Risk Sharing in Defence Contracts

With the defence budget secured for the next 5 years Ministry of Defence has to guard against suppliers sitting back and padding out their contracts, or so says the Telegraph.

Arms companies are to be warned that the Government’s Budget commitment to boost military spending is not a licence to rip off the Ministry of Defence, which will “not tolerate inefficiency or poor performance”. Defence Secretary Michael Fallon will use a keynote speech on Friday evening at the world’s largest military airshow to fire the warning shot across the bows of some of the UK’s biggest companies. “While the defence budget is now protected, that doesn’t mean going back to padding profit margins through fat government contracts,” Mr Fallon is due to say.

Battle of Britain one minute and telling the defence industry off another, Michael Fallon is certainly having an interesting week.

It goes on to describe how the MoD will expect greater risk sharing;

The Government will expect industry to take on more of the risk involved in future projects, the minister will also warn. This could come in the form of sharing cost over-runs

What makes this interesting is that it is quite obviously a hit piece by the media relations chaps at the MoD in order to shift the blame for any future bad news on major projects on to industry. Looking back at the major projects I posted last week, where there was a distinct lack of green in the traffic light reporting.

And how about this gem from the article;

Building the Navy’s new aircraft carriers was originally budgeted at £3.65bn, though the final figure is now £6.2bn after specification changes by the MoD

Of course, specification changes by the MoD were responsible for some cost increases but the majority were caused by MoD and governmental indecision.

CVF and JCA

Industry is not entirely without guilt but I think the customer has much more influence on cost overruns, as any casual analysis of recent major projects would demonstrate.

The MoD might like to dwell on that.

 

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From Luddite Lodge
From Luddite Lodge
July 17, 2015 8:23 pm

Like changing from Cat and Trap and F35C…

Chris
Editor
Chris
July 17, 2015 9:17 pm

Industry is to take more risk? According to the creator of MOD’s competitive procurement dogma, the risk is already placed upon the contractor as MOD believes that is where it belongs. Well it would, wouldn’t it. Perhaps then MOD intends to add contract clauses that generate profit for MOD should risks materialise, no matter how they are caused or who is responsible? There will be a long queue at the exit made of potential bidders marching away from MOD contracts. What organisation would risk its future on a contract for a dozen aircraft or a hundred vehicles?

confused
confused
July 17, 2015 9:41 pm

I always thought the whole point of the CVF design was that it was supposed to be built ready to switch to CAT Trap in refit as aircraft have 20 year life where as it is expected to last 50Yrs, So why couldn’t they change design BEFORE they built it?

AO
AO
July 18, 2015 5:44 am
Reply to  confused

I may be wrong, but actually adding the kit for CAT is ‘quite’ simple-ish at the desk level … it’s the knock on effects of having this switch – more personnel to operate and maintain it, more stores for spares for the kit, routing power/steam depending on the CAT type to the those parts of the ship, etc. It would be a major ‘refit’ to make the change once construction had started. Also, I believe one large factor in not making the change to CAT was the ability (or not) to change the UK F35 order from B to C model.

Not a Boffin
Not a Boffin
July 18, 2015 6:45 am

Because the cost of doing it is primarily a timing thing.

1. The ship design has sufficient space (both volume and area), weight and stability margin and power margin to accommodate EMALS & EARS. But – that is just the provision of those features and the production of the associated general arrangement drawing to confirm where the systems go, although the power management software does apparently have the functionality to deal with the power fluctuations for EMALS launch shots and EARS recoveries written in.

2. What was not contracted for when the design was approved, was the myriad of detailed design drawings and calculations which cover the local structural detail (seats, brackets, weld procedures, inserts), electrical system design (local cabling, control boxes and their associated compartment arrangement drawings). They weren’t contracted because doing so would have cost time and money, both of which were in short supply and at the time the STOVL jet was still the assumed choice.

3. That’s important because when the option to go for the CTOL deck was looked at, QNLZ was well through build and POW was just starting. In order to avoid nugatory work and cost, you’d have to stop the build process while the design information was generated (probably about a year by the time all drawings are Class approved etc) which means you’ve got some 5-6000 people unable to do much on the ships – scheduling is a big issue, you can’t do some things on a ship in build unless she’s structurally complete, floating etc etc. Who was going to pay the wages of those 5-6000 people while the ships were essentially in hiatus? You’re basically adding several hundred million and at least a years delay into the programme – plus that delta in actually fitting the systems. The ACA weren’t going to be liable and MoD couldn’t afford to be liable, which is why it stopped.

4. That doesn’t mean you can’t do the fit at some future refit. The detailed design work and project planning to add those systems (and remove/change what’s on there at the minute) can be done once the ship is in service and in advance of any refit, which means you can allocate the people and materials to do it cost-effectively.

Repulse
July 18, 2015 8:52 am

I think you can only expect companies to share the risk if there is a commercial upside beyond the specific contract. By this I mean, the company has the opportunity to gain reward from the risk by selling elsewhere. Fundamentalist these significant projects are so tied to UK requirements there is little scope for this.

TrT
TrT
July 18, 2015 12:36 pm

It sounds great in theory, but which risks?
No private concern would, should, or indeed could absorb the risk of the treasury deciding to delay a project by two years, which is effectively what happened to QE, or cutting an order in half, which is what happened to T45, although that had over ran by some 60%, but cancelling 6 drove that up to 100%

And of course, governments are oddly unwilling to push through on shared risk even when its iron clad.
The UK ordered the A400m on a “fixed price” basis, EADS couldn’t meet that price, rather than point out that that was EADS problem and nail them to wall in court, someone made a political decision that being good Europeans was more important than defence.
Im no sure Daves Boot Laces and Phils Fork supplies would get the same treatment….

Theres also the risk of risk.
EADS (as currently owned and financed) quite possibly could have survived the enforcement of the UKs fixed prices, but a lot of smaller firms couldnt, the owners are unlikely to pump more money in, so the MoD ends up owning a stable of small defence suppliers it forced in to administration?

Allan
Allan
July 18, 2015 3:52 pm
Reply to  TrT

“…..but a lot of smaller firms couldn’t, the owners are unlikely to pump more money in, so the MoD ends up owning a stable of small defence suppliers it forced in to administration?”

Or the small firms don’t even bother with MoD work….leaving the field wide open to the, umm, Big Boys and Girls who can take a telling off but won’t get one from the MoD as the MoD will be depending on the Big Boys & Girls to deliver……

…..and surely the Big Boys and Girls wouldn’t then seek to gain an advantage in pricing due to the lack of competition……would they….

Aubrey's Shadow
Aubrey's Shadow
July 18, 2015 4:06 pm

It’s all hot air. As many commentators have said, the big companies will be having a snigger. There is no way that i can see the buyers (military and civilian) in MoD getting the better of professional sellers in this field. And in any event, you just have to look at the big companies’ bottom lines – see many net profits at 10% or more ? The reality is that the procurement process needs to be more realistic from the off, and a sensible account taken of the likely end pricing. 2 carriers for £3.6Bn ? who ever seriously believed that was going to happen apart from the politicians maybe ?

More risk would equal more reward, and I fancy I’d put my prices up at the start if that was forced on my company.

Chris
Editor
Chris
July 18, 2015 4:12 pm

AS – ref putting prices up – I put exactly this argument to MOD; that by making industry hold all risk the contract price includes a large chunk of contingency – in essence MOD is paying the price for rework whether it happens or not. Much more sensible for MOD to keep the risk and pay for rework/other get well activity only when its needed. It would also inject a bit more rigour into the procurement process; rather than the customer holding out for every last drip of capability no matter how affordable it might be, if they were digging in their own pocket a much greater degree of pragmatism would surface.

Opinion3
Opinion3
July 18, 2015 4:50 pm

As many have pointed out risk sharing isn’t exactly straight forward with the limited number of customers and suppliers and domestic capabilities are considered of utmost importance. However where the government could push more risk on the suppliers is to develop their own technologies, products and prototypes using their own funds. Taranis and a new advance trainer jet shouldn’t need government funding because if Bae is serious about staying in the aerobusiness it must invest.

Chris
Editor
Chris
July 18, 2015 5:40 pm

Op3 – yes that is one view. I might suggest an alternate view though. If HMG invests in technologies or products, progress will be faster. Commitment from the customer will draw investment into the project (assuming there is a degree of public knowledge of it) like a flame draws a draft and in doing so burns all the brighter. The win for HMG (and therefore the Taxpayer) is that in funding the project it has at least a proportionate share in the IP and can directly profit from exports. This was the model used in the 50s – except the funded design houses were Gov’t Establishments – when there was a lot of defence export and a lot of spin-off into the broader manufacturing sector. It would be interesting to see what proportion of exports by value was in the defence sector, and what proportion was in directly linked business sectors (shipbuilding, civil aircraft, radar for airports & ships, lorries, radio equipment etc), all of which fed the wealth of the nation. If you demand businesses fund all their own research and prototyping then HMG benefits little (mere duties on sales & profit) from future contracts whether domestic or export, and nothing at all if the investing business is based abroad.

Aubrey's Shadow
Aubrey's Shadow
July 18, 2015 5:43 pm
Reply to  Chris

Chris – agree, but from personal experience, and of course on much smaller contracts, it can all be done very effectively if there is common sense used by the Government buyer, a bit of give and take, mutual respect and an appreciation on both sides of lifetime customer/supplier value. It can be done, but I think it depends on the individuals involved, though admittedly less so as the contracts get bigger. I’d love to know, if anybody else might, how it worked with capital ships such as dreadnoughts a century ago, and how the risk balance worked then…..?

Chris
Editor
Chris
July 18, 2015 6:26 pm

AS – I suspect there was a lot more inherent patriotism in the late Victorian/Edwardian era such that working to help provide defence of the realm would have been considered a duty not to be shirked. And of course there was good profit to be made if the job was done right. These two together would have made a much more cooperative working arrangement than the current structure supports. MOD it seems has adopted the attitude of ‘Master’ in its business arrangements with the industrial ‘Servants’ resulting in very little willingness to cooperate.

Opinion3
Opinion3
July 18, 2015 7:16 pm

. I agree wholeheartedly the Government must invest, and should invest. However, the general sentiment both within Government and indeed on this and other forums is that 1Bn for a T45 is very expensive and we need to go safe with the T26. This sentiment is shared across so many other different projects as well. In the early 1900s warships were designed and not even built. They were technical exercises. Now I have no idea who paid for this, but it helped keep the Navy strong and the industry effective.

Chris
Editor
Chris
July 18, 2015 7:39 pm

Op3 – I suspect the Admiralty played a large part in financing state of the art designs. I note when Churchill became First Lord of the Admiralty he revised the design of the next generation battleships from coal to oil burners, engaged Admiralty minds on the use of military air power and created the Landships Committee that funded and guided the invention of the tank. It strikes me that unless the Admiralty was already instrumental in the funding and direction of R&D these initiatives would not have gained the traction they did.

Aubrey's Shadow
Aubrey's Shadow
July 19, 2015 3:52 pm

I’ve worked as a military hardware user, a civil service buyer (secure radios/surveillance kit) and now as a private sector owner/seller, so have a fairly good perspective I think. Though again, I’d have to qualify that by saying that none of the contracts I’ve dealt with in any capacity have exceeded £10m ea. I do think that much of the project success or otherwise is down to the skill and talent of the purchaser, the relationship that is built, the tone of the dialogue, the leadership (above management…) and the degree of intelligent involvement and physical presence at production. How much relevant and honest information can you get from a few quiet words with off-guard engineers at the coal-face !! The politicians are the black sheep in the mix, and frankly, I think if I had been the seller of T45s and Carriers, I’d have had my PR Department on over-time selling the simple message that government had turned £600m destroyers into £1Bn ones, and similar with the carriers through pissing about with order numbers and delivery schedules. It was a simple message to get out, and they lost the PR on it, when they never needed to, as HMG was not going to penalise them out of spite by buying elsewhere, and administrations come and go anyway.

Ron5
Ron5
July 19, 2015 3:58 pm

Unrealistic budgets cause a lot of the angst. As pointed out above, the original QE budget was ridiculously low. Couldn’t even the dumbest UK politician look at the cost of building a US carrier and ask how could it be 75% cheaper to build an equivalent in the UK? And the T45’s at a billion each? Makes the Arleigh Burkes seem a bargain.

Opinion3
Opinion3
July 19, 2015 10:19 pm

@Ron5

I am not promising that the carriers would have come in on budget but delaying the the build was THE reason for the overspend. Chopping and changing the design also resulted in a later cost, although I believe, this, unlike the Gordon Brown delay, has been fairly well documented and published as an ‘unavoidable’ and outside the Carrier Alliance’s control.

The review and publishing of the carrier being over budget was and remains disingenuous. But it served both Labour and the Conservatives to pass the blame on elsewhere.

Engineer Tom
Engineer Tom
July 20, 2015 10:43 am

There is also the issue that the MOD procurement teams don’t accept the equipment into service, with the RN that often involves having to up the specs from what the procurement teams had agreed, as otherwise the vessel would not be accepted into service.

Slightly Agricultural
Slightly Agricultural
July 20, 2015 2:22 pm
rather than the customer holding out for every last drip of capability no matter how affordable it might be, if they were digging in their own pocket a much greater degree of pragmatism would surface.

That’s supposed to be the idea with the new financial model – the forces have the pot of money and they hand it over to DE&S to buy them things they ask for. Dicking with the requirement directly (and visibly) affects their pot of money and what they can buy with it, the hope being that they’ll stop changing their mind so much.

Only, soon DE&S is going to start billing for their time on a project as well. I’ve said to many people – I hope I’m there with popcorn the first time someone tries to explain to the Army that all the available hours have been used up and work will cease unless more money is forthcoming. Because in my experience that attitude is not one they can comprehend or appreciate!

HMG was not going to penalise them out of spite by buying elsewhere, and administrations come and go anyway.

Tell that to BAE. I’ve heard a lot of rumours that they were never going to be allowed to win the FRES SV contract…

And that HK lost the sharpshooter contract in part to stop them getting cocky.

Orders from on high are not unknown.