Ministry of Defence: Acquisition and support of defence equipment Contents

Conclusions and recommendations

Non-competitive procurement of defence equipment

There can be valid reasons for the Department using a non-competitive approach to procurement, including national security considerations and because there is only one suitable supplier. However, in the absence of competition it is more difficult for the Department to be sure that it is paying the best possible price. In 2014, the Single Source Contract Regulations were introduced to increase transparency around contract costs. The Single Source Regulations Office was also established to make recommendations to the Secretary of State on the contract profit rates and to issue guidance on costs that can be claimed by suppliers.

1.The Department lacks a coherent approach to increasing competition in its equipment procurement and, as a consequence, is struggling to make progress in reducing the level of single source procurement. The proportion of contracts let competitively has remained unchanged for five years at around 50%, despite the Department’s commitment to competition as the default option. We accept that 100% competitive tendering is unlikely; circumstances can arise where only one supplier has the ability to meet demands for particular equipment, or security considerations mean the Department has to contract with a trusted national supplier. But there is little evidence yet of a coherent strategy to increase competition, despite the Department’s claims that it is changing practices and the mind-set amongst staff. We are concerned that Commands may still be specifying requirements to dictate single source procurements with a preferred supplier. They may also change the requirements for an existing procurement fundamentally, but place the additional work with the existing supplier instead of re-competing it.

Recommendation: The Department needs to have a clear strategy for increasing competition which will see real savings materialise. We are not pushing for competitive procurement on every occasion as we recognise that there can be valid reasons sometimes for why single source procurement may be appropriate. Nevertheless, we look to the Department, frontline Commands and project teams to take a competitive approach where it is best, and to seek strategic opportunities to stimulate the market in order to reduce the number of occasions when it uses single source procurement.

2.There are still too many contracts outside the Single Source Contract Regulations and some suppliers are still failing to cooperate. The Regulations are leading to increased transparency and improved information for contract managers, and are strengthening the hand of commercial staff in contract negotiations. However, not all contracts are being brought into the regulations. The Department has particular difficulties with contracts that pre-date the Regulations that may be brought into the regime ‘on amendment’, although this requires contractors to agree. Only eight such contracts have been included since the Regulations were introduced in 2014. There is also uncertainty about whether particular sub-contracts qualify for the Regulations. With the Regulations giving the Department the power to disallow whole categories of cost, some suppliers are still refusing to be subject to the Regulations or provide all the required information.

Recommendation: We expect to see the Department meet its target of 100% of all eligible contracts brought within the regulations by 2019–20. Where suppliers refuse to comply with the regime, the Department should develop and apply appropriate sanctions. In defence procurement, where public scrutiny is often limited because of security concerns, it is particularly important that the Single Source Regulations Office has effective oversight.

3.The Department has made promises of significant savings arising from application of the Single Source Contract Regulations, but actual savings achieved so far are very limited. The Department has a target of securing £1.7 billion in savings from the application of the regulations over 10 years, which is an important contribution to managing its wider affordability challenges. It claims to have made £313 million in potential savings so far, shared between cost avoidance and cashable savings, although it is unable to be precise about the balance between the two. Money has already been taken out of the budgets and the Department believes it is on track to meet the overall target. However, it has made a slow start. Actual savings achieved to date are only £3 million, and realisation of further savings will depend on effective management of the contracts over their lifetimes. This in turn will depend on the success of efforts to transform DE&S, and the successful recruitment of staff with commercial skills. When we next examine the Department’s Equipment Plan, we will check on progress with savings arising from the Regulations. We are sceptical about the robustness of the £1.7 billion savings target.

Recommendation: The Department must improve its information and performance monitoring systems so it can effectively track progress against its savings targets and intervene in a timely way to increase momentum. The Department should demonstrate to the Committee at the earliest opportunity that actual savings are being achieved.

4.The Secretary of State’s review of the regulatory regime provides an opportunity to strengthen the Regulations and the powers of the Single Source Regulations Office (SSRO). SSRO does not have many of the powers of a typical regulator. We are concerned, for example, that it does not have timely access to all the contractual information it needs to carry out its role and that suppliers’ data submissions can be made without senior executive confirmation that data are accurate. We are also concerned to hear of the Department’s inability to require the inclusion of eligible amended contracts within the Regulations without the supplier’s agreement. The Secretary of State has now completed his review of the Regulations and is due to announce the results in due course.

Recommendation: The SSRO needs appropriate powers and access to information to do a rigorous and independent job. We expect the Department to set out:

how the SSRO’s powers will be strengthened; and whether, and if so, how contracts will include a requirement on contractors to provide the SSRO with appropriate, reliable data and contractual information.

5.It will be particularly important that the Department does all it can to ensure that UK suppliers, including smaller companies, are not disadvantaged as a result of Brexit. The Department realises that it needs to be vigilant as the country leaves the European Union that UK defence contractors are not disadvantaged in selling their products or entering into international alliances, with part of the Department’s role being to encourage and help British industry to be successful. There is the risk that exit from the European Union may further limit choice if it affects UK industry’s ability to participate in collaborations. The Department accepts that “we [the UK] do not have the ability indigenously to supply all of the equipment that our armed forces need”. The Department also says it wants to avoid falling into the traps it has in the past of bigger companies in the UK supply chain absorbing smaller companies, with the result that its ability to procure competitively is reduced.

Recommendation: The Department needs to do more to maintain diversity amongst smaller suppliers, and to safeguard the interests of British industry after we have left the European Union.

Support arrangements and cannibalisation of navy equipment

The Royal Navy operates ships, submarines and helicopters to meet the United Kingdom’s defence requirements. They are complex systems with many parts, requiring the Navy to have spares to be used either during scheduled maintenance or if the original parts break unexpectedly. DE&S puts in place support arrangements for equipment, but when parts are unavailable, the Department can authorise that parts are taken from other vessels, a longstanding process known as ‘cannibalisation’.

6.The Department’s arrangements to support in-service Type 45 destroyers and Astute-class submarines have not been adequate. The Department admits that there have been issues with the support of both these vessel types since they were brought into service. To address the recognised shortcomings, the Department said it had recently spent £8 million on Astute-class parts and, in 2016–17, further invested in the Type 45 support arrangements. The lack of operational experience and performance data for these new vessels has made it harder to predict their support requirements. Ineffective support contributed to increased ‘cannibalisation’, where parts are taken from one vessel to keep another one in service. Over the last five years, there has been a 217% increase in cannibalisation of Type 45s and a 107% increase for the Astute-class submarines. Each instance can increase costs, divert resources and create additional risks, particularly if parts are taken from the production line. Despite the need to make future efficiencies across defence, the Department tells us that the Navy will be adequately resourced to provide its future objectives.

Recommendation: The Department must make sure it adequately funds the provision of spares for its future new ships–the aircraft carriers and the Type 26 and Type 31 frigates—in order not to repeat the same mistakes made with the Type 45 destroyers and Astute class submarines. It should provide an assessment of what it sees as an acceptable cost envelope for spares that balances competing risks, including the costs of oversupply, risks to effective deployment, and delays in receipt of spare parts.

7.The Navy and DE&S have not always ensured that spare parts are available when required for ship and submarine maintenance. The Department acknowledged it could improve its planning of maintenance by considering its requirements further in advance and ordering parts from contractors earlier. In September 2017, only 67% of parts ordered by the Ships team in DE&S, and 58% by the Submarine team, were delivered on time (against targets of 95%). The maritime supply chain improvement programme aims to improve planning, alongside addressing the 21% shortfall in staff who are qualified in commercial and inventory management. Inadequate maintenance planning increases cannibalisation risks; in the last five years 60% of ships and submarines requiring cannibalised parts were in maintenance, an increase from 27% to 89% over the period.

Recommendation: The Navy and DE&S should work with contractors to better plan for scheduled maintenance and ensure that parts are available when required so that the now smaller Royal Navy can fulfil its operational commitments.

8.The Navy has become more reliant on equipment cannibalisation, with some pieces of equipment being repeatedly cannibalised. The Department has previously agreed with this Committee’s findings that, although cannibalisation may be necessary in some circumstances, it should not be used routinely. However, over the last five years ship and submarine cannibalisation has increased 49% across the Navy. It has become routine for some pieces of equipment, with 26% of all cannibalisations involving the same specific type of equipment on three or more occasions. During 2016–17, the Department also relied on cannibalised parts to resolve 28% of Astute-class defects. The Permanent Secretary told us he is not uncomfortable with the overall level of cannibalisation across the Navy, although he is concerned that it is happening with great frequency with certain items. He has asked the Department to address this as a matter of urgency.

Recommendation: The Department must deliver on its undertaking that cannibalisation should not be routine, particularly in relation to repeatedly cyclical cannibalisation of parts. To this end, the Department should, by the end of September, write to the Committee identifying revised targets for acceptable, safe levels of cannibalisation, and what additional actions could be undertaken to reduce it.

9.The Department expects vessel cannibalisation to decline but cannot say to what extent, or by when, and has no upper limit on what level it would tolerate. The Department expects the cannibalisation of Type 45 Destroyers and Astute-class submarines to fall. It does not have a threshold for an acceptable level of cannibalisation, although it does have an equivalent threshold for Merlin helicopters. It does not have the data, controls and processes to routinely monitor cannibalisation and its costs across the Navy. The Department acknowledges that the National Audit Office report has provided it with valuable new insights, and says that applying new data analysis techniques should improve its ability to predict and manage the demand for spare parts. The Department acknowledges that cannibalisation also takes place across the Army and Royal Air Force, but cannot quantify to what extent.

Recommendation: The Department needs to ensure it has adequate data to better understand and respond to cannibalisation trends so as to implement our recommendations across both the Navy and the other Front Line Commands.

Contingent liabilities

In negotiating contracts, the Department needs to identify any potential contingent liabilities. These are potential uncertain obligations that may arise if certain events happen. They are frequently indemnities built into contracts during negotiations that limit the liability of private sector firms, and require HM Government to cover the remaining costs. Because of the possible cost implications for the taxpayer, contingent liabilities require scrutiny by HM Treasury and Parliament. Departments must comply with long established procedures for notifying the Treasury and Parliament before entering into contracts containing contingent liabilities.

10.The Department has repeatedly failed to comply with long established procedures, denying both Parliament and the Treasury the opportunity to scrutinise the extent to which the taxpayer might be exposed to huge liabilities. The Department is required to seek approval from Treasury and notify Parliament of the existence of contingent liabilities when agreeing a contract. The Department has now drawn our attention to 16 cases going back to 2007 where it had failed to comply with requirements. As a result, in most cases, Parliament has not had the opportunity to scrutinise and raise any objections, even though the taxpayer could be exposed to huge costs. These failures are signs of an organisation with weak internal controls and senior management oversight. We are also surprised that, before we challenged them on the point, the Department had been unaware if there were consequences for the legal status of contracts where it has not complied with due process before entering into them, and that it is unable to quantify the possible exposure in many cases.

Recommendation: The Department must ensure all contingent liabilities are notified properly to the Committee and the Treasury. We expect it to take disciplinary action if this does not happen. We expect the Department to set out clearly the rationale for contingent liabilities in all cases, and to rigorously place a value on the liability involved, wherever possible, working with others as necessary.

23 March 2018