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NATIONAL AUDIT OFFICE REPORTBYTHE COMPTROLLERAND AUDITORGENERAL Ministry of Defence: DefenceProcurement in the 1990s ORDEREDBY THE HOUSE OF 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.. ” 1 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s 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 number of 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 2 MINISTRY OF DEFENCE: DEFENCE PROCUREMENT IN THE 1990s 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.

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