Examination of Witnesses (Questions 20-39)
5 MAY 2004
SIR RICHARD
EVANS, MR
NICK PREST,
MR JOHN
HOWE AND
MR SIMON
FROST
Q20 Mike Gapes: Does anybody else want
to say anything?
Mr Frost: The view I have is perhaps
a little more cynical in that I feel that playing cricket when
everyone else has great big baseball bats is perhaps a British
way of doing things but is not terribly effective. They will do
what they want to do and we just need to recognise where we are.
I think that is perhaps the first thing and that is being pragmatic
about all this. The other point I would like to make is that,
if big investments are being made in those countries' industries,
they are hard-headed people and they will get their money back
and the way they get their money back usually is in the cost of
support. All I would ask is that perhaps, in these procurement
decisions, the UK should look very carefully at what the life
cycle cost in reality is going to be, not least through access
to rights over technology that will now allow MoD to actually
maintain and support that equipment in years to come. So, it is
not a question of handouts, it is a question of what we are actually
buying, a very clear-headed question about the support costs and
life cycle costs of such equipment. I do not think any government
is subsidising an industry to no purpose. It is subsidising an
industry because it thinks it is economically beneficial to its
own country.
Q21 Mr Roy: First of all, I was very
interested in your comments about lack of investment in shipyards
especially in Clydeside. Years ago, I only wish that managers
with powers such as yourself would have listened to trade unionists
when we were making those very same arguments. However, I am still
caught between what you were telling us and what you were saying
and what was said in the Daily Telegraph when one of your
spokesman was talking. In that quote, it was said that there had
been expressed an interest in looking at any approaches and that
offers to increase shareholder value. That is slightly different
from shipbuilding in the future and the shareholder value.
Sir Richard Evans: I think the
shareholder value issue is inherently related to the well being
of the business itself. It is not simply a matter of selling the
silver in order to pass it across to the shareholders. The shareholders
have an interest and a stake in this sort of business, all the
employees have a stake in the business and the managers have a
stake in the business but, at the end of the day, we have to do
what is the right thing to develop the business and, as I say,
the fact of the matter is that here in the UK and across Europe
there is too much capacity in this business at the present time.
I think that a lot of the investment we are putting into the naval
shipbuilding business today is not simply directed at improving
the facilities and the fabric of the buildings etc that people
work in, it is actually building up and reconstituting the intellectual
capacity that was closed down when the Naval Architects Office
was closed and therefore redeveloping a design capability not
just for the ships but the integration of the systems that actually
go into those ships and it is very interesting today that, if
you go up to Barrow and look at the engineering block there, there
are significant numbers of people who are moving from the south
of England and are actually transferring those skills up into
Barrow. The same sort of thing is going on in the yards in Glasgow
as well. To do that, we have to fundamentally have a capacity
that is matched to the market. If somebody can do that better
than we can do it today, it is in everybody's interests that we
should listen to what—
Q22 Mr Roy: I am just talking about a
difference in emphasis. I thought you were giving an approach
where you were actually putting public interest a wee bit more
focused as opposed to shareholders' value and I think it would
be wrong, if anyone is watching this, to say that Sir Richard
is really putting a great emphasis on the need for public interest
when, a couple of days ago, your company was saying that it was
really all about shareholder value and it would be wrong for anybody
to take that message away from what you said earlier on.
Sir Richard Evans: If you think
there is a wide difference or disparity in those views, then,
I am sorry. I genuinely do believe that it is very easy to absolutely
crystallise one particular piece of interest as being in the interest
of the shareholders, one in terms of employees etc. At the end
of the day, what we want to do is to see this business being hugely
successful. If somebody can make a better job of that for the
reasons that I have described, it will be completely wrong for
us to prevent it happening. Conversely, if we are able to do that
in partnership and with our partners here in the UK, that will
be absolutely fine as well.
Q23 Mr Roy: If I can just take that one
area, for example, where I suppose the public interest and shareholder
value that you hold so dearly would certainly join up in relation
to value for money. Both you and your Chief Executive over the
last couple of months have questioned the MoD's definition of
value for money. How would your company like to see value for
money defined?
Sir Richard Evans: I think in
the context of a specific definition we would like there to be
a much wider definition of value for money than is the very narrow
definition that the Procurement Agency actually takes. I very
much hope that as defence industrial policy gets better and better
people will begin to think differently and people will begin to
take a different view of it. I would just like to give you one
example where I think this is highlighted. It is an actual example,
and I go back again to the Hawk decision. The recommendation from
the Procurement Executive to ministers was to acquire the Aermacchi
plane. We had various doubts and reservations about the way the
analysis had been carried out, particularly the cost of ownership,
but nevertheless we were not party to it, this was a competition
position between two separate entities. The UK Government in the
early 1970s awarded to the predecessor company, now part of BAE
Systems, Hawker Siddeley, again as a result of competition, the
design and development of an advanced jet trainer for the Royal
Air Force. At the time the value of the contract was about £350
million and in today's money that is about the equivalent of a
billion. The contract was implemented. Subsequent to that, and
as a result of that, the UK has sold 800 Hawk aircraft around
the world generating sales value today to the equivalent money
of about £15 billion. In our view, supported by the professionals
in the sales organisation, in the MoD, there is a view that there
is a continuing market for the Hawk, albeit with further development
that you would expect to take place over a period of time, that
would result potentially in a further market of about 400 to 500
aircraft. In the decision taking or the recommendation that was
made to the ministers, there was absolutely no account taken of
that additional value to the UK. You might argue why should the
MoD take it into account? Are they paid to take that into account
or not? I think that is one of the wider value issues that should
be taken into account. I can tell you that since that decision
was taken, the Indian Government have placed an order for 66 Hawks
which, had that decision gone against us, would not have been
placed. The Indian requirement will almost certainly exceed 200
aircraft. There is a huge replacement programme for earlier Hawk
aircraft that have already been delivered. I can genuinely see
us actually being able to sell a further 400 to 500 aircraft.
On the basis of an investment made 20-odd years ago, £350
million, to throw that away and actually give another five billions'
worth of business to the Italians or somebody else, and at the
same time shut a factory and make a lot of people unemployed,
whatever the bloody rules of economics are, that is certainly
not economics as I understand it. Somehow in the process of evaluation
that was the recommendation that was made. How on earth it could
have been made, I cannot believe. Ultimately it required the Secretary
of State for Defence to issue a ministerial directive to overturn
it. This is the lunatics having taken over the asylum.
Chairman: You have made your point. Frank,
carry on.
Q24 Mr Roy: You spoke at great length
and, I have to say, a lot of it was going over my head there.
Can we focus in a wee bit more. The question was how do you define
value for money in such a way that the Government does not?
Sir Richard Evans: I thought I
had given a reasonable example. Had the recommendation been adopted
by ministers that was made by the procurement organisation, I
think that we, the UK, would have lost business to the tune of
about 500 more aircraft in the export market. That has a value
to the UK. It is a huge amount of money that goes to the Exchequer.
Nowhere in the recommendation is that brought into account. My
point is that when you look at these sorts of recommendations
there is a much wider issue and this should not be looked at absolutely
narrowly, and even looking at it in a narrow sense we think it
was an injustice anyway.
Q25 Mr Roy: How has the Government responded
to you?
Sir Richard Evans: The Government
responded by issuing a ministerial directive forcing the Ministry
of Defence civil servants to change the recommendation to sign
up for the Hawk—it has not been signed up at the moment
but it has been announced—and the result of that is patently
clear for all to see, that already we now have an additional 66
aircraft in the order book that we would not have had otherwise.
Chairman: We have got another 15 questions
to ask still, but I take your point.
Q26 Mr Jones: You say obviously the MoD
is the main customer and you made reference to exports in terms
of their importance. The defence industry is obviously very important
to many of our constituents in terms of jobs and in terms of UK
plc. What damage has been done to that, not just to your company
but to the industry in general, by the allegations this week in
The Guardian newspaper? Is it important that when we are
winning contracts abroad, we are not just seen to be winning because
we have the best product but we do it in an ethical way? Clearly
there are issues which affect your particular company but obviously
it paints a broad brush picture across the defence industry in
general. What can you do to actually put forward the best face
of UK plc defence when you have got allegations that clearly are
being made and are being used by those people who are against
the UK defence industry?[1]
Sir Richard Evans: These allegations
stem from one source, which is The Guardian newspaper.
This is a campaign that has been running for a long period of
time. In the context of the recent allegations, which incidentally
I would remind everybody are always published either at the time
of our Annual General Meeting or the time of our results in order
to inflict the maximum amount of damage on us, there is actually
nothing new in them. When we completed the Marconi transaction
we gave absolutely definitive and binding commitments to the Government
of the United States in the context of adopting completely the
US Foreign Corrupt Practices Act. That was implemented and we
actually had a team of lawyers from the US responsible for giving
advice in the context of the way in which American companies have
implemented this process and it was taken on board with all the
safeguards, including hotlines, whistleblowing, etcetera.
Subsequent to that, of course, the OECD recommendations were implemented
and here in the UK they were put into legislation through the
Anti-Terrorism Bill, became law in Parliament and those constraints
go much, much further than the US Foreign Corrupt Practices Act.
I am satisfied, insofar as I reasonably can be, that all of the
appropriate safeguards exist in our organisation, but I have to
say that when these allegations are made they are obviously damaging.
Nobody thus far has produced evidence to us, despite the fact
that we have made a number of invitations to people to do so,
other than that which was ultimately submitted to the SFO. Obviously
if there is new evidence available and it is brought forward then
clearly it would have to be investigated. Certainly in the context
of the practices that we and all other companies work to, because
all of us have to operate within the framework of the law, we
have a duty to our shareholders to ensure that we are completely
compliant with the law, not just here in the UK but wherever we
are operating.
Q27 Mr Hancock: Are you saying that article
was not true?
Sir Richard Evans: I am saying
that the allegations contained in this article are of wrongdoing,
and I think you have got to be quite careful about how you define
wrongdoing in these contexts, certainly the allegations and assertions
of the laws being broken, etcetera, are allegations that
I at this time, and regularly, completely refute. Until there
is some evidence that we have broken the law that I do not have
at the moment, obviously I have to continue to refute it.
Q28 Mike Gapes: You may not have broken
the law in the context of the UK but nevertheless you might have
made payments to members of the Saudi royal family which would
be regarded as unethical or immoral. If we have changed our practices
as a result of recent US legislation or anti-terrorism legislation
that is all to the good, but clearly there are issues that date
back a number of years. As far as I have seen, the allegations
are something that goes over several years and talks about events
three, four, five years ago, at least. Would you agree with me
that in the past there has been lax practice and that things have
been done that would not be tolerated today?
Sir Richard Evans: I think that
business practices have been changing over a period of time. I
can certainly assure you that we, and I believe most companies,
are not in the business of making payments to members of any government.
I would just like to reiterate that not only are we bound here
by the laws in the UK but we are bound by the laws wherever we
operate. This is not a question of people passing, as you suggest,
large sums of money to employees of governments, it is just not
the way that business is done. There is a huge amount of speculation
that goes on on this subject and it makes good copy possibly but
it is pretty far from the mark.
Mike Gapes: We will await the outcome
of the investigation, I think.
Q29 Mr Cran: Can I move us on to the
question of risk sharing. The danger of this whole issue was recognised
in the original document of 2002, Defence Industrial Policy, which
must be bedtime reading for the lot of you. It says: "If
this risk becomes unmanageable, it could have serious implications
for the companies involved and the equipment programme as a whole".
That is fairly clear. I think the Committee was interested, and
I certainly was, when your Chief Executive was put in front of
the Committee of Public Accounts on 23 February this year, and
he said this: "Industry took far too much risk in the past
and we, BAE Systems, are not doing it in the future." I mean
no impropriety about that whatsoever. "There is a far more
attractive market in the United States if the MoD terms of trade
do not change." That is a powerful statement. You must certainly
agree with it, Sir Richard, but does everybody else agree with
that?
Mr Howe: Risk was one of the points
I alluded to earlier, I think it is one of the defects of the
present system that not enough is invested in exploring and limiting
risks at the beginning of major projects and decisions are taken
to embark on major projects without sufficient investment on that
front. I would agree with you on that front. I have to say primarily
I think the solution is in the hands of the customer to make sure
that he does not take these very large decisions to proceed with
major projects until sufficient preliminary work has been done
because obviously, as you implied, risk cannot simply be passed
on to industry. If a project does not work or is not delivered
then the customer suffers at the end of the day. It is a joint
problem.
Q30 Mr Cran: I take it that there are
no dissenting voices to that?
Sir Richard Evans: No.
Mr Prest: No.
Q31 Mr Cran: Where is the balance? Clearly
you have been making representations to the Government, I would
be very surprised if you had not, particularly on the 2003 completion
of the review of this particular document. The question is (a)
whether you have made representations and (b) what has been the
Government's reaction to that, or the MoD's or whoever?
Sir Richard Evans: I think also
at the PAC meeting to which you referred, both the Chief of Defence
Procurement and the Permanent Secretary made exactly the same
point that we have been making, and that is that we have to find
a way of getting a much better balance on the whole issue of risk.
Reference was made to the National Audit Office report on major
projects where, from memory, I think the figure reported in the
context of pre-main gate expenditure was 4.4 per cent against
a recommendation contained in the smart procurement arrangements
of 15 per cent. That gives you a measure of the gap. Both sides
have learned an awful lot out of this. There is a sort of dichotomy
in this in that to get to what is called main gate and, therefore,
to get approval, you have to have a price for the programme and
you have got to have specific delivery dates identified with that
price. The fact of the matter is I think we are all agreed that
through circumstances we have been forced to go to main gate far
too early, ie before we have expended 15 per cent of whatever
it is to de-risk the programme. I have to say that it is a consistent
criticism, it is in the existing NAO report but it has been in
many earlier NAO reports, that the original price and dates for
delivery that are quoted to get through main gate virtually all
change, without exception, over the life of the programmes. As
I say, the Chief of Defence Procurement was saying exactly the
same as we are because this is an issue of mutuality. It is just
as important to them that they understand what it is they are
paying for and when they are going to get it as it is for us to
understand that we can actually design and build and deliver it.
This is not an issue where we are on opposite sides of the fence.
There is a lot of work going on at the moment to get a much better
understanding of how we achieve these objectives.
Q32 Mr Cran: This is a rather important
issue for you certainly, for all of you. Could give the Committee
a sense of when you think that you are going to get a resolution
of this? A lot of work is being done, you say.
Sir Richard Evans: I do not think
that there is a big bang solution to this, that we are going to
wake up one morning and say that suddenly we have got a complete
answer to this. In part, at any rate, the answer to this depends
upon the specific programmes. There are things that are happening
that you can look at today that will give you, and should give
you, encouragement on this. The carrier programme is a really
good example where the original intention was to go through main
gate in something like March time and that was largely because
the existing pre-contract funding effectively ran out at the end
of the financial year. We and Thales, who are in the partnership
in the context of being required to bid who had bid and created
the partnership in the context of continuing with this programme,
were advising the MoD that there had been insufficient de-risking.
From memory, at that time I think the amount of expenditure in
what we call the de-risking phase was about two per cent compared
with the 15 per cent, not even where the NAO average of 4.4 per
cent was, not anywhere near it. The result of that is that the
programme has not been presented for main gate approval. Additional
funding has been found to keep pre-main gate funding running forward
and that will enable a lot more work to be done. Both of us are
very clear that we do not want to go to main gate until both of
us are confident on what it is we are pricing and offering on
delivery and for the supplier and for the buyer to have a reasonable
degree of confidence that that is what he is going to get.
Mr Howe: I have nothing to add
to that at all. Good progress has been made by the team in continuing
with the design, so I would not like you to think that the work
has been going badly. The work that is going on at the moment
to complete the design and to assess the risk associated with
that is essential before the Ministry takes that big decision.
Q33 Mr Cran: In asking my next question
I do not want to imply that you are not going to succeed in the
dialogue that you are having with the Government over this issue
and that you are not going to reach a rapprochement. Your
Chief Executive did actually say: "There is a far more attractive
market in the United States if the MoD terms of trade do not change".
What is it about the US market that makes it so attractive, apart
from, I guess, the money, the technology and all the rest of it?
Is that transplantable into the United Kingdom?
Sir Richard Evans: Certainly it
is transplantable. It is interesting that pretty much the same
contracting processes were operating in the United States something
of the order of 12/14 years ago as are operating here today with
regard to programme launch, lack of investment and de-risking
etcetera that virtually brought the entire US defence industry
close to bankruptcy. It caused a complete reassessment of the
whole of the contracting processes and procedures to be introduced
and those procedures that are operating today in the US are very
much in line with the recommendations that we would make today,
and have made today, to the MoD. They are largely about breaking
these programmes down into bite-sized opportunities, not having
to definitively say on day one "this is what it is going
to cost and this is when it is going to be delivered", desirable
though that would be to do if we could do it, ensuring that sufficient
de-risking has been undertaken before we get to the point where
we are definitively pricing and at the same time recognising that
if you do not start with a delivery date and do not start off
with a price, there have got to be some review points in those
programmes where both sides can step back from it. For instance,
if we see the risks, and even on the US basis after the programme
had been launched there are review points, and if the risks are
working out not to be in line with the initial assessments that
were made then the buyer has the opportunity to say "We either
want to stop the programme and review the programme or there are
certain circumstances in which we can abandon the programme because
there is no point travelling in hope here if the costs are going
to continue to escalate because we cannot get the risk under control".
Secondly, against that, there is obviously a very different corresponding
position and view of profit. The actual profit allowances in the
United States are vastly different from the profit allowances
here in the UK. In competitively contracted business—I stand
to be corrected on this—I think the current profit rates
in the US are running at about 12 per cent on sales. Indeed, the
Pentagon themselves recently have been seeking to increase the
rates of profit in order to improve the financial health of the
contractors in order to be able to get more investment from the
contractors back into the R&T budget. Corresponding numbers
here in similar circumstances under the current arrangements are
probably more like five per cent. There are two issues, one is
a much more sensible view towards the management of risk, the
assessment of risk and breaking programmes down into manageable
pieces without at the front end committing ourselves for the next
25 years and at the same time looking at how you get the risk-reward
ratios into the right balance in the context of what the contractors
can actually earn. Under those circumstances, the Pentagon, ie
the procurement agency of the United States, has every right to
come and expect the companies to be investing into R&T to
support defence programmes.
Q34 Mr Cran: To state the obvious, I
guess you have been making exactly the same points to the Government
and I guess the Government are considering it.
Sir Richard Evans: Absolutely.
I do genuinely believe, notwithstanding where the NAO have been
coming from, that the procurement people in the MoD are looking
at some of these arguments, there is certainly the issue of risk
assessment and the agreement now is that there is going to be
much more money spent on that risk assessment phase than has historically
been the case. That is desirable and that is certainly going to
happen at the US end. As always, the problem with the MoD people
is simply budgetary constraint. The process of government accounting
has always been a bit of a mystery to those outside it but it
seems to me at the moment that the great problem the MoD has is
that its actual liabilities in terms of current programmes, notwithstanding
what it may have to do tomorrow, in respect of the programmes
that it is currently committed to, exceed what we would describe
as the asset base, which in their case is the budget. In the external
world, the next stop is to go and talk to the administrators.
There is a certain amount of sympathy we all have for the MoD
and to do these things differently does in the short term sometimes
require additional investment but in the long term, over the life
of these programmes, will without a doubt pay back very handsomely.
Q35 Mr Cran: My last question is simply
this: just so that we know how far you are prepared to go to back
your views, and all of you hold them very strongly on this particular
subject, have any of you actually withdrawn from a contract, assuming
the terms of the contract allowed it, where it became apparent
to any or all of you that the risk that you were being asked to
take was too great, or becoming too great?
Sir Richard Evans: I can give
you one recent experience where we were in the consortia we were
operating with for the tanker programme and we simply walked away
because the amount of risk that we were being asked to take could
not be justified and there was a potential issue in terms of whether
the consortia bidding for that, which we were in, ultimately could
afford to expose sufficient of its balance sheet to the potential
liabilities. There are other examples as well.
Q36 Mr Cran: Any others, so we may know
if this is common practice?
Mr Frost: Yes, but on a much smaller
scale where on one or two UK programmes the volumes were so small
and as an equipment supplier the numbers of aircraft were so small
that it simply would not justify the amount of investment we would
have had to put into both the proposal costs, which were significant,
and of course the unfunded elements, such as development. I would
like to add a comment. It seems obvious to me, just looking at
it from that level and from a distance, as to why any risk equation
in selling defence equipment to the US would look totally different.
It is simply a matter of scale and volume. If my company is going
to sell one thousand ship sets of something, we are much more
likely to increase the ante in the risk we take on the non-recurring
development end compared with a programme, perhaps, where the
UK is buying 50. It is simple economics.
Q37 Mr Hancock: What about when you are
buying two, like two carriers? Are you close to the breaking point
on the risk assessment you have made on the cost of the carriers
and your ability to carry that risk?
Sir Richard Evans: As yet, there
simply has not been sufficient work done to get us to the point
where anybody, and by that I mean anybody on the industrial side
or anybody on the procurement side, could realistically today
make a full assessment of risk. If it were the case that you could
make that assessment of risk then this programme would have gone
through main gate and, as I have said previously, it has not done.
I suspect there is probably realistically at least another year's
worth of work to be done before we begin to see whether the scale
of risks here can be managed and how they can be managed.
Q38 Mr Hancock: This really relates to
working in alliances, does it not, and whether or not it can materialise
as a financial gain for the company as well as offering the defence
industry stability. Why do you think there is so much speculation
about BAE Systems remaining the prime contractor for the carriers?
Sir Richard Evans: First of all,
I should say that the original decision that was announced was
that there would be an alliance and the alliance was between BAE
Systems and Thales. That was announced after the result of the
bids was made public. We and Thales then basically brought our
teams together under an alliance and have been working under that
alliance very satisfactorily ever since. I think our concerns
now are that what is actually developing is some sort of procurement
committee and this programme, which is certainly the biggest single
military programme that would have been launched in recent years,
is in some way going to be managed by a committee. The committee
will be chaired by a procurement officer from the Ministry of
Defence who will have a balancing vote on the committee. We are
somewhat concerned when it comes to the issue of who is responsible
for what risk whether a committee can adequately deal with the
management of a programme of this scale. We have no problem at
all if that is what the customer wants to do because, let me be
clear, it is the customer's prerogative to decide how he wishes
to have his programmes managed. If we were not to be within that
committee grouping in the ideas that are just being bounced around
at the moment then quite clearly we would want to become a subcontractor
to the management team and make our shipyards available and all
of our engineering skills available in order to make the programme
a success, not to be sitting as part of a committee at the top
that may generate risks that ultimately would become uncontrollable.
Absolutely we recognise if that is what the customer wants to
do then he is entitled to do it.
Q39 Mr Hancock: Providing he pays.
Sir Richard Evans: Well, at the
end of the day, providing this committee can manage the programme
within the budgets which have been agreed when it does go through
main gate, we know that everybody will be deliriously happy and
rightly so as well because it is a hell of a challenge, but if
that were not to be the case, if people start sort of shuffling
the deckchairs around looking to see who is actually responsible
for whatever the failings are, it is a bit like good old-fashioned
consortia where everybody has got a bit of it, but no one individual
is actually responsible. However, under the current proposals
or as they were proposed, there is no doubt about it that Thales
and we together, shoulder to shoulder, are absolutely locked in
in this right at the front end of it.
Chairman: Thank you. We will come on
a little later to this.
1 Ev 130-131 Back
|
