Examination of Witnesses (Questions 80
- 99)
TUESDAY 13 MAY 2003
SIR RICHARD
EVANS, MR
NICK PREST,
MR JOHN
HOWE AND
MR COLIN
GREE
Q80 Mr Howarth: Finally, can I just
ask you in relation to the Defence Industrial Policy paper, there
is reference in it to a Defence Export and Market Access Forum
which obviously touches on all the things we were talking about
just now. Can you tell us what benefits you hope to obtain from
this forum? Has it met? Has it got an agenda? Is it making progress
or is it perhaps just another talking shop?
Sir Richard Evans: This is a forum
that was specifically set up post the announcement in October.
It is chaired by the head of Defence Export Services, Alan Garwood.
To my knowledge it has certainly launched itself, it has had at
least one meeting and there may have been others as well. There
is a specific agenda which it is addressing. My belief is that
this group will make a valuable contribution to improving our
ability to drive into the export markets. Within that agenda it
is specifically addressing this issue of markets where there are
obstacles that have to be overcome, and that obviously includes
a number of countries in Europe as well as North America.
Q81 Syd Rapson: The Defence Industrial
Policy is very strong on competition and it claims that it is
going to be the bedrock of procurement policy but we do know that
there are long-term problems that can arise that are locked in
and we need to review them. The document promises a "systematic
and deliberate" examination of the long-term consequences
of its decisions for a particular market and in particular if
they need they can bring competitions to a halt, and the Type-45
destroyer programme is one of those. As industry continues to
rationalise, do you see other market sectors where their longer
term competitive health is at risk?
Sir Richard Evans: I am not sure
that I do. We are talking here about are there sectors of the
industry other than naval shipbuilding where the actions that
were taken specifically, for instance, on Type-45 to collapse
the competition programme were taken. I think the answer is I
do not think that is a problem. My understanding of the position
within the procurement organisation is where those considerations
create a situation where it is sensible to do that, they will
actually do it. On the industrial side our argument is the sooner
the decision is taken in order to get to a choice in the context
of the contractor or the partner, the better it is for everybody.
There are a number of pieces within the industrial policy that
have been created that will make that easier for the IPT leaders
to do. I think it is right that we should get a copy of the notes
for guidance that have been issued because in there you will actually
see some specific references in terms of advice that is given
down to the working levels where these things have to be implemented
that give great emphasis to this specific point. I think that
where it makes sense what we will see is this is the practice
that will follow.
Q82 Syd Rapson: So it is necessary
to ensure the long-term health to review very systematically how
we have done things, as we have with Type-45. That is a good move?
Sir Richard Evans: We and the
customer side of the fence, prior to that decision being taken,
could have continued spending together substantial amounts of
money continuing the competition but not actually getting the
value that we could get out of what we spent. I think the fact
that we actually brought that to a conclusion, in that particular
case, and got VT and ourselves together at an earlier date than
would otherwise have been the case, was a good thing in terms
of moving the programme forward. The demonstration of that is
that the programme, at the moment, is running extremely well.
Q83 Syd Rapson: I am very grateful,
coming from Portsmouth, that you did come to an arrangement with
Vosper and cleared the blood away from the scene. With fewer and
fewer prime contractors, is the MoD faced with having to consider
non-British suppliers to maintain competitions for their equipment
sector?
Sir Richard Evans: The answer
is absolutely it is. It is a complete inevitability of the situation
that the UK—and they are not alone I might add—faces.
Interestingly, certainly at the prime level today, the degree
of competition that the customer here in the UK enjoys is probably
greater than it has ever been in the past.
Mr Prest: It is worth adding a
supplementary that competition should not only be thought about
in terms of competition at the prime contract level. As a very
crude rule of thumb you could say that the prime contractor, if
you added development and manufacture of a large project, probably
not more than 30%, at the most, of the value of the project would
be within the prime contractor's own hands in terms of the management
and manufacturing and at least 70% would be bought out. There
is plenty of scope for intensive, second-tier competition even
in a situation where a prime contractor is nominated, and it may
well be that there will be more of that in the UK scene as things
go forward, with obviously the ability of the ministry to deploy
international competitions as well where they think the circumstances
are right, but that is not the only way to drive value into a
project.
Mr Green: That is the point I
wanted to make, and that is that competition is just one way of
assuring value for money; partnership is another. It seems to
be that there is a belief that partnership is inimical with competition,
and that is not true; it is a question of making sure that you
complete the appropriate part of a project at the appropriate
point in time. Some projects were started that, frankly, should
not have been started and others have been stopped which should
have been stopped earlier. So there is a whole process of working
together that needs to be better understood than is presently
the case.
Q84 Mr Cran: Just three questions,
to tease out what you really were saying in answer to my colleague
Mr Rapson. You are all, as it were, prime contractors (you are
"primes", as it were). The question that interests the
Committee—and this is very interesting in the light of the
statistic that you, Mr Prest, gave us, which is that only 30%
of the value of the contract is, in your bailiwick, the rest is
out with it. Is that correct?
Mr Prest: It varies from project
to project. I think if you look at a systems integration platform
manufacture that would be a fair ratio.
Q85 Mr Cran: That being the case,
the question that interests the Committee is what happens to the
small and medium-sized companies below, which you clearly depend
upon, really, rather tremendously? The question is: is it only
those companies who bed themselves within you, either formally
or informally, that get the sub-contract work or not? Just talk
us through the whole issue.
Sir Richard Evans: Can I highlight
one or two points on this issue of supply train management, which
is really what we are addressing here, which are hugely important
in the context of the well-being of the industrial base in defence
terms here in the UK. There is an enormous amount of pressure
on the supply train to day, brought about by a lot of the more
recent dynamics in terms of efficiency drives and improvements,
lean manufacturing, etc, which is really causing the primes to
substantially reduce the number of suppliers that they directly
engage. Therefore, what historically has been the supply chain
is being increasingly encouraged to create clusters of excellence
in order to reduce the supply train for the primes and, therefore,
take over substantial parts of the chain itself that were otherwise,
obviously, distributed.
Q86 Mr Cran: Are these formal clusters?
Or do they just come together?
Sir Richard Evans: Not formal
clusters. They come together and, in many cases, the primes are
actually operating as a catalyst to encourage a number of these
supply members of the chain to come together and create these
clusters of excellence. To do that these organisations need a
lot of support from the primes, particularly the smaller companies.
They do not have the resource or the capability—both human
and financial resource—to invest on a scale that is necessary
in every case to create excellence. Therefore, there is obviously
an interest on the part of the primes to support these companies
in these clusters to become world-class in the areas in which
they are operating. However, there is no doubt that this is putting
tremendous pressure on the whole of the supply train, and we are
beginning to see some members of the traditional supply train
actually losing their positions. Obviously, that potentially has
a big effect, particularly when you are looking at international
competition in terms of tendering. Nick is absolutely right, and
I can certainly confirm to you, that in the context of our big
programmes business, the average in-house content of those programmes
is about 30%. So 70% of virtually everything that we deliver,
one way or another, we buy in through the supply train. So actually
getting these efficiencies into the supply train is enormously
important to the future health of this business. If you look at
it another way round, whatever we do to improve our own efficiencies
only affects 30% of the product cost. We have a really big vested
interest to help the supply train to become as efficient and effective
as it possibly can. One of the ways of doing that is to create
these clusters where the suppliers themselves can add greater
value out of working together and creating a common purpose without
giving up the independence of their ownership, and all the rest
of it. This, actually, is an area that is highlighted in the Aerospace
Task Force's work that has been going on, but it is very easy
to forget that underneath, where guys like us sit at the prime
level, there are an enormous number of people employed in this
industry who depend upon us in the context of their well-being.
It is fine, we may negotiate deals in the context of foreign products
that we buy, etc, but ultimately these organisations depend upon
the technological capabilities that they bring to the prime level
when the UK prime is actually leading the programme. I think it
is a hugely important point that is often forgotten. You see guys
like us pretty regularly but there are a hell of a lot of people
you do not see here who are absolutely critical to the well-being
of this industry.
Q87 Mr Cran: It is your view, is
it, that that sector is vibrant and is capable of delivering what
it is you need?
Sir Richard Evans: Some parts
of that sector today are under the most enormous pressure in the
context of their survival. It is not untrue to say there are some
important parts of that chain that are seriously threatened, particularly
from international competition—quite often, I would say,
where that competition is not competing on absolute equal terms.
Q88 Mr Cran: We do also hear that
that may be so simply because—and we have used the word
already—of the "dominant" position that you are
in already, as we are now calling you "primes". The
fact is you just dictate the conditions to them, and they take
it or leave it. That is the other side—
Sir Richard Evans: It is the other
side of the coin that you can quite rightly identify with, but
I can tell you it only needs quite often one of the smallest members
of the chain to decide they do not want to trade with us to create
the biggest mayhem in the context of our ability to produce and
supply that is imaginable. Do not under-estimate the importance
of these guys to us; they are hugely important and we absolutely
have an obligation and a duty to these people to make sure that
they are getting a proper crack of the whip, because without them
we cannot exist.
Q89 Mr Cran: Just one short question:
as I understand it, what is happening in Europe is there is a
tendency towards ad hoc arrangements, or ad hoc joint ventures
and so on, for particular projects. The proposition is put to
us that that is far better for the small and medium-sized suppliers
that you and I are talking about; it retains their independence
and so on. Is that something you recognise or reject?
Sir Richard Evans: No, I do not
recognise that at all. I think it depends on the structure of
the programmes. If you have got them in traditional, what has
been described in the past as juste retour, where they
are in enormously complex work-share agreements and particularly
where there are competing companies in different countries who
have particular levels of expertise that have been generated out
of investment that has been made in previous years and they will
fight to get work in accordance with their share of whatever the
programme is relative to that expertise, that does create situations
where the allocation of work is done on a less than adequate basis.
I think life is a lot tougher for many of these smaller guys in
these big, complex multi-billion collaborative programmes than
it is dealing on a straight UK or UK/American supply deal.
Q90 Chairman: Mr Howe, following
on what has been said by Sir Richard, if I got his figures correct,
70% ends up outside BAE SYSTEMS. Because Thales is incredibly
diverse in its structure and the range of products it produces,
does it have a policy of sub-contracting outside the Thales operation
or is the company large enough to be able to supply most of what
it requires in-house?
Mr Howe: I cannot quote the precise
ratio but it must be very close to the 70/30 that you have heard
about, because Thales is, on the whole, a horizontally and not
vertically integrated company. So we are very dependent upon our
suppliers too for a large proportion of the products we sell on.
On the whole we do not have a great hierarchy below the main company
of wholly-owned suppliers of component parts.
Q91 Chairman: Is that Thales UK or
Thales in general?
Mr Howe: I am talking about Thales
in general but it is certainly true in the UK.
Q92 Chairman: If it is possible to
find out the figures, it would be quite interesting.
Mr Howe: I can easily find out
the figures.
Q93 Mr Howarth: The Defence Industrial
Policy Paper warns against burdening prime contractors with unmanageable
levels of risks that will not lead to efficient project performance.
Do you see this as a fundamental shift in the attitude of the
Ministry of Defence, or is it a reminder to themselves to avoid
the experience of Nimrod II?
Sir Richard Evans: It is a combination
of the two. I think there is a recognition that when you look
at the increasing complexity of a number of these programmes,
we all need to have a much better understanding of what the risks
and, for that matter, what the opportunities are in the programme
itself. Nimrod was an interesting example where a major piece
of the problem was what was described as being concurrency, where
because of the compression on the delivery time scales we really
were required to move to production before we had got sufficient
stability in design. Hindsight is a pretty exact science, but
I think the lessons that have come out of this and other programmes
as well—and, incidentally, the UK is not unique in this
regard; the US, interestingly, is littered with many more examples
of this sort of problem than we have had here in the UK—mean
there is a genuine recognition (and I think it is a good thing)
that both sides need to understand as early as possible what the
risks are. We need to be able to orchestrate the way in which
we contract these programmes in a way that does not inescapably
tie-in the purchaser to a programme that, clearly, has got risks
that are not being managed out of the design and, conversely,
does not actually lead to the supplier facing the same problem
as well. So I think that the moves that have been made—and,
interestingly, we expect the Carrier programme to follow the same
sort of principles—which much more closely mirror the current
US experiences, are actually in the interests of everybody.
Q94 Mr Howarth: I must say, I thought
the way the Carrier programme was done, where the Government invested
a lot of money in trying to deal with the project was absolutely
right and, as you said, very much typical of the United States.
Given that that was, at that stage at least, a successful experience,
can you say in what way you think, across the PFI board, you would
like to see a shift in the balance between the MoD and the private
sector in taking these risks? It does seem to me that it is unreasonable
to shift such a large risk burden on private equity shareholders—ordinary
people in this country—for the benefit of the Government
to produce defence equipment to safeguard the security of the
United Kingdom.
Sir Richard Evans: PFI generally
is a completely different level of risk to the risks that are
associated with, for instance, the Nimrod programme. PFIs generally,
not absolutely exclusively, but generally, are much more financial
risks related to typically a 20-year time-span where various assumptions
have been made upfront with regard to utilisation, interest rates,
a whole raft of issues, and I do not think it is reasonable to
compare that level of risk to what I would call absolute, technical
risk, particularly in areas where we are really treading in completely
new territory in the context of pushing the technology boundaries
out in order to achieve the requirements of a particular specification,
so I, first of all, separate those two. Is it reasonable to be
pushing what is effectively balance sheet commitment on to industry,
and this certainly is not unique to the aerospace industry, it
applies across a whole raft of businesses, and is it right actually
to move that off the government balance sheet into the private
sector? Well, that is really a matter for the Treasury, but providing
it is done—
Q95 Mr Howarth: Well, it is a matter
for the private sector as well as to whether it is prepared to
assume that and place it on its shareholders.
Sir Richard Evans: I was just
coming on to say that providing it is done in a way which actually
is measured in the context of the risks which are entailed in
it being capable of being identified and understood and priced
into the programme, I think it is perfectly acceptable. We have
been in the aircraft leasing business for the last 15 or 20 years
and it is a massive part of the financial services business. Properly
managed, properly understood and properly applied, I think it
is a very good piece of business.
Q96 Mr Howarth: Turning to the Carrier
programme, which, as I say, I think was particularly well handled
at the outset certainly, but there is now this curious arrangement
whereby the Ministry of Defence is taking a 10% share of the ownership
and, therefore, by implication, the risk of the project, how do
you see this working out? Is this a model for other equipment
programmes? You have already said that you two are getting on
fine together, that the former antagonists have combined and the
guy who is holding up is the guy who is holding 10 per cent and
putting the deal together.
Sir Richard Evans: Well, the answer
is we do not know. This has never been done before. We are in
completely new territory. Certainly in traditional defence procurement
terms both here in the UK and, for that matter, anywhere else
around the world, to my knowledge, it is pretty unique. If this
actually produces a better management structure, then the answer
to the question would be yes. However, I think the thing that
we do need to bear in mind on this issue is that life has been
littered in this business with sort of so-called consortia arrangements
where it has been exceedingly difficult to figure out who ultimately
has been in control. There needs to be, just like in any organisation,
clear lines of responsibility and accountability, so we all know
who is actually responsible for doing what. Now, I think, and
John will help me, do we have 300 guys together at the moment
within the joint team?
Mr Howe: Yes.
Sir Richard Evans: They are actually
driving forward the specification and the sort of remits to try
and get us to contract at an early date. These guys, or certainly
the guys at the top of this team, are not tasked with deciding
how this is going to work and we will only enter into this together
if in fact we believe that it is the right thing to do.
Q97 Mr Howarth: Presumably if this
does work, then you will be less vigorous in your assertion to
BAE in particular or Mike Turner's assertion of, "Actually
we are not prepared to take on a fixed-price contract anymore
and we want to return to a cost-plus arrangement"?
Sir Richard Evans: No, that is
not the case.
Q98 Mr Howarth: How do you respond
to that?
Sir Richard Evans: Our situation
is pretty damned straightforward. It makes sense to price what
it is you can define. It does not make sense to price that which
cannot be defined. The road to doing that is littered with misery
and agony for everybody. We are really saying, and I think that
the changes which are taking place that really began with Type-45
and will now exist on Nimrod and Astute and into the Carrier programme,
we are basically saying, "When we are satisfied that we have
maturity in design, then we will actually move to pricing a phase
of the programme", and it requires two to decide that you
have actually got to that point. I think that is a pretty sensible
thing. Now, you would not go and buy something from the shop down
the road, saying, "I want to buy something that is going
to create music", and the guy says to you, "Well, come
back in two years' time, so give me the down-payment now and you
will see what you are going to get in two years' time", would
you? Or would you? I do not think you actually would. I certainly
would not.
Q99 Mr Howarth: Yes, but turning
to Colin Green of Rolls-Royce, I do not think you are quite the
same kind of business. Colin Green of Rolls-Royce, you are actually
at that sharp end of technology and your predecessor company went
bust 30 years ago because it had not managed to de-risk a project.
Do you agree with Sir Richard and his way forward?
Mr Green: I do not think we should
cross swords on the history of 1971, but—
Chairman: Whose Cabinet was it?
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