Examination of Witnesses (Questions 20-39)
MINISTRY OF
DEFENCE
1 FEBRUARY 2006
Q20 Mr Curry: I understand the logic.
That was because the French decided to replace a carrier, not
to go nuclear but to go with a conventional carrier. So far as
I am aware one of their old carriers is currently stuck in the
Suez Canal or trying to make its mind up about which way to go
out of it. My interest is how you fix the entry cost, as it were,
to this. It is innovative, I think it is very sensible. I am then
going to ask you, does this arise from very specific one-off circumstances
or are there projects in which you think this might be a way forward
to getting round the dilemma of a normal multinational arrangement?
Sir Peter Spencer: Certainly it
is not the first time it has happened because it happened in the
reverse way when the UK bought into the missile project for the
major weapons system fitted into the Type 45 Destroyer and we
judged with France and Italy, who had funded the early stages
of development of their version of the system, what they had spent
on the bit which would be common to the UK and we agreed to pay
a percentage of that and agreed the way in which those payments
would be made. We have adopted the same logic on this occasion
and we have indicated to the French the amount of money which
we have spent which would be relevant to what is called the common
baseline design because the ships will not be exactly the same
for obvious reasons, they are flying different aircraft. We had
an interesting and amicable, but fairly tough commercial negotiation
on the value which we put on what we had produced and what we
thought was an appropriate contribution from France. They had
to look at their own business case to make sure it satisfied the
test in France that this did represent a value for money proposition
for them compared with a national programme. Fortunately for both
sides we have converged. What was very important was that we had
in place arrangements which then did not inadvertently cause us
to make slower progress through the next phase and we have put
in place arrangements which the French are content with. At the
end of the demonstration phase we will take a look and see to
what extent there are further economies. The fundamental principle
here is that those economies need to be jointly proposed by industry
because the lessons we have learned from a lot of the earlier
collaborative programmes is that if governments get together,
fudge issues and then try and force industry to sort it out, the
project often ends in tears. We do have examples, such as the
Storm Shadow in UK industry and SCALP missile in the French industry
where UK and French industry got together and said we can meet
your separate proposals with some technology which is common and
we will then make it bespoke for your separate purposes and then
gainshare the benefits of that. If we incentivise industry, as
we shall, to gainshare the benefits then we will get sensible
proposals because they will put forward something that they know
is going to work and they will share the benefit of it.
Q21 Mr Curry: What we have had up
to now is an arrangement which covers a project up to a certain
point but perhaps some more genuinely joint development work might
then take place later under the sort of scenario you just outlined.
Sir Peter Spencer: Absolutely.
If, for example, we decided to buy the same main engines then
although it might not look as if buying three sets as opposed
to two sets represents huge economies of scale, there will be
some economies of scale, but there are always quite a lot of non-recurring
costs in setting up production lines which will then be shared.
Q22 Mr Curry: On the agreement as
it is at the moment, what will the total saving be, as it were,
to British expenditure because of French participation? How much
will we not have to spend, as it were, because the French are
spending?
Sir Peter Spencer: At the moment
the net cost to the UK Exchequer will be at least the £55
million which France are going to pay regardless of whether or
not we go into manufacture, together with one-third of the demonstration
costs for the common baseline design, which will probably be in
the order of another £40 million. Should the French go ahead
they will then pay a further amount. The intention, recognising
industry's contribution to this, is to make some of that available
to recycle through the project to incentivise greater levels of
joint procurement so we get even higher net savings.
Q23 Mr Curry: That brings me to my
next question. I understand that the Chancellor's billets-doux
about the Spending Review which is now being embarked upon have
been popping through letterboxes quite recently. How much of this
is the Chancellor going to take, as it were, and how much does
he think you might get rewarded for good thinking on this? How
is this reflected in your baselines?
Mr Jeffrey: This is catered for
in the existing baselines but clearly the next Spending Review
will cover a period towards the end of the decade. The position
we have reached in Government generally, as you will know, is
that it was decided not to have a Spending Review this year but
instead to spend this year looking across Government at a set
of wider issues, looking at areas that could be examined to see
if there is any serious scope for savings and then moving on to
a conventional Spending Review covering everything next year.
It would be unwise of me to speculate on the outcome of that,
but clearly some of the issues that we are discussing here—
Q24 Mr Curry: The French cheque arrives
this year, does it? The French cheque goes in the Barclays account
this year, does it?
Sir Peter Spencer: We will get
one payment this financial year and one payment the next financial
year.
Q25 Mr Curry: So it falls within
the scope of the existing financial framework?
Sir Peter Spencer: It does, yes.
Q26 Mr Curry: Talking of engines,
on the joint strike fighter there is quite a lot in the papers
about the alleged debate with the United States as to whether
or not they should commission two engines or a single engine.
How important is it to the UK that Rolls-Royce should have part
of this action?
Mr Jeffrey: We certainly think
it is important and we have been saying so to the United States'
Government, largely on the basis that clearly UK industry is involved
in the second engine but also that to have an alternative is always
a more comfortable position than to only have one. This is an
issue that the US Government still has very much in its sights
and we will be keeping closely in touch with them.
Q27 Mr Curry: What would be the consequences
if they took a decision which was an adverse decision as far as
we were concerned?
Mr Jeffrey: The immediate consequence
would be that it would be necessary to pursue the programme on
the basis of the other engine that is currently being considered.
I do not know whether you would like to add to that, Sir Peter.
Sir Peter Spencer: So far as the
cost to the Ministry of Defence in initial acquisition, as we
do not yet know what the cost of one engine versus the other might
be. It would be too early to give you an exact figure. In a big
market and with the sort of competition which could be mounted
we would obviously hope to get some benefits. We would expect
to get some benefits, from a competitive arrangement, but it would
do nothing to stop us achieving the capability that we need. We
would need to examine the impact on the prices which are charged
in the light of better knowledge nearer the time when we make
that production decision.
Q28 Mr Curry: The decision on the
engines will not influence the number of aircraft we expect to
take, will it?
Sir Peter Spencer: I have no reason
to suppose that it would because I have no reason to suppose that
the cost differentials would be so great in a non-competitive
environment and a competitive environment, but I cannot give you
an absolute assurance of that in the absence of any data.
Mr Jeffrey: Be in no doubt that
we would prefer to see a second engine and the US Government is
aware of that.
Q29 Sarah McCarthy-Fry: I would like
to go back to the point that the Chairman made right at the start
about decreasing costs being primarily due to reductions in numbers
or capability of equipment. I would like to ask Lt General Fulton,
do you think it is reasonable to bring projects back on track
by reducing capability?
Lt General Sir Robert Fulton:
I think it is entirely reasonable. That is what we ought to be
doing and, indeed, it is what we have been recommended to do by
this Committee in the past. There is a process of working out
in the first instance what it is that we think we would like to
have and then the Assessment Phase is responsible for working
out what the cost and time implications of that are. What we are
seeing here is that process working out in practice. Clearly we
cannot have everything in terms of numbers and in terms of quality
of equipment that we would like in an ideal world, everything
is a balance. I think this reflects exactly the process we ought
to be going through.
Q30 Sarah McCarthy-Fry: Looking at
the Defence Industrial Strategy with our new mature, grown-up
partnership with industry, do you think it would be fairer to
more adequately define our requirements rather than saying "This
is the Rolls-Royce" and bidding for it to actually say, "This
is what we think we need and can do within cost"?
Lt General Sir Robert Fulton:
The question was asked earlier about metrics of performance. One
of the ways in which we have taken that forward in the capability
area is to define for each project as it comes forward to Main
Gate a threshold level of capability and an objective level of
capability, the threshold being, as the name implies, below which
it would not be worth buying the equipment if it could not do
a certain number of things, but clearly some areas into which
we would like it to go. That is how we now define the trade space
so that as the project goes forward the directors of equipment
capability and the project team leaders understand where the envelope
sits for their cost, time and performance trades. That is what
we share with industry. As the requirements are exposed to industry,
very often that fruitful relationship with industry that you have
described leads to a process whereby industry can identify things
that they could put into the programme, and the precision-guided
bomb is a very good example of that where we had a requirement
for it to be targeted by a laser designator and industry came
back and said, "Actually, the one that we have already has
a laser seeker head in it. It would cost us more to take it out
so, therefore, why don't you have the laser literally free of
charge". The engagement of industry allows us to understand
not only where we need to make greater provision either in cost
or time but also where we can get more for our money. This is
all part of the process.
Q31 Sarah McCarthy-Fry: It sounds
as if what you are saying is that you do not say, "This is
the outcome I want to achieve, what can you make me that will
do it", but you go to them with a specific requirement.
Lt General Sir Robert Fulton:
The point of the concept phase of the so-called CADMID cycle is
to identify what the end user, the front line command, would like
it to do and how it would fit into the plans. That then sets an
agenda for the Assessment Phase and the industrial companies that
are conducting the Assessment Phase understand the envelope within
which they are working. That then goes forward in most cases,
but not all, to a competition for the Demonstration and Manufacture
Phase which has by then refined some fairly broad statements,
some fairly high level statements, some fairly aspirational statements,
into some hard criteria against which, firstly, they are going
to compete and then against which they are going to manufacture.
Mr Jeffrey: I think the crucial
thing is in the Assessment Phase there should be intelligent discussion
involving the procurement people, the military customer and the
supplier in the spirit of openness that you mentioned earlier
so that sensible judgments are made about where there should be
any give in capability. It should not just be a question of lopping
off bits of capability. The NAO Report in the case studies gives
some good examples of where that has been done quite well.
Q32 Sarah McCarthy-Fry: I will come
back to that. We have been talking so far about projects that
have yet to get through Main Gate. Can we talk about projects
that are actually here. We have got 19 out of the 20 top projects
that are still £2.7 billion or 10% over budget. Do you anticipate
that you are going to have to make further significant cuts in
capability to get back on budget?
Lt General Sir Robert Fulton:
The Report identifies those projects which are over the original
budget and also identifies the measures that we have taken, in
some cases in those projects themselves and in other cases in
other projects, in order to live within it. That is not done arbitrarily
but in all cases it has been done on the basis of an assessment
of what capability we are going to need in the sort of timescale
that we are talking about here. For example, in some cases there
are reductions in torpedoes because not only do we have fewer
ships, helicopters and planes in the timescale we are talking
about but also we perceive that in comparison to other threats
the submarine threat will have reduced and it is more important
to use the money that we were going to allocate to the anti-submarine
threat to another emerging threat. It is a case, not just within
this population of projects but across the whole of the equipment
plan, of understanding which aspects of our capabilities should
be on the increase and which we can afford to take and which we
can afford to do with less of.
Q33 Sarah McCarthy-Fry: I was not
quite clear from reading the Report, on the plans you have put
in place now you expect to bring all of your projects in on cost,
do you?
Lt General Sir Robert Fulton:
Both in terms of this project population and in terms of the equipment
programme as a whole I would certainly hope to bring the programmes
in on cost because any change in one area means that we have to
take something out of the project somewhere else in order to live
within our means. I would prefer to be able to do that change
as a result of just a capability assessment but as we have discussed,
and as the Report makes clear, all of these are a balance of cost
and time. It might also be it is not just that a particular project
is going over in cost but it might be going over in terms of time
and then we would have to understand what that would mean in capability
terms and also in payment profile terms because clearly we pay
for these when we get them. This is a constant juggling act between
these three components. I do not expect ever to get to complete
stability, so I expect that this will be a continuous process.
Anyway, the world around us is changing all the time and, therefore,
we have to respond to that.
Q34 Sarah McCarthy-Fry: Can I ask
Mr Jeffrey, we do seem to have made some progress this year on
reducing costs, do you anticipate that graph will be going down
in future years?
Mr Jeffrey: I think there is still
some time in this year to go so we cannot be absolutely certain
of that. One thing I was going to say in response to an earlier
question, if I understood it correctly, was we certainly do not
expect to get to the point where the total estimated cost of the
20 top projects is what it was originally estimated to be. These
20 include some of the great disasters of the past where costs
have escalated substantially. What we are very keen to do is to
hold the position we have achieved and not see, unless it is absolutely
inescapable, any further increase in the cost of these projects.
Q35 Sarah McCarthy-Fry: If we go
to paragraph 2.19 on page 23, it talks about the early engagement
of British industry within the Assessment Phase and some experimental
approaches that were done in MARS and in Watchkeeper and IFPA.
Were the early results that have come back from that fed into
the DIS and informed you that might that be the way forward? Have
you got quantifiable evidence on these programmes?
Mr Jeffrey: What did strike me
reading this Report, and preparing myself for this hearing, was
that one or two of these—Watchkeeper in particular—are
very good examples of what I was saying earlier about the intelligent
use of the Assessment Phase. It reflects the spirit of the Defence
Industrial Strategy but whether it fed directly into it, Sir Peter
may want to say something.
Sir Peter Spencer: It did feed
straight into it. One of the Smart Acquisition principles was
that should have a more intelligent engagement with industry and,
as we recognised three years ago when we did a stock take of the
implementation of those principles, there was a problem with compliance
and take-up. This has been very much reinforced by these worked
examples where we can see the benefit of a more sensible engagement
with industry and that is very much one of the principles of the
Defence Industrial Strategy and it does not make it an easy relationship.
Tough love is probably the best way of describing it in terms
of the fact that you have got that close engagement with industry,
which does not necessarily mean in any way that it is going to
be something easy for both sides to work at. The trust comes from
openness and success builds upon success and we have certainly
now got a core of people inside the military customer community
and inside the team leader community who are the evangelists of
this approach. We have "Learning From Experience" sessions
at my headquarters so that people can come and hear how those
successes were achieved and industry comes in as well.
Q36 Sarah McCarthy-Fry: Would you
say that the ability of industry to work with your procurement
process should in the future be part of the evaluation process
as to whether that particular contract ever should—
Sir Peter Spencer: Yes, it will.
If you look at the worked example of Watchkeeper, we started out
competitively. When we had enough evidence to demonstrate that
we knew who the winner was, we deselected the rest of the field
in return for locking in the supplier with the terms and conditions
and basic price models and then worked together to understand
the proposal much better. One of the problems we have had in the
past with competitions was that it was all done a bit at arms'
length so you chose the result of the competition on the basis
of the information that you had but then when you started to test
it in greater detail which you needed to produce a detailed negotiated
contract you tended to unearth problems and that did not help.
Now, we delay the Main Gate capital investment decision until
we have matured the commercial understandings as well and that
means closer engagement with industry.
Q37 Mr Mitchell: I am a newcomer
to this so I know what the average Guardian reader knows,
which is nothing, about the whole subject but I think dealing
with major projects there is a long history of overruns and ex-projects
which turned out to be fantastically expensive which we never
should have done. I wonder what the main problem is? Have you
have got a uniquely incompetent set of contractors who cannot
supply to price and to contract or a uniquely inadequate supervisory
process on the part of the Ministry of Defence who cannot see
things coming in on time and their orders can be delivered.
Mr Jeffrey: I think the main problem
in the past, if you look at the history of some of the big projects
that are still in this list of projects, like Nimrod and Astute,
was that bids were made to accomplish projects which turned out
to be unrealistic and assumptions were made about how much risk
could in practice be transferred from Government to supplier which
did not turn out to be realistic either. My reading of it is that
all the efforts over recent years, Smart Acquisition, the changes
that have taken place under Peter Spencer's leadership, are intended
to build better processes so we do not pretend that we can transfer
risk when we cannot, so that we do assess the viability of projects
extremely carefully and not commit ourselves until we are pretty
confident about cost and timescale. It is a gradual process. I
am very keen, as I said at the beginning, in my time to advance
that and to get to the point where we are producing results that
this Committee will be satisfied with.
Q38 Mr Mitchell: That is a nice straightforward
answer. Is there a problem in the sense that there are so few
suppliers in this area you are pretty well at their mercy?
Mr Jeffrey: I do not think it
is quite that. The only thing I should have mentioned in response
to your first question was that a lot of this, in my view, is
about the people we employ. I have visited the DPA once and I
think we have well-motivated staff who are doing their best but
we do need to look, and are looking, at how we train them and
the skills they have and the way we apply them. I do not think
it is shortcomings in the industry, although there may well have
been in the past. Industry is changing rapidly.
Q39 Mr Mitchell: There is only a
limited number of suppliers, are there not? You are pretty well
dependent on them?
Mr Jeffrey: Nonetheless there
is a measure of competition and there is also a growing habit
of constructive collaboration, if I can put it that way, through
alliances with a number of partners in the industry. I do not
know if Peter would like to add to that but clearly it is the
core question.
Sir Peter Spencer: We publicly
recognised that a whole list of issues had not been properly addressed
both in industry and inside the Ministry of Defence. We have been
working hard on making the improvements which are necessary in
both places and it has been recognised in the NAO report that
we are moving in the right direction. The frustrating thing is
that five of the projects which are on the current list of 20
will still be on that list of 20 in five years' time because of
the way they are selected. Unlike a company which with a really
bad piece of business can do a write-off, get it off the books,
take its medicine from the shareholders and then move on, we continue
with this toxic legacy for some years and part of the challenge
is how we try retrospectively to deal with the problems which
needed to have been sorted out ab initio. When I make that
statement it sounds like an excuse but it is not. It is a reality
and some of the best people that we have got slug it out trying
to retrospectively deal with these projects for which we just
wish we had not signed the contracts on that basis. We are constrained
by the art of the possible under contract law. Sometimes we look
at cancellation options and we find that in return for the privilege
of killing the project off we would pay exactly the same amount
of money to have nothing. Then the General says, "Oi, where
is my military capability?", so you then have to factor in
the cost of doing something else. It is going to be a long haul.
We are going to have to demonstrate to this Committee, to ourselves
and to others that we are genuinely moving in the right direction.
Part of the frustration is if you look at Javelin which comes
up as a really good little project—and by the way achieved
its in-service date in July, four months earlier than predicted
last year—it makes one glorious appearance in this Report
and then disappears. Meanwhile, Astute, Nimrod, Typhoon, Type
45 and some of the other old lags go stumbling on. I am not here
to tell you my hard luck story but I am here to try and put this
into a context to establish realistic expectations of when the
bottom line is actually going to change which is why we are interested
in measuring year-on-year changes.[1]
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