development Development Fixed price 1977 UK competition vehicle with production options Production Firm price 1995 Non-competitive (GKNfor bath1 0,
Notes to table
Definition of terms used Category by value Cat. A +?500M+ Cat. B SlOO-499M cat. c f 50-99M Cat. D E 25-49M Cat. E E O-24M
Main contract(s) D & P Development and Production
Contract type(s) Fixed pride - payment is made upon the contract price uplifted by agreed inflation indices Firm price - payment is made upon the contract price only Maximum - contractors’ costs are paid up to an agreed ceiling price Target cost - a target cost within a maximum price is set, the contractor retaining a proportion of any incentive fee underruns and paying a proportion of any overruns
Explanation of typeof contract (1) Competition limited for security reasons (2) Contract placed with original design authority (3) No overseas tenders received (4) Competition limited to contractors with previous project involvement (5) Only one contractor responded to two invitations to tender (6) Government policy is to place shipbuilding contracts only with UK shipyards
37 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Annex 2: List of companies and Trade Associations contacted by the National Audit Offke
Airscrew Howden Beaufort Air-Sea Equipment British Aerospace Defence BP Chemicals Dowty Fairey Hydraulics FR Group GEC Ferranti Defence Systems Ltd. Hunting Engineering Insumat Kidde Graviner Land Rover Lucas Aerospace Marshall of Cambridge Meggitt Aerospace ML Aviation Pilatus Britten-Norman Rediffusion Simulation Rolls-Royce Science Systems Limited Shorts Brothers Smiths Industries Thorn-EMI Westland
Society of British Aerospace Companies Defence Manufacturers Association Electrical Engineering Association
38 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s
Annex 3: Comparison of United Kingdom and Overseas Procurement practices
1. As part of their fieldwork the National Audit Office carried out a review of procurement practices in other countries to assess any differences in approach between that adopted in the United Kingdom and practices overseas; to evaluate the comparative success of the United Kingdom approach; and to identify any lessons which could be usefully learned from overseas practice.
2. The table below illustrates, for those procurement areas which are employed in several other countries, the level of application relative to the United Kingdom. Where insufficient information was available no assessment has been made. Care is needed in the interpretation of the table. For instance, the fact that overseas procurement by other countries is generally higher than in the United Kingdom in many cases, [eg Denmark, the Netherlands and Norway) simply reflects the fact that these countries are forced to purchase equipment from overseas due to a lack of national industrial capacity in certain defence fields. Equally, a “higher” application does not always represent something to which the United Kingdom should aspire. For example, although the United States is assessed as “higher” against the Contracts Bulletin, this is because, by law, virtually all military requirements with a value in excess of $1,000 are advertised. This leads to a vast number of tenderers and competitions which are extremely expensive to run. 3. Thirdly, where some countries are regarded as having a lower level of application than the United Kingdom this does not just mean that the United Kingdom is performing outstandingly. Rather, as is the case with France in relation to competitive procurement, it can reflect the fact that the country concerned has, for national reasons, placed less emphasis on a particular approach or technique. Overall, from the results of the survey, the National Audit Office concluded that the Department were performing well compared to other countries.
country Type 01Procurement Procurement Practices Competitive Overseas Collaborative Olf-the-Shelf Prime Reliability & ILS Contracts Contractorship Maintainability Bulletin Australia H H H H L L Belgium L H L H : L ; Canada H s L i Denmark : H L H L L ; FWW H : L L Germany : k H S L L : Netherlands H L Norway : i L : b L : Portugal L H L Sweden : E L : k k United States L L L : S s s i
Key: H: Higher level of application than United Kingdom s: Similar level of application to United Kingdom L: Lower level of application than United Kingdom Source: Based on data drawn from responses to questionnairereceived from 7 countries. 4 fact finding visits and a survey of defencejournals.
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