Conclusions and recommendations
1.The Ministry of Defence committed itself to new equipment purchases arising from the 2015 Strategic Defence and Security Review before it had established how these would be paid for. The 2016 Equipment Plan (the Plan) contains £24.4 billion of additional commitments. Only £6.4 billion of this increase is to be met by additional funding from outside the Ministry of Defence (the Department). To meet a significant element of these new commitments, the Department must generate £5.8 billion of new savings from projects within the Plan, in addition to further savings of £1.5 billion from the wider Defence budget, which is itself already under increasing cost pressure. While over a year has passed since the publication of the 2015 Strategic Defence and Security Review (the Review), the Department has not yet identified how all the required savings will be achieved calling into question the affordability of the Plan and whether all current commitments can be met. This risk is exacerbated by the fact that the Department has yet to realise £2.5 billion of savings brought forward from last year’s Plan.
Recommendation: When the Department presents the next Equipment Plan to Parliament, it should report on progress being made against its 2015 and 2016 plan targets, and detail the impact on the Plan of any shortfall in available funding resulting from a failure to meet these targets, including any resulting time slippages or cost increases on individual projects.
2.Uncertainties and over-optimism in project costs mean that the cost of the Plan might be significantly understated. The Department’s current costing practice, which does not adequately take account of the inherent uncertainties in the costs of projects at an early stage of development, can lead to significant understatement in the likely cost, at a time when the Review has resulted in a higher proportion of large, early-stage projects in the Plan. The Department’s Cost Assurance and Analysis Service reported that the costs in the 2016 Plan were understated by £4.8 billion, without taking into account cost uncertainty inherent in the new commitments introduced by the Review.
Recommendation: The Department must ensure that costings for the new projects introduced into the Plan by the Review are put on a firm footing as quickly as possible, with appropriate input from the Cost Assurance and Analysis Service (CASS), and incorporate any increase in cost into next year’s Plan.
3.The Department is experiencing continuing problems in delivering the Astute submarine programme within budget. There is a risk that these problems will be repeated with the Dreadnought submarine programme given that the estimated costs for this programme are already increasing. For a number of years the costs of the Astute and Dreadnought submarine programmes (collectively known as the ‘Nuclear Enterprise’) have continued to rise despite the general stability of Plan cost estimates. CAAS estimates that there could be further significant cost increases. To address problems of cost growth and poor performance by contractors, the Department is putting its faith in a number of structural changes, notably the appointment of a Director General Nuclear, and the creation of a separate Submarine Delivery Authority, with its own chief executive, to oversee the management of nuclear procurement. Under this umbrella, the Department plans to introduce more rigorous contracting approaches based around incentives and penalties for future submarine procurement, together with the management of the Dreadnought programme through an alliance with industrial partners, as used with the Queen Elizabeth Carriers.
Recommendation: In addition to its ongoing commitment to provide Parliament with an annual update on the future nuclear deterrent, the Department should report on the progress made to finalise the structure for the management of nuclear programmes, and report how the new governance model is addressing the failures of the past.
4.Over a period of years the Department has failed to agree a workable way forward with the prime contractor on the procurement of the Type 26 warship, which has compromised maritime capability and placed further upward pressure on costs. The Type 26 Global Combat Ship is the highest-value non-nuclear procurement in the Plan. The Review significantly changed the requirement for this equipment, reducing the number of Type 26 ships from 13 to eight, with the shortfall in ship numbers to be filled by the creation of a new class of general purpose frigate. The Department told us that the contractor will belatedly ‘cut steel’ on the project by the end of 2017, and the contract, when in place, will hold the contractor to challenging milestones linked to penalties and incentives. It also appears that the Department is considering a radical new approach to ensure competition in the procurement of the new class of general purpose frigate. However, any departure from traditional procurement practices may have major implications for the Department’s relationship with key UK defence contractors and the Government’s wider industrial strategy. The challenges in maintaining the balance between ensuring value for money and the wider industrial strategy are also evident in the decision to purchase equipment, such as the Poseidon Maritime Patrol Aircraft, from abroad.
Recommendation: As part of the development of the Government’s industrial strategy, the Department should clarify how it will balance the potentially conflicting priorities of maintaining the UK industrial base with maximising value for money and long-term skills retention for the services and industry from major equipment procurement.
5.The recent fall in the value of the pound against the US dollar may lead to significant cost increases for equipment purchased in US dollars. The pound is currently trading at more than 30 cents below the exchange rate used by the Department in its cost estimates for the 2016 Plan (US$1.55 to the pound). The Plan contains expenditure of 28.8 billion in US dollars over the next 10 years. While the Department has partly mitigated the risk of currency fluctuations by entering into forward purchase contracts, these will expire in the 2018–19 financial year. Consequently, if current exchange rates persist, the cost of the Plan will increase by approximately £5 billion pounds. The Department and the Treasury have not yet decided whether such additional costs would be met by the Treasury, or whether some projects would have to be curtailed to accommodate the increased costs.
Recommendation: Before the Department presents the next Equipment Plan to Parliament it should establish whether the Treasury will fill the funding gap created by exchange rate fluctuations, or whether the Department will have to find the money from its own budget. These discussions should also focus on the current forward purchase policy, and whether a three year window gives sufficient protection given the long-term nature of the Department’s projects.
6.There is no longer any scope in the Plan to cope with new equipment requirements resulting from emerging threats. In previous years the Department maintained ‘headroom’ within the Plan to fund new projects should they be required to meet emerging threats or new requirements. However, in the 2016 Plan, all of the Department’s £10.7 billion headroom has been used to contribute to the funding of the new commitments arising from the Review. The Department maintains that headroom was always intended for situations such as the new commitments in the Review, but accepts that there is now less scope for emerging requirements. We are very concerned that the Department can no longer accommodate new requirements to meet a change in the nature of threats without disrupting the existing equipment programme, meaning that any new capabilities that need to be included in the Plan in future years can only be funded at the expense of existing projects.
Recommendation: Future Equipment Plans presented to Parliament should show the impact of accommodating any new requirements on existing plans. As well as indicating what capability has been changed, the Department should show the incremental costs associated with any decisions to re-scope, cancel or delay existing projects, even where these occur beyond the current Plan.
24 April 2017