SUPPLEMENTARY ANSWERS FROM THE MINISTRY
OF DEFENCE FOLLOWING THE ORAL EVIDENCE SESSION ON 3 MAY (19 MAY
2000)
1. Question: What consideration has the MoD
given to alternatives raised in the committee's Defence Research
report—namely establishing DERA as a trust or publicly owned
corporation, or making much more extensive use of joint ventures—and
on what basis did the Department decide not to raise such options
in the most recent consultation document [QQ 12-14]?
2. As part of the options analysis phase
of the study the Department considered all three of these options.
The Department's conclusion, supported by specialist financial
and legal advice, was that each had significant disadvantages
and would be unlikely to meet the PPP objectives. For that reason,
they were not put forward in the most recent consultation document.
The committee will be aware that a variant of the publicly owned
corporation model, which would involve the sale of a minority
stake to external investors, is described in the consultation
document released on 17 April 2000. This model was developed as
an attempt to address some of the weaknesses inherent in a solution
based on a plc wholly owned by the MoD. However, as described
in the consultation document we concluded that even this revised
model would not meet our objectives.
3. The major weaknesses of the specific
models identified by the committee are summarised below.
(a) The Trust Option. Adopting a
Trust structure would not expose DERA to the commercial incentives
and disciplines necessary to help it meet the changes in the environment
within which it operates. This would be particularly the case
for a non-profit distributing trust vehicle. From the perspective
of DERA's MoD customers, these factors could lead to reduced incentives
to deliver enhanced performance and value for money. A trust would
have less flexibility in raising future finance as it would not
have share capital or be able to issue shares. Funding could only
be raised through debt issues. This could constrain DERA's development
in the future; it would also potentially reduce the scope to raise
proceeds in the PPP transaction itself. In addition, the debt
funding required to establish a trust would be likely to require
a greater degree of specific security—for example through
income guarantees—than other PPP options. This could reduce
MoD customer flexibility and leave Government as a guarantor of
liabilities incurred by the Trust in a way that would not be necessary
if private equity investors are introduced. In a Trust structure,
there would also be uncertainty about the status of employees,
who would almost certainly not qualify as government employees
for the purposes of international collaboration work, thus making
it difficult to maintain important collaborative programmes.
(b) Publicly Owned Corporation. In
general terms, many of the weaknesses with the Trust model were
also likely to apply to a publicly owned corporation. Overall
it was concluded that this model would provide few additional
freedoms over those currently available to DERA as a trading fund
and would not therefore help the organisation meet the challenges
it will face over the next few years. Although staff would be
employees of a publicly owned corporation, they could not legitimately
be described as civil servants, and this was a cause of discomfort
to our collaborative partners.
(c) Making greater use of joint ventures.
Recent reinterpretations of HM Treasury rules have given Trading
Funds such as DERA the freedom to enter into equity joint venture
relationships. DERA has already taken advantage of these new powers
to pursue a number of initiatives, in particular in technology
spin-out. The recent joint venture with NXT plc for voice recognition
technology is an example of an arrangement of this type. It is
anticipated that, both pre and post PPP, further joint ventures
may be entered into, subject to commercial justification. However,
this approach to business development has several limitations
as a primary PPP route:
i. Any joint venture will tend to be narrowly
focused on a particular technology or business case and is unlikely
to bring the benefits that MoD is seeking to the wider organisation.
ii. A multiple joint venture approach may tend
to fragment DERA over time.
Overall, whilst joint ventures represent a valuable
route for exploiting technology within DERA, they do not in themselves
meet all the PPP objectives.
4. Question: The Chairman quoted extracts
during the session from Mr Jagger's letter of 23 February 1999
(ref D/DPT/8/1 (50/99)). What are the main points of similarity
and difference between the Core Competence model postulated in
February 1999 and the version included in the latest consultation
document? What changes have been made to address in particular
the concerns of the unions, industry and the US authorities [Q34]?
5. It is not normal practice to comment
on the contents of internal correspondence that has been released
without authorisation. However, in order to assist the work of
the committee we will respond to the specific question asked.
6. An initial PPP options study was carried
out between September 1998 and April 1999. A first version of
the Core Competence concept was proposed during this study, and
was the subject of a degree of evaluation work. This work was
completed in March 1999. It was accepted that this specific Core
Competence model contained a number of significant weaknesses.
However, the conclusions of the analysis were that, with substantial
additional work, it would be possible to produce a revised Core
Competence model that was capable of meeting the PPP objectives.
This did not affect the MoD's overall conclusion that the Reliance
model appeared at that time to offer the most promising PPP approach
and should form the basis of further consultation. The consultation
process subsequently indicated, however, that stakeholders had
a number of concerns about the Reliance approach and, as a result,
the scope of PPP work was broadened to examine other possible
models including Core Competence. Details of the other main alternatives
considered have already been provided to the committee.
7. The Core Competence model identified
as the MoD's preferred PPP option in the consultation document
released on 17 April 2000 differs in a number of ways from earlier
versions. The main concerns highlighted in relation to the original
model arose primarily as a result of assumptions over the nature
of the division between Retained DERA and NewDERA. An important
capability for Retained DERA would be the ability to pull together
the results of programmes carried out by NewDERA and other commercial
organisations, academia, or generated from collaborative programmes.
There was an initial perception that the posts for such "knowledge
integrators" within RDERA would be filled by taking a horizontal
slice across DERA at the level of Technical Manager. This would
potentially have deprived NewDERA of a key capability to pull
together the results of scientific programmes to allow it to continue
to provide advice to its main customers and to support the development
of new ventures. The original proposal also assumed that MoD would
retain the Centre for Defence Analysis (CDA) in its entirety,
an approach which, it was argued, would deprive NewDERA of the
analytical capability which adds value to its core science and
technology work. Taken together, these two factors would have
significantly altered the potential business model for NewDERA
and impacted on its commercial prospects, potential for offering
job security, and its attractiveness to potential investors.
8. In addition, it was felt that filling
the "knowledge integration" posts through the approach
described above would have created an RDERA which had a disproportionate
number of senior level staff, a significant percentage of whom
would be nearing retirement age. This raised concerns about the
sustainability of the organisation and its ability to remain technically
current and continue to refresh its skill base.
9. The additional work to refine Core Competence
has produced a much more flexible approach to filling the "knowledge
integration" posts. Under the current proposals, it is envisaged
that the task would be carried out within RDERA by small teams
that would include staff at a variety of levels of seniority.
In addition to their primary task, these teams would also be involved
in international collaboration, the conduct of research at the
level of defence systems, and would interact closely with the
staff retained to work on sensitive programmes. This model produces
a much more equitable division of key staff between the two organisations,
whilst ensuring that each has the necessary capabilities and expertise
to carry out its defined role. The approach would also ensure
attractive and varied career opportunities for staff in RDERA
and create a sustainable organisational structure. The more flexible
approach avoids the risk of dilution within NewDERA of the individuals
it regards as key to the development of commercial business. This
fact, combined with the proposal that NewDERA could keep a minority
of CDA staff would allow it to continue on its existing business
model, and consequently enhances its potential in the private
sector and its attractiveness to investors.
10. It was unclear at the early stages in
the development of Core Competence whether it would be practical
to achieve a clear separation of DERA into the two distinct organisations
without significantly affecting the service delivered to customers.
Consequently, the DERA Partnering Team, DERA, and MoD customers
have conducted a pilot exercise involving a number of DERA sectors
to assess the practical issues that would be associated with making
the division proposed in the consultation document. The results
provide a high degree of confidence that such a split could be
made in a way that will meet the wider PPP objectives whilst continuing
to fully meet MoD's requirements.
11. In summary, the current Core Competence
model has been structured to address a range of issues raised
by PPP stakeholders. The separation between Retained DERA and
NewDERA meets the most significant concerns raised by industry
and our collaborative partners, all of whom wished to be clear
about whether staff with whom they had dealings were in the private
or public sector. Retained DERA is intended to contain sufficient
technical expertise to reassure our allies that they would continue
to be able to deal with Government staff who had the specialist
knowledge to contribute fully to international programmes. Although
consultation is still at an early stage, encouraging responses
have already been received and the proposal appears to have been
welcomed by industry as a practical and sensible way forward.
We hope that the unions will recognise that this approach creates
two vibrant and sustainable organisations, both of which are capable
of offering exciting and stimulating career opportunities for
scientists.
12. Question: What was the basis for selecting
a figure of 35% as the presumed private stake for a "Public
Sector Option" [Q48]? What other possible figures were considered,
and why were these rejected in favour of the 35% assumption?
13. The 35% figure was intended to be illustrative
of the type of stake that might be offered in a Minority sale
and is not intended to represent a preferred figure. In arriving
at the illustrative stake, however, the Department took account
of factors that would impose certain constraints on the range
of feasible stakes to offer:
(a) To preserve the Minority sale concept,
less than 50% of the equity can be sold.
(b) It was assumed that in addition to any
stake sold to outside investors a certain percentage would be
made available to employees, in order to provide additional incentives
for them within the corporation.
(c) The proportion of equity sold would need
to be sufficient to give investors a meaningful stake. This was
important not only to make the corporation attractive to potential
investors, but also to ensure sufficient commercial involvement
to introduce private sector disciplines and incentives. In the
case of a flotation, there is also a requirement in the UK that
at least 25% of the equity should be in public hands.
14. If this model had been pursued, the
actual size of stake to be offered to wider investors as well
as employees would have been determined during implementation
in the light of market conditions, investor appetite and the expected
value of the business in the PPP.
15. Question: What is the MoD's (and its
advisers') latest view of the potential receipts for the MoD and
for the Exchequer overall, from the proposed public-private partnership
in DERA [Q86]?
16. The potential receipt from any DERA
PPP transaction will depend upon a large number of factors. Some
of these, such as the state of the markets at the time the PPP
is implemented, are not wholly in MoD's control. Others, such
as the extent to which a persuasive technology investment case
can be constructed for the new DERA, require substantial further
work by MoD, DERA and their advisers. Even if there were much
greater certainty in these areas, the size of the potential receipt
will depend upon yet further factors such as the proportion of
the new DERA shares to be sold and the methods of sale.
17. MoD's advisers have carried out limited
preliminary valuation work using discounted cashflow and multiple-based
valuation techniques to inform MoD's assessment of the options
for DERA. However, these have focused on identifying very broad
ranges of value rather than attempting a single-point assessment
of potential receipts, and have not yet taken full account of
certain potential sources of value in DERA (such as from technology
exploitation where DERA's track record is only beginning to develop).
18. Given the current uncertainties in valuation,
and the commercial sensitivities of this information, and having
sought specialist city advice, the MoD feels that it would be
detrimental to the ultimate goal of achieving best value for the
taxpayer to speculate at this stage about the size of likely receipt.
19. Question: The MoD provided some details
of DERA's site strategic development plan during its Defence Research
inquiry. Can the MoD provide a more up to date summary of the
development plan [Q89]?
20. An updated version of the Estate Strategic
Plan has been produced and is enclosed. The Committee is requested
to note the release conditions described in the covering note
to this response.
21. Question: What are the possible options
for the future of a Defence Diversification Agency and its relationship
with Retained or NewDERA and what is the MoD's current thinking
on the likely way ahead [Q109]? What progress has been made in
setting up the Defence Diversification Council [Q106]?
22. The MoD sees a continuing need for the
three main activities currently being performed by the Defence
Diversification Agency (DDA), which can be summarised as follows:
(a) To encourage the widest possible exploitation
in the civil sector of defence technology.
(b) To provide information on defence equipment
procurements and trends to inform the defence industry's own diversification
planning.
(c) To facilitate civil sector "spin-in"
to defence programmes.
The DDA was established within DERA last year,
with a permanent Director appointed last summer. The Agency is
already making a major contribution to defence diversification.
23. Options for the future of the DDA include
a range of possible organisational solutions, incorporating the
DDA and its activities within NewDERA or Retained DERA or possibly
elsewhere in the MoD. The Department is considering the implications
of the various possible options, in the light of the work done
by the DDA to date. Once a firmer view has been reached on an
option that can be recommended, the Department will consult more
widely and make detailed proposals for the establishment of the
Defence Diversification Council, which will have a major role
in taking forward defence diversification activity.
24. Question: The committee would be grateful
for any further information it can provide about which sites may
be classified as "strategic assets" and on which side
of the New/Retained divide they are likely to fall [QQ128, 134]?
25. The term strategic assets has generally
been used to refer to equipment and facilities, not just sites.
DERA has several hundred facilities, virtually all of which provide
a capability of importance to one or more MoD customers. There
is no central list of such facilities since they are an integral
part of DERA's individual business. A list of specific facilities,
which currently receive special attention as strategic assets,
has been previously provided to the committee.
26. There is an existing process for consulting
relevant MoD customers when disposal of a facility is under consideration,
and it is proposed that the special share would contain provisions
requiring NewDERA to follow a similar process when considering
closure or disposal of designated strategic assets. During implementation,
detailed work would be carried out with DERA and its customers
to agree the list of facilities which would be given this status.
We also anticipate that, as a responsible supplier, NewDERA would
not wish to jeopardise its relationship with its major customer
by closing facilities without first discussing the issue with
the relevant part of MoD. In addition, contractual safeguards
would also protect access to facilities required as part of a
specific project.
27. It is too early to say which assets
will be in RDERA and which in NewDERA and final decisions will
be dependent on the feedback from consultation. However, in general
terms, where entire business units are retained in RDERA, for
example the Chemical and Biological Defence sector or DERA Radiological
Protection Services, ownership of the assets will remain with
them. Where MoD is retaining individuals from departments that
will continue to exist in NewDERA, the general principle is likely
to be that NewDERA will retain the assets. It is likely that in
certain cases RDERA would establish a contractual agreement with
NewDERA for access to facilities that were required for specific
tasks. MoD customers are already charged for the use of facilities
within the current DERA that are used to support their programmes.
Consequently it is not anticipated that there will be any significant
changes to facility costs resulting from the proposed new arrangements.
28. Question: Does the MoD envisage any mechanism
under the public-private partnership for ensuring that NewDERA
retains particular key staff or teams after it is incorporated/floated?
29. Currently the existing DERA organisation
has no particular mechanisms for retaining key staff or teams,
and indeed DERA faces difficulties in competing with industry
for staff with expertise in specific areas of technology. NewDERA,
as a private sector company, will enjoy a greater range of options
to address this problem. These may include not only pay and other
reward flexibilities, but also potentially the opportunity for
staff to have an equity share in the success arising from the
exploitation of their ideas while at the same time remaining in
NewDERA and producing new, innovative ways of meeting defence
needs. It will be very much in the interests of NewDERA to ensure
that it retains those individuals and teams instrumental in meeting
the needs of its principal customers in the MoD. Although RDERA
is unlikely to have the same range of pay freedoms, it will continue
to offer scientists the opportunity to carry out exciting and
stimulating work in a range of professional areas. We are confident
that both organisations will be capable of attracting sufficient
high-calibre staff to carry out their respective missions.
30. Question: In deciding whether to grant
permission for NewDERA to engage in "defence manufacturing"
activities what criteria will the Department apply?
31. NewDERA will remain a very significant
supplier of science and technology to MoD for the foreseeable
future and, as such, will have a powerful business incentive to
protect its independence and integrity through internal processes
and appropriate values and culture. In order to provide additional
assurance, NewDERA will be subject to a compliance framework that
will include a prohibition on defence manufacture to be enforced
through retention of a special share.
32. In relation to defence manufacturing,
it is not proposed to prohibit NewDERA from undertaking any activities
performed by the current DERA. The prohibition is intended to
be consistent with the present restrictions on the development
and manufacture of equipments for sale by DERA, which are set
out in the Framework Document that governs the activities of the
trading fund. It is recognised that for this prohibition to be
effective it must be defined in an unambiguous way and, similarly,
the processes and procedures used to administer this provision
must be clear and not intrusive.
33. It is recognised that more detail will
be required following consultation to define fully the term "defence
manufacture" but it will be based on the following broad
principles:
(a) NewDERA would not, without the express
permission of 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.
(b) Unless there was a clear conflict of
interest, NewDERA 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 NewDERA can influence the design
of new defence systems.
34. Question: What is the MoD's latest assessment
of the number of DERA staff that will not be required, neither
by NewDERA nor by Retained DERA? Who will pay for redundancies?
35. Staff numbers within DERA have varied
in response to customer requirements and changes in the funding
available for defence research. Such rebalancing has been ongoing
in DERA over the last seven to eight years, with a shift in demand
away from traditional technologies and facilities such as wind
tunnels and ranges towards "new technology" areas such
as biotechnology and communications. DERA's size has remained
broadly constant through this rebalancing. This process is independent
of PPP and would be expected to continue. The committee will be
aware that, as a separate initiative, MoD is introducing greater
competition into its research programmes. DERA's success in winning
work will potentially have an impact on overall staff numbers,
but this will occur regardless of the PPP process. It has never
been an objective of the PPP to reduce staff numbers and indeed
the opportunities provided by this process to develop new markets
for DERA's products should have a positive effect on job prospects.
Consequently it is not anticipated that PPP will cause a significant
reduction in staff numbers. It is expected, however, that, as
at present, the costs of any redundancies would lie where they
fall.
36. Question: How much may it cost to divide
staff, facilities, information systems and databases between the
NewDERA and Retained DERA organisations? What arrangements are
likely to be followed to transfer existing pensions to NewDERA,
and what is likely to be the aggregate value of pension commitment
transferred by MoD to the new organisation?
37. Details of the division have not been
finalised and will be dependent on the results of the consultation
process. So far only broad estimates of the likely costs of initial
separation have been made. However, these estimates are sufficient
to give confidence that any costs will be small in relation to
the overall size of the project.
38. The creation of NewDERA would present
staff with the option to transfer accrued PCSPS benefits into
the NewDERA pension scheme. This option would be provided under
a bulk transfer arrangement on the basis provided for in the recent
Cabinet Office statement of practice for staff transfers in the
public sector. The aggregate value of pension commitments transferred
will depend on the number of staff exercising the option to transfer
accrued benefit and this is unlikely to be known until after vesting
day of any NewDERA organisation. It should be noted that although
the pension transfer represents a cash cost to Government, it
is neutral in overall terms as it represents a removal of an element
of Government's ongoing pension liability.
39. Question: The consultation Document speaks
of retaining all of the capabilities of the Centre for Defence
Analysis, but only the majority of staff. How will that be possible?
40. The functions undertaken by the CDA
are fundamental to the business of the MoD as a whole, by sustaining
impartiality and supporting major expenditure decisions and the
coherent development of future defence policy. At the same time,
it is recognised that including a number of CDA staff within NewDERA
would allow it to continue to operate under its current business
model and would add value to the other capabilities offered to
customers. Both of these aspects are likely to have a positive
effect on NewDERA's ability to win new business and on its attractiveness
to potential investors. CDA has capabilities in several technical
areas, each of which typically comprises a number of staff and
analytical models. Although it is proposed to retain the full
range of capabilities in MoD it may not be necessary that the
current level of staffing is required to meet only those requirements
that must be carried out within Government. Although further work
would be required after consultation, there is confidence that
in some instances it is possible to create an adequate level of
capability within Retained DERA to meet MoD's impartiality requirements
in a particular area without keeping 100 per cent of the current
staff. This would free up a number of CDA employees who could
potentially transfer to NewDERA to provide the company with a
core analysis capability. In those areas where it is possible
to carry out work in the private sector, NewDERA would remain
accessible as a potential supplier to MoD.
41. Question: Of the DERA departments to
be kept in Retained DERA, which ones are intended in particular
to provide sufficient assurance to US authorities to protect UK/US
collaborative research?
42. The creation of a Systems Science Sector
within Retained DERA will ensure that MoD retains a systems research
capability and a source of impartial advice, manages and participates
fully in Government to Government collaborations, and has an overview
across the breadth of defence science and technology. It is, therefore,
this Sector which will provide the assurance of our continuing
support for international research collaborations to our partners,
including the US, and help to maintain and develop our collaborative
links. During consultation, we will also be discussing with our
allies the detail of the processes and principles that would govern
the handling of collaborative issues throughout the implementation
and transition periods.
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