Defence Equipment 2010 - Defence Committee Contents

2 Funding of defence equipment and support

The funding gap

54.  In our Defence Equipment 2009 Report we noted that many defence commentators had raised concerns that the equipment plan was underfunded. RUSI Acquisition Focus had reported in RUSI Defence Systems Spring 2007 that "The equipment plan has been estimated as underfunded by some £15 billion or more over its ten-year period".[121] In oral evidence last year, CDM told us that he was unable to estimate the size of any funding gap, and described the RUSI figures as "a tad ill-informed".[122] The Minister for Defence Equipment and Support told us that "the equipment programme is an affordable programme. We have had to make an adjustment about exactly the pace with which we are bringing certain things forward and …some of the priorities are being increased and others set back a bit".[123] At a conference in April 2009, he was recorded as saying:

The idea of a defence deficit of £15 billion or £10 billion or £20 billion—think of a number and double it—is fantasy. There is no such deficit. That figure has no relevance to any reality at all and I am the man who ought to know.[124]

55.  We returned to these questions during our current inquiry in the light of data published by the NAO which concluded that the defence programme was unaffordable. In Chapter 2, we referred to the NAO's evaluation that the size of the ten year funding gap was between £6 billion and £36 billion, depending on budget growth assumptions.[125] When asked whether he agreed that the equipment programme was "unaffordable on any likely project of future budgets", CDM said "Yes, I do".[126] Guy Lester attempted to quantify the extent of the funding gap for us and stated that:

On the basis of our forecasting, at the start of the 2009 planning round and the equipment examination we assessed that we were about £21 billion over-programmed over ten years.[127]

By the end of that planning round, the beginning of this planning round, we were about £6 billion over-programmed over ten years.[128]

£21 billion became £6 billion because of the action we took in the 2009 planning round and the equipment examination. It was not changing the parameters, it was just doing what our planning rounds always do, which is balancing the books and prioritising.[129]

56.  In terms of whether real savings had been achieved or whether programmes or expenditure had merely been delayed beyond the ten-year horizon of the equipment plan, the Minister for Defence Equipment and Support said that:

We have undoubtedly pushed some things beyond the ten-year mark and we have taken some things out altogether. What you are asking is the breakdown of those two things and I cannot give you off the top of my head exactly the breakdown between those two categories, I am afraid.[130]

In a follow-up memorandum, the MoD advised us that around 40% of the £15 billion reduction was achieved by deferral of expenditure beyond the ten year planning horizon of the programme.[131] Vice Admiral Lambert acknowledged that the tactic of delaying projects beyond the planning period had been used on occasions:

In the past with a ten-year programme there has been a temptation to push things just beyond the ten-year point so that you do not have to worry about them until the following year when they will creep into the programme, so we have started to look at a 20-year plan. It is something that was suggested by Mr Gray and we are in the early stages of doing that to make sure that we try not to be tempted to push things just beyond the bit that everybody is concentrating upon.[132]

57.  When asked what changes had been made to reduce the funding gap from £21 billion to £6 billion, the Minister for Defence Equipment and Support judged that he could not provide us with any further information without jeopardising the MoD's ability to manage its equipment programme. He said that "we do not normally go into the details of what we have in the ten-year forward programme … otherwise I shall create a precedent which will probably be very bad for a lot of us".[133] He went on to say that:

I do not want to go through that programme with you because we manage this programme on an active basis and we change things quite frequently in the long term programme, and it damages our commercial position with the industry if they know too precisely what exactly it is at any one time we are planning to buy and when we are planning to buy it.[134]

We wrote to the MoD to ask for an explanation of how the savings had been achieved. The MoD's reply confirmed that whilst the aircraft carrier delay had saved £450 million in the first four years, it had added £674 million over the ten year planning period of the equipment programme. It identified only one specific substantial saving of £2.6 billion, which was achieved by delaying the FRES UV programme, and no explanation of any other significant savings, other than to state that:

A further approximate £7.8 billion was removed through other programme changes in the Equipment Examination. The 2009 Planning Round delivered a further £3.3 billion of reductions to the 10-year equipment programme.[135]

58.  The evidence suggests that at the time that MoD witnesses gave evidence to our Defence Equipment 2009 inquiry, the MoD was in the process of taking steps to manage a funding gap of £21 billion. Witness denials at that time of the existence of such a gap now appear disingenuous. The Minister for Defence Equipment and Support told us he could not provide any information about how the gap was reduced to £6 billion, nor the proportion of expenditure which was merely postponed beyond the planning period. When we pressed in writing for further details, the MoD provided little extra information. We reject the MoD's arguments for refusing to disclose the measures it took in order to reduce the funding gap to £6 billion. We cannot fulfil our scrutiny role if the MoD refuses to provide such information about its activities. We note that the Gray report made recommendations about public scrutiny of the equipment programme and we return to this issue in paragraph 87.

Cost of delays

59.  The NAO Major Projects Report 2009 noted that the MoD's strategy for managing the funding gap has been to make changes which made the equipment plan affordable in the early years, but increased the overall costs in the long term. It concluded that this approach represented poor value for money:

In recent planning rounds, the Department concentrated its efforts on ensuring that the Equipment Programme was affordable in the early years, and on creating room in the budget for improvements in capability that were relevant to current operations. Since any radical changes in planned Defence capability would fall to be made in a Strategic Defence Review, the Department chose to make savings by re-profiling expenditure on existing projects and reducing the numbers of equipment being acquired on others. These decisions were necessary to ensure that the programme was affordable in the next few years, but they increased the overall procurement costs and represent poor value for money on the specific projects affected.[136]

60.  The Minister for Defence Equipment and Support accepted that delaying programmes introduced additional costs, saying that "When you push things forward it always involves a cost and I do not dispute that".[137] He stated that it was "a necessary thing to do" and "a good deal better … than cancelling a major defence programme".[138] He suggested that this approach was a normal financial discipline, saying that "Every family, every business in the country has to live under financial disciplines, and if you put off purchasing something when you do purchase it it may cost more; that is a fact of life".[139] The NAO Major Projects Report 2009 questioned this rationale. It acknowledged that Government departments frequently made prioritisation decisions to defer projects which were not yet underway, if insufficient funding was immediately available. It commented that, whilst the deferred projects might then be subject to cost inflation, in terms of the overall portfolio of projects the effects were generally compensatory. However, it went on to point out that:

This logic does not apply to cost management by deferring a project by 'slow down' once it is underway. This will typically drive substantial real cost increases into the project. This has been the case with some of the recent decisions taken by the Department, most notably on the Queen Elizabeth Class aircraft carriers.[140]

CDM explained that it was sometimes necessary for the MoD to pay industry to do the job over a longer period of time in order to maintain core skills.[141] This appears to be the case for example in the delay of the Future Carrier programme where an undertaking was provided "to provide stability for the core shipyard workforce".[142]

61.  The NAO estimated that in 2008-09 there was "a net increase in costs of £733 million in year as a result of the Department's decision to slip the introduction into service of projects for short-term affordability reasons".[143] The Nimrod Review described some of the human costs of delays and the risks of running on existing capability for longer than had been intended, stating that if there had not been delays in the Nimrod replacement programme, "XV230 would probably no longer have been flying in September 2006, because it would have reached its Out-of-Service Date and already been scrapped, or stripped for conversion."[144]

62.  The Gray report set out some of the practical consequences of using delays to manage the funding gap and made its own estimates of the costs of systematic delays:

The result is that programmes take significantly longer than originally estimated, because the Department cannot afford to build them at the originally planned rate. They also cost more than they would otherwise because the overhead and working capital costs of keeping teams within industry and the MoD working on programmes for a much longer period soaks up additional cash. The MoD also has to bear significant costs in running on old equipment because the new equipment is not yet ready for service.

Across a large range of programmes, this study found that the average programme overruns by 80% or c.5 years from the time specified at initial approval through to in service dates. The average increase in cost of these programmes is 40% or c.£300m. This study also estimates that the 'frictional costs' to the Department of this systematic delay are in the range £900m-£2.2bn pa.[145]

The process for arriving at these estimates is described in a nine page appendix to the Gray report.[146] The review team arrived at the figures by adding together the extra procurement costs for MoD; extra procurement costs for industry; capability gap costs (such as procuring additional equipment under UORs); run-on equipment costs; and MoD intramural costs. In some cases the team had to make estimates since MoD did not hold sufficient data for more accurate analysis and its calculations were based on a number of assumptions, some of which some MoD witnesses challenged. For example, Dr Andrew Tyler disputed the inclusion of costs for overcoming technical issues in the category 'unproductive project costs', saying that "Overcoming technical issues is what we do. We are buying technically very complex pieces of equipment, and a lot of DE&S is focussed on solving technical issues."[147] He added that "My personal view is that it is a number which has been somewhat exaggerated for the sake of effect, and I think that is unfortunate."[148] Guy Lester told us that he disagreed with Gray's estimates of frictional costs, saying that "intuitively, it is an implausibly large figure".[149] In response to an oral question, the Minister for Defence Equipment and Support dismissed Gray's estimate of frictional costs, stating that:

Of course I noticed that rather startling figure when I read the Gray report myself. The right hon. Gentleman … will also have noticed that there is no evidential basis for that statement anywhere … The very fact that the figure ranges between £1 billion and more than £2 billion shows, I think, how imprecise that statement inevitably is.[150]

63.  Bernard Gray explained to us the methodology which his review team had used, and said that:

We have put the first estimate that anybody has ever tried to put on the table to try and capture the costs of the delay in the system because it is only when you measure things that people start paying attention to them. I am sure that it would repay further work to try and refine this and we would be interested to participate in a debate which did that ... The key point is that, whatever the precise number is, it is a large number of hundreds of millions of pounds at the least which is going to non-productive work inside the Ministry of Defence as a result of the way they organise themselves.[151]

Lord Drayson, Minister for Strategic Defence Acquisition Reform, told us that he accepted Gray's analysis of frictional costs, saying that "The Gray report does say that this is not an exact science … but the point that it makes is a very fair point and I do recognise it and I do accept it."[152]

64.  According to the NAO, in recent planning rounds the MoD's strategy for managing its unaffordable equipment plan has been to re-profile expenditure by delaying projects so as to reduce costs in the early years of the plan. However this practice increases overall procurement costs and represents poor value for money. It is clear from NAO data that the 2008-09 re-profiling exercise added £733million to the future costs of the core equipment programme.

65.  The Gray report estimates that the 'frictional costs' of delays within the equipment programme are in the range £900 million to £2.2 billion a year. Although some of the DE&S witnesses did not accept these estimates, they were unable to provide alternative figures. The MoD is spending hundreds of millions of pounds a year on unproductive activities because it has commissioned more work than it can afford to pay for. It is shocking that the MoD has apparently made no attempt to calculate the extent of such costs and that it has therefore taken decisions to delay projects without understanding the full financial implications. The MoD must develop a system for calculating the full extent of the cost of delays and that such costs are explicitly documented in all future revisions of the equipment plan. The MoD should confirm that the full extent of the cost of delays will be explicitly documented in its annual reports to Parliament of the cost and affordability of the equipment and support programmes against the ten year planning horizon agreed with HM Treasury.

Defence research spending

66.  The research and technology budget has fallen from £540 million in 2007-08 to £471 million in 2009-10 and will decrease further in 2010-11 to £439 million.[153] Fifteen years ago, in 1994/95, MoD research expenditure was £665 million, which equates to £947 million in 2008/09 terms.[154] In our Defence Equipment 2009 Report, we pointed out that the UK's future military capability depended on the investment made today in research and development and the military advantage achieved at any one time depended on the research and development investment made over the previous 25 years. We expressed our concern then that defence research spending had been cut, [155] and there are no signs that the situation is improving. We also drew attention to this issue in our MoD Winter Supplementary Estimate 2009-10 Report.[156] The Defence Industries Council published a report, Securing Britain's Future and Prosperity, in September 2009, which highlighted the cut in defence research funding as a key issue facing the industry:

… investment in research and technology in the UK has been declining recently and a reaffirmation of a commitment to funding in this area is critical to the future of the sector. Without a strategic approach the UK will lose key capabilities.

There are, however, serious budgetary pressures. The Defence Industrial Strategy acknowledged that total UK research and technology funding had fallen as a proportion of GDP from 2.3 per cent in 1981 to 1.9 per cent in 2005. It is a matter of great concern that research investment has fallen back even further since 2005, whilst that of our competitors continues to increase.[157]

67.  The MoD Annual Report and Accounts 2008-09 stated that a review of programmes had resulted in "funds being reprioritised into activities better aligned to Defence's strategic needs".[158] In its written submission to us, the MoD explained that the research activities reduced or stopped as a result of strategic reprioritisation were "Maritime, Land and Air domains, Weapons, C4ISTAR, ballistic missile defence and climate research" and that the main areas which had expanded were "counter terrorism and support to operations".[159] Industry witnesses explained some of the implications of the cuts in the research budget. Ian King, Chief Executive BAE Systems plc, commented on the apparent lack of strategic planning, saying that "In the absence of a Strategic Defence Review cutting back on R&D at this stage does seem to be putting the cart before the horse. You really need to have a plan. There is a long cycle for this activity. We are not talking about huge amounts of money that the MoD spends on R&D and it is precipitous to do it before we have got a clear Strategic Defence Review."[160] He identified three areas of concern, saying that:

One is it is one of the few things that has been analytically proven is that spending on research and technology six to seven years from now means a direct link to the quality and nature of our defence products and equipment. We are storing ourselves up a problem. Who knows who and what we will be fighting in seven years' time … Two, it is totally contrary to the beliefs of most political parties that we are seeking to rebalance the economy and create a high value, high technology industrial base out of the pieces that remain in this country.[161]

His third point was that a cut in R&D spending sent out bad signals to those considering whether or not to invest in the UK defence industry.[162]

68.  The Gray report suggested that the research budget cuts were another consequence of the MoD's "squeeze on short-term cash expenditure" and its efforts "to manage an over large programme". It stated that this approach to managing its resources:

… reduces funds available for technology demonstration or risk-reduction activities which might reduce risk in new procurements. It depresses spend in areas such as research and technology, where by their nature, budgets tend to be committed less far ahead, and so are vulnerable to a cash squeeze.[163]

CDM did not disagree with this reasoning. He told us that there had been reductions in total research and technology spending and that "I think that is a pity but, there we are, we have to balance the budget."[164] He added that "I hope we do not cut any more in future years."[165] The Minister for Defence Equipment and Support said that "We cannot buy everything we would like to buy in any given year… so we have to make these difficult decisions and these difficult sacrifices, and we have to decide that we are only keeping what is the highest priority in terms of defence capability."[166] He added that "We have come down to this level of around £450 million … and my hope is that we do not get too much below that. That is certainly my hope and intention."[167] Tom McKane, Director General Strategy, MoD, told us that the volume of spend on civil research was growing rapidly and becoming more significant than defence research, and that the MoD needed to find ways of using that research to improve its capability in a more agile way than at present.[168]

69.  The research budget appears to be another casualty of the MoD's short term efforts to manage its equipment programme funding gap. We were told that cuts had been made to balance the budget and that such difficult sacrifices were necessary in order to continue to deliver the highest priority defence capabilities. We believe that spending less on research and technology will make the UK Defence industrial base progressively less competitive and will make the Defence Industrial Strategy inoperable. To compromise the future development of defence technology, in order to make proportionately small short term contributions to the management of the equipment programme funding gap, is ill-judged. The research programme cannot be turned on and off at short notice and the benefits can only be realised with a consistent and long term commitment of resources. We are sceptical about the implication that the MoD can balance cuts in its own research budget by making greater use of civil research and ask the MoD to explain its proposals for doing this.

121   RUSI, Defence Systems Spring 2007 Back

122   HC (2008-09) 107, Q 189 Back

123   ibid., Q 392 Back

124   Punching above the Budget: A Prospect Seminar, 1 April 2009,  Back

125   NAO, The Major Projects Report 2009, p 4 Back

126   Q 69 Back

127   Q 72 Back

128   Q 73 Back

129   Q 75 Back

130   Q 454 Back

131   Ev 125 Back

132   Q 454 Back

133   Q 444 Back

134   Q 450 Back

135   Ev 121 Back

136   NAO, The Major Projects Report 2009, p 4 Back

137   Q 434 Back

138   Q 435 Back

139   Q 436 Back

140   NAO, The Major Projects Report 2009, p 5 Back

141   Q 89 Back

142   HC Deb, 11 December 2008, col 67WS Back

143   NAO, The Major Projects Report 2009, p 7 Back

144   Charles Haddon-Cave QC, The Nimrod Review: An independent review into the broader issues surrounding the loss of the RAF Nimrod MR2 Aircraft XV230 in Afghanistan in 2006, "The Nimrod Review", 28 October 2009, p 12 Back

145   The Gray report, p 7 Back

146   ibid., Appendix G Back

147   Q 80 Back

148   ibid. Back

149   Q 79 Back

150   HC Deb, 2 November 2009, col 566 Back

151   Q 642 Back

152   Q 713 Back

153   HC Deb, 12 March 2009, col 615W and HC Deb, 11 November 2009, col 404W Back

154   Ev 95, These figures are estimates provided by the MoD for this inquiry, whereas the figures in the previous sentence represent the science/innovation/technology top level budget which accounts for "the majority of research expenditure". Back

155   HC (2008-09) 107, para 162 Back

156   Defence Committee, Second Report of Session 2009-10, MoD Winter Supplementary Estimate 2009-10, HC 150 Back

157   Securing Britain's Future and Prosperity, Defence Industries Council, September 2009, pp 10-11 Back

158   Ministry of Defence, Annual Report and Accounts 2008-09, HC 467-I, p 4 Back

159   Ev 94 Back

160   Q 382 Back

161   Qq 387-388 Back

162   Q 388 Back

163   The Gray report, p 7 Back

164   Q 107 Back

165   Q 110 Back

166   Q 510 Back

167   Q 511 Back

168   Uncorrected transcript of oral evidence taken before the Defence Committee on 9 February 2010, HC (2009-10) 223-i, Q 104 Back

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