House of Commons - Defence

Select Committee on Defence Sixth Report

4 The Defence Industrial Policy

Progress in implementing the Defence Industrial Policy

101. The Defence Industrial Policy was launched in October 2002, after 18 months of discussion between the MOD, DTI and industry.[161] The Policy covers four broad areas—Acquiring Capability for the Armed Forces; Market Access; Research and Technology; and the Future.[162] There were six 'Overarching Themes':[163]

Provide required equipment at best value for money at a price we can afford
Review policy and implementation
Treat all defence suppliers that create value in the UK fairly, regardless of ownership
Maximise economic benefit to the UK from defence expenditure
Maintain close dialogue with industry
Sustain an environment that enhances competitiveness of defence industry

102. We examined the Policy in last year's Defence Procurement report and concluded:[164]

We very much welcome the publication of the Defence Industrial Policy, bringing as it does a useful, though overdue, increase in transparency to this important area. The way its provisions and statements should be interpreted will inevitably have to be developed; by further debate and through "case law". Indeed, in some areas, including the use of competition and open markets and in risk management (two of the perhaps more contentious of its themes), the Policy's utility will be evident only with the passage of time.

First Review

103. The First Review of the implementation of Defence Industrial Policy[165] published in November 2003 set out the progress that had been made in the first year since the Policy was launched. The Minister of State, Adam Ingram, summarised the First Review as follows:[166]

Since we launched the policy we have worked closely with industry to develop and pursue a joint implementation plan. We have completed a review of progress over the first year. During this time our close and productive relationship with industry has developed further and we have agreed how we will take forward our common aims over the next few years.

The policy has been a significant driver in bringing together Government and industry, resulting in better communication and access to information. We both recognise that the policy is for the long-term and that it will take some time to measure the full effects on defence programmes and the industry that supports them. We remain committed to the policy and will continue to monitor its effectiveness and to develop best practice in this area among the MoD acquisition community. We will also continue to work to improve access to overseas defence markets and to maximise the benefits from our investment in research and technology.

Industry's view

104. From the written evidence we received, it was clear that the Defence Industrial Policy has been very much welcomed by the defence industry, and that industry was keen to see the Policy developed further and implemented in full. Indeed, the Defence Manufacturers Association considered 'the successful implementation of a DIP…. crucial to the future defence policy, security and strategic independence of the UK'.[167]

105. A consistent message from the evidence we received from industry was that the main impact of the Defence Industrial Policy to date, was the improved dialogue between industry and government. John Howe, Vice-Chairman of Thales UK, told us that 'there is actually more dialogue between industry and Government …. than there was a few years ago'.[168] His view was echoed by the Defence Industries Council, who acknowledged that the Policy had 'intensified the dialogue between HMG and industry about the economic implications of defence'.[169]

106. The Defence Manufacturers Association concluded that 'after some 20 months of the policy being launched no identifiable, tangible benefits have been delivered to date',[170] but acknowledged that the Policy was not expected to lead to significant changes in the short term. The Defence Industries Council considered the achievements to date to have been modest, noting that 'it is hard to point to examples of positive application of the Policy, and decisions could still be taken that would run counter to any coherent framework on industrial capability'.[171]

107. In several areas further progress was needed in implementing the Defence Industrial Policy, or the Policy needed to be developed further, or there were other concerns relating to the Policy. These included:

The need to develop an Industrial Strategy
The need to implement the Policy through the procurement process
Consolidation in the UK Defence Industry
Issues relating to open markets and access to technology
Relations between MoD and industry

Industrial strategy

108. A common concern identified by industry was the need for clarification on what UK industrial capabilities and defence industry would be required in the future. This was emphasised by John Howe, who told us that:[172]

there is still some way to go in one particular area which is clarity about what kinds of industrial capabilities and indeed what kinds of technologies are judged to be of crucial strategic importance in the long term. What kind of industry does the UK think it is important to have in the future? What kind of capabilities is it important to retain for strategic reasons? That is the area where I think we need to go on working to achieve more clarity.

109. Sir Richard Evans, Chairman of BAE SYSTEMS, also highlighted the need for industry to have 'some clear indications as to what the long-term requirements are particularly in terms of where we are going to invest R&T for the future and we need that a lot more quickly identifying than appears to be the case at the moment'.[173] He considered that 'we should…. identify those areas that are strategically important for us in the long term and together concentrate our joint resources into making sure that we stay in the premier league in those areas'.[174]

110. The VT Group[175] considered that at the strategic level greater openness regarding long term government expenditure planning would be helpful. This would not be detailed information on individual programme budgets but more general data on for instance future expenditure in a general capability area. They considered that this would reduce uncertainty for industry and encourage more effective investment decision making.

111. Lord Bach also agreed that the main area where the Defence Industrial Policy needed to be developed further was in producing an industrial strategy to sit alongside the industrial policy. He told us that 'we need to further develop and state what technologies and industrial capabilities are of the greatest importance to us in maintaining existing capabilities, and which ones we expect to require in the long term'.[176] He told us that a meeting had taken place with the National Defence Industries Council at the end of May 2004 and that:

the NDIC supported fully our approach to an important development of an existing part of the policy, namely…. our emerging work on industrial strategy. We are aiming to identify more explicitly the technical capabilities that we need to meet defence needs now and well into the future. We will assess the importance of sustaining these capabilities in the UK for national security, for technology, or for wider economic reasons. This is a complex undertaking that will take some time to do properly'. [177]

112. We welcome the fact that MoD has recognised the importance of establishing an industrial strategy to sit alongside the Defence Industrial Policy, and that work is now in hand to take this forward. Such a strategy needs to provide industry with a clear picture of which industrial capabilities and technologies are considered to be of crucial strategic importance in the future. We recommend MoD take forward this work as a matter of urgency.

113. In terms of specific sectors within the defence industry which need to be retained, Sir Peter told us that:[178]

The nuclear sector is very important in terms of supporting the submarine building programme for a nuclear steam raising plant. The surface shipbuilding sector is very important in terms of ensuring that we have actually got the capacity, the skills and the capabilities to deliver the very large programme which is planned for surface shipbuilding, but we have got a bit of a gap in the meantime, which is a worry, and the work is wholly aimed at how we keep those key skills in place and reassure the companies concerned that we are looking at this intelligently.

114. Sir Peter recognised that MoD had 'a responsibility to industry, as well as to the taxpayer, to make the most efficient use of those industrial assets'.[179] In terms of the criteria to be used to decide which sectors of the defence industry it was vital to retain, Sir Peter told us that:

We can all think of areas where we currently have industry and where the instinctive reaction is to say, "We need to keep it in being", in perpetuity perhaps, but we have to test those against some criteria. The first is, are they absolutely critical to national security. The answer for nuclear is self-evidently, yes…. Secondly, is it imperative for defence capability, in other words are we going to need to have these skills in the longer term to support the front line, in other words are we going to need to upgrade them through life and respond to urgent operational requirements during operations. Then there are the wider technical benefits for the nation, do we need these skills for wealth creation, and then there will be area employment issues.[180]

115. We consider it critically important that MoD develop clear criteria for deciding which sectors of the defence industry it is vital to retain in the future. Issues such as security of supply, in particular to meet urgent operational requirements, should not be underestimated in making such decisions. Much equipment being procured today will be in-service for the next 20-30 years or more and will need to be upgraded and maintained. The imperative of retaining the skills within the UK to undertake such work must be recognised. This applies across the range of equipment: from the highest level to the most basic of military requirements.

Implementing the Defence Industrial Policy through the procurement process

116. A common concern relayed to us was that the wider factors to be taken into account in acquisition decisions (which are set out in the Defence Industrial Policy) tended to be considered only at a very late stage in the procurement process. Sir Richard Evans, for example, told us that the policy is 'a good start but it is absolutely not going to make progress until people implement it through the procurement process and, right now, there is insufficient evidence to say whether or not that is being done effectively across the board'.[181]

117. Lord Bach acknowledged that this was a legitimate concern, and told us:

I think there has been a tendency for it to be considered at a late stage. I think on occasions it is the sort of thing that has been left, as it were, to ministers to consider when the advice comes up to them from officials. I think that is changing…. I do not think it should just be left to ministers at the end to consider these wider issues I think they should be part and parcel of procurement processes from the start'.[182]

118. We are concerned that the wider factors to be taken into account in procurement decisions are still often being considered at a late stage in the process. We expect the Defence Procurement Agency to ensure that additional guidance or training is provided to its staff to address this issue.

119. In last year's report on defence procurement,[183] we referred to the Advanced Jet Trainer Programme and the 'unsolicited offer from BAE SYSTEMS to supply its Hawk 128 for that programme'. At the time, we understood that MoD was expected to decide whether to select the Hawk 128 or open up the programme to international competition. We considered the Hawk case to be an early test for the Defence Industrial Policy, not just in terms of taking account of the long-term prospects for competition, but also in terms of managing risk because the aircraft chosen for the Advanced Jet Trainer programme was then likely to be subsumed in the Military Flying Training System PFI programme.

120. MoD announced on 30 July 2003 that it was to purchase 20 Hawk 128 aircraft with options to buy up to another 24. MoD's news release[184] announcing the decision noted that MoD had originally explored the possibility of a PFI arrangement with BAE SYSTEMS, but the terms proposed by the company did not offer value for money for the taxpayer.

121. Lord Bach told us that, in terms of specific examples of where the Defence Industrial Policy has had an effect on a procurement decision, 'The one I would say it has certainly had an effect on what was the Hawk decision'.[185] Sir Richard Evans also referred to the decision to procure Hawk trainer aircraft, and told us 'If this policy is going to be effective, we really should not be having situations where Secretaries of State are issuing ministerial directives to their departments in order to turn over recommendations that have been made'.[186] Sir Richard told us that the recommendation from the DPA to the minister was to acquire the Aermacchi aircraft rather than the Hawk, and that in coming to that recommendation there was 'absolutely no account taken of that additional value to the UK'.[187] He said that since the decision was taken, the Indian Government had placed an order for 66 Hawks which, had the decision gone against BAE SYSTEMS, would not have been placed. He said he could 'genuinely see us actually being able to sell 400 to 500 aircraft'.[188]

122. Sir Peter Spencer would not comment on the detailed advice to ministers, but said that the suggestion that the advice from the DPA to ministers was to opt for the Italian Aermacchi bid was factually incorrect.[189] He considered the episode to have been a good example of the Defence Industrial Policy working 'because if you read the defence industrial policy it says, "We will address these issues upfront before we invite competitive tenders."' [190]

123. We believe that the decision by the Secretary of States to procure the Hawk trainer aircraft was a sensible one, which has resulted in substantial exports for the UK. Possible exports should always be a factor which is taken into consideration in making procurement decisions, and which should be considered at an early point in the procurement process.

Consolidation in the UK Defence Industry

124. The Defence Industrial Policy states that:

The UK defence industry embraces all defence suppliers that create value, employment, technology or intellectual assets in the UK. This includes both UK and foreign-owned companies.

Restructuring of the defence industry brings increasing commercial opportunities for UK companies, and economic and technological benefits through inward investment into the UK. The UK industry cannot grow by meeting domestic requirements alone, nor can all the technologies required by the Armed Forces be sourced from the UK. We will not constrain UK companies from expanding into new markets, except where national security clearly requires otherwise.[191]

125. Sir Richard Evans told us that 'although there has been a huge amount of consolidation that has taken place already, it is not going to stop where it is'.[192] He considered that the US was likely to be the main predator and that if the process continued 'the UK is simply going to become the American metal basher'.[193] However, Sir Peter did not think this was likely to happen.[194]

Recent consolidation in the UK defence industry

126. At the time of our inquiry there were a number of proposed take-overs and reported take-overs of UK defence companies. These included an offer from General Dynamics of the United States for Alvis; an offer from Finmeccanica of Italy for GKN Westland; and reports that BAE SYSTEMS was considering selling its marine division.

127. Nick Prest, Chairman and Chief Executive of Alvis, pointed out that defence was now an international industry, and noted that Alvis had bought businesses in Sweden and in South Africa. He referred to the offer from General Dynamics for Alvis and told us that the reason why these developments were taking place was because companies believed that a bigger international spread in their business would give them access to a wider range of markets, and would enable them to draw on a wider range of sources of research and technology.[195] In the event, BAE SYSTEMS made a counter-bid for Alvis, and it was reported that General Dynamics had declined to revise or extend its offer.

128. We asked Lord Bach about the offer from Finmeccanica for GKN Westland—the UK's only defence helicopter manufacturer. He told us that 'These are private companies which are entitled, on the face of it, to engage in what transactions they wish to, subject to regulations and subject, of course, to our being satisfied over a number of very important issues, including security of supply'.[196] He added that 'It really is time that we left behind the concept that what actually matters in the end is where the ownership of companies actually resides from one day to another, from one month to another. What matters is where the work is done; where the work is produced; where the technology is; and where the value is in the broadest sense'.[197] He added that [in relation to GKN Westland], 'We will want to talk over matters which relate to much more than just security, but also relate to jobs, work that is promised for the future and what their intentions are…. we have to accept that it is a global defence market'.[198]

129. We asked Sir Richard about the reports that BAE SYSTEMS' naval shipyards might be acquired by a French company. He told us that there had been no discussion of any consequence about selling the naval shipyards to the French, and the French had not made any offers to buy the shipyards. However, he added that, if a proposal was put to BAE SYSTEMS and 'we can see a way of more efficiently securing a long-term interest of this business, we will follow it'.[199]

Ownership of companies

130. In terms of ownership of companies, Sir Peter would not comment on recent cases, but noted that the 'Ministry of Defence is able to make representations on two principles, one is security and the Office of Fair Trading will be looking at competitive issues'.[200] He added that 'The whole process is becoming increasingly global. We need to be very clear about the principles which apply here and security of supply during future operations and over time is clearly a key concern of the Ministry of Defence'.[201] In his view:[202]

The restructuring will be inevitably…. a matter for the shareholders of the companies concerned, and there are limits as to the ability of the Ministry of Defence to alter any of that…. If hypothetically you get a change of ownership which gives a strong underpinning of a company to ride out the peaks and troughs of our own demand on industry because they are able to provide work from elsewhere, that can actually be very helpful as a component of nurturing the industrial base over time.

131. Lord Bach told us that 'BAE SYSTEMS, and other British companies, have bought and purchased companies all over the world, particularly in the United States, and are absolutely entitled to do that. We also, in this country, are willing and happy to see companies that originated in other countries buy into the United Kingdom too'.[203] However, on the issue of overseas companies acquiring UK companies, he told us that 'Of course it is a concern' but noted that 'these companies that are owned abroad and invest heavily in the United Kingdom and create and sustain jobs here, sustain and create technology here, as far as we are concerned, and this must be commonsense in the global defence market, are to be treated as British companies'.[204]

132. We recognise that defence is a global industry and that consolidation in the defence industry can bring advantages, such as gaining access to a wider market. However, there are also possible disadvantages in that UK defence companies which are owned by overseas companies are more likely to be susceptible to job losses or cuts in investment if the parent company experiences problems. It is of real concern that in recent months, the UK's only defence helicopter manufacturer has been taken over by an overseas company, and the UK's main armoured vehicle manufacture was almost taken over by an overseas company. When overseas companies bid for UK defence companies, we expect MoD to consider fully issues of security and the impact on competition, and make the necessary representations where appropriate. It would be a terrible loss if the UK's remaining defence companies merely became 'metal bashers' for overseas defence companies. We expect MoD and the DTI to stand ready to take action to counter this risk.

Open markets and access to technology

133. The Defence Industrial Policy states:

Protectionism is not a viable way forward, but we recognise that not all governments approach acquisition with similar openness. We will continue to press for freer access to overseas markets. We aim to improve the flow of defence information and technology access across borders, and to enable the UK defence industry to compete on merit in other markets.[205]

134. We examined the issue of open markets and access to technology in last year's report on defence procurement.[206] We were happy to lend our weight to a campaign to address the lack of open markets in other countries and looked to ministers and their officials to maintain pressure for reciprocal treatment from other defence manufacturing countries. We concluded that 'The UK defence industry would suffer more than most from a retreat into protectionism. It is precisely because of the success abroad of UK firms that pressure must be maintained on the US and European countries to level the playing field'.[207]

135. In terms of the progress that had been made in opening up markets, Sir Peter told us that 'we have been working hard…. both in the United States and within Europe'.[208] However, UK contractors were still experiencing difficulties selling to overseas markets. Sir Richard Evans told us that 'in defence terms, the UK is the only genuine open market in the world today…. For UK contractors to compete in America or to compete in many…. European countries is exceedingly difficult…. it is in everybody's interest that all the markets are as open as possible and that is how we generate real competition and get the benefits from it'.[209]

136. There are alleged to be signs that the defence market in France is changing—John Howe told us that 'as far as the French market is concerned, I would not argue that it is as open as the British market is, though it has been opening and the French part of Thales would argue that now they do have to win their business in competition which is much stiffer than it would have been a few years ago'.[210] However, it is not clear whether this meant international competition.

137. The VT Group[211] suggested that a new industry/Government approach to securing greater access to global defence markets should be developed and implemented. They considered that, by developing a common position on this issue, both industry and Government would be able significantly to strengthen their understanding of what trade barriers actually exist at present. This seemed to us to be something which should be taken forward.

138. In last year's report on defence procurement, we examined a number of issues relating to the United States—including the threat of a more protectionist approach and delays in securing a UK waiver from the US International Traffic in Arms Regulations (ITAR). The Government's Response[212] to our report noted that 'On his recent visit to Washington, the Prime Minister secured an agreement with President Bush radically to improve the sharing of defence information and technology between our two countries. The Government is also working with the US Administration to secure a waiver for the UK from the US International Traffic in Arms Regulations'. Sir Peter acknowledged that 'this Committee has been extremely supportive of ministers and of the Ministry of Defence in discussing in the United States the general concerns about access to technology, and the results of that were the prospective Buy American legislation which was passed last year was a good deal less problematic than it might have been'.[213]

139. Despite the efforts that have been made by ministers and the MoD, it was disappointing to learn that little progress has been made and that the issue of protectionism in the US has re-emerged. At a UK/US Defence Industry Seminar held in London on 2 June 2004, Lord Bach raised his concerns about protectionism in the US and noted that, in contrast to European moves to reduce market barriers, there were some in the US who wished to move in the opposite direction—to close off opportunities for cooperation and to erect barriers in the marketplace. Lord Bach told the audience that this would 'undoubtedly harm the UK both in capability and industrial terms, and will also damage US industry with which we have a close relationship and from which we acquire important elements of our national capability'. He said:

Last year we had to deal with the implications of the Defense Authorizations Bill which sought to introduce overt protectionist measures to US defence procurement. It seems like we have escaped from that damaging proposal only to be confronted with another. It's got a new name—4200, new wording and a new strategy. But its supporters and its intentions are the same. And I have no doubt that once again we will need to expend time and effort in countering these proposals…. I am encouraged to learn that the US Administration has expressed its opposition to this language in the House version of the bill…. We have seen some concrete actions from the Administration. For instance we agreed the terms of the ITAR Waiver in May last year. Delivery of the waiver is now long overdue and the frustration that we feel and the messages that it sends are counter-productive. I note that the House version of the 2005 Defense Authorizations bill also includes language which, if enacted, will further impede the introduction of an ITAR waiver. Again I am pleased to see that this language has been opposed publicly by the US Administration'.

140. A recent article in a defence journal[214] claimed that the UK Government 'has threatened to ban US contractors from significant defense work here if protectionist measures proposed by the US House Armed Services Committee Chairman Duncan Hunter become law.'

141. We are dismayed that a waiver for the UK from the US International Traffic in Arms Regulations (ITAR) has still to be secured and that the introduction of protectionist measures in the US have re-emerged. In addition to the potential damage to both the UK and US defence industries, there is a real risk that the close relationship between the UK and US could be harmed. We note that the US Administration has provided support to the UK on these matters, but it is essential that that support is translated into real results. We again lend our support to ministers and the MoD in addressing these issues.

142. On the issue of problems with access to technology, Sir Richard Evans cited the example of the Joint Strike Fighter. He told us that 'I think the JSF is a classic example. It is no good when you have signed up and paid your cheque over then trying to go back to negotiate the release of technology'[215] He pointed out that in the case of the Joint Strike Fighter there would probably be two or three major updates throughout the programme and these will be undertaken by Lockheed in the US and not in the UK.[216]

143. We raised this concern with Sir Peter Spencer who told us that the issue of access to technology was an extremely sensitive area for the United States. He said that a Bilateral Defense Acquisition Committee has been set up.[217] This is a senior forum between the Unites States Department of Defense and the United Kingdom Ministry of Defence and its terms of reference include to 'Develop and co-ordinate efforts to improve information and technology exchange including the timely release of classified and sensitive information'[218] He added that 'we have identified the specific areas which need to be followed through, including the Joint Strike Fighter…. So far as access to technology which is needed by British Aerospace to discharge its responsibilities as subcontractor to Lockheed Martin on Joint Strike Fighter, we have been getting there'.[219] He said that 'We need to know that we can operate this thing effectively in operations, not join a queue and get the thing fixed six months later'.[220]

144. The issue of access to technology on the Joint Strike Fighter was also raised by Lord Bach at the UK/US Defence Industry Seminar on 2 June 2004. He noted that 'We had a difficult start to exchanging the necessary data and technical information on this programme, but a concerted effort at the most senior levels on both sides has delivered success'. However, some reports in the media have suggested that there was continuing concern among the collaborative partners on the project about US restrictions on information sharing.

145. Information transfer delays, on programmes such as the Joint Strike Fighter, can prevent co-operating industrial partners from fulfilling their contractual obligations. We note that a Bilateral Defense Acquisition Committee, involving the UK and US, has been established and that it is tasked with developing and co-ordinating efforts to improve information and technology exchange including the timely release of classified and sensitive information. We note that MoD considers that, on the Joint Strike Fighter programme, the necessary data and technical information is now being exchanged, and we expect MoD to ensure that this remains the case.

Relations between MoD and industry

146. The Minster of State, Adam Ingram has said that, since the launch of the Defence Industrial Policy, 'our close and productive relationship with industry has developed further.'[221] However, in the run-up to our evidence session with the Defence Industries Council, a number of press articles had reported that the relationship between MoD and the UK's largest defence contractor—BAE SYSTEMS—had reached an all time low.

147. We asked Sir Richard Evans about his company's relationship with MoD. He considered it to be pretty robust but thought it would get quite a bit tougher given the issues presently under discussion.[222] However, he also believed that:

We need to put this behind us and have a fresh start on this…. I want it to be quite clear that in the context of my position and indeed Dick Olver, who is taking over from me in July, our objective is to have a proper and good relationship with the most important single customer that we have.[223]

We were interested in Lord Bach's view on MoD's relations with industry and, specifically, with its largest supplier. He told us that:[224]

I really do not think the fact that there is tension between industry, on the one side, and the Ministry of Defence, on the other, is necessarily a bad thing…. As far as BAE SYSTEMS are concerned…. The relationship is often satisfactory, and sometimes good or better.

He went on to say, 'I actually accept what you said to Sir Richard—which was that it was important that all sides do their best to make sure that the relationship was a workable one, and one that got better rather than worse'.[225] He considered that was happening.

148. For the Defence Industrial Policy to succeed, it is important that there is a constructive relationship between MoD and the defence industry. We are disappointed to learn that there have been difficulties in the relationship between the MoD and the UK's largest defence contractor—BAE SYSTEMS. We note that both MoD and BAE SYSTEMS recognise the need to rebuild their relations, and we encourage them to push forward with their efforts to do so.

161 Speech by the Secretary of State at launch of the Defence Industrial Policy, 14 October 2002 Back

162 Policy Paper 5: Defence Industrial Policy, Ministry of Defence, 14 October 2002. Back

163 First Review of the implementation of Defence Industrial Policy, October 2003, www.mod.uk Back

164 HC (2002-03) 694, para 23 Back

165 First Review of the implementation of Defence Industrial Policy, October 2003, www.mod.uk Back

166 HC Deb, 13 November 2003, col 24WS [Commons written ministerial statement] Back

167 Ev 129 Back

168 Q2 Back

169 Ev 112 Back

170 Ev 129 Back

171 Ev 112 Back

172 Q 2 Back