Examination of Witness (Questions 160-179)
12 MAY 2004
SIR PETER
SPENCER
Q160 Chairman: A question on streamlining
the equipment approvals process and the cost of bidding. I read
an article recently in which you stated that the approvals process
needed streamlining and this was echoed in last week's session
with industry. How would you like to see the current approvals
process changed, and how would this help ensure that the projects
are delivered more to cost, more to time and more to the specifications
demanded?
Sir Peter Spencer: There are two
separate questions there which are inter-related. In terms of
the approvals process the length of time taken by the Ministry
of Defence to make a decision on an initial gate proposal or a
main gate proposal has been too long in the first instance because
people have been concerned about whether or not there is enough
evidence to support the basis of the proposal and therefore there
has been an enormous amount of circulating of papers in draft
and different parts of the organisation with good intentions bringing
an independent scrutiny to bear on various aspects like risk and
commercial arrangement and all the rest of it. The net result
has been inconsistency as it has gone through that process and
it is because we have effectively been regarding approvals at
the main gate as an event as opposed to a process. When you accept
something into service and prove that it has actually got all
the performance that you think it should have, that is a process
which takes some time. You do not do it all on one day so what
we have put in place are arrangements which seek to get much greater
consistency in the demonstration, independently verified by appointed
centres of excellence of various aspects of the approval, so that
when the document comes to investment approvals report it is not
a huge thing with lots of annexes and complications but it is
quite a thin paper that says, "The top statement in this
area is as follows ... It has been independently verified by so-and-so.
If you and your staff wish to verify it for yourself here it is."
It concentrates the board's mind on the key issues of the decisions
that need to be made. The reason why we have had problems in getting
through the initial gate is because there has been a subtle but
quite important departure from the original assumptions behind
the proposals for initial gate which was a relatively low level
hurdle where you would test out lots of propositions and you would
say we have got a capability gap here, here are the options for
meeting it, and here are some of the procurement options and have
a plan for converging that down or stopping it and saying if this
proposition is not maturing let's stop it. In reality virtually
none of those proposals was ever stopped. So the people who were
properly concerned about controlling the overall amount of programme
that we were going to take on began to insist that there was a
much greater degree of proof at the initial gate than had been
envisaged, but of course the project had only just started then
so we then ended up with quite a lot of what I would call "solutioneering"
and narrowing the choices in quite detailed numbers and arguments
before you had even gone into the assessment phase, all of which
held the process up. In those two areas, the Investment Approvals
Board and the Ministerial Steering Group, to which I have referred
earlier which Lord Bach chairs, are very supportive in bringing
forward ideas which are going to streamline those arrangements
so there is much more confidence when we put the proposition forward
that it is going to go through in an acceptable timescale.
Q161 Chairman: Is there any problem with
the cost of bidding? I know the Vice Chairman of Thales raised
that question with us last week.
Sir Peter Spencer: Certainly I
accept the proposition that time is money and if we set out in
good faith together believing that a bidding process is going
to take two years and it takes three and a project team is in
industry for three years rather than two that has a cost that
they had not anticipated. Our Defence Industrial Policy and the
way we are aiming to implement it says we will not run these things
beyond the point at which they are going to deliver benefits.
So we certainly recognise the need to make earlier down selection
decisions. It is a proposition that is unanimously supported with
industry but with one caveat; they would prefer to be selected
as the winner!
Q162 Chairman: Apologies to you, Sir
Peter, I was trying to catch the next question so we can escape
for a vote and come back. Please carry on.
Sir Peter Spencer: My point was
we accept that it is in everybody's interest to make quick and
efficient decisions but industry usually has the unspoken caveat
that a quick decision is great as long as they win it.
Q163 Chairman: Do they say, "We
cannot afford to wait too long. The process has cost us £1
million or whatever to put in a bid. We are not going to spend
the time to do it"? Has anybody complained to you about the
timescale?
Sir Peter Spencer: Certainly people
have made the point to me, especially in the context of PFI programmes,
as to the length of time it takes, and I have done some analysis
of about a dozen DPA-PFI projects and the length of time it has
taken from issuing the PQQ, which is before the invitation to
negotiate, from which point industry would start to take a serious
interest to placing a contract, and the average turned out to
be three years. That is too long. I do not think we will ever
match the time that is taken in some other parts of government
where there are standardised contracts and they are largely repeats
of something which was completed elsewhere. We are talking with
industry on this in terms of what we need to do and to set a target
internally of the sort of time line which we would aim to achieve
and it would be considerably shorter than three years.
Q164 Chairman: If you require something
and you know a company can deliver, do you have an opportunity
of short circuiting the whole process by saying, "To save
on two or three years in a competitive bidding situation, you
can deliver the goods so we will arrange a contract with you and
work out the cost?" Is that an option or do you have to go
to competition always?
Sir Peter Spencer: Competition
is the starting point for all high-value projects so long as you
believe you can get genuine competition. There have been examples—and
I cannot illustrate it immediately with one that springs to mind—where
you could take a look and believe the competition would not necessarily
deliver value for money because in reality the ability of one
party to deliver cost-effectively what you need is so much greater
than the other. Under those circumstances competition can be fairly
misleading because you would probably get a better price and better
arrangements in engaging in a non-competitive pricing arrangement
although I have to say that one of the major benefits of competition
if you can run it effectively is not necessarily in the number
you think you are going to pay on day one, it is actually achieving
the numbers you finally pay when the contract is delivered. That
in turn is a function of the terms and conditions of the contract
which you negotiate and once somebody knows they are going to
get the contract anyway it does, understandably but frustratingly,
lead to a certain inflexibility in being willing to negotiate
those terms and conditions.
Q165 Rachel Squire: Can I ask you about
the Future Aircraft Carrier and certainly impress that I take
an interest not just as a member of this Committee but also as
the MP for Rosyth Dockyard which is very keen indeed to get a
major share of the work. We concluded in our last report on defence
procurement in this Committee that "the alliance approach
for the Future Carrier Programme deserves support as a model for
trying to avoid some of the pitfalls of the Nimrod and Astute
programme." However, last week we were told by industry of
a concern that the alliance was developing into a sort of procurement
committee. Can you say, Sir Peter, what plans you have for changing
the arrangements for the alliance and the arrangements for the
management of the programme, and how they would impact on the
in-service date for the carriers?
Sir Peter Spencer: I hesitate
only because we are engaged in quite sensitive negotiations with
our potential suppliers here and I do not normally negotiate in
public, but as a general approach we have benchmarked against
the best practice in the petro-chemical industry, pioneered by
companies such as BP and CONOCO. I have looked at the way the
alliance operates at Terminal Five with the British Airports Authority
at Heathrow, and there is a great deal of evidence to demonstrate
that the detail of the alliance which will deliver the best outcome.
We could learn a lot from those exemplars—and it is not
a committee so it is a slightly unfortunate term to have used.
This has been independently assessed by people who have no axe
to grind on this, who are not involved in defence, who are experts
on procurement. It has been independently reviewed by the Office
of Government Commerce and I have discussed it at some length
with Sir Peter Gershon so I am actually taking quite wide-ranging
soundings here because the one thing which we all share is that
we do not want to allow the aircraft carrier programme to degenerate
into the problems that have beset Astute and Nimrod. I believe
that there is a great prospect here for going forward together
and getting this alliance to deliver and there is no consequence
on the In Service Date of the carriers which depend upon those
alliance arrangements. In fact, the work on the design of the
carrier continues to mature and the design maturity of the warship
is considerably more advanced at this stage already than any other
previous warship where we have gone to place the contract, but
we are still in the derisking phase and all parties agree that
it will be mutually beneficial for us to recognise that having
spent about five per cent of the budget to date on the assessment
phase that there are strong arguments to continue to mature our
understanding of the design of the system integration aspects
and of the supply chain aspects which are crucially dependent
on how we use all of the shipyards in the UK that are potentially
going to be involved in this in order to have a much better understanding
of the performance time and cost parameters which would be set
at the main gate of capital investment decision-making.
Q166 Rachel Squire: Would you like to
give any comment on when you think that main gate will be reached?
Sir Peter Spencer: It was planned
and publicly stated to be the spring of this year.
Q167 Rachel Squire: Yes, by the Minister.
Sir Peter Spencer: It is an indicator
of the extent to which Lord Bach and the Secretary of State have
been receptive to the proposal that we need to change the way
in which we do procurement, along the lines I outlined in the
stocktake, and that they recognise that it is more important to
get this right than to tick the date off in public. That is quite
a big decision really and I am extremely grateful for their support.
We have put a proposal to ministers and it is being discussed
at the moment with the Chief Secretary, so it is a bit difficult
for me to make a public statement which appears to pre-empt that
agreement, but we would be seeking at this stage to continue at
least until the end of this calendar year. We will be doing work
in the assessment phase which would have been being done during
the first stages of development or demonstration and manufacture,
so it is not delaying anything, it is actually maturing it so
we understand it better before we set the time and cost targets,
and this is very much the case of what would be happening in the
civil procurement sector for complex projects so they would not
be declaring the sanction prices and dates until they had understood
the problem better.
Q168 Rachel Squire: I was going to ask
you to comment on Sir Richard Evans who told us last week there
was "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" Given what you
have just said about towards the end of this calendar year but
also emphasising that should not be seen as a major delay, are
you saying that Sir Richard in evidence in his statement was fairly
accurate in talking about another year?
Sir Peter Spencer: What I have
said is consistent and what I also said is I was not in a position
to give you a precise date because it was being discussed at ministerial
level with another government department. So it is rather hard
for me to make a public statement. I think the key point here
is that we are in agreement with all of the key players here that
there is benefit in continuing to mature by an extension of the
assessment phase because we are still designing work which we
will be doing in an extended assessment phase which would otherwise
have been done in the demonstration phase but we would to a certain
extent be guessing how much it was going to cost and precisely
when it was going to come in. At the moment our plan is to come
in on the declared in service dates but those will normally be
set at the main gate decision and when we have continued to derisk
this proposal.
Q169 Rachel Squire: Just two other questions.
Picking up on some of the points you have made about how this
whole model has been developed, are you satisfied that the MoD
has got or is gaining the appropriate skills for the role that
it is playing in this new form of alliance?
Sir Peter Spencer: Yes, otherwise
I would not be doing it.
Q170 Rachel Squire: And also picking
up on your point about cost, the memorandum submitted to this
Committee on the Future Aircraft Carrier gives a current cost
estimate for the two carriers of around £3 billion, but press
articles have reported that the industry considers the cost to
be nearer £4 billion. Would you like to comment on that and
particularly what is your view on accepting smaller carriers if
the cost turns out to be nearer £4 billion than £3 billion?
Sir Peter Spencer: At the heart
of this lies a discussion on how are we going to go to contract.
You have to ask yourself the question what are the motives in
somebody talking up the price, but we have very good metrics,
independently verified, of what we know this carrier can be built
for and so in terms of the quality of information in a more enlightened
form of contracting we would expect this thing to be settled in
the fullness of time but it will be done through a private conversation
and not through the press. The discussion is actually very harmonious.
Rachel Squire: I am delighted to hear
it.
Q171 Chairman: I hope you are right because
if a company says the cost is £4 million, British Aerospace
has been through the process before of bidding low and then having
to come to an agreement afterwards. Is this crying wolf do you
think or maybe, as you have said, the procurement process in the
last couple of years has not gone swimmingly well so is it possible
that your profit calculations or their budget calculations have
gone wrong?
Sir Peter Spencer: If you look
at the record of the complex projects of the petro-chemical industry
they were in exactly the same position ten years ago and they
discovered that if you had a contract in place which rewarded
people for delivering below the target price then you changed
the whole dynamic of the relationship between the client and the
supplier because you work together to mutual benefit with the
prize of earned profit at much higher levels than you would normally
have made for a given time, so you make a virtue over beating
the price. If you, on the other hand, and again look at the construction
industry and the petro-chemical industry, they found that if you
went for a fixed price percentage then the danger was that if
the price went up—and it could be laid at your door as the
client and the motive was very much on the supplier to try and
prove that—then not only did you pay the extra money but
you paid the percentage reward on top of that because you were
paying a percentage fee. We are finding a way of breaking out
of that cycle and there is a huge measure of agreement that we
must and we can find a more constructive way of delivering the
outcome which we need, and if we were trying to insist on a fixed
price contract I would absolutely share your concern, which is
why we are not trying to do that. As we are talking about sharing
of risks it is not in my interests to delude ourselves into how
much it is going to cost. We will work from the basis of demonstrable
evidence as to productivity norms in terms of design and build
and integration and setting to work. So for all of those reasons
I think you just have to recognise that a great deal of what is
speculation in the media at the moment is trying to anticipate
the outcome of a very important negotiation which is being conducted
as a matter of some urgency by the appropriate levels in the organisation,
with the aim of getting this sorted out.
Q172 Chairman: If the MoD or DPA is sitting
on top of this new structure will the MoD accept its share of
the risks if they are playing an important role and not just stand
back and let the two partners in the alliance deliver the goods?
Sir Peter Spencer: Well, let me
take you back to Nimrod. The MoD stood back but it still carried
the risk. The difference here is that it deluded itself into thinking
it did not carry the risk. It thought it had transferred it all
one way. Because we have drawn the conclusion, together with industry,
that there is always going to be risk for all of us here, and
we never could transfer the operational risk or the time risk,
then at least it has got ourselves sensitised to the fact we have
to be engaged positively to play a part and that by talking to
your suppliers during the course of a project you are doing the
right thing and you are not going to get infected by some terrible
disease and therefore you have to stay away from them. The concern
previously was we had wrapped up the incentivised contracts so
tightly that if you forgot to say without commitment good morning
that would go down as a default because it was a bad morning because
it rained that day. It is a question of understanding realistically
where the risks are, doing our best to manage them down before
we commit ourselves, having a real understanding of how the risks
are going to be shared and, more importantly and more positively,
how the reward will be shared for success because the aim is to
make this project a success, and although there are some exceptions
the record of companies like CONOCO and BP at achieving success
for the benefit of all concerned is quite striking, and as we
obey the same laws of economics, we are the same biological species
and we obey the same laws of physics and engineering there is
no reason why we should not be able to emulate that practice.
Q173 Chairman: The MoD has not shown
itself to be a scintillating entrepreneur and if they are sitting
in a role that is on top of two commercial enterprises, then you
are relying on their quality of decision-making (of which precedent
does not give one total encouragement) that this strategy is going
to work.
Sir Peter Spencer: I do not recognise
your description of the MoD sitting on top. What you create is
a team. If you would like me to arrange a briefing for you on
how these alliancing arrangements have worked, to be done by somebody
outside the Ministry of Defence, you might find that extremely
helpful.
Q174 Chairman: Yes, that would be quite
helpful.
Sir Peter Spencer: That is the
way I have explained it within the Ministry of Defence. I have
to say I do not entirely accept that there is an absence of entrepreneurial
spirit inside the MoD. The roll-on roll-off ferry PFI contract
I think shows remarkable entrepreneurial thinking from the Ministry
of Defence, and there are a number of other examples. My aim is
to try and roll that out more consistently across defence.
Q175 Mr Havard: What I am supposed to
understand from you is this general process that you are describing
in relation to this contract is now effectively going to become
a process that will apply full stop as a general way of understanding
and dealing with large projects from your side?
Sir Peter Spencer: Not in all
cases. There is a whole spectrum of partnering possibilities.
Q176 Mr Havard: Okay, so your approach
to the air tanker might be slightly different than what we have
seen in the carrier and in relation to X it might be slightly
different again but you will have a bag of tools.
Sir Peter Spencer: A bag of tools
and you intelligently select the tool for the job by examining
the particular nature of the given project.
Chairman: One last group of questions,
Mike Gapes?
Q177 Mike Gapes: I would like to take
you back to the remarks you made to my colleague Mr Havard some
time ago about what you described as a "redefined" date
for Typhoon and the fact this was a £1billion hit. I refer
you to the National Audit Office Major Projects Report 2003, which
reported that at the end of March 2003 the Eurofighter/Typhoon
had experienced a cost increase of £2.3 billion over the
original approval and 54 months slippage against the original
in-service date, and just over £1 billion in-year cost increase.
Can I ask you in the light of that report and the fact that it
is said that the second tranche was expected to be ordered around
the end of 2003 (and we are now nearly at the middle of 2004 but
there is still no sign of an order being placed), why is there
a delay and when is the order now expected?
Sir Peter Spencer: The delay is
because we have not yet, or have only just recently, had a proposition
from industry addressing the price which we are being invited
to pay. So until that proposition was forthcoming, I was not in
a position to even think about letting the contract.
Q178 Mike Gapes: So the delay is entirely
the fault of industry?
Sir Peter Spencer: No, I did not
say that. I said until recently we had not had the price. The
price is only as good as the accompanying information and there
has been a great deal of detailed discussion with industry as
to what the necessary conditions would be before we go forward
to place a contract for the next tranche, because we have still
not finished the main development contract. So we have to define
what the build standard is going to be of the tranche two aircraft,
and that in turn depends upon how we define the end stage of the
main development contract and how we then define the build standard,
which will be a combination of reflecting that capability and
some work on obsolescence which needs to be done particularly
on the five main computers in the aircraft. We also said that
we would need to reassure ourselves that satisfactory progress
had been made on tranche one performance as a fighting aircraft
in terms of meeting what has been defined as the interim operational
clearance. So we can see that the aircraft is maturing into the
capability which is needed. This is a necessary part of de-risking
the proposal for the build of tranche two, otherwise we will be
faced with large financial contingencies to cover risks which
we do not fully understand. So it is a negotiation to get a proper
understanding of what it is we are going to get for our money
and a proper understanding of the de-risking of the technology
as we finish off the development contract.
Q179 Mike Gapes: Last week we were told
that the Government is seeking to introduce a new variant of the
aircraft and to introduce that variant in tranche two, and that
is a ground attack variant. Clearly if the MoD are seeking to
add to tranche two, that is going to lead to further costs of
some kind and further delay, and we had the Chief of the Air Staff
in March, on 24 March, telling us in his words that the key "is
to ensure that our platforms are adaptable so we can change the
nature and/or scale of the capability we deliver from them."
He talked about computing systems, software centres, weapons and
connectivity, "all of that is what we are building into Typhoon."
Is not part of the problem here that the actual definition of
what is needed is being changed as the project is going on, adding
to the costs?
Sir Peter Spencer: There are a
number of quite important points in that which I need to disentangle.
The need for the aircraft to be adapted for multi-role capability
comes as a direct result of us incrementally moving towards the
performance which is now needed in defence. When the aircraft
was conceived and the numbers were conceived, we believed we then
had a much higher need for air defence and an air defence specialist
platform. This platform is inherently adaptable. All of the operational
analyses and our recent operational experience demonstrates that
what we need more of now is air-to-ground, and certainly in terms
of the Coalition needs there is no shortage in air defence assets
but there is a shortage in the multi-role capability which will
be needed. The pricing of tranche two production is entirely separate
from the enhancement programmes to make it multi-role because
there will be very little physical change to the aircraft to actually
make it multi-role because that sort of adaptability has been
built into the basic design. Those enhancements are very largely
the software enhancements to the mission system of the aircraft,
which will be loaded into the aircraft's computing systems. So
we are not going to be physically changing the aircraft design
in order to be able to make it air-to-ground, we will be adapting
its software through life, and that will be part of a separate
discussion in two phases at the moment for enhancing that operational
capability. So that is not a reason for there to have been a difficulty
in pricing this.
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