Select Committee on Defence Minutes of Evidence

Examination of Witnesses (Questions 229-239)


28 FEBRUARY 2006

  Q229 Chairman: Welcome to all three of you. We are very grateful to you for coming to give evidence about the Defence Industrial Strategy. I wonder if I could start off by saying that in your memorandum you welcome the DIS but you state that "It will be important for the MoD to provide further clarification on what the report means for the whole of the defence industry . . ." Sir John, welcome. Would you like to give us an idea of what you would like to see by way of further clarification?

  Sir John Rose: I think that will happen over time. The point is that this is a strategy document and the key of any strategy is that it needs to be implemented, and we will need to be very engaged with MoD, as industry and through the trade associations who are partners with industry, to ensure that the steps are taken and the changes are made both within the customer and within the supply base to ensure that we achieve the objectives that have been pretty clearly set out in the Defence Industrial Strategy.

  Q230 Chairman: What about the fears that have been expressed by some people that some small and medium scale defence companies might gravitate to other sectors, such as the oil sector, do you have any views about that?

  Sir John Rose: In some ways I think the DIS should help rather than hinder the SMEs. The whole objective of the DIS is to create greater transparency about the opportunities that are available to companies in their dealings with the defence customer. As you know, if you are going to try and make decisions about where you invest your money then having some clarity about where you will get your returns is pretty important and therefore this is a good first step in improving the transparency both for the larger companies that interact with the MoD and for the smaller companies.

  Q231 Chairman: You said in some ways the DIS should help SMEs. Do you think there are ways in which the DIS would not help SMEs or would hinder them?

  Sir John Rose: I do not think there are any ways in which it would hinder the SMEs at all. The big step forward is in transparency.

  Q232 Chairman: Do you think there is sufficient coverage within the DIS of SMEs?

  Sir John Rose: I think there is. We have got to be clearer about the role of the strategy and the customer. The SMEs are part of a supply chain. Some of them will be direct suppliers to the defence customer and some of them will be suppliers to the prime. In both cases it is helpful for them to know the likely direction of investment either in the primes who are their customers or in the MoD who is the direct customer. The SMEs were involved in the debate that took place around the creation of the DIS largely through the trade associations, of which they are members, but also with representation on the DIC, so they got a good voice in the conversation. It was equally the case that the primes talked to their supply base to try and make sure that they understood the direction that this debate was taking, but my colleagues may have views to add to that.

  Dr Howes: I think there has been a tremendous amount of activity working with supply chains in the industry over the last few years. Some of that is industrially driven and some of it has been very driven by MoD itself as it has taken a greater interest in supply chain relationships and supply chain management. I would agree with Sir John that the direction that the DIS has given as to where the market is going, how the customer wants to be, how it wants to buy, gives tremendous clarity for those supply chain improvement programmes.

  Q233 Chairman: Do you think the MoD and the DTI do understand the supply chain and the best way to manage them?

  Dr Howes: For the MoD it is the start of a journey. I think there has been a lot of honesty that there is not a tremendous visibility right down to the bottom. I am not sure there could be because some of the supply chains are very large and they are very complicated. That is just the world of defence business as we see it today. So I do not think MoD could expect to have complete visibility of that, but I think that it is moving in the right direction in terms of working with industry to try and understand those relationships. The DTI, in extending that into the regions with colleagues in the RDAs and with the devolved administrations as well, it has tried to get a focus through things like the Manufacturing Forum, the Aerospace Innovation and Growth Team and the Electronics Innovation and Growth Team. A lot of that work has gone on the effectiveness of the supply chain. So no longer is the DTI looking at companies as isolated pillars but it is trying to look at performance across the supply chain. I think we are all moving and growing in the same direction. What the DIS now gives us is the customer end to really stimulate the right kind of supply chain improvements for the future.

  Q234 Chairman: So the Defence Industrial Strategy is the start of the journey for the MoD and the defence industrial policy was not?

  Dr Howes: Following the publication of the defence industrial policy the MoD did begin this focus on supply chain management and supply chain relationships, but I think the DIS will give it the focus that it needs. I think for me, in the document itself, on page 28, there is a diagram in there that actually describes where the MoD has been in its procurement and what its vision is. I actually think that this is a very helpful diagram for us all and particularly for industry because this shows the extent of the change. If you imagine the implications of that in the supply chain, yes, it is the start of the journey because there is clearly a lot to be done.

  Sir John Rose: I think the biggest contribution to the SMEs is the recognition that having a successful domestic industry is a key objective. For the SMEs having a successful domestic industry is crucial. SMEs have a relatively short reach. Many of them tend to be taken to market through the primes or the sub-primes or the major integrators and that reach tends to be national and not international because by definition they are small- and medium-size enterprises, they cannot afford necessarily to enter other markets and it is difficult to do so and expensive to do so and takes a lot of time. So the best thing for the SMEs is a successful industry domestically.

  Q235 Mr Borrow: The Defence Industrial Strategy is important in the sense that it sets a framework within which industry can operate, but the assumption behind the strategy is that industry itself will need to reorganise and reshape itself to meet that framework. Could you say a little bit about how you see that reshaping taking place and in which sectors there will be mergers and which sectors will be most involved in that reshaping?

  Sir John Rose: I think we all have views on that. I think it is impossible to predict. I think industry as a whole responds to its customer. We do that in the commercial sectors and we do that in the defence sector. We will respond as an industry to changes that take place in the MoD as a consequence of the implication of the DIS. Clearly there will need to be changes in the MoD in terms of the way that they operate with industry. I could not possibly predict what will happen in terms of the central consolidations in particular. All I would say is that the nature of industry has been that over time the supply chain has become more consolidated because at the top of the supply chain there is a drive for simplicity. Let us take as an example Rolls Royce. If we developed an engine in the late Eighties we would have had 250 or more suppliers; our latest engine has 71. They are bigger and within that there have been some system integrators who have taken on more responsibility and they need to be bigger because they take on more risk, they have to take on the investment requirements, the R&D requirements and so on. I think the industry will simply respond to the demands of the customer in the way it structures itself because that is what industry does.

  Dr Howes: It is probably worth just saying that on the whole when you speak to companies further down the supply chain the DIS is seen as a good opportunity for industry to transform and to prosper as long as it is able to invest and I think that will be the challenge over the next year as the sector strategies begin to develop. Many of them have milestones this year to do with setting up partnering agreements and deciding the future. As those begin to mature I think we can then judge what sort of reshaping there will be in industry.

  Mr Turner: I believe industry and businesses will go where the market is. BAE Systems is a global defence company. That is why you have seen us expand in the United States, which is clearly the most important market for defence research, technology and procurement. You have seen us expand in other parts of the world like Australia and Sweden and South Africa and indeed we are now investing in Saudi Arabia in line with the government requirements of the King and the Crown Prince there to see investment in skills and employment at the highest level in Saudi Arabia, and clearly there is a market in those countries. The good news for the UK now is that at long last we have a DIS in the UK and my board and my shareholders at long last can see the possibility of a sustainable profitable future for the business in the UK and that we can, as we do in other parts of the world, supply the highest level of capability to the Armed Forces. That is what we are about, the highest level of capability wherever we operate in the world to those Armed Forces in America, Sweden, South Africa, Saudi Arabia and in the UK but also making a return to our shareholders. Industry goes where the market is and now that we have a DIS I think there is a strong market in the UK which was not there previously.

  Q236 Mr Borrow: Specifically on BAE Systems, you may not be able to divulge very much at the moment, but is the Defence Industrial Strategy affecting the way in which your company plans for the future and reconfigures itself and reshapes itself within the UK?

  Mr Turner: Absolutely. The basic shape of BAE Systems has evolved over the last few years. You have seen us grow in the United States because it is the most important market, you have seen us reduce our investment in businesses in Europe because we believe that there is a real question mark about the future of defence in Europe compared to other parts of the world, and you have seen us investing in Saudi Arabia. Now that we have this strategy in the UK I think there is real potential for the UK defence industrial base which we did not see before.

  Q237 Mr Borrow: There has been quite a bit of talk in the press in the last year or two of a merger or some collaboration between BAE Systems and another major company in the United States. Would you say that the Defence Industrial Strategy affected those issues or is that still a live issue?

  Mr Turner: I think what the Defence Industrial Strategy has done is encourage BAE Systems to remain and to invest in the United Kingdom. The talk in the press some years ago about a merger was all part of a recognition by the board that we needed access to US technology. The UK no longer invests sufficiently in R&T, as I think has already been said, and therefore we needed access as a global defence company to the world's most important market. Clearly with the weakness of my company a few years ago one way of accessing the United States would have been by a merger with one of the big players in the United States. I think that is far less likely now. We are a much stronger company now and we have managed to grow organically and by acquisitions in the United States. We are now an $8.5 billion turnover company in the United States. We have access, therefore, to other technologies, to the market and therefore a merger strategically is no longer necessary for BAE Systems.

  Q238 Chairman: And you say it is far less likely.

  Mr Turner: It is not necessary for us now to execute our strategy by a merger, but it does take two to tango and at the moment I can assure you there is nobody talking to us. We will keep looking for organic growth in the United States and acquisitions in the US. The budget going forward in Congress for 2007 is $73 billion on R&T, it is huge and it is very difficult to see how the UK and Europe can match that. If the UK Armed Forces are going to have the very best capabilities that they must have to peace keep and peace make then the UK has got to have access to the very best and that is what we intend to do.

  Q239 Chairman: When I asked you whether it was far less likely, as you had previously said, you said it was less necessary but you will still be looking. Can I press you on what you previously said? Is it far less likely?

  Mr Turner: It is far less likely, yes, but not impossible.

  Chairman: I was not asking for a commitment written in blood.

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