Ministry of Defence: Acquisition and support of defence equipment Contents

1Non-competitive procurement of defence equipment

1.On the basis of a Report by the Comptroller and Auditor General we took evidence from the Ministry of Defence (the Department) on what progress it is making in improving the value for money from non-competitive procurement of defence equipment.1

Reducing the amount of single source procurement

2.The Department requires high-quality equipment to fulfil its operational objectives. Since 2012, the government’s stated policy has been to use competition wherever possible in order secure the best value for money. Nevertheless, there are a range of circumstances where there may be only one appropriate supplier.2 The Department told us that in a perfect world all contracts would be competed, but the desire to retain sovereign capability, as well as consolidation within the defence industry, meant that in some cases there were a limited number of suppliers able to provide the sophisticated equipment that was needed by the armed forces.3 Despite the desire for greater competition, the proportion of contracts let competitively has remained largely unchanged for five years at around 50%.4

3.The Department said that it had made significant attempts to develop the competitive landscape in the UK, and there had been a reduction recently in the value (as opposed to the number) of contracts let non-competitively; around 36% over the last three years as opposed to 51% over the last nine.5 It said it had tried to change the mindset within the Department and be more challenging about business cases when they proposed a single source approach.6 Approvals mechanisms within Defence Equipment and Support (DE&S) and, for bigger contracts, in the Department’s Investment Approvals Committee, were designed to challenge any attempts to tailor specifications in ways which could only be met by one supplier. The Department is to set up “pre-sourcing” committees in 2018 to gain a better understanding of the requirements of the services at an earlier stage so that they can be met through competition.7 The Department is concerned that requirements change fundamentally part-way through a procurement, which effectively creates a new requirement, but with a single supplier already tied to the project.8 On a more positive note, the delegation of budgets to the commands as part of the Levene reforms had made the commands far more careful about how they spent their money, and reduced the likelihood of poor value for money decisions.9 The Department said it was also talking to potential suppliers earlier in the process, and considering more widely what the market can offer.10

4.Despite these initiatives, the Department said it did not expect to see a “massive reduction” in the proportion of non-competitive contracts given the continuing consolidation of contractors. It said its priority was to get the right solution, rather than drive down a percentage for the sake of it. It considered that good value for money could be secured in variety of ways, including single source contracts.11 However, the Department recognised that improving how it specified requirements could greatly increase the number of low-value procurements open to competition.12

Scope of the Single Source Contract Regulations

5.In order to secure better value for money from non-competitive procurement, in 2014 the Department introduced the Single Source Contract Regulations (the Regulations). These apply to non-competitive contracts over £5 million and qualifying sub-contracts over £25 million, which are known as Qualifying Defence Contracts.13 The Department said that the regulations were a great improvement on the previous regime established in 1968, and were seen overseas as an innovative regulatory practice.14 The Regulations are leading to increased transparency and improved information for contract managers, and are strengthening the hand of commercial staff in contract negotiations. Some suppliers have been holding out against the Regulations, but DE&S told us that this picture is improving.15 A particular concern is that the SSRO is not getting timely access to the information it needs and to which it is entitled. In particular, senior staff in suppliers are not obliged to provide any assurance that the data supplied are correct. We are pleased that the Department is actively considering how these issues can be remedied.16

6.The Department said it was trying to place high-value contracts under the Regulations as quickly as possible, and still aimed to have 100% of all eligible contracts under the Regulations by 2019–20. The Director General for Commerical at DE&S told us that within that organisation 92 new contracts were eligible and, of these, 90 were now Qualifying Defence Contracts, and two had been exempted for business reasons.17 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’, since this change requires contractors to agree to their incorporation within the regime. Only eight such contracts have been included since the Regulations were introduced in 2014. There is also uncertainty about whether qualifying sub-contracts are being brought within the regime. The Department told us that they are making progress on this.18

Savings achieved

7.One of the main aims of the Regulations is to reduce the cost of procuring equipment. The Department has a target of £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 on which the Committee has commented regularly in the past.19 The Department said it had so far made reductions of £330 million to initial contact prices. The Department told us that it was confident that most of this was genuine cashable savings, rather than simple cost avoidance. On this basis, it had already removed these amounts from the budgets of the projects concerned by mutual agreement. It considered it was on track to deliver the forecast savings and was undertaking work to improve its confidence in tracking and delivering the savings. However, actual savings achieved so far are only £3 million.20 Realisation of further savings will depend on effective management of the contracts over their lifetimes. This in turn will depend on the outcome of efforts to transform DE&S, and the successful recruitment of staff with commercial skills who will manage the contracts. The Department said it was making progress here and DE&S had increased its commercial staffing by 234 in 2016–17, whilst reducing by over 50% its use of external manpower.21

Strength of the regulatory regime

8.The Defence Reform Act 2014 also set up the Single Source Regulations Office (SSRO). It has a number of roles including recommending to the Secretary of State the baseline profit rate for non-competitive contracts each year, issuing guidance on allowable costs and issuing opinions and determinations on issuing arising from contracts.22 The interim Chief Executive of SSRO considered that the organisation had had a successful first three years and created a framework within which there is greater clarity about allowable costs and profit rates. This had helped the Department to make savings and enabled industry to secure a fair return. Although the C&AG’s Report highlighted some tensions in the early days of the SSRO, he said that the organisation had worked hard in the last year to build further its relationships with the Department and industry. For example, it had released more information about its methodology for calculating the profit rate and was consulting more with industry.23

9.The Department said one of the benefits of the way in which the Regulations were framed was the requirement for a statutory review on a regular basis—initially after three years, and then every five years thereafter.24 The SSRO, industry and the Department have made recommendations for changes to the Regulations. The SSRO currently does not have many of the powers of a typical regulator. We heard that the SSRO had made recommendations for powers in several of the areas discussed during our session, including timely access to all the contractual information SSRO needs to carry out its role, and to address the Department’s inability to require the inclusion of eligible amended contracts within the Regulations without the supplier’s agreement.25 In December 2017, the Secretary of State announced that he had completed his review and would make a further announcement “in due course”, which the Department told us is likely to be very soon.26 The Permanent Secretary said he could not pre-empt the decisions of the Secretary of State, but he said it was important that the Regulations could not be undermined.27

Continuing support to British industry and Brexit

10.There are a number of significant procurements to be completed in the coming years. The Department explained that the recent Type 26 frigate contract was the first occasion for a first-in-class ship where it had used a “target cost incentivised framework” approach, rather than contracting on a traditional “cost-plus” basis. It was also trying to move its supply chain away from cost-plus contracts.28 Another imminent procurement is the Mechanised Infantry Vehicle. The Department told us that no final decision had yet been made on who to contract with or on the final specification. At this time, the Department said there remained every opportunity for British suppliers to compete for this contract.29 The Department also commented that it hoped to maintain appropriate diversity within the supply chain, including at the smaller end in the UK. It also did not want to fall into the traps it had in the past whereby large companies in the UK supply chain absorb some of the smaller ones, with the result that the ability to procure competitively is reduced.30

11.We asked the Department whether it thought that the UK had the onshore ability to deliver the needs of the Ministry of Defence and our armed forces in the future, particularly in light of Brexit. The Permanent Secretary said that “Strictly, the answer to that question must be: no, we do not have the ability indigenously to supply all of the equipment that our armed forces need.” He added that it was important to be vigilant as the country left the European Union that UK defence contractors were not disadvantaged in selling their products or entering into international alliances and stressed this was something the Department was intensely aware of and working hard on alongside colleagues across government.31 He said that he did not want to be complacent about relationships that may emerge that disadvantage UK companies in an international environment, with part of the Department’s role being to encourage and help British industry to be successful in this area.32

1 Report by the Comptroller and Auditor General, Improving value for money in non-competitive procurement of defence equipment, Session 2017–2019, HC 412, 25 October 2017

2 C&AG’s Report, paras 1.2–1.4

3 Q 45

4 C&AG’s Report, Figure 3

5 Q 47

6 Q 49

7 Qq 51,53

8 Qq 52, 95

9 Q 52

10 Q 56

11 Qq 60–61

12 Q 53

13 C&AG’s Report, paras 1.9, 4.7, footnote 14

14 Q 69

15 Q 75; C&AG’s Report, paras 6, 4.5

16 Qq 92, 97–99; C&AG’s Report, Figure 8

17 Q 74

18 Q 94; C&AG’s Report, paras 4.6–4.7

19 C&AG’s Report, para 4.16

20 Qq 100–104

21 Qq 108–111; C&AG’s Report, para 4.16

22 C&AG’s Report, para 3.8

23 Qq 78–82, C&AG’s Report, paras 3.10–3.11

24 Q 69

25 Qq 91–92

26 C&AG’s Report, para 3.12, Qq69–71, Ministry of Defence written statement, HCWS351, 14 December 2017

27 Qq 91, 99

28 Q 107

29 Qq 39–41

30 Q 94

31 Q 112

32 Q 113

23 March 2018