Select Committee on Defence Ninth Report

The MoD's newly preferred option

10. The MoD's preferred option, as set out in the latest consultation document, is now the Core Competence model. This would involve splitting DERA into two — a 'New-DERA' which would be incorporated as a private company and later floated on the Stock Exchange, and a 'Retained-DERA' which would comprise about a quarter of the existing organisation. Perhaps the key feature of the Core Competence approach, that distinguishes it from the previously preferred Reliance model, is the much more substantial part of DERA that will be retained within the MoD. This includes, according to the MoD, the key activities within the MoD which the earlier consultation exercise had shown to be particularly important—

  • the integration of different elements of knowledge and research to provide high level advice to the MoD to aid its decision making process;
  • work of a particularly sensitive nature; and
  • sensitive work related to government-to-government international programmes.[45]

More specifically, Retained-DERA would keep:

  • The Chemical and Biological Defence Sector (Porton Down)—720 staff[46];
  • 'All of the capabilities and the majority of the staff' from the Centre for Defence Analysis[47] (paragraphs 36, 37);
  • the Defence Research Information Centre—50 staff[48];
  • the Defence Radiological Protection Service—90 staff[49];
  • another DERA organisation, whose details and staff numbers are classified[50]; and
  • 'sufficient other staff from across DERA to provide a capability for impartial advice and knowledge-integration to MoD; to collaborate with allies on joint programmes; to carry out work in areas of particular national sensitivity; and to provide the necessary management and administrative resources.'[51]

11. The MoD believes that these capabilities, kept within Retained-DERA, would allow it to have the knowledge needed for decision-making, to keep particularly sensitive areas in-house, and to accommodate international collaborative research programmes.[52] It considers that the division between Retained-DERA and New-DERA would ensure that both have the capabilities and staff to meet stakeholder requirements, assure continuing viable businesses, and a large enough critical mass to be successful in providing a career path to attract and develop employees.[53] These are amongst the issues we explore in the sections below, which examine the implications of the new proposals.

Adjusting to a new research environment

12. In our Defence Research report we explained how the MoD does not see DERA, as currently configured within the public sector, as being sufficiently flexible to be able to keep abreast of a changing research and technology environment. The MoD considers that DERA needs to adapt to reflect the increasingly global nature of the market for exploiting technology, and the increasingly dominant lead that some civil sector technologies have in the defence arena. It wanted to bring a commercial environment to DERA, to allow it better to raise the capital and to attract the staff it would need to deal with those challenges, at a time of reducing budgets. In its response to our report, the MoD asserted that—

    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.[54]

    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. The MoD is also concerned to structure DERA to address the challenges presented by greater globalisation of defence and the defence industry. [55]

13. Such forces of globalisation mean that the MoD might wish to turn to a wider range of sources for its knowledge and research, and at the same time to take its own knowledge into civil markets. The need for greater exploitation of DERA's intellectual property is one of the key arguments that the MoD has consistently used to justify the requirement for a public-private partnership. It revolves around the question of the funding required for opening up opportunities to exploit developing technologies—money which the MoD is increasingly unwilling to dedicate to this area. The MoD has consistently maintained that it is constrained by its research budgets, and in our current inquiry the Minister told us that the status quo for DERA was not an option because—

    ... the need for research and technology funding is on an exponentially rising curve ... It is very important to introduce the opportunity for private capital into DERA so that DERA can meet its investment needs, and that it should thereby be able to accelerate the way in which it can co-operate with the private sector ...I do not think it is possible just to keep going back to the Treasury and asking for more money over these issues, because I do not believe that the sums of money that the Treasury would supply—even if it were minded so to do— would be sufficient for the needs.[56]

We should remember, however, that if the need for research funding is rising exponentially—an assertion questioned by the Defence Manufacturers Association[57]—this has not prevented the MoD allowing the supply of such funds to fall (albeit only arithmetically) over the last few years. The DMA expressed their continuing disappointment about the adequacy of the rationale for the public-private partnership put forward by the MoD, and the 'shameful' way research funding has fallen.[58]

14. The Minister also stressed the increasing importance of exploiting civil sector research for defence purposes—

    The civil sector is increasingly investing in areas of technology which are also relevant to defence, and we need to find new ways to take advantage of this. At the same time, DERA's core funding from the Ministry of Defence has declined significantly over the last ten years. I stress that is not because we do not value DERA's products—we do—but it is largely because our procurement process is geared to buying whole systems from industry. The way to respond to these changes is not simply to argue for more money. The answer is to allow DERA to exploit more widely its treasure trove of knowledge and ... ideas.[59]

Ever since the MoD's original intention to explore a 'part privatisation' of DERA emerged in 1998,[60] the MoD has sought to present a declining MoD budget for defence research as an immovable constraint making the search for external finance seem the only option available. As we commented in our Defence Research report, 'it is disingenuous for the MoD to suggest that funding constraints are driving the need for a public-private partnership, as though this is a factor beyond its control'.[61]

15. Against such a background, in seeking to exploit DERA's intellectual property the MoD envisaged that a private sector DERA would be better able to reward and retain key staff, and to raise capital. The latest consultation document picks up the theme of the previous proposals, that a public-private partnership would offer opportunities for more flexible rewards for staff—

    Ministers are keen to explore at an early stage options for involving all those DERA staff who transfer to the private sector in the public-private partnership, through an employee partnership scheme, so that they may share in the future success of the business and are rewarded for their part in the progress the company makes towards achieving a successful public-private partnership.[62]... The advantages of the public-private partnership solution include the opportunity to maintain a higher level of employment and the potential for more flexible and appropriate market-oriented reward systems, as well as expanding the opportunity for personal development.[63]

16. When we considered the 'Reliance' model last year,[64] we noted that DERA staff could be properly rewarded and motivated without DERA being privatised. We have no reason to change that assessment in the light of the more modest proposals for partial privatisation now being put forward. The terms and conditions of Retained-DERA's staff must be protected. However, an additional problem with the new proposals is that there would initially also be 'a high degree of collocation, with staff from both New-DERA and Retained-DERA being present on most sites',[65] and there is, it seems to us, an inevitable and demoralising problem when one organisation's (perhaps more-secure) staff will have to rub shoulders daily with those of the other body who could rapidly become better rewarded and resourced. As we discuss later in this report, with DERA, more than with most organisations facing privatisation, it is difficult to assess the likely value of the company when it is a fully listed plc. Indeed the multi-stage method proposed for the privatisation implicitly reflects this. We believe that the financial structure of New-DERA should be arranged so that its executives do not benefit disproportionately from any appreciation in the value of New-DERA shares arising from property sales or other windfall profits.

17. In similar vein, it would appear that New-DERA's ability to attract private-sector capital under the Core Competence model would be similar to that of the privatised elements of DERA under the Reliance approach. Again, when we evaluated the Reliance approach last year we considered that attention might better be directed at adjusting Treasury rules to give DERA greater financial freedom, before turning to a public-private partnership.[66] The new public-private partnership proposals repeat the MoD's requirement for sufficient private sector involvement in DERA for it to raise capital to exploit its intellectual property, and to introduce more flexible rewards for its staff. As the Core Competence proposals do not change those underlying assumptions, we remain unconvinced about the justification for a public-private partnership

18. The Core Competence model, and the greater detail recently emerging about the way a public-private partnership would operate, suggest that—like the Reliance model before it—it will have implications for the MoD's relationship with industry and its collaborative partners and for its 'intelligent customer' capability, which we now explore.

Implications for industry

19. New-DERA's activities will have implications for industry as it seeks to exploit its intellectual property. In its response to our defence research report, however, the MoD also saw a public-private partnership as an opportunity to balance DERA's excursion into civil markets with giving others greater access to areas of research that had previously been DERA's preserve—

20. Arming New-DERA in this way exposes again the defence industry's long held concerns about DERA using intellectual property to which industry may have contributed, and about DERA competing for MoD research work which industry has sometimes seen as falling naturally within its own domain.[68] The consultation document is coolly confident, however, about the public-private partnership being able to satisfy industry's specific concerns in these areas—

    The UK defence industry expressed a clear wish that its intellectual property would continue to be fully protected and that it could have confidence that MoD procurement decisions were underpinned by impartial scientific advice and analysis. The retention of key advice-integration activities within the MoD should largely meet these concerns, and a contractual framework would ensure that New-DERA can only use third-party intellectual property for the purpose for which it was supplied. The separation between private and public elements would introduce a new clarity to the relationship between the MoD and New-DERA, levelling the playing field and placing New-DERA on the same footing as the rest of industry in competitions for technical support, advice, and research provision.[69]

21. As regards the exploitation of intellectual property, DERA's chief executive told us that—

    Generally speaking the rubric is that the intellectual property belongs to the company with whom we are working and we retain the rights to use that intellectual property for Crown purposes, for MoD purposes ... The intellectual property that DERA owns at the moment is principally not the intellectual property which has come to DERA from industry because ... that still belongs to industry and can only be used for government purposes. The intellectual property which has come from the scientists in the laboratory out of their own heads is currently owned by DERA ... Without the exploitation of that intellectual property [DERA] has no value at all.[70]

Nevertheless, industry continues to seek assurances about the way intellectual property will be handled under the Core Competence model, as it did under the Reliance proposals before it.[71] The US Department of Defense also had concerns about this issue, which we explore at paragraph 43.

22. The latest consultation document states that New-DERA, as in the privatised DERA of the Reliance model, would not be permitted to engage in defence 'manufacturing'.[72] Sub-contracted manufacturing work for defence manufacturers would be subject to prior MoD approval.[73] 'Manufacturing' is an imprecise term, however, with prime contractors for defence equipment projects increasingly acting as 'systems integrators' pulling together and coordinating the output of other firms who undertake the physical manufacture of an equipment's different systems. On this issue, DERA's chief executive was careful to leave the way open for New-DERA to undertake this form of 'manufacturing',[74] and Mr Jagger told us that he envisaged that the MoD would "clearly want DERA to do ... some systems integration, because that is an important role it performs for [the MoD] ... at the moment. But there are clearly areas where industry is concerned about that".[75] Our subsequent written questions to the Department did not provide much clarification of the MoD's intentions, with apparently potentially contradictory statements that, on the one hand—

    New-DERA would not, without the express permission of the MoD, be permitted to undertake the manufacture or supply of equipment, products or systems whose principal use is intended to be for a military, defence or security application, other than small numbers of prototypes or demonstrators.

And on the other hand—

    Unless there was a clear conflict of interest, New-DERA would be permitted to act as a systems-integration contractor and to work in partnership with, or as a sub-contractor to, industry. This is seen as an important mechanism for ensuring that the results of work within New-DERA can influence the design of new defence systems.[76]

23. The Defence Industries Council told us that the question of what manufacturing New-DERA would be permitted to do 'lies at the heart of whether the defence industry will be able to form a trusting relationship with New-DERA, that is essential for this new arrangement to achieve wealth creating benefits for the UK'.[77] New-DERA's potential involvement in 'defence manufacturing' needs to be clarified by the MoD if it is to go ahead with a public-private partnership. However, we regard this problem principally as yet another example of the unnecessary entanglements that this ill-conceived proposal brings in its train.

24. During last year's inquiry, some in industry argued that if a public-private partnership were to proceed then DERA should be made to stand on its own two feet, without favourable treatment or feather-bedding from the MoD. When in this latest inquiry we asked the MoD if New-DERA would have to fend for itself immediately after it were set up, Mr Jagger told us that—

    It would also be very bad for our attempts to get value for money if we were to try to float DERA with no continuing work programme, no order-book in effect. So we would envisage a tapered approach where the amount of competition is gradually increased over a small number of years. I do not know, but to give you an idea, five or seven years, after which substantially all of [the MoD's work] might be competed ... It is an absolute total commitment by us that all competitions will be on a level playing field. That is an assurance we have given to industry, and would expect to be held very strictly to it.[78]

25. Mr Jagger also drew our attention to the practical difficulty of switching on day-one to competing all of the MoD's research programme, most of which is currently allocated to DERA. Contract writing, he told us, was a complex and difficult process, involving specifying a research requirement and looking at how the MoD would pay for it in a structured way.[79] By the same token, it is perhaps surprising is that the Department considers that it will be able to write contracts with New-DERA, for the MoD work it will do from day-one, of sufficient rigour to deal with a commercially-minded private-sector DERA. The Core Competence model also implies that existing day-to-day informal working relationships within DERA will have to be put on a contractual footing, which may well serve to obstruct or delay such interfaces.[80] This inconsistency highlights the essential contradiction in the MoD's approach to the public-private partnership. It apparently seeks to launch a private sector commercially-motivated organisation to exploit its capabilities aggressively, but at the same time the Department also seeks to maintain the cosy and trusted relationship it currently has with DERA. The MoD appears to be trying to have it both ways, particularly in the eyes of DERA's other stakeholders.

26. In regard to industry's role under the public-private partnership, there is also a more fundamental issue about the extent to which the private sector might be willing to undertake all aspects of the MoD's current research programme. The Defence Industries Council highlighted a concern that even with fair competition there were areas of research in which industry would not wish to be involved—

    We do remain very concerned that Government appears to be relying on the private sector to replace public funding of defence research and technology to an extent which is frankly unrealistic. Industry is bound to have to focus on near-to-market technology investment, where a clearer return is visible. Government cannot avoid taking responsibility for the longer term work if we are to sustain an adequate level of modern defence capability delivered through a smart procurement process.[81]

45  MoD Consultation Document, op cit, para 6 Back

46  Ev p 26, para 9 Back

47  MoD Consultation Document, op cit, para 12. The MoD notified the Committee of the number of staff likely to be involved, but this information is classified Back

48  Ev p 26, para 9 Back

49  ibid Back

50  ibid Back

51  MoD Consultation Document, op cit, para 12 Back

52  MoD Consultation Document, op cit, para 6 Back

53  MoD Consultation Document, op cit, paras 13-14 Back

54  HC (1999-2000) 223, para 59 Back

55  ibid, para 55 Back

56  Q 6 Back

57  Ev pp 35, 36 Back

58  ibid Back

59  Q 1 Back

60  There were rumours of a 'part-privatisation' of DERA in 1998, on which the Committee reported in its Sixth Report of Session 1997-98 (HC 621), which were subsequently announced as public-private partnership proposals in the Strategic Defence Review published in July 1998 Back

61  Ninth Report, Session 1998-99, op cit, para 59 Back

62  MoD Consultation Document, op cit,, para 28 Back

63  MoD Consultation Document, op cit, para 29 Back

64  Ninth Report, Session 1998-99, op cit Back

65  Ev p 27, para 12 Back

66  Ninth Report, Session 1998-99, op cit, para 79 Back

67  HC (1999-2000) 223, para 55 Back

68  See eg evidence from the Defence Manufacturers Association (Ev pp 35, 36) Back

69  MoD Consultation Document, op cit, para 34 Back

70  QQ 90-93 Back

71  Ev p 35 Back

72  MoD Consultation Document, op cit, para 23 Back

73  ibid Back

74  Q 110 Back

75  Q 111 Back

76  Ev p 32, para 33 Back

77  Ev p 35 Back

78  QQ 113, 115 Back

79  Q 114 Back

80  Ev p 37, para 2.5 Back

81  Ev p 35 Back

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