House of Commons - Defence

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—

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—

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—

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—

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—

DERA has a considerable technological and knowledge 'product' but channels to markets to exploit this fully 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 the MoD, necessary to ensure that the 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.[

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—

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

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—

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—

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—

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