Oral evidence: The Defence Materiel Strategy, HC 876-iiWednesday 12 February 2014

Oral evidence, 12 February 2014.

Witnesses

Bernard Gray, Chief of Defence Materiel and Jon Thompson, Permanent Under Secretary, Ministry of Defence, gave evidence.

Chair

Good afternoon. This is a continuation, in a sense, of the evidence session we had in December, and we are most grateful to you both for coming—we do try not to keep our witnesses waiting. We are trying to get our heads around precisely what the new entity is and how it is formed, so we will be asking you lots of questions about that. Mr Gray, may I begin with you? We have a new entity. What is its precise description? It is not a non-departmental body exactly. What is it?

Bernard Gray

It is a non-departmental body. In Managing Public Money, there is a set of descriptions of types of non-departmental public body, which include things such as trading funds, Next Steps agencies and so forth, and there is a classification that in other terms might be called “other” whereby they basically say that if it is none of the above, it can still be a non-departmental public body of a certain description, which is called a bespoke agency.[1]

Chair

A bespoke agency, Mr Thompson?

Jon Thompson

Correct. Managing Public Money was amended by the Treasury in 2013 to give much more flexibility on what kinds of arm’s length body you can create, and this is us exploring that new freedom, which was defined in that new version of Managing Public Money in 2013.

Chair

How will it be better than the present DE&S?

Bernard Gray

The purpose of putting it into this kind of organisation is to give it significant additional freedoms that are not available to the mainstream civil service.

Chair

What freedoms?

Bernard Gray

The freedoms to vary pay for people within the organisation, to vary recruitment policies, and to manage inside a total cost envelope, rather than manage to the grading structures and headcount specifications that exist today.

Chair

Will it enforce any new disciplines?

Bernard Gray

The entity of itself is a sort of permissive thing. It would allow us to do things that enable us then to seek to strengthen particularly some of the specialisms within DE&S where we are short of people, such as engineering, programme management and finance disciplines, which I have spoken about in previous evidence sessions.

Chair

So, it gives freedoms rather than disciplines?

Bernard Gray

I interpreted your word “discipline” to mean a specialisation—the discipline of finance, for example. Is that not the sense in which you mean it?

Chair

Well, it does not force DE&S to do anything in particular then?

Bernard Gray

It creates an entity that allows the DE&S greater management freedoms to do things; DE&S still has to do them.

Chair

Okay.

Jon Thompson

It also enforces, if I might say, one of the three original significant issues in Bernard’s report from 2009—that is: what is the interface between the Department and DE&S as an entity? What it does is force us to work how that interface works into a more commercial arrangement.

Mr Havard

I understand that disciplines can mean different things. You are going to hire and fire people, which is one set of changes that you have to manage; then there are financial accounting processes, how you relate to the market, hard charging and all of that. Are they all included in that broader definition of the different disciplines that you can introduce, and how you relate to international accounting standards, Treasury rules, Yellow Books and whatever?

Bernard Gray

We will have to publish a plan, which then has to be endorsed by the owners council—as with other NDPBs, there would be an owners council, which would probably be chaired by Min DEST.

Jon Thompson

Yes.

Bernard Gray

We have to agree that plan with that council, and also be held to account by Jon for the execution of that plan. They would look to us to put in the hard charging, the clear interface between the front-line commands and ourselves, and then against our work plan consider how we would resource that. To pick a topical example, for some time we have been short of airworthiness engineers—I have made this point before—and Jon might say to us, “What is your plan for addressing that shortfall in aerospace engineers, using the freedoms that you have now got?”

Mr Havard

I understand the stuff about people, but are those other freedoms any different from things that you would have been able to do in the current circumstances? What are the differences? What can you do under a new regime that you could not do under the old one?

Bernard Gray

Yes, they are different. We have been trying to recruit people to disciplines such as airworthiness for a significant period of time—for the past 18 months to two years. Having tried to do that internally, about nine months ago we appointed PwC to help us with external recruitment. They are struggling against that marketplace because we are not paying enough money. We have had a variety of exchanges with central HR at the Ministry of the Defence and more widely about having freedom to pay more money to that group of critical workers that we do not have, and we have been unable to get that freedom agreed because of its potential knock-on consequences for the rest of the system. So what we are seeking to do is draw a boundary around it and to say, “Within this boundary, to get this job done, we recognise that we need to be able to vary terms and conditions in a way that we can’t today.”

Jon Thompson

DE&S will not be able to walk away from it being a central Government body, audited by the National Audit Office. It will not be able to walk away from producing annual accounts in accordance with normal central Government arrangements, or from IFRS. Those things are constant.

Chair

We will come back to several of those questions. You mentioned the owners council. Who will be the owners council?

Jon Thompson

The normal arrangement we have for arm’s length bodies, such as the Hydrographic Office as a trading fund, is that you have an owners council chaired by the relevant Minister, which includes those people who work within the Ministry of Defence who essentially “own” the arm’s length body. In this case, there would be a director general in the Ministry of Defence headquarters who will look after all of our arm’s length bodies: DE&S, the Hydrographic Office, the Defence Support Group, a range of museums and so on. That person would also be on the owners council. We would also expect the chairman, the chief executive and other relevant executives from DE&S to be on the council. The purpose of the owners council is to review the progress of DE&S against the corporate plan, which is agreed in advance of any relevant role, looking at performance in all of its various respects.

Chair

Is it different from the board of DE&S?

Jon Thompson

Yes.

Chair

Then why is job you have just referred to not being done by the board of DE&S?

Jon Thompson

Because we would expect the board of DE&S largely to be non-executive—you may want to come back to that—and to include the executive to focus on the internal running of the organisation and the delivery against its corporate plan. The owners council looks at the performance of DE&S from the perspective of the Ministry of Defence—in other words, looking at longer-term strategy. Is it is delivering what we want it to deliver under the agreement that we reach between us? There will in the end be an agreement also, similar to a trading fund agreement, that specifies how we would work together. So it is looking at it through a slightly different lens: it is looking at the performance from the perspective of the Department, not the internal management of the organisation.

Chair

Is Mr Gray on both?

Jon Thompson

Yes.

Chair

Then how can he look at it from those two completely opposing perspectives?

Bernard Gray

My sense of that would be that, whether I am actually a member of it or asked to attend it might be a question, but the owners council would want to question me about the performance of the organisation. So the principal reason I am there, I think, is in order to provide information to the independent, effectively, representatives of the shareholder. That is a way of thinking about it.

Jon Thompson

This is totally standard practice for arm’s length bodies.

Chair

We will come back to this. How will it help everybody to deliver better capability to the armed forces?

Bernard Gray

“It” meaning the owners council?

Chair

No, sorry. I mean the new entity.

Bernard Gray

The purpose of the new entity is to address the questions that we have discussed here before about having the skills and personnel to be able to get the job done that we need to do, where we are both short in number and in expertise in a whole bunch of areas. Part of the whole point of the materiel strategy—one of three core issues—is to be able to raise our capability to get the job done. This is the vehicle that has been chosen in order to execute that, and therefore we would expect this to improve the performance of the delivery of equipment and reduce the cost of supporting equipment to the armed forces.

John Woodcock

Permanent Secretary, following on from the Secretary of State’s evidence session, may I ask why you think this new model is so much better than the GoCo, given that you were prepared to request a letter of direction if the Secretary of State were to go forward with the GoCo model?

Jon Thompson

Why do I think this is better than a GoCo?

John Woodcock

Yes, so much better that you were prepared to do that.

Jon Thompson

I don’t think those two things are linked. To be clear, the GoCo did not proceed because having received one initial bid, it was our joint view that there was a lack of competitive tension to be able to conclude from initial bid to some final agreement. We agreed that well ahead of the date on which bids were to be received. When we received one bid, we discussed it with the Defence Secretary and we recommended that we stop that competition and therefore we considered alternatives. Work had already been carried out fairly extensively about what all the other alternatives were. Some can relatively easily be dismissed—for example, a trading fund cannot apply to this model because more than 50% of the income does not come from non-MoD sources. So we ended up with recommending a model which provided two of the fundamental three issues which were in Bernard’s original report: first, a stronger interface between DE&S and the Ministry of Defence; and secondly, help Bernard to be able to get the capacity and capability he needs to be able to deal with a task.

John Woodcock

Can I press you on this? Is it really credible for you to say that you were genuinely open-minded about the GoCo right the way through and it was solely the fact that there was a single bidder which made you recommend that it ought to be stopped?

Jon Thompson

The Chairman asked me that at the last meeting I came to in relation to the accounts. I believe my answer at that time was that it was a question of whether we can demonstrate value for money. As the accounting officer and previously the finance director at the Ministry of Defence, it is all about whether we can demonstrate value for money. In our joint opinion, you could not demonstrate that in going down to one bidder; therefore, we had to recommend that it stopped. That is what the data tell you.

John Woodcock

Sure, but it is true that you had quite serious doubts, regardless of whether there was one bidder or two, as to whether the GoCo model could provide the value for money that justified the level of risk that moving to a new model was going to take.

Jon Thompson

It is my view that a GoCo is a model that could conceptually work, if you could run a competition that gave you enough competitive tension to give you the evidence that there was value for money. That remains our advice to the Secretary of State in relation to why he should keep those elements of the Defence Reform Bill, which might give enabling power to the Government at a future date.

John Woodcock

“Conceptually” is rather weak, isn’t it?

Jon Thompson

There are all kinds of good ideas that we want to explore on occasion. It seems to me that what we were trying to do was potentially a world first. I think that is the position that we have taken. We were pushing the boundaries on what a GoCo might be able to do. I do not think that we should shy away from doing something. It was a brave thing to try to explore; it didn’t work, therefore we recommended not doing it.

Chair

Courageous?

Jon Thompson

I would not have gone quite to the “Yes, Minister” statement. It was certainly innovative and we explored it and it did not quite work, and therefore we recommended that it stopped. I do not see anything wrong with that.

Bernard Gray

Can I add something in support of what Jon just said? In September last year when, as is on the public record, I think, we had a Cabinet Office review, KBR dropped out of the competition, taking the number of competitors from three to two over the course of the summer. Over the course of September, broadly speaking, the Cabinet Office reviewed the viability of the conversation. As well as talking to them, Jon and I had a meeting where we discussed our personal opinions about the viability of the competition. We were of the view at that time, with two external bidders and the internal DE&S-plus reference, we had a viable competition; but it was equally our view in that meeting that, if we dropped down to one external bidder, we would not have a viable position. We were clear about the criteria for success in September.

Chair

That is interesting, because it took some time for the Secretary of State to announce that, as a result of dropping down to one bidder, the competition was over. Why was that?

Bernard Gray

There is a variety of issues in that. One issue on which I gave evidence the last time I was here was that the one bid was very attractive.

Chair

You were tempted?

Bernard Gray

I don’t know that one has to put it in emotional terms. You look at it and you say, “Just before I throw this away, is this potentially interesting? Is there enough in it to make us revise our previous view?” We have more data than we had in September—there are 1,200 pages of documentation here. You want to look at it and figure out whether you can deliver that outcome and the saving that is implied by it. We had that debate over a couple of weeks. Before you make a decision of that moment, you might say, “We are pretty clear what the boundary conditions are for success,” yet, with 1,200 pages of documentation, you want to check that your original assumptions are correct before you make a decision.

Jon Thompson

It was certainly worth reading. It supports my view to Mr Woodcock that it was conceptually worth exploring.

Mr Donaldson

Mr Thompson, what steps do you need to take to become a trading entity?

Jon Thompson

There are two fundamental issues that we need to agree about the relationship between the Ministry of Defence and DE&S. One of those is similar to a trading fund agreement and the other is a corporate plan. The agreement sets out between us what our respective roles and responsibilities are and the plan sets out the performance of the entity going forward. Both of those will be required. We are also working on how the governance of the new organisation works both internally and in relation to the owners council. That is a stream of work that needs to be completed. Separately, Bernard is working on the capacity and capability issues—that is not particularly relevant to whether it is a trading entity or not, but you may want to come back to what injection of capacity and capability he needs. And we are in negotiation about potential HR freedoms, which, in my opinion, will be essential in order to operate the organisation in the way we would like to.

Mr Donaldson

Mr Gray, what challenges and risk do you face as the move towards a trading entity goes forward? Can you also advise whether the Comptroller and Auditor General and the National Audit Office will audit the accounts?

Bernard Gray

Taking the second question first, the answer is yes. We remain a part of the Ministry of Defence and we will be audited as part of the Ministry of Defence for those purposes, and we will go the PAC on the equipment plan, as now. So nothing basically changes in relation to the audit and holding-to-account process. As far as the challenges that we face are concerned, apart from the mechanical things that Jon is describing of writing the stuff down and getting it agreed between Government Departments, which is more of a bureaucratic challenge than a business challenge in a way, those are the things that we have to get done. We have to get our business plan together, we have to get the freedoms agreed and so on and so forth. Therefore, in getting the organisation stood up, we have to get over those hurdles, so those are the risks in a sense. As far as the migration of the business is concerned, I think it is a much more straightforward issue, because effectively everybody in the organisation remains as civil servants: they are not being TUPE-ed into a different type of organisation in that sense. We carry on with business as usual in that organisation over this transition at the end of March. Effectively, the business plan we will be creating will be giving effect to a lot of things that we have been trying to do anyway. We will go through how we are going to try to address the skills shortfalls that I have talked about before. We need to stand up our own independent HR organisation and so forth, because that was largely centralised some years ago. There is a set of other challenges. We then need to target everybody around the plan. I see that as a continuation of a journey we are already on, rather than a major transition.

Mr Donaldson

When will you be in a position to deliver a set of annual auditable accounts?

Bernard Gray

In the normal course of business over the year. I do not anticipate us changing the audit schedule that exists today.

Jon Thompson

So it is the summer of 2015. The end of the first trading period will be the end of 2014-15, so it is the summer of 2015.

Bernard Gray

Typically, we put them in three months after the close of the financial year, or thereabouts.

Mr Donaldson

And how confident are you that you will be able to implement hard charging by April 2015?

Bernard Gray

That is a significant piece of work that we have to do. We are confident about it, but there is a lot of work to do. To be clear, if that proves a difficult task—it has been implemented elsewhere in the MoD without it being particularly difficult, at DSTL and other areas for example—we can also run it in a shadow form for a period of time. It is a useful discipline, but it is not absolutely essential to have it on 1 April 2015. If it did not happen for some reason, the business does not stop.

Chair

You say “run it in a shadow form”. The entire entity will be run in a shadow form, according to the MoD evidence given to us recently.

Bernard Gray

My point is only really about the attribution of people’s time, which is what we are talking about here. The hard charging relates to how much of people’s time, in a professional services firm kind of way, goes into particular projects. I think that this is a useful discipline on team size so that customers can understand how much effort is going into any particular team activity, but it is a relatively small proportion of the total. If it was not available for some reason, we would carry on with that in its current form, whereby people’s time is not attributed in that way, so we would be no worse off than we are today. That is my point.

Chair

Okay, I accept that, but going back to running something in a shadow form, how long would you envisage the possibility of running hard charging, to start with, in a shadow form from April 2015?

Bernard Gray

Our plan is not to do that, but to execute it for April 2015. My point is that if, for argument’s sake, the IT development or the systems integration—because it has to sit on DII and there is some complexity in all that—took longer and we ran hard charging in a shadow form for 12 months, that would not be the end of the world.

Chair

Okay. Your answers to our recent questions over the past few weeks have suggested that the entire entity will be run in a shadow form from April 2014 to April 2015.

Bernard Gray

That is correct.

Chair

When was that decided?

Bernard Gray

In December when we made the decision to implement this plan.

Chair

When will the accounts be auditable by the National Audit Office? In other words, will the shadow entity’s accounts be auditable by the National Audit Office in the same way as the full entity’s?

Bernard Gray

Can I draw a distinction between two blocks of money? There is the block of money that is the equipment plan—the new equipment plan, the EPP—and the support plan, the ESP. That totals up to about £14 billion, and that is obviously the bulk of what we spend. That is unaffected by all this, because we are not shadow charging that. The accounting for that exists inside a billing to Navy Command or Air Command today: “Here’s your share of the equipment plan.” The bit we are talking about here is the operating costs of DE&S, which are of the order of £1 billion. That will be audited essentially as it is today, as part of the Ministry of Defence’s overhead in the shadow year, and it would then chop over to the new basis of time charging, if that is available, from 2015. The hard charging question is about attribution of cost, not about the totality of cost, so I see the NAO process as largely undisturbed by all this. The major issue around the equipment plan is invariant through the process: the NAO audits it exactly the same now as it will in future. The form of the accounts for the operating cost will change as we move to hard charging, but again, I do not think that that represents a significant problem for the NAO, which would audit them in the normal frame, whereby we have to submit accounts just after the end of the financial year, and it audits them in the few months thereafter.

Mr Brazier

Could I shift the spotlight to the customer function, which figured prominently in the original Gray report? Mr Thompson, who sits on this new customer board?

Jon Thompson

We would expect it to be essentially the five customers of the organisation: the three front-line commanders, who everyone will be familiar with, plus the joint forces, and we have kept a number of so-called strategic programmes in the head office. I think that the Committee is familiar with the fact that we have delegated the equipment plan down to the four military commands, but we have kept a small number of so-called strategic programmes in head office under the Deputy Chief of the Defence Staff for Military Capability. So you end up with five customers.

Mr Brazier

In the 1960s, the decision was taken to bring them all together with the Department, so that there is always one customer. Mr Gray commented in his report on how complicated the interface was with one. Will this make it easier?

Jon Thompson

No, it potentially makes it more complicated, as it has done with the budget management of the organisation, so we need to be transparent about this. The recommendation of Lord Levene’s report on defence reform was that we should delegate the budget from the head office into the commands, and that is what we have done: we have moved from a financial relationship of one to one to one of five to one. On the back of that, we are, if you like, changing the business relationship to reflect the flow of money. It potentially makes things more complicated.

Mr Brazier

Let’s look at some of the examples from the ’60s of why they put the four organisations together. Let us suppose tomorrow you had, speculatively, a query over a medium-size troop-carrying helicopter. The Army has one solution and the RAF has another solution. Who will pull it together before it goes near Mr Gray to decide who it will belong to?

Jon Thompson

The role of the Deputy Chief of the Defence Staff for Military Capability, working back to back under the Levene model with the director general of finance, is to run the Military Capabilities Board, which is a coherence organisation that looks at the individual plans of the front-line commands, which they have to do annually for a 10-year forecast and make sure they are coherent. He is responsible for making sure that if that scenario were to arise, he resolves the issue himself as a three-star. If he cannot resolve it himself, he now has direct access to the Armed Forces Committee, also created on the back of Lord Levene’s report, which is charged by the Defence Board to resolve those kinds of issues and prioritise defence investment.

Mr Brazier

Who sits on that Committee?

Jon Thompson

On the Armed Forces Committee it is the Chief and the Vice-Chief of the Defence Staff, the four military commanders, Mr Gray and myself.

Mr Brazier

Right. Moving on from the structure of where we are now, how much of this is established and in place? Are the new five-part capability arrangement and the structures you mentioned all in place now?

Jon Thompson

We implemented all of those changes in April 2013. The Armed Forces Committee came into being slightly before that, in late 2012, but we implemented those changes in 2013. We delegated the budget in 2013. The Military Capabilities Board has been running since then.

Mr Brazier

This is perhaps the one question that is for both of you. Has this yet delivered any concrete benefits? Have we seen some changes? There have been hints that there have been fewer changes to the plan and so on. Have any measurable changes taken place in terms of that crucial customer relationship?

Jon Thompson

From my perspective—Bernard will undoubtedly want to add to this—there is much more stability in the equipment plan. We are not seeing the board or the Armed Forces Committee being asked to make the kinds of scales of changes that were being asked for pre-2012 and definitely pre-2010.

Bernard Gray

I agree. When I arrived at the beginning of 2011, still in the outwash of some of those issues coming into the budget setting for 2011-12, the Defence Board, which was the only competent body, in EU-speak, to deal with that, was spending its time going through line items of £5 million and £10 million, arguing about whether we should have this, that or the other thing. The combination of the cuts in the forward programme, which balanced the programme that we went through in the defence review into PR12 and the way in which—to pay tribute to Steve—Air Marshal Hillier ran that central organisation not only meant that the programme was very stable but he exercised significant discipline in avoiding constantly changing our mind. We have not faced the first problem of trying to get a quart into a pint pot. We are getting a pint into a pint pot and Steve has done a very good job of disciplining us to not change our minds about that. My personal observation would be that the chiefs working on the Armed Forces Committee work in a very collegiate and coherent way to come up with a settled view about what the approach to any individual issue is, including under circumstances where there is tension about the allocation of resources. My observation would be both that the Defence Board, the Armed Forces Committee and Steve’s military coherence organisation are working very well.

Mr Brazier

A quick final question: who will chair this owners council?

Jon Thompson

The Minister for Defence Equipment, Support and Technology—Mr Dunne currently.

Mr Gray

I am no sluggard. I have done 17 years in Parliament, I was a civil servant for five years before that and I spent donkeys’ years at university, but I find all of this stuff incredibly byzantine—Schleswig-Holstein incomprehensible, not to put too fine a point on it. I am glad that you don’t. That is why you are here, I suppose. What concerns me is that if someone like me cannot understand it, and therefore nobody else can—

Chair

Does that follow?

Mr Gray

No, that doesn’t follow, Chairman, thank you very much. How on earth is it all going to be accountable? How are you going to be held to account so that we know that the things that you are doing are the right things financially and practically?

Jon Thompson

As I said earlier in relation to Mr Havard’s question, the current arrangements within the Treasury for IFRS and accounting and so on would apply. We have a new set of accounts that defines the organisation that is subject to separate National Audit Office scrutiny. You have an owners council. You now have a definable five-year corporate plan. You have an agreement about how the two entities work together. Some of those pieces of the machinery are new. The primary responsibility within the Department for holding DE&S to account would be with the owners council, but at the entity level, clearly it would be with the chairman and the non-executives of the organisation to hold Bernard to account for the delivery of the performance, too. So there are new methods of accountability in the system that are not there now.

Bernard Gray

Can I have a go at that?

Mr Gray

Please.

Bernard Gray

On the levels of accountability, clearly I would be accountable to the chairman for the running of the organisation. I also still work for Jon, so in routine meetings and in holding-to-account meetings, and into an annual assessment of what we are doing, there would be an accountability into my executive line management, as well as to the chairman. We would be accountable to the owners council. I am assuming that this Committee would want to continue to call me and that I would come.

Mr Gray

You or the chairman, or both?

Bernard Gray

I rather think that’s your choice. For argument’s sake, let us assume that you choose both.

Jon Thompson

The options are for you to choose one or the other, or both.

Bernard Gray

Additionally, although we have not talked about it, I think the proposal is that I would be an additional accounting officer for the purposes of the overheads—£1 billion of DE&S operating costs. In that guise, I would attend the PAC. I attend now anyway, in relation to the equipment plan, but I would also have to attend and account for the operating overheads of DE&S as well.

Mr Gray

But you wouldn’t be the accounting officer for the actual spend; just for the overheads within DE&S.

Bernard Gray

That is correct. Jon is currently the accounting officer for all of it, and I would become, under the way that Managing Public Money works, the accounting officer for the bit for which I am directly responsible, which is the overhead.

Mr Gray

And Ministers? Where do they come in all this?

Bernard Gray

We account to Ministers as and when they ask us. There is a Defence Board every month, where we are accountable to the Secretary of State and we provide a lot of management information that goes into that. If they have particular issues on particular topics, we attend at their pleasure.

Jon Thompson

What the agreement between the Ministry and DE&S in future will do, and the corporate plan, is allow the Minister to have a regular monthly meeting to go through performance as the chairman of the owners council. That is what we would expect. The Minister has now got the actual mechanic of how he holds Bernard and the organisation to account for its performance.

Mr Gray

I really haven’t got the remotest idea of what we are talking about, quite frankly. It seems remarkably confusing. If I cannot understand it, how can the people out there listening understand it? However, hopefully our learned advisers will understand it and they will be able to give us tough questions to ask for next time. That is all I can hope for.

Ms Stuart

The reference to the Schleswig-Holstein question tempts me to ask which one of you is dead, which one is mad and which one has forgotten. I remember that that was the answer to the Schleswig-Holstein question. Occasionally, Committees are faced with witnesses who are not terribly keen to appear in front of them, and then they have to, kind of, coerce them. You say it is our choice. Will there be a stage at which you can provide us with a grid as to where the buck stops when? If you say it is our choice whom we ask to come, that puts us in a position when one or the other does not want to come. Where precisely in the grid does the buck stop? I still do not understand it.

Jon Thompson

We can provide you with a grid.

Ms Stuart

Which actually says what kind of stream of decision making will ultimately end up with which one of you, so that if neither of you, or the Minister, wish to appear in front of the Committee, we know exactly who to pin down.

Jon Thompson

I don’t think that is particularly difficult. We can provide you with a grid to show you who is responsible for what. Chairmen of arm’s length bodies regularly appear before Select Committees with or without chief executives. I am happy to do the grid.

Ms Stuart

No, no. When you make a decision, quite frankly neither of you are terribly comfortable with answering in public. If you are in the position of the Chairman of the Defence Select Committee, and you want to be assertive in demanding who appears in front of us, it would be quite useful to know with whom the buck finally stops.

Chair

I am content with Mr Gray’s answer that we shall decide who we want in front of us, and I think that Mr Gray is content with his answer. Let us move on to John Woodcock.

John Woodcock

Briefly, as a follow-on from that, isn’t there a danger that this relatively more complex accountability structure under the revised organisation will be a brake on progress compared with the relative commercial freedom of a GoCo?

Bernard Gray

I think there are different challenges in the two.

John Woodcock

Yes, but this is one of the challenges of the new organisation.

Bernard Gray

There are always complexities in any change, and there are problems associated with the status quo. You have to look at all the counterfactuals in all those situations and ask what would have happened if you had carried on and didn’t make any changes. On the one hand, you would not have any of the problems of change; on the other hand, I would not have enough airworthiness engineers and others to do the job.

John Woodcock

Forgive me, I was not talking about the process of change, but rather the revised accountability structure once changes are made, which, as you have described, is a relatively complex thing. That must be a danger to manage, compared with the, I presume, relatively greater freedom to operate from a GoCo.

Bernard Gray

I do not see it that way. The Levene process that Jon described is a genuine additional piece of complexity that we have to deal with that is designed to force the individual services to make trade-offs about their priorities within their budgets. That is the thrust of that process, but I do not think that the owners council will be a particularly complex or onerous structure.

Jon Thompson

If your question is whether the accountability systems would be significantly different if we compare and contrast the two models, the answer is no. The GoCo would have created something like an owners council—it would have created a governor function; that is what we envisaged. It would have been an arm’s length body owned by the Government; that is what a GoCo is. Therefore, the accountability arrangements would have been broadly the same.

Chair

Moving on to commercial partners, Madeleine Moon.

Mrs Moon

Mr Gray, can you explain what strategic partners you are seeking from the private sector? Who are you looking for?

Bernard Gray

We are looking for three types of entity or company: first, a programme management organisation, which will give us greater skills in formatting and then managing the complex programmes on our way through; secondly, an IT system set of firms or firm, which will implement some changes to the management information systems—we can talk about that in a bit more detail—and thirdly, an HR-type support organisation, which will be brought in to help us stand up our stand-alone HR function, which at the moment we do not have in house.

Mrs Moon

How will you procure them?

Bernard Gray

We are going to run competitions over the course of the first half of this year, running from about now to about the recess—that kind of time—and we are currently in consultations with the marketplace about the exact form of those packages, how we put those procurements together, how we sequence them, and so on, in order to ensure that we have the best possible competitive opportunities for ourselves when we go to market.

Mrs Moon

How many staff are we talking about?

Bernard Gray

Being provided from the outside?

Mrs Moon

Yes.

Bernard Gray

We have not determined that, so we are looking partly for people to bid to us what they think that the job will be worth. We have some ideas in our mind. It’s not a huge number. I am kind of reluctant to go there, because I don’t want to prejudice the competition in a sense, but I could maybe write to you privately with what our ballpark figure is.

Mrs Moon

I think that would be helpful, because otherwise, if you don’t actually have a figure in your head, they could sell you whatever they want to sell you.

Bernard Gray

I do have figures in my head; I just don’t want to say them.

Mrs Moon

No, no, I appreciate that. I think the Committee is happy with that response; that’s not a problem. How long are these contracts with the three different types of private sector companies? How long will they be for?

Bernard Gray

That is part of what we are consulting about. We imagine at the moment—our central assumption going into this is that we would have an initial period of three years, which might be extendable by one year and then, potentially, another year, so in our jargon, 3 + 1 + 1. That’s our initial assumption. However, they differ in type, I think. We think that the second and third packages—so a package around IT and a package around HR—would actually be a job-and-finish thing. There would be an implementation of some changes and it would then be left with us, and therefore that is a one-shot operation by those people. There is some question about, I guess, updating those systems; but broadly speaking, we think about those as a one-shot. The programme management organisation, I think, is more likely to be an enduring relationship, because we want to make sure that those disciplines are applied to the business on an ongoing basis. So we might well let a contract for that period, but I imagine that the second and third packages would then fall away and the first one might endure.

Mrs Moon

So you are going to procure them in a different order, so, actually, you procure HR first. Is that what you’re saying?

Bernard Gray

No, we will probably procure the programme management company first, but it is possible to run them all in parallel. One possibility, however, is to run the programme management one first and then have a debate with whoever the selected partner is on the programme management side about their views about which of the IT packages were relevant, because there is quite a close interaction between the two, and then there is a choice, which is fairly open to us, about whether to run with the HR package at the beginning or to wait and consult on that.

Mrs Moon

So you consult the project management company on the HR package. I can understand what you are saying about the IT system. I’ve got no problem with that. It just seems a little bizarre to consult people who you employ about the HR package about their employment.

Bernard Gray

No, it is not about their employment. There are a relatively small number, which are actually about, that would sit in there. They are employed under a contract as contractors, so they are not in our structure. What I am concerned about is the part of what is currently DE&S, which is, in scope—ballpark— we’ll call 10,000 people. It’s how do we set up the HR system, grade our organisation, because at the moment it exists on a sort of standard civil service grading structure? That may or may not be the most appropriate way for us to run in future, because we think that it does not sufficiently recognise the specialisms that we’ve got and the market demand for those specialisms. So it’s a moot question at the moment about whether we just determine that in advance and go now, or whether there is any merit in picking the brains of people who in large programme management organisations around the world are doing this all the time. We may get more data from them because we might assume that we do it in this way and they say, “Actually, we tried that, but it turned out that it was better to do it some other way.” It is six and two threes in my mind at the moment about which is the better course.

Mrs Moon

How much preliminary conversation are you having with these sort of contracting companies? Are you already saying, “This is the sort of people we’re looking at.”? How much are you putting the specification in their hands and guidance about what it is you are looking for?

Bernard Gray

Against all three work packages, we have already put out a skeleton structure to the marketplace, and we are consulting on that right now. As I say, for fairly obvious reasons, our main focus is on the programme and project management stream. That is the most important stream. We are in very significant dialogue with about eight companies in that field. We are saying, “This is what’s in our mind.” We are asking them in a variety of ways. We have had industry open days, we have had some questionnaires, and we have had, or are in the process of having, one-on-one meetings with each of the firms where we say what is in our mind, they say what is in their mind and we then try to synthesise a view that drives what we want in the way that will get us the best market response.

Mrs Moon

How willing are contractors to work within the framework agreement for technical support? Are they happy with that?

Bernard Gray

This would not fall under that.

Mrs Moon

It wouldn’t?

Bernard Gray

No. At the moment, people who are already registered under that framework agreement can bid in packages. The procurement method we will use for this is an open competition through the OJEU process. We are not using FATS for this purpose.

Mrs Moon

Okay. On the companies that you are hoping to procure, are you going to be looking for any particular technical expertise in defence procurement and working in that field?

Bernard Gray

What we are really looking for is complex programme management that spans a number of disciplines. We have a lot of expertise in-house on defence issues. What we need is more of the programme management and finance expertise to synthesise the two together. I feel I am short on programme management finance expertise; I do not feel I am short on defence expertise.

Mrs Moon

Is there any nervousness in the private sector about the fact that the GoCo is effectively not dead but just sleeping quietly and could be brought back? Is that of any concern? Will it influence people’s capacity to bid?

Bernard Gray

We have not heard that. My assessment would be that people are looking at the attractiveness or otherwise of this initial 3 + 1 + 1 package, and they are debating that. I have not heard anybody say, “I don’t want three to five years’ work, because something else might happen later”.

Chair

Conversely, is there any nervousness among those who say, “Oh no, we’ve just been through all this”?

Bernard Gray

I think money speaks, and business is business. People want to do business, and we have significant positive engagement from a whole variety of firms about a desire to do work for us.

Chair

Some of whom, presumably, were involved in the GoCo negotiations.

Bernard Gray

That is correct.

Chair

And those who put in a bid might feel that they had a bit of an in, mightn’t they?

Bernard Gray

They might do, and of greater concern to us is that people who didn’t put in a bid feel that they might not have an in.

Chair

How can you reassure them?

Bernard Gray

That is part of the consultation process that we are going through. We need to make sure that we structure this competition in such a way as to minimise both the fact and the perception of that bias.

Chair

But they will say, “Yes, of course he says that.”

Bernard Gray

I appreciate that. We need to do more than that. We are looking at a number of things in order to try to do that—what additional information could we disclose to the market more generally to give everybody a common information baseline, so that they all feel equally well informed? How can I reduce the costs to people of participating in the process? A factor in this is, “Do I feel I’m going to have to invest a lot in the bid process in order to potentially win the work?” Therefore, we consider what we can do that simplifies the competition and makes it more about saying, “Tell me what kind of skills you can provide that would be useful in a complex management system”, rather than “Tell me what you would do with the Navy”. It is about asking them about their skills, not asking them about our problem directly. There is also a question for us—I don’t really want to go into it at this time, but I would be happy to answer questions on it next time I came, or possibly in a note—about how we might structure that competition. We are thinking about ways in which it would be structured that would give people reassurance that there was something worth competing for.

Chair

Another way you could deal with it this time would be to say, “We have led them, Duke of York-like, up the hill, and this time we will pay their bidding costs.” Have you considered that?

Bernard Gray

That has been raised, but I think the Ministry of Defence is reluctant to set a precedent in that direction. I also do not think it will be necessary. I think we can structure something that gets a competition going without going that far, but I am very interested in making sure that we reduce people’s bidding costs as far as possible.

Mr Havard

Can I ask where you are currently? You have put forward an argument that you need project management skills and all that. I understand all that in general. For various reasons, I have had discussions about your organisation with certain individuals in different places in the last few weeks. I understand you currently employ contractors. For example, you have a contract with Capita, I understand. Within that, people from Capita then get work to you and all the rest of it. You have a strange community of people that you have to buy in currently and manage, as I understand it. Could you say something about what that currently costs? It seemed to me from the discussions that the flow of work that goes to these people is not necessarily as predictable as you might like it to be. Therefore you have to buy people and keep them on the books, but they are not 100% productive to you, for various reasons. Would you say something about what that is currently? As you move in transition over the next 12 months, how will that be managed?

Bernard Gray

I think the situation is as you describe. I think Mrs Moon referenced the FATS structure. FATS is one dimension of how we get contractors of the type that you suggest. There are other contracts which are not. This is a framework agreement, so, permit me 30 seconds of Schleswig-Holstein. We are either obliged to run an open competition, which is the kind of thing we would do for these business partners, where we run through a process that can take between four and six months, in a relatively straightforward case, to appoint somebody. We have a bunch of contractors that we appoint on that basis. In order to try to short circuit that for the availability of some things that we know we need on a reasonably regular basis, we effectively pre-qualify quite a few firms who apply. I cannot remember, but I think we run this every two years and say: “Can you pre-qualify to be on this framework?” We are then able to appoint them in a 10-week process rather than a 20 to 30-week process. Taking the FATS, which is the fast track, and the wider body together, there is about £400 million worth of that kind of activity going on annually, and has been going on for a long time inside DE&S.

Mr Havard

And about 1,500 people, I understand.

Bernard Gray

I don’t know the number, but I know the money, so I would not be surprised. One of the points about the freedoms and where we intend to put the boundary, is around our current operating costs, which is largely around our staff and around that £400 million. We then say: “How do we make best use of all that money as a single entity?” Why have we ended up with £400 million worth of work going to outside firms? Part of that is a trend that has been in place for a long time, around trying to squeeze down the number of people inside our organisation. Effectively, we have then ended up with jobs that still needed doing, which we have then bought in as part of an equipment programme. So we will have a programme to buy a vehicle, or whatever it is, and we would appoint outside people who had the skills and increased the number of available people to do particular specialist jobs. Part of what I am trying to do is be able to employ some of those people rather than pay contractors. It would be cheaper for me in some cases if I could actually hire somebody permanently, rather than pay contractors, but I have, until now, been bound not only by the total pay bill but the number of people we can employ. So a significant freedom that we would get is to make or buy decisions about skills. We would probably hire some people and cut our bill by being able to do so, because we would have a total cap on the amount of money we spent, not on the number of people we employ. At one end of the scale, though, there will be some jobs where we just don’t have enough work to have people on staff. We have a few ship architects, for example, but we are probably always going to want to go out to the market for ship architects from time to time, because we have occasional peaks in our work when we are designing a new ship. But, in some other areas of general finance or programme analysis or construction, we could bring that in-house. I would see that the number of people actually being employed inside DE&S as permanent employees is more likely to go up than down and our external consultancy spend would come down.

Mr Havard

Luckily, I speak fluent Schleswig-Holstein—it’s one of the things we do in the valleys.

John Woodcock

Briefly to go back to the Chairman’s line of questioning, you must accept that the damage done to your commercial reputation from the aborted GoCo process will make it harder to drive value from your strategic commercial partners in the revised entity.

Bernard Gray

I do not accept that at all. I do not think that that is a logical conclusion.

John Woodcock

Not logical?

Bernard Gray

Why is that true?

John Woodcock

The very fact that you are considering paying the bidding costs in future suggests—

Bernard Gray

I think I just said that I was not.

Chair

I think he said it was raised.

Bernard Gray

I think people raised it and I said I was not going to do it.

John Woodcock

You know far more about commercial practices than me, of course, but the private sector commercial operators will price in risk and uncertainty. Do you not accept that there is an added level of risk and uncertainty from the way that the GoCo process ended up collapsing that will be priced in and come back to the public sector?

Bernard Gray

No, I do not accept that. My view is that the process that we are going through now of examining what the proposition that we will then put to the market is specifically designed to make sure that we are able to run an effective competition that people are interested in participating in. I am going through, in some detail, with all eight firms—including in the course of this week—what their interests are, what their red lines are, what their concerns are and what our issues are in order to describe a centre of gravity, so that, by the time we launch the competition, we will have something that everybody has confidence in.

John Woodcock

Okay, let me try one last direction on that. One of the reasons that the Secretary of State cited for abandoning the GoCo process was lack of confidence in the financial baselining of the Department. That is quite a stark admission of the Department’s inadequacy, is it not? That is information that is now known, which was not known. Do you not think that the commercial sector will price in that lack of knowledge and that that will come back to us?

Bernard Gray

No, because we are not contracting for the same thing. To take the question in two parts—I think I have described this here before—the GoCo arrangement would have put the private sector in the lead, with the public sector in support. They, therefore, would have been on the hook for the financial performance of the business, so the baseline was incredibly important to them. I will come back to the question of the baseline in a second. This arrangement puts the public sector in the lead, with the support of the private sector. We are asking them to supply us with people, skills, capabilities in particular areas and some organisational ability. There will be a question around driving performance on some parts of their fee, which we are currently discussing with them, but it is not dependent on the baseline in the same way as it was in the previous structure, because it is different. As far as the baseline is concerned, I think, to be clear, the issue is not particularly about what the baseline is around a relatively small margin. The question is, in my understanding, if you contract on that baseline, can you be definitively sure that some deviation from that, if we appear to be saving money, is attributable to the GoCo contractor, or might it either have happened anyway or represent a programme slip, the money for which might have to arise later? I think the problem that Jon perceived from a finance and accounting officer perspective was the second-order effects around the margins, not what the totality of the programme cost. I do not think, therefore, that it is a stunningly bad admission of a lack of understanding on our part. We have a very good track on where the Department’s expenditure is, and I think in the previous Major Projects Report, the one about to be published and in the one after that, you can see a lot of stability in that programme. That is because we have done a lot both to size the programme appropriately and to manage it better.

Jon Thompson

Just to be clear, I agree with all of that.

John Woodcock

That takes us on to earned value management. Given the question about the baseline, what makes you think you are going to have the capacity and the degree of sophistication that earned value management is going to require in DE&S?

Chair

I want to come on to earned value management in a more expanded way, first, to talk through precisely what it means. Your enthusiasm is running away with you.

Sir Bob Russell

Mr Gray, did I hear you correctly when you said that you expected the number of staff to increase and that you would bring in-house some of the work from outside, as it were?

Bernard Gray

I do not definitely know that. In the total balance, I think I can reduce costs by in-sourcing some jobs.

Sir Bob Russell

Of course, that would fly in the face of 30 years of Government policy—Thatcherite, Blairite and the current Government—of outsourcing, and the Prime Minister’s boast that he has reduced the power of the state, with fewer state employees and expansion of the private sector. Does the Secretary of State for Defence agree that there should be a reversal of 30 years of successive Government policy?

Bernard Gray

I don’t think this is a policy question. It is practical question about where money best goes. I am saying that we would make a set of make-or-buy decisions in individual cases about where that work best sits. We are going in both directions. We are saying that, in the case of programme management, we definitely do not have enough of that and probably cannot afford enough of it all in-house, so we are going to buy in some of that from the outside. I am also saying that there are some lower-value routine tasks that currently the headcount control totals oblige us to put outside that we could take inside and get done. I think it will be a mixed market and a more rational basis on which to allocate resources, to have the freedom to say what counts as the money. We will undoubtedly be under some imperative to reduce our costs over time—a discussion yet to be had. We will have some kind of pressure downward on costs and we will have to accommodate the cost of employing business partners and try to rationalise what we are doing, as Mr Havard referred to. Effectively, it is a tactical patchwork quilt of contracting arrangements at the moment. I want that to be rationalised to reduce our costs. One way to reduce costs may be to in-source some jobs.

Sir Bob Russell

The thinking behind my question was not that I agreed with the Government policy of the past 30 years, but the freshness that there is another side to job creation and retention that is not always outsourcing. I just make the observation that this could be the beginning of a new direction after 30 years of outsourcing.

Chair

Thank you very much for that observation. Moving on to Julian Brazier.

Mr Brazier

I have a quick supplementary. With two earlier sets of questions, you mentioned a shortage of finance people. The last time I saw a table, which was several years ago, it showed every single category of employment in procurement. Each of the main technical disciplines, scientific and engineering, had declined. It showed a decline in the number of qualified contract staff. The one thing it showed was a significant increase in the number of finance staff. Could I ask for an updated table? Could you send us a table showing us overall, compared with where were 10 years ago, say, how many you have got in each of the major categories, including finance, within your empire?

Bernard Gray

Within DE&S, I am happy to provide some analysis.

Mr Brazier

Within DE&S, yes, thank you.

Jon Thompson

Obviously, we would encourage more finance staff in the Ministry of Defence, given the challenges that we have got. I would say that as a qualified accountant, wouldn’t I?

Bernard Gray

My observation would be, that whatever trends you might have seen in the numbers—and I don’t know if Jon would agree—that while the position is improving, the level of financial literacy across the Ministry of Defence still leaves something to be desired.

Jon Thompson

This is one of those areas that is a good illustration of what Bernard was talking about. Given what we can pay for certain grades of staff, it is extremely difficult to recruit, and therefore we go down the route of temporary labour. What these flexibilities may allow us to do is to recruit more openly in the open market and employ more people. It is a classic example of that.

Chair

We now come back to the issue of earned value management, which you are bringing into DE&S—you were about to say something, Mr Gray.

Bernard Gray

I was not sure whether Mr Brazier had a substantive question that got lost then.

Mr Brazier

No, that was all I was going to ask. I am slightly surprised, though, that, in terms of losing money in the process, the record keeping end of it, if you like—the financial end of it—is seen as a bigger problem than the absolutely critical shortage of qualified commercial staff who are up against some of the best commercial lawyers in the world.

Bernard Gray

I don’t remember saying that it was a higher priority. I just gave it as a “for instance”.

Chair

I think Mr Brazier may have heard that from Mr Thompson. Let’s move on, shall we?

Bernard Gray

But that was a joke.

Jon Thompson

It was a bad attempt, obviously.

Chair

On earned value management—talking about financial literacy—you are bringing it in to the DE&S. What is it?

Bernard Gray

It is a methodology that is quite widely used inside large programme organisations. To try to simplify into common English, it is used to track how far through a project you are against what percentage of the budget you have spent. It disassembles the project into quite a lot of individual steps and says, “Have we passed this point or that point or the next point?” That tells you how far through you are and then allows you to track that against the amount of money you have spent to understand whether you are on track with the programme.

Chair

And how do you bring it in?

Bernard Gray

Well, we need a number of things. That includes having enough people who understand at the beginning how to work that system, which is a reason for recruiting a programme management company—we have pockets of people who use this, but that is not by any means universal. We need a framework and an agreed way of doing it, because there are a variety of flavours of how people do this behind the basic methodology. We need to adopt a methodology and have enough people inside the organisation who can then start to train the rest of the organisation. We put in place some IT systems and some management information; we adopt a methodology for doing it; we have some people inside the organisation who know how to do it at the strategic level; and then we go through a set of training programmes about implementing it with us and, I have to say, with industry. We are critically dependent on the information we get from industry to be able to populate that system, so if industry can’t do it, we can’t do it.

Chair

You mention putting in place IT systems and financial systems. You will remember from your 2009 report that you said that the IT systems and financial systems simply weren’t there.

Bernard Gray

Yes.

Chair

Are they there now?

Bernard Gray

No, which is why we need work package two to implement them. The core of work package two around the IT systems is to implement both a programme management system and a finance system that will allow us to have much better granularity about all that.

Chair

And when will all that be in place?

Bernard Gray

It is probably a two-year job—something of that order. Perhaps two to three years to have it fully up.

Chair

I think it is time for your question, John Woodcock.

John Woodcock

First of all, as a prelude, as I was asking before, this is just like smart acquisition, from 1998, isn’t it? You don’t have a very good track record with doing that, so why are you going to be able to do this?

Bernard Gray

I don’t think that it is just like smart acquisition in 1998, as somebody who was around at the time. The principal focus there was around the creation of project teams. Prior to that, DE&S had sat in the finance directorate, the engineering directorate and so on and so forth, and that file was passed round. We didn’t have an integrated project team structure. That was changed under smart procurement and, by and large, that change has been very successful, I think. There are some other changes, where, as a result of that, we did not place enough emphasis on functions. So, on Mr Brazier’s comment about engineering and so on, in focusing down on the teams and the delivery of projects right now, we slightly let go—the Department—of managing careers inside those streams. We let it be a free market thing where it allocated itself and there was not much emphasis on the disciplines. One of the things we are dealing with here is putting much more emphasis back on the disciplines. There is also the need for the appropriate separation between the front-line commands and the DE&S as an appropriate boundary. That boundary was eroded over time. I don’t think that there was the same emphasis on trying to get more skills in or particular skills like EVM—

John Woodcock

EVM?

Bernard Gray

Earned value management—and on career development of people. One of the risks in this structure is whether the entity’s freedoms and flexibilities survive over time. Does the Government allow it to continue to exist in that form? We debated this a lot over the last two or three years. One of the attractions of the GoCo is that it puts that body at arm’s length, and therefore there is a contractual boundary which makes it more difficult for the Government to fiddle. We clearly don’t have that under these circumstances. We have other advantages. It is less of a transition, but it requires disciplined behaviour on behalf of the Government not to pull up the plant as soon as it starts to grow. It is a different iteration on from smart procurement.

John Woodcock

And do not the problems that you have acknowledged with the financial baseline beg the question that you will be able to achieve this level of sophistication. Secondly, should you not be focusing on using the extra capacity to sort out the baseline, rather than on this new venture?

Bernard Gray

I do not really see them as distinct activities. The new body is a way of executing the next steps of the plan. Jon and I would say that we have made a significant amount of progress over the last three or four years in sorting out the financial problems of the Ministry of Defence and the programme management problems of the Ministry of Defence. We are now moving to the next step of a journey. We have made significant improvements. That shows in a whole variety of statistics, which we can go into if you want. I think there is strong evidence that the situation has improved. It is our job as managers to move this on to the next level and say, “How can we improve it further?”

Derek Twigg

Mr Thompson, I am trying to get to grips with what happens if something goes wrong and it does not get its trading status in 2015. What review mechanism do you have in place in the Department as the accounting officer? What are those milestones? We have heard about skill shortages and so forth. What is your biggest concern as the accounting officer?

Jon Thompson

Just to be clear about the question: my concerns about the performance of the organisation?

Derek Twigg

About whether it can meet the 2015 deadline.

Jon Thompson

The way in which we have changed the overall governance of this programme since the Defence Secretary made his announcement is that the matériel programme was being run and chaired by Bernard, who under the GoCo model would become the governor, so it was logical that he would have been the architect of that and created the arrangements. Because of the way that this reform is now changing, I have taken over as the chairman of the Acquisition Architecture Board which runs the programme. Bernard leads on the delivery of DE&S and we have introduced other parties in terms of building up the customer and/or running the trading fund agreement and all of that. So every two weeks, I am aware of all of the moving parts of what is going on to deliver this programme over the forthcoming period. From 1 April, we will put in the owners council. Ministers are then involved on what I would regard as being a monthly basis in terms of the conversations I have had. I have plenty of information that is flowing to me on a fortnightly basis and, from 1 April, on a monthly basis.

Derek Twigg

So Ministers will be involved monthly?

Jon Thompson

They will be involved monthly in terms of the setting up of the owners council from April 2014. So there is much more information available to me as the accounting officer about the development and the delivery of the plan that we have agreed and we are working on together.

Derek Twigg

What are the key milestones during the next 12 months from April onwards? You must have a plan that says you expect to achieve X, Y and Z by certain dates.

Jon Thompson

There are key milestones about agreeing a corporate plan and about setting out the agreement and reaching an agreement through a process of clarification and negotiation. There is clearly a milestone about appointing an independent non-executive chair, and that is something that I am leading on myself. Those are all key milestones for us. Appointing the partners is clearly a milestone through 2014. Those are all indications, I think, that we are getting on with the delivery of the Defence Secretary announcements. Those are all key milestones for me.

Derek Twigg

So all of them would have to be delivered, then, to go forward as a trading entity in 2015.

Jon Thompson

I think those are all essential requirements for us to deliver the reform, yes.

Derek Twigg

Yes, we just wanted to be clear on that. You mentioned—maybe Mr Gray could answer as well—the issue around negotiations with the Treasury about freedoms, particularly on pay. I assume you have market-tested the levels of pay that are paid in the private sector, which you may need to go to, to attract people in the organisation. I wonder where you are with those negotiations yet, and are you confident that you will get that sort of freedom?

Jon Thompson

We are not currently negotiating at that level with the Treasury. What we are trying to negotiate with the Treasury is two things: first, a financial envelope in which the Treasury and I can understand what the current cost is of employing staff and temporary labour under the various contracts and—

Derek Twigg

But we do not know that now.

Jon Thompson

No, we do know that now.

Chair

We are just about to come on to that, yes.

Jon Thompson

We do know that and we can define that, and there will be an expectation that that would go down over a period of time, as part the arrangements that we would reach. The second part of the negotiation is about giving us as much freedom, if you like, so the DE&S Board has as much freedom to operate within that envelope as we can negotiate. Let us be frank about it: we are in the space of trying to negotiate as much freedom within that envelope as possible, but with some appropriate controls which we would operate through a remuneration committee of the organisation. I am trying to give the DE&S Board as much freedom to operate within the civil service pay system as we can.

Derek Twigg

Mr Gray, you mentioned before, when we discussed the IT systems, that they are not in place currently, but might take two to three years to get sorted, which were your words. I wonder how that sits with ensuring that the organisation will be fit to go ahead as a trading entity in 2015.

Bernard Gray

We have IT systems in place; they are just not adequate, so it is not true to say that our—

Derek Twigg

But they are not the IT systems you want to be in place.

Bernard Gray

We have financial control systems that are there to make sure that payments that are made are appropriate, and so on. It is a question around financial modelling, so how are we able to estimate and understand where we are in individual programmes and how far through the budgets are, and what risks we are exposed to—in particular, not only within the programme, but then aggregating that up to the portfolio corporate level? So we need to improve on the situation that we have had for a long time. We can only do that as fast as we can do it, and we will do it as fast as we can do it, but if I could wave a magic wand and say, “That’s in place tomorrow,” I would, but it will take a period of time. The important point, which I think I went into a bit before, was around what the trading nature of the entity is that would be dependent on this. The only area which is directly affected by this is: are we taking the cost which we know for the overhead of the organisation—for the cost of the staff and so on—and do we attribute that out to our customer base or not? That is the part that is required for the trading entity to be fully effective as a trading entity, so it is looking at the overhead. That is not the issue that I am talking about, which is around control of the programme. So I need better management information to be able to get better value out of the £14 billion a year programme and that is a period work. The issue around is a much more narrow IT task of time recording and time attribution for the overhead of the business, which would need to be in place before you could fully stand it up as a trading entity.

Mr Havard

On earned value management and all the rest of it, these value management systems have been around for years—McKinsey and others have been making a fortune out of them. I understand what they are for. You want to transition from that to hard charging, which we talked about earlier—or the one helps to inform the other. You have a series of techniques and processes trying to help you with both management information systems and financial information systems, to give you internal knowledge that you can then use to charge and to contract properly with others, but others need to understand what those processes are, so they can properly relate to you. Essentially, that is it, is it not? Can you explain how that works? You are saying that you need computer systems to help you to do it, so the level of sophistication, in terms of your ability to do this at the moment, is not as great as you would like it to be. Why are you doing it the way you are doing it? Would it not be better to concentrate just on improving the existing management information and financial systems? Why are you going down these routes to do it? People understood the old system and they might not understand the new one.

Jon Thompson

I think that there is a significant difference. EVM is to be applied to the £14 billion of the equipment programme, and time recording, hard charging or whatever is to the £1 billion of the cost of running the organisation. There is no obvious and necessary hard link between those two. They are applied to different costs to improve your financial management of the organisation. Does that clarify?

Mr Havard

It does. I think the problem that not only I have, but the public and everybody else has, is that the language gets a little interchangeable. They do not understand that these things with fancy titles have meaning and the meaning is as you described it, rather than something else, and they are not conflated.

Chair

Thank you. Moving on to the issue of freedoms, Madeleine Moon.

Mrs Moon

Forgive me, but I get the impression that the reason we are going down this route is a little bit of what Bob Russell talked about in terms of successive Governments cutting the number of people who work in Government Departments. You add into that a 1% pay freeze in the public sector, so people are jumping ship and going into the private sector, and the nasty suspicion I have is that what we are going to do is buy them back in. Are you going to be keeping a record of how many ex-military staff you re-employ back into the system? I see an awful lot of senior military leaving and entering the private sector. Will you keep track of how many of them are coming back in, just so that in future we can throw parliamentary questions at you and have accurate figures if our suspicions are correct?

Bernard Gray

I am sure our HR recording system will catch that, which will allow us to report on it. Can I push back about whether it is a nasty suspicion or not? In most of the private sector today, there is a work force that moves from time to time. The market flows and people go to work in different places at different times, and nobody thinks that that is a terrible thing. Because most of the skills we have—there are some particular military ones, which we will perhaps come back to—around engineering, finance and programme management are not, generally speaking, needed in big numbers in the wider civil service, we compete heavily for them with the private sector, and we have to be able to trade on terms with the private sector, either to keep or to get those people. We have a lot of tech firms around the Bristol ring road. To my mind, if someone came to work for us for 10 years and then went to work for Airbus for five years and then got promoted and came back to work for us for five or 10 years, I would not think that that was a bad thing. I think that is someone who has developed their career and has gone and made themselves more employable, and we have been able to be attractive as an employer. They are bringing back into us not only the skill that they had, but the expertise that they have from working outside for a period of time. I think that the historical model, where we recruited everybody at 16 or 21, depending on whether they were an apprentice or a graduate, and we gradually got leached out over time—we lost the better people over time—but we never recruited people mid-career, was a bad thing. I think being able to hire people from the outside world, and accept that some people are going to get promoted and get opportunities and leave us for the outside world, is a good thing.

Mrs Moon

A lovely picture, Mr Gray, but on the other hand, what we are doing is taking them in at a young age, paying an awful lot of money to train and educate them and then they get poached by the private sector, which then sells them back to us at an even higher premium. That is happening not only in Whitehall but across local government.

Bernard Gray

I don’t know about local government, but today we are quite a competitive employer at 21. It is when you get to your mid-30s that we become an uncompetitive employer, particularly in specialist skills. At the moment, we are losing people, as we have described on a number of occasions here. I can see how we have hot spots in particular skills where we need more people, because we are not able to be competitive on pay and potentially in career development. Yes, we have mapped that and the more specialist a skill is and the more senior you are, the more we are adrift from the market. We have a map of that. I cannot just rely on a youth training scheme—on developing our own football team in-house—saying, “We just recruit a lot more people at 21 and hang on to them.” We certainly need to make sure that the pay of people inside the organisation in critical skills makes them want to stay rather than leave, and that would be part of us looking at the HR grading structures, but we also have shortages of engineers in senior posts today that we need to fill. I do not have the luxury of taking a purist position, saying, “Oh well, we trained somebody, and they went and worked somewhere for five years. I am definitely not going to employ them, because I am now paying them some higher number than I was when they left.” I need the skills to run the business to drive value—the purpose of this is to drive value in the £14 billion to make sure that the taxpayer and the armed forces get the value that they want.

Jon Thompson

There was a National Audit Office report on precisely the question that you asked and on what Bernard was trying to set out. It was published after Christmas and related to the senior civil service and particularly their skill sets, so there is hard data from the NAO on the issue. I can tell you what it says if you want.

Mrs Moon

Please do.

Jon Thompson

It essentially says that on average, the senior civil service is paid 35% of its market worth, and that the more that you get into specialist skills, particularly finance and commercial skills, the bigger the gap gets. That is a systemic issue across the civil service.

Mrs Moon

Which is why some of us would argue that a flat-rate 1% pay rise across Government Departments is nonsense. But moving on—

Chair

Let’s move on.

Mrs Moon

I am aware that at the moment you have an in-principle agreement with the Treasury on pay and recruitment. When is that actually going to move from being in principle to being a firm agreement? When will you know that?

Jon Thompson

We are in live negotiation every day at the moment. Bernard and I were discussing that only on Monday. We need to bring it to a head fairly soon, to the point where Ministers can have a discussion—presumably between the Defence Secretary and the Chief Secretary to the Treasury. There are ongoing daily negotiations, but they need to be crystallised to the point of what our differences are, if there are any, and that needs to be taken to the relevant Minister so that they can have a discussion about it.

Mrs Moon

But you do not have a timetable for that.

Jon Thompson

We have to be able to do it before 1 April, in my opinion. It is my opinion that we need to bring that to a head, so that Ministers can have a conversation shortly—preferably this month.

Chair

Before the Budget might be sensible?

Jon Thompson

Before the Budget would undoubtedly be sensible, yes. That is where we are.

John Woodcock

Just to follow up from that, can you tell us what you have banked so far, so we can understand how the negotiations are going?

Jon Thompson

Not really.

John Woodcock

I understand that it is a live negotiation, but you will forgive our suspicions—we do not blame you for this—that actually the Treasury may not have given up anything other than principle. We need to know that, given the time scale that there is now, so we can be helpful.

Jon Thompson

One of my desires for trying to bring it to a head—so that we can get the Defence Secretary and Chief Secretary into a room—is so that there can be a political conversation about that issue.

John Woodcock

So you are stuck. They are not giving you anything yet and you need to unblock it at a political level.

Jon Thompson

I don’t think that is entirely true. There is an ongoing negotiation, but in any negotiation you get to the point where you need the two principals in a room. It is our view that we are reaching that point.

John Woodcock

Would it be fair to say that you are frustrated by the level of progress so far?

Jon Thompson

I wish it was quicker, yes.

Ms Stuart

I have a quick question for Mr Gray. My memory may be playing tricks on me, but I seem to recall that several years ago when you came before the Committee one of your greatest concerns was that as there was a set of redundancies across the MOD and a cutting down on employment, you had no control over who went and who stayed.

Bernard Gray

That is not quite true.

Ms Stuart

The real question that that leads on to is: do you feel that the new arrangement gives you the kind of freedom that at that stage you felt that you did not have?

Bernard Gray

The specific situation that we were in was that it was a voluntary scheme, so people chose to apply for it or not. The reason why I do not think it is quite true to say that we had no control over it is that we could choose which applications to go we accepted. People might be in high-skill areas. We kind of had a points ranking system whereby we could say, “Fundamentally, how desirable is this person to us?”, and we would not, broadly speaking, accept people for a voluntary severance package above a certain level of desirability to us, so we did have some control over all that. One of the points that I am trying to make is that the way we are trying to get over this issue in the future is through a carrot rather than a stick approach. I need to make it an attractive place to work from a pay, career progression, flexibility and responsibility point of view to get people in and keep them in.

Ms Stuart

To clarify, up to this point you could say, “No, we won’t give you a severance package because we would like to keep you,” but under the new arrangements you can say, “And we will give you more.” That will be your perfect situation—to end up enticing them to stay.

Bernard Gray

I do not really want to get into negotiation with the whole work force. Conceptually we might, although I am trying to draw a distinction between a redundancy thing and an individual case on a particular day. Probably the way we would work it is to make sure that in the particular skill areas, we are competitive in the marketplace. If we move to a position in which we are competitive in the marketplace, someone says, “Give me another 20% or I’ll leave,” and we feel that we are able to recruit at that level, we might have to say, “Well, we’re terribly sorry. We can’t meet your personal ambitions on this point. If you have a job somewhere else, we wish you well. We think that we can employ people to do this job at this level, which is now competitive whereas it wasn’t before.” I think that is unlikely to happen extensively—there might be the odd individual case, but not extensively a gun-to-the-head negotiation; it would be an attempt to make sure that we were properly found in the first place.

Mrs Moon

Mr Thompson, I have this lovely little video running in my head of you running back and forth across Whitehall between the Ministry of Defence and the Treasury, getting agreement here on this and then having to run across the road to get them to agree to it.

Chair

I thought it was always like that.

Mrs Moon

Indeed. It’s just that now I have Mr Thompson in the video. I will put myself to sleep with this image. Can I just clarify something? Have the Ministry of Defence and the Treasury at least agreed what the overall cost envelope for pay and consultancy is that you will operate on and, if they have, what is it?

Bernard Gray

I think that there is an agreement at ministerial level about what the envelope is. I think that people are still working through the definition of what that means—not quite post by post, but area by area. The translation of that agreement into the practical—“Okay, so this agreement in principle means this exact number of people and this exact set of circumstances”—is part of the ongoing discussion.

Jon Thompson

Just to make this conversation slightly more complicated, I think Ministers have announced that we are also descoping DE&S, so we are removing the naval bases from DE&S to return to the Navy; we are removing the information systems and services organisation to go into the joint forces command; and we are in a market process to outsource the logistics commodities and services organisation. Broadly, between 7,500 and 8,000 staff would come out of DE&S through those processes, so we need to take that into account too, to get down to what would ultimately be a much smaller DE&S.

Chair

Because there is not enough change going on in the MOD as it is.

Jon Thompson

We are attempting to do quite a lot in one go, yes.

Bernard Gray

One of the points I was making in the 2009 report was that DE&S is too large and that the management task is too great and does not allow the senior leadership of the organisation to focus on what really matters to DE&S. At the moment, for largely historical reasons, I am the owner of the naval bases—Portsmouth belongs to me, which is quite gratifying in a way, but a bit odd. I think the First Sea Lord should be responsible for the naval base, and he agrees. At the moment, there is a large engineering community there who work for me, and there is obviously all of the Navy and the ships. From 1 April, the Navy will become responsible for managing the naval bases and their operations, which has been agreed for 12 months or so as a perfectly sensible thing to do. Jon has given additional focus inside the Ministry of Defence to pushing IT issues, and he has appointed a CIO. It has therefore made sense to move ISS, which is effectively our IT department, under her, which allows her to focus full time on IT and stops IT being one of the 12 things that I have to do.

Mrs Moon

Mr Brazier referred to your empire. I hadn’t realised that you are an empire with a navy.

Bernard Gray

For the next six weeks, anyway.

Mrs Moon

I asked how much the cost was. Are you able to share that figure with us? The cost of the envelope.

Sir Bob Russell

Not the back of the envelope.

Mrs Moon

No, not the back of an envelope; the overall operational cost envelope. Do we have a sum? Are you able to share it?

Bernard Gray

Part of the process is that, again for historical reasons, the DE&S has a top-level budget, one of seven top-level budgets inside the MOD. We have that budget today, which is our staff and associated costs, which is something over £1 billion, which we talked about before. Again, largely for historical reasons, some of the costs that are in the DE&S top-level budget do not relate to DE&S, and some of the costs that do relate to DE&S are not in the DE&S top-level budget. When the Ministry of Defence was all one thing, it did not really matter exactly where you accounted for what. Part of the benefit of clarifying all of this is to make sure that by bringing some discipline to that, my budget reflects accurately all the costs of DE&S and that other costs move to the right budgets. In round terms, we have a staff cost of around £1 billion and we have consultancy, FATS and technical support of around £400 million, which today is mostly in the equipment plan. Those are the round numbers, but we have to see the detail as well as the big blocks that Jon has talked about. There is some debate, for example, on how many of the commercial staff sit within DE&S and how many of the commercial staff sit in the front-line commands or in the centre of the Ministry of Defence. That is an ongoing debate, and it needs to be reconciled. The cost of those people therefore needs to be allocated. We are talking about between tens and hundreds of people, but we need to nail that down from within this rough envelope.

Jon Thompson

We would be happy to let you know when it is done.

Mrs Moon

Thank you. We could have got there so much quicker.

Bernard Gray

I am just trying to give you the information that I have.

Mrs Moon

No, what you have given me is how difficult it will be in the future for parliamentary questions to pin down where people have to go for a particular answer. You said that they were going to lose 7,500 people in logistics. Where are they going?

Jon Thompson

Sorry, I said 7,500 by adding three functions together: information systems and services, the naval bases and the logistics commodities and services. Those three functions add up to roughly 7,500. The logistics commodities and services are about 2,500 people.

Bernard Gray

Naval bases are about 2,500, and ISS is about 2,000, or something like that.

Mr Brazier

Where is logistics going, though?

Jon Thompson

We have launched a market process to outsource logistics. We have shortlisted, and the bidding is currently live, I believe.

Mrs Moon

So 7,500 people are going to go into the private sector, and we are going to—

Jon Thompson

No, sorry. Let me be really clear. The naval bases are moving from DE&S to the Navy. There is no privatisation in that move. The information systems and services organisation is moving from DE&S to the joint forces command under the new chief information officer, so that is within the Ministry of Defence. It is only the logistics piece, the 2,500, that is subject to the current outsourcing.

Bernard Gray

And that is largely the storage and distribution activity: logistics, storage and transportation within the UK, currently to Germany and over to other training establishments, like Canada. In the 2010 defence review, the Department decided it did not need to own all that activity but could effectively have that service supplied.

Mrs Moon

So, again, when we ask you questions about the people in these new management consultant companies that you are bringing in, we will be able to pin down how many of those are ex-military? I just want to be clear on that.

Bernard Gray

Yes.

Mrs Moon

Thank you. Finally, in case there is something that we have missed, has the Treasury placed any other constraint on you that we are not aware of now? Is there anything else that you would like to tell us about now that is a constraint from the Treasury?

Jon Thompson

I am not aware that there are new constraints that the Treasury is trying to impose on us. Over and above the current arrangements as set out in Managing Public Money, the framework for public reporting and all the Cabinet Office controls, I am not aware of any new things being put forward. We are trying to remove ourselves from some of those controls, not add new ones.

Chair

Mr Thompson, you said that over time, there would be a reduction in the overall operating cost envelope. Is the logic of that based on the descoping that you are talking about? If not, what is it based on?