3 Building open and honest relationships
with industry
14. The Defence Industrial Policy published in October
2002 recognised that the Department and its main suppliers are
in a long-term mutually dependent relationship. The Policy states
that a thriving, innovative and competitive defence industry is
essential to provide the Armed Forces with the equipment which
they require, on time, and at best value for money for the taxpayer.[25]
The Department considers that its relationships with industry
are generally good, although there have recently been well publicised
tensions with parts of BAE Systems,[26]
with which the Department has contracts worth some £37-38
billion.[27]
15. The Chief Executive of BAE Systems told us that
his company had made the wrong strategic decision to accept the
Nimrod contract in the mid-1990's. At the time, the Board had
been convinced by a presentation made by the programme management
team who assured them that it would be a profitable contract.[28]
As recent experience on the Support Vehicle programme highlights,
a similar culture exists within the Department, and has led to
short term decision-making and over-optimism in estimating costs
and timescales on many projects. There are few examples where
a judgement has been made not to proceed with a project, although
the decision not to procure an acoustic sonar buoy for the Nimrod
after estimates of the cost of the programme had tripled does
provide an isolated example.[29]
16. Following the publication of the Major Projects
Report 2003, Sir Raymond Lygo, Chief Executive of British Aerospace
during the 1980's, said that the company consistently underbid
for contracts knowing that it could recover the true costs when
the project was underway. This is a very serious charge and a
practice which we would view as completely unacceptable if it
were shown to be happening. Mike Turner, the current Chief Executive
of BAE Systems, stated categorically that the company did not
knowingly underbid for contracts. Sir Kevin Tebbit added that,
even if underbidding had been prevalent during the era of cost
plus contracting 20 years ago, the Department now had a sophisticated
system to understand the price base of bids, and said he was absolutely
certain that underbidding was not taking place today.[30]
We will want to be satisfied of the continuing effectiveness of
this system as we consider future equipment acquisitions by the
Department.
17. The Defence Industrial Policy states that "the
Government is responsible for providing the Armed Forces with
high quality equipment at best value for money for the taxpayer.
It is also firmly committed to the UK manufacturing sector, and
to promoting a strong and competitive UK defence industry, bringing
economic and technological benefits to the nation. The Government
must take decisions within a policy framework that recognises
any tensions between these two objectives." The July 2003
decision to purchase up to 44 Hawk 128 aircraft from BAE Systems
to meet the requirement for an Advanced Jet Trainer provides a
good illustration of these tensions.
18. The Accounting Officer's analysis of the case
for procuring the Hawk 128 took into account industrial capacity
and employment arguments, but because of issues about the timing
of the order, and on the grounds that an international competition
would offer the most likely prospect of a value for money solution,
he sought a Direction from the Secretary of State for Defence
to proceed.[31] In his
evidence the Chief Executive of BAE Systems noted that BAE Systems
would be making only a 7% return on the project, and argued that
the Department adopted a very narrow definition of value-for-money
which failed to take account of exports, wealth creation and the
defence industrial base.[32]
19. When the contracts for the Astute submarine and
Nimrod aircraft were placed in the mid-1990s the Department considered
that the best way of delivering the capability was by putting
responsibility for managing risks in the programme, as well as
in delivering the programme, on to a prime contractor. On these
two programmes the approach failed. The Department is going without
equipments they need, BAE Systems has lost £1 billion on
the deals,[33] the Department
will have to contribute an extra £1.5 billion and will receive
three fewer Nimrod aircraft (worth £180 million) than planned.[34]
The Department now believes that there is a limit to which it
can transfer financial risk and that operational or time risk
cannot be transferred.[35]
The Defence Industrial Policy therefore states that "we will
seek to provide a more appropriate risk/reward ratio for programmes
with high technological risk".
20. The Astute submarine and Nimrod aircraft contracts
were placed with fixed price contracts covering both development
and production. The Department and BAE Systems disagree on what
the best pricing mechanism is for highly complex technology programmes
where there is excessive risk. BAE Systems favours cost plus arrangements.
The Department considers there are more robust arrangements which
would protect the taxpayer as well as be fair to the supplier.[36]
Figure 4 illustrates how the various pricing options available
may be better suited to particular combinations of risk and certainty
of outcome. Using a variety of pricing methods should allow the
Department and industry to achieve a fairer risk and reward balance
appropriate to the circumstances of an individual programme. For
example, a fixed or firm price may be more suitable for production
work once the design is stable than for most early risk reduction
work.[37]Figure
4: Alternative pricing mechanisms
Notes
Cost plus:
Where a contractor is paid his agreed costs plus an agreed profit
rate.
Target cost with maximum price:
A target cost is established together with an arrangement to share
the amount by which actual costs are above or below the target
between the Department and the contractor. There is a maximum
price above which the contractor has to bear all the costs.
Fixed price:
An agreed price that is subject to variation to take account of
inflationary and/or exchange rate movements.
Firm price: An
agreed price that is not subject to variation for inflation.
25 Ministry of Defence Paper 5, Defence Industrial
Policy Back
26
Qq 191-192, 281 Back
27
Q 42 Back
28
Qq 28-30 Back
29
Q 90 Back
30
Qq 9-11 Back
31
Qq 12-14 Back
32
Q 15 Back
33
Qq 29-32 Back
34
Qq 28-42 Back
35
Qq 23-24 Back
36
Qq 105-107, 140, 152-155 Back
37
Qq 5, 59, 66, 73 Back
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