Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 40-59)



  40. Yes, but the footnote is still relevant at the bottom of page 5 because it says "These figures take account of revisions to the Major Projects Report 2000 approvals baseline for 7 projects", and it names the projects, "brought about by more accurate information on interest on capital charges becoming available".
  (Sir Robert Walmsley) What it would look like without that I do not know. In some senses that is a question for the author of the report.
  (Mr Banfield) It would not look markedly different. There are only two of the projects where there was any significant variation and they are Apache and Merlin Mk 1 and we can provide figures for both for you.

  41. Am I right in thinking that in terms of the Apache it would then increase the projected overrun?
  (Mr Banfield) I will just check the figures for you and come back to you later on.[2]

  42. Throughout the report comments are made about the increasing inflation costs; I am thinking particularly of paragraph 1.14 and Figure 5, inflation cited as one of the major cost increases historically. May I just check? Is any account taken in the figures you have here of the reduced costs of borrowing? You mentioned the opportunity costs which are incorporated in here. Is that taken into account in the figures we have in the same way as the projections about increasing for inflation?
  (Sir Robert Walmsley) We are still working on a six per cent discounting rate and a six per cent interest on capital charge. These are figures which are set by the Treasury; I think they are across government and not just for the Ministry of Defence. Though sometimes I have to admit in recent months occasionally I have heard talk of lower figures being possibly contemplated, for now it is still six per cent.

  43. How would that affect your projections here?
  (Sir Robert Walmsley) I worry about it a bit. This is quite a complicated answer and I am not even sure I am going to make sense to myself but I shall just try it. When you are looking at projects on a through-life basis, you do not know the costs you are going to incur in 20 years' time anything like as accurately as the costs you are going to incur in 10 years' time. So there is a sense in which discounting long-term future costs avoids you making optimistic assumptions about what is going to happen in the long term. I am a little bit worried about equating costs in the year 2010 with costs which arise in the year 2001 because actually I know that industry, when they are assessing whether something is a good move or not, use discount rates of 15 or 20 per cent and I think there is an interesting discipline there. I have to say we are not prohibited from using such rates.

Mr Steinberg

  44. On page 4, Figure 1, it seems with the new system in being the report gives a very favourable account. When I actually look at the projects, it does not ring true. You have, for example on ASRAAM, two out of the three performance parameters worse, Apache two out of the three, the S&T Update two out of three. What is the increase in time and the cost increase in the ones which have not gone right, which amount to just below 50 per cent of the projects? Fifty per cent tends to have at least one of the performance indicators going wrong. Or am I reading it wrong?
  (Sir Robert Walmsley) No, you are absolutely correct. I have not sat here and tried to claim credit for this report. What I can tell you is that it is better than it has been in the past and that does not in any sense mean that we are falling into the trap of starting to think that a small cost increase is okay. It is simply better than a big cost increase. I know we have to continue to work at it, but if you look at Apache, you can see that as a result of bearing a somewhere approaching £100 million cost increase last year, in an overall sense, if you look at Figure 2, you will see that Apache is smack in the middle with a zero cost variance. We had some good luck, which may well have come to do with exchange rates or whatever. We have now been punished on Apache as a result of the £/$ exchange rate and we have had a £17 million charge for inflation. We take the rough with the smooth and it is absolutely right to say that is unsatisfactory, but it has brought it back to where it was when it started.

  45. In our brief it tells us that the submarine update has got worse, which you can clearly see in two of the three. We are told that the cost increase is something like £80 million and there is a 12-month delay. How does that correspond to the other ones which have got two out of the three with a cross beside them in terms of delay and cost increase?
  (Sir Robert Walmsley) You are absolutely right, there is an £18 million cost increase on the Swiftsure and Trafalgar Class Upgrade. I have to say that is to do with the sonar, which is Sonar 2076, which has proved, probably as some people predicted but I did not, even more difficult than we expected it to be. We have taken very serious steps now to re-align that programme. It will be at sea in HMS Torbay within a month or two. It has already passed sufficient tests for me to be quite satisfied that it will give the commanding officer of the ship a safe performance when he has dived and in not too many months a very good performance. This is an enormous undertaking and I am desperately sorry that it has not worked out perfectly. It is not far off. I am not sheltering behind delays in submarine refits because if they had not occurred, this sonar would still have been in trouble on the timetable.

  46. When I had a quick look through, and I cannot pretend I have read every word in this report because I have not, when watching Arsenal versus Aston Villa yesterday afternoon which was boring enough so I was being bored twice, when I read through these blue pages, most of them seemed to say late, late, late. How many of these projects are actually delivered on time?
  (Sir Robert Walmsley) I shall be able to answer that question because there is a graph which will show us. I unfortunately have read every single word in this report, because I am required to do so. Table 7 on page 10. We have one which will be delivered early, which is MRAV, and then we have two ASTORs, which is five business jets with the world's most advanced surveillance radar in them which will be delivered on time and Astute, which is a programme of three attack submarines, which we are currently forecasting will be on time. Those which are in pale blue down towards the bottom have all entered service already.

  47. So two thirds of the projects tend to slip.
  (Sir Robert Walmsley) You make a very powerful point. I ran a conference with industry for the Defence Procurement Agency this year, which was an extremely successful event compered by Mr John Humphrys, who kept us all on our toes throughout a very stimulating day. The theme of the conference was "Right on Time". I absolutely acknowledge that we need to get better at keeping these projects to time. The Chairman's opening question was: what am I doing about these things? Technology is the biggest single cause of delay and I have talked about technology readiness levels, but better project management, seeing these problems coming before they hit you in the face, is actually quite an important part of responding to difficulties and this Committee has encouraged me to use earned value management and that is under way.

  48. I remember the last time both you and Sir Jeremy were here together you told us about the ship which had been ordered without any sonar and it was added later. That worried us at the time. What also worries me is cost reduction. Can we go to page 24 and Figure 17? I am trying to be helpful because it seems to me that if we are putting pressure on you all the time to reduce, reduce and reduce costs, you can only achieve reductions by leaving something off. The ship with no sonar to chase submarines sounded a bit farcical at the time and you guaranteed that was not the case, but it is a worrying thing that if scrutiny committees like ourselves and Government are telling you to cut back and cut back and you are cutting back and cutting corners and the equipment is not as it should be, then it should be said. If you look at Figure 17 it tells us that the stakeholders in the Department have three cost reduction targets, the first stakeholder has to look for a £2 billion cost reduction in the Strategic Defence Review, a £750 million reduction in the Public Service Agreement and a £200 million reduction in the Business Plan. How are these figures arrived at? Does someone just say "Let's save £2 billion here and £200 million there"? How do you arrive at these figures?
  (Sir Robert Walmsley) It sometimes feels a bit like that but it is not like that. We started off with the Strategic Defence Review. In round number terms across the 10 years of the equipment programme there is a £60 billion budget assigned. I am talking round numbers now. During the discussions on the introduction of Smart Procurement we were asked what we thought we could do with this if we were given some freedom to move things around. We probably talked about trying to do something in the region of two per cent and somebody squeezed us up to something a bit closer to four per cent. So there is a bit of "What do you think you can do?" and you saw with Skynet 5 we took nearly £500 million out of the programme.

  49. You do not say you want to build a ship without any sonar.
  (Sir Robert Walmsley) No, we do not. That is back to the point which the Chairman raised. I did say it is quite difficult to go on making cost savings on a properly drawn up budget. You just cannot do it. If you insist on doing it, then people will start drawing up budgets which have a little bit more room in them than they should have. I am very cautious about this but I was quite happy with the initial thing because it was our first chance to apply Smart Procurement principles and we have delivered in our budget—but I agree that it is only a budgeting tool—that £2 billion of savings.

  50. What about the £750 million?
  (Sir Robert Walmsley) We have just about done that and we shall be struggling now year on year to find another £200 million. I absolutely do not want to get into the position of perverse incentives, that is to say padding the budget.

  51. Why has it said in the business plan that there will be a £200 million cost reduction for 10 years? Why ten years and why £200 million?
  (Sir Robert Walmsley) It is £200 million for each annual ten-year planning round. Over 10 years that is an average of £20 million per annum. I do not see how we can possibly continue with that for ever unless we have improper budgets.

  52. Why was the Strategic Defence Review over the period 1998-99 to 2007-08 and the Public Service Agreement over 2001 to 2004? Why over different periods?
  (Sir Robert Walmsley) It is the time the agreements were struck. The Strategic Defence Review reported in July 1998 so our equipment ran for 10 years from that point; so up until 31 March 2008 was the 10-year period. The Public Service Agreement was struck later.

  53. Can we go to paragraphs 3.6 and 3.7 and I must admit I was getting very confused as the game proceeded? What is the total cost of reductions? Are we talking about the £2 billion, the £750 million and the £200 million, then a further £2.4 billion?
  (Sir Robert Walmsley) No; no, absolutely not.[3] You can add up the three figures, but they occur over different periods. You can add the £2 billion to the £750 million and then in theory a further £20 million each year, but I do not see that going on for ever. What I am much keener on is keeping an absolute determination to secure the cost efficiencies which working closer with industry and making sure that projects work more closely together as well as my teams working more closely with Admiral Blackham's area. It would be important that you hear from Admiral Blackham on the subject of costs.

  (Vice Admiral Sir Jeremy Blackham) Cost matters to me a very great deal. The key issue for us always is the trade-off between costs and capabilities. We set ourselves a set of key requirements, we then try to negotiate with an IPT and he with industry to see what we can get for that and then we have to consider whether what we are getting is sufficient for the purpose, whether there is a trade-off to be engaged in, whether we can relax a requirement because the particular eventuality is sufficiently distant or remote and we can get a better price, bearing in mind that whatever we save on one project can be spent on another. There is a constant trade-off going on, but not a trade-off as far as we are concerned which would produce a piece of equipment which does not meet the need we foresee for it.

  54. The Chairman touched on this point and I come back to it a little. We are also told that 12 projects accounted for 70 per cent of the cost reductions. What about all the other projects which are covered by Smart?
  (Sir Robert Walmsley) In terms of major projects—not Major Project Report projects—those are projects which cost more than £20 million each, there are about 80 or so.

  55. What percentage of Smart costs are a percentage of the total defence budget?
  (Sir Robert Walmsley) I mentioned the total equipment costs over the 10-year period as being around £60 billion, that is £6 billion per annum. You have seen here that the total savings add up to something around £3 billion, that is £2 billion plus £750 million plus £200 million and that is, as near as makes no difference, five per cent of the equipment programme.

  56. What is the cost reduction on all defence expenditure.
  (Sir Robert Walmsley) The capital equipment programme is about one quarter of the defence budget, so it is just a little more than one per cent or so of the defence budget.

  57. I did not understand a lot and most of my questions are based on what I did not understand. Paragraphs 3.6 and 3.7 went on to say that the Department will track 11 projects which cover 60 per cent of the expected cost reductions to see whether the forecast reductions are met. What I could not understand was why the others were not included.
  (Sir Robert Walmsley) We could track everything all the time.

  58. Presumably you could only get a true picture if you track everything.
  (Sir Robert Walmsley) We do track everything in the sense that every project's budget is scrutinised, jointly I may say, by Admiral Blackham and myself once a year on a rather long hot day in the summer when we do go through the lot. We are tracking that each project does not slip in a little private budgetary increase for no purpose. We do track very carefully each project's budget. In terms of the Smart savings, we decided that we would separately track what had been achieved on the dozen or so biggest hitters.

  59. One thing which struck me which I could not understand was whether when you go for a project you have the money available. Do you know that you have the money available or do you plan a project and then hope to get the money eventually through a general budget or are you certain of having the money available when you plan a particular project? I got the impression when I looked at Figure 9, where it talks about changed budgetary priorities, that when budgets were approved you did not necessarily know that you had the capital to go ahead with that budget and you hoped that you might have it at the end of the day.
  (Sir Robert Walmsley) I never seek tenders from industry without the money to pay for an economic tender. That is my working rule. We do not involve other people in spending money unless we have the resources to do it, except on a very few occasions and we then tell them that unless the offers are really attractive . . . The budgetary process belongs entirely to Admiral Blackham and he should answer your question.
  (Vice Admiral Sir Jeremy Blackham) Perhaps I should start by saying that I would never go forward to seek approval for a project if I could not satisfy not just myself but the approval authorities that we had a budget line which was sufficient to cover that project. The equipment budget is about £6 billion a year, it is quite specific, during the period of the spending review, whenever that is, and an assumption is made as to what it is likely to be outside that period. It is a given as far as I am concerned, so I have an equipment budget which runs over a 10-year period. That budget is made up of a number of lines which are the project lines and the costs for those are supplied to me by the integrated project team leaders who have the figures from their own experience, through consultation with industry, through the use of the specialist procurement services within the DPA. There is a string of budget lines. My basic aim is to produce an equipment programme which satisfies the overall equipment capability requirement and falls within that budget. Indeed I am required to produce a budgetary plan every year within the budget and explain the extent to which it does or does not meet the capability requirements which have been identified. Every project has a budget line which is sufficient for that project to the best of my knowledge at the time we go forward.

2   Note by witness: Without the revisions to the Major Projects Report 2000 approvals baseline, the forecast cost variance at Main Gate would be unchanged for Merlin Mk 1 at +30%, and would be -2% rather than zero for Apache. Back

3   Note by Witness: The £750 million Public Service Agreement (PSA) target is derived from the £2 billion Strategic Defence Review target and the new £200 million cost reduction target. The PSA target represents the value of these savings in the period 2001-02 to 2003-04. Savings against this target are part of the profile of the £2.4 billion set out in figure 15 of the MPR 2001 report. Back

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