THE
FUTURE
OF
DERA
Paragraph 55
We have identified many areas where we consider
that the MOD's initial proposals are flawed or where significant
issues remain to be resolved. Our misgivings concern the MOD's
analysis of the case for change summarised above, as well as the
attendant risks.
DERA's key challenge in the future relates to the
changing face of the MOD's research programme which is DERA's
core business. The complexity of fast-moving emerging technologies
means that the modernisation of DERA must continue, to enable
it to be more agile and competitive in this new environment and
to enable it to reach out and do business with industries who
are world leaders in these technology areas. MOD is also concerned
to structure DERA to address the challenges presented by greater
globalisation of defence and the defence industry.
DERA's success in surviving the changes it has faced
so far stem from the benefits granted as a result of its Agency
and Trading Fund status which include the freedom to:
- manage its own investments;
- keep a proportion of profits to fund investments;
- negotiate new terms and conditions for staff.
However, these freedoms have limitations in two areas:
staff and access to capital. The retention of the ablest and most
imaginative scientists is an increasing problem. DERA needs to
have the ability to recruit rapidly and imaginatively and to adequately
reward staff as an incentive towards scientific exploitation.
DERA has a considerable technological and knowledge 'product'
but channels to markets to fully exploit this are thin in all
but a few core areas. In addition, there is a perception that
DERA enjoys a privileged position in its core market and in its
access to Government funds and that it is competing alongside
industry in what is seen as a protected position. The increased
use of competition in the research programme and other work from
MOD, necessary to ensure that MOD is getting best value and ideas,
will do much to improve this issue, but it would be unfair not
to allow DERA to be exposed to potential attrition in its key
market without, at the same time, allowing it to find work in
other markets.
MOD officials are continuing in their work to achieve
a PPP solution for DERA which will strengthen its ability to continue
to provide world class scientific research, while at the same
time preserving the UK's essential defence interests and maintaining
valuable collaborative relationships.
Paragraph 58
One year on, the MOD's expenditure projections
in the Comprehensive Spending Review show that no headway is expected
to be made in turning round that relative decline in the UK's
position. Despite the poor prognosis, the MOD's work on Towers
of Excellence, which will begin in earnest next year, is already
drawing the conclusion that Government funding for defence research
can be reduced further.
The MOD fully accepts the importance of defence research,
in enabling the armed forces to stay ahead of continually developing
threats from potential adversaries.
The Government is spending substantial sums on defence
research, over £400m per year, and will continue to do so.
The level of funding for research, however, must take account
of the many other competing calls on resources allocated to defence.
The MOD's work on Towers of Excellence is not concluding that
defence research can be reduced still further. As the evidence
to the Committee on Towers of Excellence made clear, the US spends
about ten times as much as the UK on research, and about two and
a half times as much as that of the whole of the European Union.
Even in the event of a considerable increase in expenditure, the
UK would be unable to match that of the US on research. These
ratios suggest that we need to be selective about the technologies
we develop nationally or on a European basis, and be prepared
to use US technologies in other areas in order to continue to
make a leading contribution to multinational operations.
The purpose of the developing Towers of Excellence
model, therefore, is to be selective in a rational way about the
research we should undertake and about making the necessary choices
in partnership with industry. It is not a model for reducing our
expenditure on research.
Paragraph 59
In a perfect world funding decisions would flow
from the strategy. The reality is the other way round. Before
the strategy work is complete the MOD is clearly determined on
a continual downward course for defence research expenditure.
The MOD has to manage many calls on the funds that it has available,
and diverting funds to research would mean less money for other
defence purposes. It is disingenuous, nevertheless, for the MOD
to suggest that funding constraints are the driving need for a
public private partnership, as though this is a factor beyond
its control. If research budgets are a critical constraint on
DERA's operations, the MOD does have the ability to raise them
to a more healthy level by re-prioritising its expenditures.
The MOD accepts the Committee's point that in a perfect
world funding decisions would flow from strategy. No organisation,
however, can develop strategies in isolation which may be unaffordable.
Strategies must take account of funding constraints, but this
does not mean that they are necessarily flawed. Funding constraints
are not the driving need for a public private partnership arrangement.
The main driver is to structure DERA so that it is best able to
provide access to the full range of technologies needed to support
defence, against the background of evolving international research
and defence procurement environments. The constraints on DERA
are related more to its current status as a Trading Fund in the
public sector, than to departmental research budgets. We would
expect any changes also to lead to efficiency improvements, from
which all stakeholders would benefit.
The MOD welcomes the Committee's acknowledgement
that MOD has many competing calls on its funds. Re-prioritising
these funds, however, cannot be achieved, without detriment to
other areas of defence to which the Committee also attach importance.
Paragraph 60
The MOD estimates that only about a half or a
third of its annual research programme ... is directed to satisfying
the 'foundation' of research work for the intelligent customer
function. This must not be seen as a baseline to which research
expenditure may safely shrink.
[MOD] told us that they would know that they had
a problem [in reaching a crisis point in declining research funding]
if they could not access the technology needed for future military
requirements in good time. By then, of course, it would be too
late.
The Ministry of Defence accepts that it is essential
to have in place a knowledge foundation across the breadth of
the defence technology spectrum to enable it to support intelligent
decision making. Funding of this foundation layer must come from
Government and in a way that ensures that it receives impartial
advice. On top of this foundation, we will be seeking to erect
a series of carefully located "towers of technological excellence"
which will extend our defence specific technologies to the level
required to produce world class equipment in selected areas. The
foundation layer has not and will not, however, be perceived as
the baseline to which research expenditure may shrink.
The Ministry of Defence shares the Committee's view
that if the point was reached where it was unable to access the
technology for future military needs, it would be too late to
rectify the situation. For this reason the research programme
is carefully assessed each year to ensure that the level of funding
is sufficient to maintain the necessary knowledge foundation,
as well as to help build the "towers" above this foundation
where appropriate. Starting in 2000 the Defence Research Committee
will report annually to the Secretary of State on the overall
health of the defence research programme.
Paragraph 62
We have strong reservations about the further
cuts being proposed in the research budget for the next few years.
Over-optimistic assumptions on the part of the Department about
the extent to which it can safely leave research to the civil
sector may put at risk the capability needed for developing new
weapon systems.
The MOD does not accept that the Committee's view
that it is over-optimistic about the extent to which it can leave
research to the civil sector. The UK is not alone in finding that
some areas of research are now being led by the civil rather than
defence sectors. This is most particularly the case in the information
technology and communications fields. The same situation applies
to the US and our European allies.
A key theme of the SDR was to be able to get more
for the same or less and no area of defence activity is immune
from this. It therefore makes sense to buy in technical know-how
when it is available and to concentrate our efforts on areas where
the civil sector has not taken the lead. Neither is the level
of resource allocation to defence research dependent on our discussions
with industry on a national defence technology strategy. The MOD
constantly strives to improve value for money. It is therefore
open to adjusting allocations within the overall research area,
as between different potential avenues of research, in the light
of technology strategy discussions, that may assist towards the
most cost effective provision of research towards the needs of
our Armed Forces.
Paragraph 66
The MOD's answers to our questions on the public
private partnership proposals clearly conveyed a sense that all
of the ramifications for exploiting IPR had still not been resolved.
The evidence we have received from industry makes
clear that the MOD has a difficult task ahead in trying to persuade
industry that DERA's mandate under the public private partnership
proposals to exploit its technology base will not put firms at
a disadvantage in terms of their ability to exploit the intellectual
property generated.
Since the Consultation Document was published MOD
has engaged in extensive discussions with industry over the handling
of IPR and, as a result of this dialogue, is fully aware of industry's
detailed concerns. Detailed arrangements for the treatment of
IPR depend on the precise nature of the PPP to adopted. Work on
this issue continues as part of the wider DERA PPP considerations.
Paragraph 70
A DERA plc would have little incentive to promote
actively the DDA's agenda of technology transfer to the civil
sector.
Defence diversification will remain an important
task. A pre-requisite for this is that those dealing with industry
on the Department's behalf must be clearly independent of vested
commercial interests of their own. DERA under a public-private
partnership does not provide that environment. A stand-alone DDA
outside DERA would lack, we suspect, the clout necessary to achieve
its objectives, and would become yet another failure in the history
of defence diversification institutions.
As indicated in the Government's White Paper on Defence
Diversification (Cm 4088) dated November 1998, it is recognised
(paragraph 5) that taking account of DERA PPP "the inclusion
of the DDA within the existing framework of DERA may¼.
be in the nature of an interim arrangement. Its positioning in
the longer term will take account equally of future arrangements
for DERA and the need for it to be capable of fostering diversification
to best effect. For this it must be able actively to promote access
to defence technology while protecting the public interest in
matters ranging from national security to the handling of intellectual
property rights. It will meet the dual objective of strengthening
industry for wider economic benefit and of underpinning the defence
effort."
The MOD Statement of Customer Needs (Figure 1 of
the DERA PPP Consultation Document dated May 1999) identified
the continuing need "to foster and develop collaboration
with UK industry and academia to exploit commercial technology
for defence purposes, to transfer technology to industry and to
generate technology within industry for timely exploitation to
deliver a battle-winning edge in military equipment". The
consultation document also recognised (paragraph 13) that any
PPP solution must be "compatible with MOD and wider Government
policy on science¼.
(and) defence diversification".
This is still our position. As announced on 26 October
work is continuing to identify a PPP solution for DERA that meets
MOD's objectives and addresses the issues raised by stakeholders
during consultation. This work is also addressing how defence
diversification will be supported in the new PPP environment.
Paragraph 72
We find no evidence to suggest that DERA is under-performing
under its present structure and public ownership. The MOD has
not made a convincing case that the incentives which might be
introduced with privatisation would be likely to bring benefits
which would outweigh the risks.
DERA is a successful organisation and the aim of
the PPP is to build on this, enabling DERA to respond to the changing
environment in which it needs to operate. It would be unwise not
to anticipate the impact of these changes which, as discussed
in the response to paragraph 55, include reduced defence research
expenditure, fast moving technology and the changed procurement
environment in the UK and Europe. The PPP is therefore not just
about correcting current difficulties, but looking to ensure that
DERA is able - into the twenty-first century- to meet the MOD's
requirements for access to world class scientific capability and
research whilst at the same time achieving value for money. The
MOD's requirements for science and technology were defined by
the "MOD Customer Needs Statement" as laid down in Figure
1 of the Consultation Document. In making a final decision about
the PPP outcome for DERA, these Customer Needs will be used as
the option evaluation criteria to identify both the benefits and
risks of each option. Risks to achievement of financial objectives
and compatibility with wider MOD and UK interests will be addressed.
It is inevitable that in a large project of this
nature there will be risks associated with certain elements. MOD
continues to work positively for a PPP result which preserves
the UK's essential defence interests and maintains valuable collaborative
relationships. One of the main aims of the consultation process
was to provide an assessment of the level of this risk and to
investigate risk mitigation options with these stakeholder groups.
Analysis of the consultation responses and continuing discussions
with stakeholder groups will inform the final decision.
Paragraph 79
The extra cost of finance might be partially eased
if the government were to issue guarantees to the creditors of
a private-sector DERA, but a simpler and less risky approach would
be to retain the Agency's trading fund status and raise its borrowing
limits. Although such borrowing (counted against Public Sector
Net Borrowing) would not breach the Treasury's 'golden rule' which
permits borrowing for capital investment, it would we suspect
offend against the Treasury's perceived determination to constrain
government borrowing more generally.
Guarantees would not be issued to the creditors of
a private sector DERA. However, it is emphasised that the question
of borrowing limits is not the central issue in undertaking this
PPP exercise. The question is not about the adequacy of borrowing
limits, but rather what DERA is able to do with its capital. A
PPP will provide a commercial and innovative environment and introduce
private sector disciplines, thus encouraging and enabling DERA
to use its capital more flexibly, for example, in pursuing commercial
ventures more widely than at present.
Paragraph 80
The requirement under a public private partnership
for the MOD to be consulted before DERA could dispose of its facilities
is an essential safeguard. Some facilities, though not fully utilised,
remain essential national assets. They play an important part
in allowing the UK to develop world-leading technologies, and
make it possible to upgrade fighting equipment already in service
at sometimes very short notice. The MOD must be able therefore
to insist that DERA retain such assets, or at least to have first
refusal to bring them back into MOD ownership. To retain such
safeguards would, however, negate much of the purpose of privatisation—the
unshackling of the Agency's management from the supposed constraints
of the public sector.
MOD has always accepted that some DERA facilities
are of strategic importance and therefore under a PPP arrangement,
MOD must retain the ultimate power to prevent the loss of such
facilities. It would operate this through its position as a Special
Shareholder with mechanisms in place to ensure that DERA activities
did not present a risk to national security, or result in the
loss of a critical capability, through either the destruction
or disposal of strategic facilities.
This protection does not "negate much of the
purpose of privatisation". The scope of the PPP solution
will extend far beyond the continued availability of strategic
assets which will form just a part, albeit an important part,
of the overall asset base.
DERA PPP aims to offer an effective balance between
the maintenance of MOD interests and enabling DERA to operate
as a flexible and responsive organisation within the private sector.
Paragraph 86
Some additional flexibility on staffing matters
would no doubt help DERA to recruit and retain the staff it needs,
including those needed for the critical technologies where skills
are heavily in demand. A public private partnership however is
not the only way, or the most cost-effective way, to achieve this.
Flexibility on staffing matters is important but
the PPP is not merely about this particular element, it is a response
to the position DERA finds itself in a increasingly competitive
environment. A PPP DERA will wish to have the freedom to meet
skill shortages, for example, but this is just a factor in a list
of benefits which a PPP DERA would deliver including the availability
of new commercial disciplines, management, private capital and
the ability to seek joint ventures on a wider scale.
Paragraph 90
The public private partnership proposals for DERA
could disrupt the partnership between the MOD and industry needed
for effective technology transfer and the implementation of smart
procurement. After privatisation the Agency's relationships with
both the MOD and industry would be compromised. A public private
partnership for DERA puts at risk the achievement of the streamlining
of the acquisition process sought by the smart procurement initiative.
It has always been recognised that the PPP outcome
needs to protect and improve effective and productive relationships
with industry, particularly in the context of the Smart Procurement
Initiative in which closer co-operation between MOD and industry
drives the achievement of better value for money and shorter lead
times in equipment procurement. The PPP solution needs to reposition
DERA within this new environment, in a role supportive of the
new relationships and industry.
The MOD's interests in Smart Procurement would be
safeguarded by the leaders of capability working groups and the
integrated project teams having a key voice in deciding which
roles DERA could play in support of MOD, or for other commercial
customers. Both procurement support work and the research programme
would benefit from the opportunity to compete their work, potentially
bringing benefits in cost, value, and effectiveness.
As MOD would retain in all cases the right to use
research results for defence programmes, technology transfer would
be effectively safeguarded and the confirmation of Integrated
Project Team leaders' freedom to compete, and a PPPs need to focus
on customer requirements should create a more productive environment.
Paragraph 93
We are not convinced that the compliance regime
of the proposed public private partnership would provide continued
integrity for the advice that DERA would provide for the MOD.
The comprehensive nature of the Compliance Regime
would be an effective mechanism for ensuring that DERA can continue
to act with integrity and provide MOD with impartial advice, whilst
also operating as a flexible and responsive organisation which
will attract investment and develop new business.
The severe constraints of such a regime would be
entrenched through constitutional and contractual controls:
- Constitutional Controls - DERA's constitution
(Articles of Association) containing a Special Share mechanism
which would specify restrictions on DERA's activities and enable
MOD to veto activities which conflict or prejudice its essential
interests;
- Compliance Committee (of the DERA Board) - with
a chairman approved by MOD, who would act independently of executive
management and be charged with ensuring DERA's adherence to the
Compliance Regime;
- Contractual controls governing the relationship
between MOD and PPP DERA, including the protection of Intellectual
Property.
These controls would satisfy the key elements of
MOD's interests which are to ensure:
- No business activities are undertaken which conflict
with or prejudice DERA's ability to provide an impartial service
to MOD;
- No strategic assets are disposed of or are fundamentally
altered;
- No improper influence is brought to bear on DERA;
- MOD has appropriate access to key staff, capabilities
and facilities;
- Intellectual Property is properly handled and
protected.
The Compliance Regime as structured would meet MOD's
requirements for impartiality and integrity because of its rigorous
nature and the fact that it can be enforced through a number of
mechanisms including the veto process. The regime would ensure
that DERA's activities would not give rise to conflicts of interest,
loss of impartiality or loss of capability, and that DERA remained
an appropriate organisation to continue to provide MOD with a
high quality service, free from vested interest and bias, and
with security and commercial sensitivities protected.
Paragraph 94
Without DERA remaining clearly within the public
sector fold, scientific expertise within the MOD is likely to
decline, making it increasingly difficult for the MOD to manage
and assess a privatised DERA's work objectively.
The ability of MOD to retain its "intelligent
customer" status has been raised by many stakeholders during
the consultation process. MOD is taking all such comments into
account to ensure that DERA PPP delivers the necessary balance
for MOD as a customer of defence research.
Paragraph 98
While the US shared many of the underlying factors
that apparently lay behind the MOD's initiative, including budget
pressures and difficulties in recruiting and retaining scientists
in important areas of technology, the DOD considered that the
MOD proposals were not the right solution. In particular, the
DOD had not been persuaded that the organisation envisaged could
reconcile the conflicting perspectives it would have - as both
an agent working for the benefit of the government and an enterprise
serving private-sector interests.
During consultation with the US DoD it was clear
that the US face many of the same challenges the MOD is addressing
through the PPP initiative, and that they were keen to understand
and learn from our approach. The views of the US and other allies
were welcome and useful and MOD have taken them into account.
Paragraph 99
We share remaining US concerns about how controls
over US originated classified information would be handled, and
how the US authorities could deal with a privatised DERA where
this would mean giving it more favourable access to information
than other (US) private enterprises.
Paragraph 101
A public private partnership for DERA risks undermining
the MOD's research collaborations, not only with the US but also
Europe at a time when the focus is increasingly on strengthening
European military capabilities. To be fully engaged in the development
of a European Security and Defence Identity and help make the
Defence Capabilities Initiative a success, Europe needs to evolve
more effective and efficient research collaboration. Putting DERA
in private hands will make it much more difficult for the UK to
be a full and trusted partner in this enterprise.
Paragraph 102
It is the consent of the US to changes in DERA's
ownership, however, that will be of paramount importance. US concerns
must be properly addressed in reaching any decision on DERA's
future structure. If the public private partnership goes ahead,
the MOD may be excluded from US technology developments, and may
not even know it. Despite any public assurances about the US's
continued co-operation, and even if the fruits of existing collaborations
continue to be gathered, the prospect of the US having to deal
with a private sector DERA puts at risk further collaboration.
Without clear and genuine acceptance by the US, the public private
partnership must not proceed.
One of MOD's aims for DERA PPP is to achieve a solution
which maintains our valuable collaborative relationships with
allies, including the US. We continue to discuss PPP with our
international partners to ensure that all concerns are identified
and are considering how these can be addressed in the PPP. DERA
PPP looks to structure the organisation to ensure it can respond
to the changing nature of international defence research and procurement
environments.
Paragraph 107
We doubt that the way that the proposed sale of
DERA is structured will achieve its full potential value. The
potential for any buyers adding value, in particular, is far from
clear. The opportunities for generating alternative income streams
are unlikely to be sufficient to make good the continuing reduction
in MOD funded DERA research. We doubt that the value of any opportunities
for further efficiencies can outweigh the additional cost of capital
that DERA will incur under the public private partnership. We
conclude that the only sustainable rationale for the sale is the
prospect of a sizeable one-off disposal receipt in about two or
three years' time.
DERA's record in generating alternative income streams
is good. The potential for additional commercial spin-outs is
considerable, but would only be possible with the introduction
of private sector funding, market disciplines and innovation.
We are convinced that the proposal for DERA will
present opportunities for further efficiencies which will outweigh
the cost of capital. Private sector disciplines and an innovative
environment will encourage and enable DERA to pursue such opportunities.
Paragraph 117
Our analysis of the challenges that UK defence
research must face in the future, and the MOD's strategy for addressing
them, leads us to the conclusion that the form of public private
partnership proposed in the MOD's consultation document will not
help to achieve these strategic goals.
Paragraph 118
We find the current proposals for DERA's future
structure incoherent and self-contradictory. They do not present
a persuasive solution.
Paragraph 121
The risks of failure associated with the current
proposals for the future status and ownership of DERA far outweigh
the value of capital receipts anticipated. We conclude that the
proposals for the future structure of DERA contained in the consultation
document are fatally flawed and should not proceed.
The MOD note the Committee's comments, which will
be taken into account (as with all other comments received) in
the continuing work to define a PPP solution which best meets
the requirements of all stakeholders.
Paragraph 119
The problems of access to capital and human resources
are largely self-imposed by the Treasury's rules. To sell your
research birthright to circumvent these theological niceties of
the government's financial rules would be a wholly disproportionate
response to the problems they present.
See answer to paragraph 72 & 86
Paragraph 120
The retention of an impartial and independent
intelligent customer capability within the MOD is of paramount
importance, however, and we do not believe that these current
proposals retain sufficient critical mass within the MOD to ensure
this.
See answer to paragraph 94.
Ministry of Defence, 17 January 2000
