PROCUREMENT AND INDUSTRY
1. A central aim of the Strategic Defence Review is to ensure that the Armed Forces are properly equipped. We need to be able to undertake a wide variety of military tasks, from peacekeeping to high intensity conflict. This in turn carries a requirement for equipment that is inherently flexible. Ensuring that the right equipment is available in the right place at the right time is the job of the MOD acquisition staffs. Equipment acquisition is a pan-MOD activity involving the Central Staffs, the Procurement Executive, the Defence Evaluation and Research Agency and the Logistics Commands.
2. Defence procurement has seen significant change over the last few years. New policies, procedures and ways of working have been introduced, such as competition, prime contractorship, pricing non-competitive contracts at the outset and collocation of the various elements of the Procurement Executive near Bristol. These have contributed to a more commercial relationship between the Department as customer and its suppliers. Many projects have run successfully on time and within budget, including the complex Trident submarine and missile programme.
3. Unfortunately, however, annual examination by the National Audit Office (NAO) of the top 25 equipment programmes led them to report that, despite the changes, many major programmes suffer considerable time over-runs. Similarly, after some years of improving cost performance in the 1980s, recent NAO reports have recorded average overall cost over-runs of 7.5%-8.5% above original estimates (excluding Trident and Eurofighter) as shown in FIGURE 1.
 
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4. The main causes of problems are:
- slippage due to technical difficulties, budgetary constraints leading to the postponement of expenditure, the redefinition of requirements and difficulties over collaborative programmes;
- cost over-runs due to programme changes, changes in equipment specification, poor estimating and inflation of prices for defence equipment in excess of inflation in the economy as a whole.
5. Of these, technical difficulties are a major cause of delay. They arise from the complexity of modern defence equipment programmes which make them inherently risky. The current protracted procurement process does not easily provide for the incorporation of technical advances during the final stages of a project. Trying to rectify this by redefining the requirement during the life of the project tends only to bring about further delays and cost increases. Delays arising from collaboration usually occur at the key decision stages, when participating nations have to reconcile their own budgetary constraints and priorities.
6. The Strategic Defence Review offered an opportunity to review the whole of the MOD's current equipment acquisition system, going back to first principles and examining every facet of our acquisition process with open minds. The Parliamentary criticisms formed a basis for this work. By discarding old practices which are no longer appropriate and learning from successful innovation in industry we have identified new ways of working and a new support organisation. As a result we are making radical changes, the most significant since the procurement organisations of the three Armed Services were brought together by the creation of the Procurement Executive in 1972. They will deliver a forward looking organisation using up to date acquisition processes and procedures. The emphasis will be on flexibility, in terms both of processes and organisation, and continuous evaluation to avoid any danger of stagnation.
Smart Procurement
7. In July last year the Defence Secretary directed that the Strategic Defence Review should include a Smart Procurement Initiative. This initiative was a joint exercise with industry, under the auspices of the Defence Industries Council. It focused on processes rather than organisations and, in consultation with industry, produced a package of measures which acknowledges that procurement is a corporate process involving multiple stakeholders, including industry. Central to its findings is a 'Through Life Systems Approach' to procurement, which defines a new equipment or a new capability in the context of its relationship with other equipments and wider defence capability areas. A coherent process for co-ordinating a new equipment's requirement, linkage with the research programme, specification, acceptance and through-life management is a prerequisite for improved equipment acquisition.
8. Smart Procurement means faster, cheaper and better. The key measures identified in the initiative included:
- fuller early planning of projects with appropriate trade-offs between military requirements, time and costs, followed by more rapid, and hence cheaper, full development and production;
- partnering arrangements with industry, particularly where competition is no longer viable;
- exploitation of new procurement techniques including incremental acquisition (where a less ambitious initial capability is upgraded in lower risk steps) to be supported by concurrent engineering processes in industry;
- improved estimating and predicting - integrated through-life cost forecasting utilising three-point estimating techniques should be applied to both time and cost and co-ordinated with the resource allocation and financial provision;
- improved commercial practices - including measures to improve incentives for contractors, use of firm prices not subject to variation for contracts up to five years duration, greater consideration of contractor past performance in tender evaluation, new intellectual property rights conditions and greater use of electronic commerce;
The sum of these measures should be a new relationship between the Ministry of Defence and its suppliers in which both sides can operate to their strengths, under formal partnering arrangements where appropriate, and which provides industry with the greatest incentive to perform. It is through the establishment of such incentives that the customer/supplier relationship can best be improved to mutual advantage.
9. Within the Strategic Defence Review, the Smart Procurement initiative included a fundamental re-examination of the acquisition process for the procurement of equipment for the Armed Forces. It looked at the way in which MOD is organised to conduct that process, and the value that each element of the organisation contributes to it.
10. We analysed how processes in use across the MOD should be adapted to exploit the smart procurement tools and identified a number of organisational models for consideration. The roles of those who identify the requirements, procure the equipment and support it during its life have all been examined to see how any bottlenecks and unnecessary bureaucracy could be eliminated. Industry representatives were included in the mixed teams which carried out the studies. In all, some 22 industry representatives were involved alongside a MOD workforce of 43, together with nine from McKinsey, a firm of consultants.
11. Mixed teams undertook a sequence of studies from which three specific concepts emerged (see FIGURE 2):
- segmenting acquisition processes into three tiers with processes tailored to each; commodity/low risk items; minor projects and major projects (with collaboration as an important sub-set);
- a single integrated project team bringing together all stakeholders and involving industry except during competition phases under the clear leadership of a team leader able to balance trade-offs between performance, cost and time within boundaries set by the approving authority;
- the need to simplify approval processes and identify more precisely within the MOD the customer for the equipment.
Segmented Acquisition Processes
12. McKinsey's work confirmed how varied equipment acquisition has become. Three main categories of procurement were identified (see FIGURE 3), each absorbing roughly one third (£3Bn a year) of total equipment spending:
- Tier I. Items available in the market, often for non-defence application, such as standard vehicles and commodity items; the key characteristic is low technical risk and unit price. Defence items already developed (such as spares/support for existing equipment) are similar, although limited sources pose extra complexity for some of these items;
- Tier II. Defence specific items for which MOD needs to be an intelligent customer, but which are of intermediate scale and technical risk (e.g., a sub-system stand-alone weapon or an upgrade to an existing equipment not involving major systems integration);
- Tier III. The most complex systems, particularly platforms, which also require the integration of Tier I and II equipments and interaction with others. Key characteristics are high unit cost, substantial technical risk and limited sources of supply. Unless purchased off- the-shelf many will only be affordable if developed through an efficient collaborative process.
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Substantial
13. The studies suggested that significantly different processes are appropriate for these tiers. There are some common characteristics: defining military need, source selection, a contract or suitable equivalent; acceptance test; and public accountability. But substantially different depths of skill and breadth of view are needed between the different categories. The allocation to tiers does not judge relative importance: a minor item can be critical to military capability when incorporated in a larger system. It is the segmenting of processes that opens up the possibility of substantial gains. For example, one industry led group looked at simpler procedures for Tier I, such as using credit cards or electronic bidding; whether there is a need for written contracts for smaller items; and the benefits of longer term supply arrangements.
14. Historically, the functions of requirement definition, procurement management and through-life support have been organisationally separated. This has produced arms-length relationships between stakeholders which makes it difficult to get the right balance between time, risk, cost, performance and through-life support. There has also been an inherent optimism in predicting technical risk costs and time-scales. SDR work confirmed the desirability and feasibility from industrial experience of a much more integrated team approach, involving not only staff expert in military needs, technology, procurement and logistics, but also the industrial suppliers (though not during the competition phases). Experience in the US and in industry suggests that such teams can both promote a successful final outcome and offer major improvements in timescale and life-cycle cost. The MOD already has experience of such teams; its Trident team for example. There is however no guarantee of success; much depends on the calibre of the team leader and his/her authority both within the team and when dealing with industry and the customer. In future the leaders of the major project teams will be selected by competition, sometimes including candidates from outside the Department, and serve from four to five years.
Procedures
15. The current process (known as the "Downey" Cycle) aims to control risk by a series of project stages with formal decision points between them. During the Cold War there was pressure for projects to be pushed forward into full development and production quickly so as to meet a specific Soviet threat, even though much risk remained: some ran into technical problems which caused delay. In the changed strategic environment we can take a different approach. More time can be taken for early concept and assessment phases, exploring options and reducing risk by testing technology (typically up to 15% of costs). Those projects that are chosen for full investment in subsequent demonstration and manufacturing phases will be better defined and involve lower risk and are thus more likely to run to planned time and cost. This different project cycle is illustrated in FIGURE 4 below.
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16. The existing approvals committee process will be modified and team leaders and customers will be able to take most decisions (with financial and technical scrutiny) but be held directly accountable for the consequences. Currently, equipment projects are formally approved at each stage in the Downey Cycle and, depending on their value, at a very senior level in the Department. While it is right, in view of the sums of money involved, for projects to be subject to regular scrutiny, the effect of the approvals process itself can be to extend the duration of a project. In future it is envisaged that projects should be subject to formal approvals normally twice only: at initiation, and prior to the main investment. Within such approvals, project team leaders will be empowered to make, and be held accountable for, trade-offs between time, risk, cost and performance. Ministers will continue to have visibility of all major or contentious projects.
Organisational Options
17. Before considering organisational options, the Smart Procurment initiative went back to first principles and considered whether MOD needs to have a specialist procurement organisation or could safely leave the whole task to the private sector. Scope was identified for out-sourcing a larger proportion of the acquisition of routine items (e.g. a catalogue of pre-priced minor IT items and general stores) and specific functions. But it was concluded that for complex projects, MOD (like other managers of large projects) needs to keep core management in- house, while buying in specific skills.
18. Various options were considered by Ministers for ownership of the Procurement Executive. The aim was to achieve greater clarity in customer/supplier relationships within the rest of MOD, and greater flexibility in personnel matters, whilst not reducing scope for personnel interchanges with the rest of MOD.
19. The MOD procurement organisation needs to have a very close relationship with its military customers, capable of bringing together a wide range of interests using the 'single team' approach. While recognising that privatisation provides greater access to private sector expertise and incentives, industry felt it would be hard to reconcile with the single team approach. It was therefore concluded that procurement should remain as an in-house function of the MOD and that our requirements would be met most effectively by turning the Procurement Executive into a Defence Agency and by creating a single, central defence customer in MOD headquarters. Since the Procurement Executive already meets many of the technical requirements of an Agency we hope it will achieve this status by April 1999.
20. The full benefits from these procurement process and organisational changes will take time to materialise, and are not solely financial. One of the principal objectives of these reforms is to prevent time and cost over-runs to ensure that the Armed Forces have the right equipment delivered at the right time and in some instances this will require a greater concentration of expenditure earlier in the procurement cycle. Capabilities may also need to be upgraded more regularly to keep pace with advances in technology.
21. That said, significant and long term benefits are expected not only for the Department as customer but also for our suppliers. These can be summarised as faster, cheaper and better procurement and improved in-service support of equipment with down stream savings in through life costs. For example, initial estimates of potential acquisition cost benefits are in the region of £2Bn. The greatest impact of the reforms will be on procurements which are currently in their early formative stages and therefore most open to change, and the expected benefits will build up progressively as the process and organisational changes are established and applied to existing and new projects. This rolling process of continuous business improvement will need to be carried forward in conjunction with industry and also our major collaborative partners.
Commercial Relationship with Industry
22. Throughout the work on Smart Procurement, the importance of a closer working relationship between MOD and industry has been emphasised. It is seen as a necessary precursor to a more efficient and effective procurement regime. Both sides acknowledged that for many the current relationship was often perceived as adversarial, caused by a lack of mutual understanding and trust.
23. The successful working relationships that have been forged during the Smart Procurement initiative, and which are already in existence in some project areas, will therefore be encouraged, sustained and expanded. This will be done through a number of routes, including: joint training, enhanced interchange programmes, and inclusion of industry representatives on integrated teams.
24. Care will be taken to ensure that closer links with industry are taken forward under clear guidelines that preserve the formal and overarching accountabilities of the Department for the integrity of the procurement process and the protection of public funds.
Making it Happen
25. In order to ensure that the changes are carried through in an efficient and effective manner a range of implementation measures has been agreed. Among the key elements are:
- a full-time implementation team including industry and limited consultancy support. This will not be another unnecessary layer of bureaucracy. Evidence from previous exercises of this kind is that implementation teams stimulate and assist change;
- development of an acquisition stream for both military and civilian staff which would provide core personnel for the Integrated Project Teams. This will be supported by training and personal development and there will be increased interchanges with industry; it should be a two way process with people from industry spending time in MOD;
- close definition and monitoring of processes backed by clear performance measures;
- a continued Ministerial lead.
A Specialist Stream of Acquisition Personnel in MOD
26. Personnel, training and staff development issues were considered as part of the review of the procurement organisation, with the emphasis on the need to support the new proposed processes and Integrated Project Teams. A clear requirement emerged for the formation of a broad Acquisition stream, encompassing military and civilian staff involved in the full spectrum of the defence procurement process, from the earliest stages of requirement formulation to the final disposal of obsolete equipment. It will cover the current operational requirements, procurement management, contracts, finance and logistics functions.
27. Fundamental to the Acquisition stream will be the definition of a comprehensive set of competences. As well as specific professional skills, these will include people skills such as team-working, communications and leadership. In parallel, schemes such as the new post graduate Systems Engineering degree course at Shrivenham, staff development schemes, and interchange and secondment programmes will be developed to support an acquisition career, and equip staff to meet the needs of the new processes and organisations. Much of the training will be undertaken jointly with industry.
Britain's Defence Industrial Base
28. In its Manifesto the Government stated that "we support a strong UK defence industry which is a strategic part of our industrial base as well as our defence effort". The way in which we have involved industry in the Strategic Defence Review demonstrates our commitment to this statement. A strong industrial base underpins a robust defence policy, so the success of both customer and supplier are closely intertwined.
29. Following the Defence Secretary's request for inputs to the Strategic Defence Review in July of last year and after wide consultation within the defence industry, the Defence Industries Council (see Note 1) submitted a paper entitled "Strength Through Partnership" in October 1997. Individual submissions to the Strategic Defence Review were also made directly from companies within the defence sector.
30. Defence export orders have reached over £5Bn per annum. They are beneficial not just to Britain's economy, but directly to the MOD. Savings to MOD through reduced fixed overhead charges resulting from exports amount to some £350M per year. In addition, the MOD also benefits through receipts from Commercial Exploitation Levy payments for the use of products whose development it has funded. These receipts have averaged some £50M per year over the last five years. The competitiveness of the defence sector, proven by its record of success in overseas markets, further helps to demonstrate the efficiency and effectiveness of those who supply and increasingly support our operations in the field.
Industrial Capabilities
31. The MOD is not alone in its recognition of the need to react to changing circumstances. The defence industrial base that supports Britain's military capabilities is also changing in response to both technological and commercial pressures. The traditional distinction between the civil and defence industrial sectors has been eroded by the increasing importance for defence purposes of technologies of civil origin; developments in electronics and information technology illustrate the point, which applies equally to our allies, that we can no longer think in terms of a defence-unique industrial base.
32. At the same time, defence industry and the defence market has become more internationalised, a trend which looks set to go further. Ownership of the defence industry is becoming more multi-national. Such supply-side developments are consistent with the emphasis in our own plans, and those of our partners, on collaborative procurement.
33. These changes are bringing about an increased level of mutual interdependence in the procurement and support of equipment. Neither we, nor our partners retain indigenously the full range of capabilities to which we need access. This more complex industrial setting makes it all the more important to take careful account of the industrial implications of the available options when taking procurement decisions. We remain committed to securing the best value for money, and each procurement decision will therefore be assessed on its merits, with industrial aspects being assessed against a range of defence based criteria. These include maintaining an ability for industry to support military operations and to regenerate critical equipment stocks, as well as other considerations, such as exports, collaboration and sustaining the future scope for competition.
Defence Industry Restructuring
34. With some 40% of output based on exports British companies must remain competitive in world markets to ensure their survival and commercial well being. The need for consolidation in Europe to maintain global competitiveness has been recognised for some time and is increasingly urgent. Our acceptance of this commercial reality is not at odds with our commitment to a strong defence industry; indeed, we see restructuring as an essential part of achieving this objective. Industry must restructure if it is to prosper in the face of competition from the US "defence giants", and if it is to be able to co-operate with the US from a position of strength.
35. The Prime Minister, together with President Chirac and Chancellor Khol, gave fresh impetus to the restructuring process in a trilateral statement which was issued on 9 December 1997. This called on industry to present their plans for industrial restructuring by 31 March 1998. The four Airbus partners (British Aerospace, Aerospatiale, DASA and CASA) responded to this challenge by presenting a joint report on 27 March. This indicates that the companies have reached broad agreement that the target structure should be a single, integrated European Aerospace and Defence Company. We welcome the broad measure of agreement reached.
36. Whilst detailed restructuring plans must be led by industry, we recognise that governments can help to facilitate such developments. As a major customer of the defence industry, we must keep them informed about our future programmes to provide a sound basis for commercial decisions. The Strategic Defence Review has set out to achieve this for Britain. And we can negotiate international agreements to underpin restructuring. In the short term, these include issues such as: security of supply, security of information, export procedures, research and technology funding, and intellectual property rights. These issues are to be addressed within a Letter of Intent which we anticipate will receive Ministerial agreement in July 1998. Italy and Spain have now joined these discussions, and we are proceeding on a five nation basis.
Collaboration
37. International collaboration is of increasing importance to our forward equipment programme. It offers tangible military, economic and industrial benefits and it is essential that the UK remains at the forefront of developments in this area of joint endeavour. We continue to work actively within NATO and with our partners in the Western European Armaments Group, which operates within the framework of the Western European Union, to identify opportunities for collaboration, promote a stronger European Research effort, establish a more open and competitive market for defence equipment in Europe and address many of the difficult issues concerning the European defence technological and industrial base.
38. British membership of Organisme Conjointe de Co-operation en matiére d'Armament (OCCAR), the quadrilateral armament structure with France, Germany and Italy, also presents a real opportunity to establish with our major European partners improved collaborative practices which deliver value for money products able to compete effectively in world markets. Our work on 'Smart Procurement' should be beneficial to such a process. We remain fully committed to the pursuit of common OCCAR objectives - which includes the extension of membership to other states and the establishment of a 'legal personality' - with our current partners.
Conclusion
39. The MOD must procure the equipment the Armed Forces need, when they need it. We must ensure that the Services have equipment which is capable, reliable, and durable. It must be procured in time, and to cost; to do otherwise, as has happened all too often in the past, would be letting down not only our Service men and women, but also the taxpayer. A radical initiative was clearly needed, and has produced a blueprint for a better way of procuring defence equipment. We now have the means at our disposal to ensure that, in future, the Services have the capability they need, and taxpayers the value-for-money they deserve.
Note
1. The Defence Industries Council is the collective term for those individual industrialists and representatives of the four major defence trade associations (the Society of British Aerospace Companies, Defence Manufacturers Association, Federation of the Electronics Industry and British Naval Equipment Association) who represent industry's views on the National Defence Industries Council chaired by the Secretary of State for Defence. This is the primary vehicle through which the MOD consults the defence industries on matters of common interest.
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