Public AdministrationWritten evidence submitted by the NAO (PROC 44)

Thank you for your letter for 13 June asking for my thoughts on the GOCO model for the restructuring of Defence Equipment and Support.

As you know, I am not able to comment on government policy decisions and Ministerial decisions on a GOCO or other reform of Defence Equipment and Support are still a long way off. The ultimate shape of the GOCO, if it is selected, is not yet clear and will depend to some extent on the proposals made by bidders in the competition which the Ministry of Defence plans to launch shortly. Success or failure of new delivery models depends as much on implementation as on the structure. I am therefore addressing my reply to the general principles which might apply to the kind of delivery model being considered.

It is worth bearing in mind the drivers of change. The Department needs not only to meet its objective with a lower budget, but also to overcome long-standing problems in managing its equipment budget. Underlying issues, which the Department has acknowledged, included a lack of clarity about where responsibilities lay, lack of transparent and shared management information and a culture of over-optimism as well as a track record of planning to deliver more than it could afford. Reforms will stand or fall by their ability to address these past performance issues.

In this context, and in our experience of looking across government delivery models, there are both opportunities and risks in moving to a commercial delivery model. Realising the opportunities and managing the risk depend very much on how a competitive process and subsequent implementation are structured. The key issues can be grouped into the following broad areas:

Skills and capability: A GOCO has the potential to access and importantly, be better able to retain scarce skills, expertise and know-how, and incentivise professional expert managers to deliver improved performance and achieve savings by deploying the workforce more effectively. But the incentives for the management need to be credible. Competition for scarce skills may simply push up the cost of employing them without increasing the overall level of capability available to the Department. Contracting out the management of a GOCO also puts a premium on the Department’s own contract management, weaknesses in which are one of the main reasons for reform.

Competitive pressure: There is scope to use competition to generate greater efficiency and innovation. To achieve the benefits of competition in the management of defence acquisition will require sufficient high-quality bidders with incentives for them to remain involved and offer a choice of cost-effective solutions. The Department will therefore need to maintain competitive tension throughout the bidding process, and potentially during the life of the contract, to achieve this benefit. It will also need strategies to ensure a competitive market exists at the end of the contract.

Accountability: A contract with a GOCO has potential to make accountability for performance clearer. The Government expects a GOCO to reduce frictional costs caused by the weak interface between the Defence Equipment and Support and the parts of the Department which request equipment and support services. But there is potential for the relationships between the organisation and the rest of the Department to remain complex, particularly in the transition to a new structure, and for frictional costs to increase or move elsewhere in the Department’s budget.

Information: Weak management information is one of the Department’s underlying problems and a contract could strengthen the Department’s position in demanding better performance information. The Department needs a good understanding of current performance and the potential to improve, and the ability to set quantifiable performance targets that fairly reflect its objectives. However, weak management information may be a barrier to the Department’s ability to set and monitor credible yet stretching performance measures. Current performance also needs to be transparent to the contractor to minimise uncertainty at the time a contract is negotiated.

Incentives: A well-structured contract could incentivise new ways of working in Defence Equipment and Support and drive out practices which have not worked in the past. There may be scope to trade increases in running costs against potentially larger savings or cost avoidance on major projects. But the incentives need to be strong enough for the contractor to commit the resources needed to perform effectively. Poorly structured incentives could encourage a contractor to focus on driving down management cost or achieve short-term improvements at the expense of more effective delivery of the acquisition programme in the long term. The contract needs to enable a flexible response to unpredictable events. A tight contract specification could prevent innovation by creating incentives to do the minimum to fulfil the contract.

Culture change: A private partner may be better placed to achieve the changes in the culture of Defence Equipment and Support which the Department considers it needs in order to control costs more effectively. But a transfer to a private sector management will require a cultural shift for the staff transferred to work effectively, which may not be achieved just by the introduction of new management.

Handling risk: With rare exceptions such as the Olympics, a private sector partner will seek to limit its risk and to return risks to the public sector when the limit is reached. The Department will need strategies to deal with a scenario where a contractor defaults or is unable to deliver improvements. It will need a credible process for resolving disagreements which will inevitably arise, designed to take into account the balance of negotiating power between the government and a single contractor.

Whether the Department succeeds in improving performance through its portfolio of transformation programmes is crucial to it improving the value for money it delivers in the coming years. The effect of transformation will therefore be a key theme of our audit work on Defence. We will be focusing our attention on the strategic risks to transformation, including the introduction of new delivery models for Defence Equipment and Support and other areas of the Department’s business. We will wish to explore all the above issues in more detail as part of our ongoing work.

I am copying this letter to Margaret Hodge.

Prepared 18th July 2013