Examination of Witness (Questions 180-199)
SIR PETER
SPENCER KCB
10 OCTOBER 2006
Q180 Mr Crausby: So can you give
us any indication as to when the contract for further submarines
will be made?
Sir Peter Spencer: Predicting
the timing of placing of contracts is not an activity which runs
very well particularly with ministers, so they will decide at
the moment of their choosing.
Q181 Mr Crausby: You see, what we
get from people at Barrow is that the skills base is absolutely
dependent on further orders, particularly as far as submarine
design is concerned. People will just simply walk away from Barrow
and not walk back. There are lots of opportunities, particularly
for submarine designers who have quite a broad skill, to travel
the world really. Their concern is that once we lose that base,
then we will just not be able to complete Astute or indeed
be capable of dealing with future submarine orders from the nuclear
deterrent point of view.
Sir Peter Spencer: I absolutely
agree with you and that is why at the beginning of this year,
on 1 April 2006, we created the post of DG Nuclear, Rear Admiral
Andy Mathews, who was the first dual accountable Director General
in both the DPA and DLO and has the oversight of all of our submarine
activity, both in-service, technology insertion and new construction,
and his job is to oversee the future of the nuclear submarine
industry and to ensure we have in place the plans to sustain that
industry over time.
Q182 Chairman: But the point which
was made to us in Barrow was that the only way you can retain
the skills is by ordering submarines.
Sir Peter Spencer: And that point
is well understood, but we have to look at the question of price
and timing and the rate at which we can afford to outturn money
in that area of the programme in order to sustain the submarine
build industry against the other pressures on the programme and
it is going to need some quite careful management.
Q183 Mr Hancock: I just cannot believe
though that people cannot see that the outturn price on boats
two and three will actually determine whether any other boat ever
gets built because there will come a time when the point crosses
the line beyond what is reasonable to pay for a fourth and fifth
boat.
Sir Peter Spencer: Precisely.
Q184 Mr Hancock: That will really
in the end be decided by the final price of boats two and three
and I think everyone has to understand that there is an enormous
risk here, that if this price just goes on and on escalating,
then there cannot be another order, the nation just cannot afford
it and, whether that does terminal damage or not to the infrastructure
at Barrow or the workforce, I think that is the reality of the
situation surely, is it not?
Sir Peter Spencer: It could be,
but I do not think it is because I have sufficient visibility
of where I think the prices of boats two and three will come out
for them not per se to provide that degree of threat to—
Q185 Mr Hancock: But we could not
build for the price of those, could we? The nation really would
be paying through the nose for something, would it not? You could
not build four and five for the same price as we will pay for
two and three?
Sir Peter Spencer: I think if
we go back first of all to the value for money argument, notwithstanding
the escalation there has been in price because of the disruption
to the programme when the design was not far ahead enough of the
production process, the outturn price of these submarines is probably
rather less than the prices which the United States Navy pay for
their nuclear submarines by a considerable percentage, and that
is in the public domain. I think the error we made was to be unrealistic
in terms of how economically we could build these submarines,
based on an unrealistic expectation from computer-aided design
and computer-aided manufacture which led to a very aggressive
degree of concurrency and of course when you are committed to
that extent and it comes unstuck, you do pay an extremely heavy
price. Even allowing for that, when we do these comparisons with
other nations, the prices we are getting, I think, even so represent
good value, but that does not mean to say we will be prepared
to settle there because clearly there were a lot of inefficiencies
due to the rebuild work. The challenge here with subsequent submarines
of course is that over time quite a lot of the technology becomes
obsolete and you have to take out that obsolescence as you go
through time. We also, just as a technicality, pay in outturn
prices, so even if in real terms submarine number four costs exactly
the same as submarine number one, the number that would appear
would be different because it would have a number of years' inflation
built into it.
Q186 Chairman: It looks in real terms,
and possibly in money terms, as though boat number two would cost
less than boat one and boat number three would cost less than
boat number two, does it not?
Sir Peter Spencer: I do not think
you can make those assumptions about boats. Three should cost
less than two and the cost of boat number one, yes, because we
will have amortised a lot of the design costs into it, so the
general trend is clear, that you can get a learning effect for
subsequent submarines. The difficulty comes when you are faced
with a new contract to place and the extent to which you continue
down the learner curve or you are affected by other influences,
and the other influences here are the disruption of the supply
chain and the fact that some of the manufacturers of quite important
components are no longer around and we are having to find alternative
sources and that is a challenge.
Q187 Chairman: Sir Peter, you are
being very helpful. The Astutes that we saw in manufacture were
being made with a very interesting method of sliding in cassettes
almost, large cabins and large bits of infrastructure being made
outside the submarines and then being slid in. When we went to
Devonport, we found that submarines which were being maintained
and repaired had to have holes cut in them and things taken out
and we wondered whether the method of making these submarines
is antipathetic to the method of maintaining them in Devonport
and whether, therefore, sufficient consideration is being given
in the manufacturing process to the through-life maintenance of
them. Do you have a comment on that?
Sir Peter Spencer: I think it
is a very good question because right at the heart of delivering
through-life capability with a new organisation is that you spend
more time and effort thinking up-front what additional investment
should be made to ensure that in whole-life terms you produce
something which is affordable, so we move from right equipment,
right kit, right price, right time to right equipment, right price,
right time, right cost of ownership. Now, the nuclear submarine
is probably the most extreme example because you have a pressure
hull and you are going to have to cut holes in it in order to
get things in and out. Part of the design process is focused on
the exit and entry routes. As you know, there are certain key
components you have to replace through life. I would need to go
back and take some professional advice on the extent to which
the Astute class differs from the existing classes so far as replacing
components is concerned. I am happy to do that, but I can only
give you a rather general, unsatisfactory answer at this stage.
It is certainly a principle which is in place at the beginning
of any major procurement programme. The fundamental question is
the extent to which it is actually applied ab initio because,
as we all know, you commit a very large percentage of the through-life
cost of ownership at the point at which you make some quite early
decisions in any design process.
Chairman: I think it would be helpful
if you could go back and look at that please.[5]
We move on to the Future Carrier.
Q188 Mr Crausby: First of all, can you
update us on the progress of the Future Carrier programme and
tell us if a date for the main investment decision has been set?
Sir Peter Spencer: We are progressing
pretty well since this Committee last enquired and a lot more
work has been done on the detailed design in the shipyards and
on value engineering so that we have moved from parametric-type
cost estimation to bottom-up estimates from the people who are
actually going to do it. We have clarified the standards to which
a ship is going to be built and the performance so as to remove
some of the ambiguities, and the industrial arrangement with the
alliance between the Ministry of Defence and the companies concerned
has settled down and is working pretty well. The common baseline
design was agreed with the French and they agreed to contribute
up to £100 million as an entry fee and to pay one-third of
the demonstration phase costs and to date they have paid some
£70 million, most of which is the first two payments of their
demonstration fee, £55 million, and the other is a contribution
towards the demonstration phase costs and there will be more to
come on that. The final £45 million will only be paid if
they make the decision to go ahead and build the ship based on
that common baseline design. We are now at the stage of due diligence
and we are now at the stage of making sure that we really do understand
the proposition which is on the table and that we actually understand
and believe the numbers. You will remember from the Tom McKane
paper, Enabling Acquisition Change, there was a part of
it devoted to better due diligence and to emulating best practice
in the private sector. With that in mind, we have had three independent
reviews just recently; one a standard Office of Government Commerce
gateway review which lasts five days to make sure that the whole
of the organisation is joined up and it has got a common understanding
of what is required and we have got a proper understanding of
the projects which interrelate with this and that we have the
right governance arrangements in place and the right risk management
arrangements in place. There has been a Red-team review of the
design led by Sir John Parker and a team of very well-regarded
independent experts to look at the design and the procurement
planning to take a look and see where there are areas which would
cause us some concern, and that report has not yet been delivered.
Finally, there has been an independent financial review conducted
by the team led by Deloitte with Rand and Jacobs. They will give
us an independent financial estimate as to what they think the
cost of this project should be because the great risk when you
have to live within a budget is that people call the number they
think you want to hear. You are so pleased that you sign the contract
and then three years down the line hard reality kicks in. We have
been there before and we are not going to do it again. It was
the reason why I refused to go to contract in April 2004. Had
we gone to contract in April 2004, in my view and this is a personal
estimate, we would be looking at a cost escalation of around £1
billion on the basis of our lack of knowledge at the time, so
all of this has simply been a relearned lesson in the merits of
getting the assessment phase done properly, to be incremental
in your thinking and not to commit yourself to very large capital
investment until you have got the necessary degree of understanding
and confidence. It always sounds so much like a blinding glimpse
of the obvious when it is spoken like that, but of course you
have to set it in the context of all the other pressures that
are on the procurement process to get on with something.
Q189 Mr Crausby: I hear that what
is really holding things up is that there is a very large gap
between the industry's estimate and the MoD's budget. Is that
the case? Can you tell us, how does the latest industry estimate
compare with what you consider to be the MoD's budget and the
right price?
Sir Peter Spencer: There is no
budget per se inasmuch as we will set the budget when we
make the capital investment decision. We clearly have a number
in mind for planning purposes because we need to give that to
those who are on the case to sort it out, but we always have the
ability, if something is going to cost something, to match our
budget to suit.
Q190 Mr Crausby: So how close are
you? Are things running smoothly? Do you think you are quite close
to reaching agreement on what the price would be?
Sir Peter Spencer: I am the great
sceptic in all this, professional sceptic, because I have got
reason to be sceptical. Those who are dealing with it are very
encouraging; they believe that what we are seeing here, which
is after all the beginning of a negotiation on price, is bound
to need some judgment as to what ultimately the price is going
to turn out to be. If you think of the contractual arrangements
here which are going to be set upon a target cost with the gain-sharing
arrangements for beating that cost, then if you stand to benefit
by making a lot of earned profit by beating the cost, you are
going to be trying to nudge the price high. We have got to find
the right point of balance which says that this is a reasonably
challenging cost to go for and if you do beat it, then you deserve
to get additional profit, so this is where the real work begins.
This is why we have gone for the sort of due diligence arrangements
I have described because we need as many views as we can as to
what the `should cost' of this project is going to be, and I am
not trying to hide anything from you, but I simply have not—
Q191 Mr Crausby: I hear that the
difference is hundreds of millions. Is that true? Is there a difference
of hundreds of millions between them?
Sir Peter Spencer: What you are
hearing is views from people in industry perhaps who have got
a vested interest in talking the price up, so that has to be taken
into account when judging what is at the heart of this. When a
project comes in, it is not just one number, as you know, but
it is a very, very complicated piece of work which has to be very
carefully analysed so that we understand what is included, what
is excluded, what we think the costs of the exclusions will be,
what we think the risks are and put a value on that risk. That
very detailed process is actually happening as we speak and all
I have to go on at the moment is an assurance from the team leader,
which is still all to play for, that he believes that it is very,
very feasible to get a contract negotiated for a price that we
can afford and that industry can deliver and that we should have
the right level of confidence that that target cost will be a
real target cost and it will incentivise industry in the right
sort of way.
Q192 Mr Crausby: What effect is this
having on the Maritime Industrial Strategy? Is it not absolutely
crucial to the Maritime Industrial Strategy? It seems to me that
we are a very long way from reaching agreement and making progress.
Sir Peter Spencer: No, if I have
given that impression, may I correct it because I do not think
we are a very long way from reaching an agreement. We have actually
come an enormously long way and what we are seeing now is the
end of a process where there are real numbers on the table and
people are going to start negotiating quite hard and that is a
process which can, only to a limited extent, be conducted in public.
A lot of it will come down to very detailed discussions as to
what the numbers actually mean and it is not lost on Lord Drayson
that the CVF project is fundamental to the Maritime Industrial
Strategy and you will remember his description of wanting to get
together the fantasy football team to deliver it.
Q193 Mr Crausby: We also hear that
the management arrangements are not proving to be robust. Are
you expecting the management arrangements to change and, if so,
soon or is that a factor in this?
Sir Peter Spencer: I cannot answer
a hypothetical question. Who has said that about which management
arrangements?
Q194 Mr Crausby: Are you satisfied
that the managing group of this project from an industrial point
of view is working well?
Sir Peter Spencer: I think so.
I think we have got two absolute stars in it. We have John Coles
who came back out of retirement to do this and it does not benefit
him much financially at all, but he does this because he has got
a real passion about wanting to deliver this. We have also got
Peter—
Q195 Chairman: Sir Peter, I do not
think that the suggestion is that the individuals in charge of
it are not appropriate, but the suggestion, I think, is that competing
some bits of Carrier, allocating other bits of the Carrier, not
necessarily the right bits to be allocated or the right bits to
be competed, and then putting them all together in a place, which
I am sure Willie Rennie will come in soon to express his view
about, but in a place which some people would say should not be
the place they should be put together. That is what some people
have been questioning rather than the individuals in charge of
it.
Sir Peter Spencer: Thank you for
the clarification, but just to complete my sentence, Peter McIntosh
who, I just wanted to publicly say, has come to us from industry,
works as a civil servant, so this is expertise we have brought
in from outside and he is doing a very, very impressive job in
giving the Alliance Management Board the leadership which it needs
which complements the leadership which John Cole is giving across
the Ministry of Defence and elsewhere. In terms of the build arrangements,
well, the Defence Industrial Strategy centres upon the need to
ensure that there is a unity of purpose and a clarity of purpose
so that industry can make its own judgments as to how and when
it needs to invest as opposed to long periods when we say nothing
to them and then suddenly a contract rolls up and meanwhile we
have had a very sort of uneven demand on their resources. So the
whole aim of the strategy here is to give that degree of understanding
and the ministerial judgment was that we needed, in the case of
Govan and Barrow and Vosper Thornycroft and Rosyth, to give that
clarity and to say, "We have got these super-blocks which
we will expect to be built in these places". There is always
a tension there between whether or not you are going to get the
right prices for that work if it is a non-competitive process,
and the way in which the alliance works, the transparency we are
getting and the side-by-side comparison we are getting gives us
the opportunity to ensure that that non-competitive process still
gives us prices which are competitive and we will then add to
that through the competitive arrangements for the rest of the
structure which is pretty simple. The skills that prevail in the
oil industry are pretty competent at bringing bits of the structure
together and sticking it together. In fact we already do this
in the warship-building industry where the bow sections of Type
45s are manufactured in Portsmouth and floated up to Scotland,
so this is not a trick which is unreasonable to ask. It is a way
of ensuring that, as we get through into this very large peak
of demand, we try to make the best use of the industrial capacity
we have got, but look through that peak of demand to what happens
on the other side to make sure that we size the industry properly
and we identify the key skills which we need in order to retain
operational sovereignty over the maritime assets in perpetuity.
Q196 Mr Hancock: I have two questions
relating to the figures that you evaluated at the time during
the due diligence process. Is it for both ships or for the first
aircraft carrier?
Sir Peter Spencer: We would be
looking at the total programme.
Q197 Mr Hancock: So for both, and
the through-life maintenance of the ships is being priced into
this equation as well, is it?
Sir Peter Spencer: There are options
for looking at the initial period of support which we will look
at.
Q198 Mr Hancock: So the time-frame
is also critical then, is it not, because you cannot agree a price
unless you have agreed a time-frame from start on the first ship
to completion on the second ship, so that is fairly critical?
Can you advise us on what that time-frame now is from the laying
down of the first ship to the operational capacity being delivered
of the second ship?
Sir Peter Spencer: Well, the separation
between the ships that forms the basis for estimating is the three-year
separation between In Service Dates which sets the relative positions
and that is the basis on which the pricing is being done, but
in any contract there will be a tender validity period during
which the prices will hold until we take them up and we would
aim to get those well outside the timescale within which a decision
will be made.
Q199 Mr Hancock: But part of the
process is also the way in these two very large ships, the largest
ships of all the Navy will have ever had, are going to be serviced,
not maintained, but just generally home-ported and serviced. Now,
the Ministry of Defence are going through this complex exercise
at the moment looking at the three bases and there are some critical
issues there and if it was not Portsmouth, the ships are too big
for Devonport, so are you being asked to look at that as part
of the work you are doing of where these ships could be serviced
if the Navy makes a decision, which hopefully it will not, which
would go against Portsmouth?
Sir Peter Spencer: All of this
work comes together with the Maritime Industrial Strategy on which
David Gould is leading for Lord Drayson and draws in the surface
ship build programme, the submarine build programme and also the
ship support programmes because we need to ensure that we recognise
that what the Royal Navy needs is delivery of through-life capability
from not only a Ministry organisation which is joined up, but
from an industry which works for the common purpose and understands
and that we understand the best way of doing that. So there is
a lot at work going on at the moment with industry in order to
tease out what the options might be. One of the realities, as
you will be aware, is if we have over-capacity, we pay an awful
lot of the budget on servicing overheads and we then have less
opportunity to actually go for what is actually needed, so there
are some quite tough decisions which are going to need to be taken.
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