Oral evidence: Ministry of Defence Equipment Plan and Major Projects Report 2013, HC 1060Wednesday 12 February 2014

Oral evidence, 24 February 2014.

Witnesses

Jon Thompson, Permanent Secretary, David Williams, Finance Director, Bernard Gray, Chief of Defence Materiel, and Air Marshal Sir Stephen Hillier, Deputy Chief of Defence Staff, Ministry of Defence, gave evidence

Chair

Welcome. This is year two of your new regime at the Ministry of Defence. Some of the top figures look better, but we want to explore underneath them a little bit, at where we see some problems possibly still existing, looking to the future. It is difficult to know where to start. I have done a little section for myself that I’ve called “Savings; Illusion or Reality?”, so it might be worth dealing with those first. If you look at page 13, paragraph 19, of the Report, those are some of the ways in which you have sought to find cash to use elsewhere. I am just wondering how real they are. One, for example, is an accounting adjustment on the A400M, which is half a billion pounds. One is about bringing the cost down simply because you are buying less gear, which of course is a way of bringing down the budget. We welcome that realism, but nevertheless that gives it to you. Then there is another little lot of savings, which are ones that at project level they don’t think exist, but you have pulled them out at departmental level with this Cost Assurance and Analysis Service, which makes me a bit suspicious that they are more figures than reality. It’s a case of “It does feel more in control, but” and the first but is: how real are some of those savings? I have given you those as examples.

Jon Thompson

Okay. I think it’s best if we just pick them up one at a time, if you don’t mind. On the accounting adjustment on the A400M, it’s best to start with David, I think.

David Williams

The A400M example is simply a profiling change as a result of the way in which we treat it in our accounts, but the up-front pressure went through our accounts in 2011-12. It means our forward programme then has less cost pressure in it as a result of us recognising—

Chair

Okay. Can I pause you there? Thank you. I thought that was what it was. Then of course what you get into, which I think will be a feature of our discussion this afternoon, is that if you put it off, inflation is likely to come in or industry costs could well come in and that £400 million figure could quite readily rise. But a reprofiling is not to me a cost saving. I can see it helps you to balance the books in year 1. It is not a cost saving. You would agree with that, wouldn’t you?

David Williams

I would, although in this case we have already taken the cost pressure through our books, so the £400 million has been recognised in our accounts already as a prepayment. The cash payments that relate to that will still go out on the same profile, but they will not hit our budget as—

Chair

What do you mean? You have taken it up, put it in the bank and saved it or something, have you? In simple terms.

David Williams

We took the full £400 million as a charge in 2011-12. Then, as we pay cash out to the Airbus consortium, we reduce the prepayment that we are holding on our balance sheet, so it is not a deferral or reprofiling in the more traditional way that you have set out.

Mr Bacon

When you say you recuse the prepayment on the balance sheet, you mean that having made the prepayment, having, as it were, dented or damaged your balance sheet, you are building it up again bit by bit. Is that what you mean?

David Williams

We reflected the charge on our balance sheet—

Mr Bacon

In 2011-12?

David Williams

As a cost to our programme in ’11-12 that we had to accommodate.

Mr Bacon

I’m just asking you to speak in normal English. You say, “We will recuse the prepayment”. Recusing is something that most people are used to witnesses doing when there is a conflict of interest, but you are talking about recusing prepayments. I am just asking you to translate that into English and, by the bye, I was asking you whether, the dent, the cost and the impact having been recognised, the recusing of the prepayment is the building it back up again—the repairing of the balance sheet? Is that what it means?

David Williams

I’ll just say yes—

Mr Bacon

Well, only if yes is the right answer.

David Williams

It is the right answer.

Chair

Well, you understand it, Richard; I still don’t.

Mr Bacon

Well, I’m not an accountant. I worked in a bank, but I just want to be clear.

Chair

Well, I still don’t understand. You paid the £400 million up front, but you are actually spending it in years 2 and 3. Is that what you are telling me, or is it that you have actually spent it but you are going to pay for it in years 2 and 3? It’s very simple.

David Williams

We are paying the cash out over the next few years, but it has been reflected as a charge in our budgets by the balance sheet adjustment in 2011-12. The cash payments then—

Mr Bacon

Again, in English, you have said that you have spent it although you haven’t actually spent it?

Bernard Gray

We have accrued the expenditure in the balance sheet and the cash flow will flow out in an unchanged manner over the next three years.

Mr Bacon

In other words, I was right the first time—you have said that you have spent it but you haven’t actually spent it. Your answer was, “We’ve committed to spending it.” I could commit to buying a Datsun—well, they don’t make Datsuns any more—or a Toyota in three years’ time, but I haven’t actually bought it or spent the money. You are saying that you have said that you have spent it, but you haven’t actually spent it, and you are going to spend it. That is what it means, isn’t it?

David Williams

Yes.

Bernard Gray

We’ve ring-fenced the money. That’s the point. In your car example, we would have set aside the money to buy the car and then the payments for the car follow in the following years.

Chair

Let me just make a point about that. You have spent it this year. You didn’t want to pay for it this year because you didn’t have it in your budget—although we will come back to the underspend—so you decided that you are going to pay for it in years 2, 3 and 4. But that is pre-empting your resources in years 2, 3 and 4. Why don’t you pay for it as you actually spend it? What is the reason not to pay for it in the year when you have spent it?

Jon Thompson

Well, because managing public money and international financial reporting standards allow you to decouple cash flow—

Chair

Don’t accountancy me. Don’t do it in accountancy terms.

Jon Thompson

I’m sorry. The Comptroller and Auditor General was agreeing with me.

Chair

No. Mr Thompson, answer the question. If you are buying something in year one, why is it that you are then choosing to pay for it in years 2, 3 and 4?

Jon Thompson

In this particular case, the accounting standards allow us to do something that is disconnected from the cash flow. That is all through the 2011-12 accounts, which were signed off.

Chair

But why do it, Mr Thompson?

Jon Thompson

I couldn’t actually answer that particular question.

David Williams

We were able to accommodate the budget hit in 2011-12 within our control data rules as set by the Treasury and the Department. Recognising it early creates financial headroom for us this year and the next couple of years.

Chair

Quite. So I am right when I said—and you shook your head—that it gave you greater flexibility in the year 2011-12, but has committed you and pre-empted your resources in the future years. You have already spent the money, so you are going to have to pay it. You are going to have to give your suppliers cash.

Bernard Gray

It’s the other way around.

Chair

It’s the other way around?

David Williams

It reduced our flexibility in 2011-12 but buys us flexibility back in the future.

Chair

Okay. Do the next one for me.

Jon Thompson

Sorry—did you say you wanted to talk about the cost assurance service?

Chair

I want you to deal with all three issues I raised.

Jon Thompson

I am sorry. What was the middle one?

Chair

It was connected to paragraph 24 on page 14.

Jon Thompson

Well, paragraph 24 on page 14 is the question of the Cost Assurance and Analysis Service.

Chair

Yes. It must be that. Go on.

Jon Thompson

Bernard, do you want to lead on that?

Bernard Gray

The difference between the previous year and the current year’s estimate of the provision that will be required by the cost analysis service relates to three items that you see there, the largest of which is the fact that we made a decision in PR12—so just under two years ago—to exclude some potential programmes from the mainstream equipment plan and to fund and recognise only those programmes that were affordable. Five billion pounds of the potential deficit that is described there related to programmes that we have excluded from the plan. Therefore, they are not relevant, because we have not funded them; any cost increase in them is not relevant because we are not doing them—at least, not at the moment. They would only become relevant if we decided to do them. Sorry—that is the £4.1 billion.

Chair

So it is a saving to the extent that you are not buying certain equipment full stop.

Bernard Gray

Yes. In a reconciliation between the two things, we had previously said that we would need £4 billion to cover off that component. We do not need to cover it off unless we choose to buy it. When we choose to buy it we have to come forward with a realistic cost for it if we choose to proceed. There is £1 billion because, as we roll forward one year in the plan, inflation over the whole 10-year period means that the total size of our budget increases by about £1 billion. If you think about it, we have a 10-year plan that was from 2012-13 to 2021-22 but is now from 2013-14 to 2022-23. Inflation takes the total amount available up by about £1 billion over that period. Five billion pounds is where the teams and the cost assurance service have been able to work together over the intervening 12 months to narrow the gap on what they think a realistic number is. Those are the sources of reduction in the proposals.

Chair

Explain to me why the assurance team has a different view from that of the project level. Give me an example of what that means.

Bernard Gray

To give you a relevant example, which we will doubtless come to later, three years ago the assurance team that was looking at the cost of the aircraft carriers believed that they were going to cost more than the team said. The teams, as we have commented here and elsewhere before, are subject to a systematic bias. They tend to be over-optimistic and not to see all the costs arising, and to be enthusiasts for their subject, whereas the cost assurance service is not subject to any bias in that sense; it is just there to tell us what the score is. There was a gap of about £600 million or so between what the cost assurance service said the carriers were going to cost and what the programme team said the carriers were going to cost. That is why in the middle of 2011 we put aside another £600 million to agree with the CAAS team about what the carriers would cost, which has played out in the negotiations in the intervening period.

Chair

So on the whole the central team tends to put the costs up, not down.

Bernard Gray

If by “the central team” you mean the CAAS team.

Chair

The cost assurance analysis service, or whatever it is, which I assume is the central team.

Bernard Gray

The only quibble I have is over the language. They don’t put it up; they tell us what they think it will cost.

Chair

On the whole, costs go up.

Bernard Gray

No. Typically, they think it will cost more than the teams think it will cost.

Chair

Yes, so the costs go up. Okay. Can I ask you something else on the actual costs? You are assuming a saving of £1 billion on Astute—is that right?

Bernard Gray

No.

Chair

How much are you assuming?

Bernard Gray

It is a relatively small sum.

David Williams

There is SEPP.

Bernard Gray

On the total—

Chair

Astute and Successor.

Bernard Gray

Across the total submarine enterprise, in the defence review in 2010 we assumed a cost saving of not quite £1 billion—£920 million, if I remember.

Chair

Okay. Let me test that assumption a little. The Report is not entirely clear about this, but the figure in the Major Projects Report on page 6, in paragraph 9 says that you saved £26 million in the year that we are talking about. Then there is another figure that talks about yet another of these weird accounting adjustments—I am always suspicious about whether they are real savings or reprofiling. If you look at figure 3 on page 20 of the Major Projects Report, it actually shows an increase in the costs of Astute. You are looking for a saving, but there is a muddled story. There is a bit of money that you have got out—£26 million, on page 6 in paragraph 9—then there is a bit more money that you have got out with an accounting adjustment, which is £72 million, but I wonder whether that is re-profiling. Then the main figure in figure 3 on page 20 of the Major Projects Report shows an increase in the cost.

Bernard Gray

Okay, so to take the last one first, figure 3 on page 20 refers to the historic cost of the first three Astute submarines, which were built between 1996 and about now. That is how much the price of those has changed. The price here reflects the re-baselining of the programme in 2003, if I remember correctly. That is a historic trend of the programme. The SEPP saving that you are talking about in relation to the total submarine enterprise—not just the building of new submarines, but the manufacturing of cores and the refitting of submarines once they are in service and all the associated basing—is assumed to drive out a saving of something over £900 million over the next 10 years. Figure 3 looks backwards over the past 15 years, and the SEPP saving that is assumed looks forward over the next 10. Finally, the smaller amount—about £25 million or £26 million—associates with the change in the cost of the Astute programme itself within the past financial year.

Chair

I understand that. I suppose the question is, how realistic is it that you are going to be able to get £1 billion out of it? Is the only way that you are going to be able to get £1 billion out by having fewer Astute submarines?

Bernard Gray

No, we are working on it significantly by changing the way that we contract with the companies. So far we have driven out about half of that cost. So something over £400 million of the £900 million is what we have achieved—

Chair

Why is that not reflected here?

Bernard Gray

Many of those happened after the end of the last financial year, so they will turn up in the next financial year. Some of it is in there, because if you look at the core production capability issues, that relates to putting in place new submarine core manufacturing in Derby, which we signed off, and that CPC saving is in this Report as an example of that. But the in-principle issue is that we are continuing to work with the three companies involved, Rolls-Royce, BAE Systems and Babcock, to get them to work together to share facilities to drive down the total cost of running the submarine enterprise. That has significant costs in addition to just the manufacturing of the individual submarines; there is a lot of infrastructure there.

Chris Heaton-Harris

I just want to skip back a bit to the cost assurance teams. We were talking about the equipment plan—it was paragraph 25, wasn’t it?

Bernard Gray

24, I think.

Chris Heaton-Harris

Yes. I am more interested in paragraph 25, which says, “Although the cost estimates have converged, there remains a significant risk that the Equipment Plan has been under-costed”. You mentioned the difference between your cost assurance teams and the other teams, and I wondered whether a healthy tension exists between those two teams. Is that something that you build in? Does that build in an over-optimistic costing on projects in the initial team?

Bernard Gray

As far as the first sentence of paragraph 25 is concerned, I think it is somewhat tautological in the sense that it says that if they have been over-optimistic, then the plan is under-costed. So I have some difficulty with that sentence. As to your main point, I think it is a healthy tension, and in fact the 2009 Report and the actions taken by Mr Thompson when he was finance director to increase the capability of the Cost Assurance and Analysis Service—we have invested significantly in that area—have substantially improved its ability to tell truth to power, if you like, in statistical bases as well as saving us significant money in its work on the aircraft carrier programme, which we will probably come to later. I think it is fair to say that there has been an adjustment between the teams, who are sometimes not keen for the full light of day to come on to assumptions they have made, with that full light of day being brought to bear by CAAS. We have all encouraged and tasked CAAS to try to do that. I think that having that robust challenge to the teams is a very healthy thing.

Jon Thompson

There was a review by the National Audit Office in December 2012 on our approval of new projects and the fact that we stopped delaying projects in April 2011—I have previously said this to this Committee. That review did indeed say that that was a more robust approach and that it had the kind of expertise we wanted. We think that having some independent challenge is a good thing for decision makers and also for the setting of the corporate provision, because this question goes to the heart of whether we should have some sort of corporate financial risk provision above the projects. That is also incredibly helpful.

Chair

Chris, I will come in on the same point. It is good to have the corporate central challenge. I do not know how big this team is, but, if you look at paragraph 30, you are really, really weak at the project level. These are just the projects that the NAO looked at—20 procurement cost lines, of which they could not do a couple because you have not decided whether to go ahead. Am I right in that? How many are we talking about?

Lee Summerfield

It is out of 20.

Chair

But the Report says, “In 11 cases, teams were unable to produce the range of costs for their projects, either due to lack of expertise within the team or because the costing techniques were not kept up to date. In 10 cases, teams could not adequately link the risks they had identified to the forecast costs”. Then it says, “We obtained reliable values for these ‘risks outside costing’ in only 13 cases”. And finally, it says, “For our sample, we attempted to find out the total value of these risks and to review why they had been excluded, but only around a quarter of project teams could provide a value supported by a list of risks.” You are sitting here telling us that it is all much tougher and better, yet the evidence suggests that there is one heck of a lot of room for improvement.

Bernard Gray

There are two separate questions. One is: is an independent challenge a useful thing?

Chair

Nobody is arguing with that, Mr Gray.

Bernard Gray

I was asked the question. The second question is: is there room for improvement in the teams? I do not think I would support your statement that it was really, really, really weak. I would say that there is absolutely room for significant improvement. That is the purpose behind my drive to improve the capability of DE&S. I absolutely agree with you about that.

Chair

You are in year three now?

Bernard Gray

Yes.

Chair

How many years have you been there? Is it your third year?

Bernard Gray

Three years, yes.

Chair

So you have done three years and you are entering your fourth year.

Bernard Gray

Yes, and I think we can see significant improvement.

Chair

You are looking at Mr Heaton-Harris—you can look at me when you say that, as well.

Chris Heaton-Harris

Margaret has got nice new lipstick on. I haven’t.

Bernard Gray

Is there a history here?

Chris Heaton-Harris

Don’t go there. I have a couple of points I would like to take up. Paragraph 30 talks about the 11 cases where teams were unable to produce. It also talks about the lack of expertise in the team because costing techniques were not kept up to date. They were the two bits of the sentence that concerned me. Because you have been going at this for a reasonable period of time, I would imagine that you would have identified the weaknesses in those teams probably before your backside hit your seat when you took the role. I wonder why it is still taking so much time to percolate this through the system.

Bernard Gray

Because we need the ability to hire better people than we have the capacity to do today. We need to be able to hire more highly paid people. If you look at where our skills are weak, the more senior people are and the more specialist they are, the more weakness and fragility we have in the system. Our best people get bid away to do the same kind of work, either in the defence industry or the aerospace industry or somewhere else. We are absolutely concerned to ensure that we have the flexibility to recruit the people we need, which is the purpose of the matériel strategy work and the discussions that we are now having with the Treasury to get the freedom we need to recruit the people we want. The problem I have had is that I have had to pay civil service rates that are not fundamentally attractive. To give you a specific example, I have been trying to recruit about 900 people over the past 12 months. Of those general administrative tasks that we have had, we have filled about 90% of the roles; of those needing specific commercial, engineering and project management skills, we have filled about 10% of the roles, fundamentally because our pay is not competitive.

Mr Bacon

What would be establishment, and how many roles are unfilled?

Bernard Gray

Establishment is about 17,000, of which about 800 or so are unfilled.

Mr Bacon

You are talking about within the area you were just describing.

Bernard Gray

The whole of DE&S.

Chair

So you become ever more dependent on your central capacity.

Bernard Gray

No. We have not only had a recruitment campaign running, we are working with colleagues in the Ministry of Defence and in the centre to get us the flexibility to hire the people we need.

Mr Bacon

Can I be clear? I think you said only 10% were filled at one point.

Bernard Gray

Of the vacancies that we had in the three specialisms of engineering, commercial and programme management, such as those needing contract management and supply chain management skills. I can look up, but I have not brought with me, the exact number of vacancies. I can certainly let you have that. That is probably between 300 and 400, taking those three specialisms together. We have filled only about 10% of those vacancies. The principal reason given to us by potential candidates is uncompetitive salary.

Mr Bacon

So there are, as it were, 390—or 370 to 420, or whatever it is—unfilled.

Bernard Gray

That is correct.

Chair

How much have you spent on consultants over the past year or so? Has that bill gone up to fill that gap?

Bernard Gray

If you are talking about the totality of FATS, which is the framework agreement we have, plus other moneys, I think it is about flat. However, the fact that we are spending that much on it is a reflection of the fact that we can’t recruit the skills that we need in-house.

Chair

So you haven’t gone up; you have stayed flat.

Bernard Gray

I honestly can’t remember the number. I would have to come back to you.

Mr Bacon

But if I am a programme manager or a commercial person or engineer and look at the job ads, and I don’t fancy it because the money is not good enough, I go and work for Babcock or BAE Systems or somewhere like that. Babcock or BAE then have to get the money from somewhere with which to pay the higher salary for that individual, don’t they? They get it from the MOD, don’t they?

Bernard Gray

I agree—it is mad. One of the many reasons I have argued that we need to be able to pay people properly is so that we can manage public money better. I absolutely want to improve the quality of the organisation, and I need to be market-competitive to get hold of these people to work for us instead of the companies.

Mr Bacon

You said that you have discussions ongoing with the Treasury on this.

Jon Thompson

Yes.

Mr Bacon

How far advanced are those discussions, and when do you expect them to conclude?

Jon Thompson

We gave evidence to the Defence Committee last week on this issue. We are currently negotiating to put the salary pay bill and the consultants’ pay bill together in one financial envelope and to be given people freedoms in that financial envelope. We are at the point where the two principals—the Chief Secretary to the Treasury and the Secretary of State—need to sit down and discuss what we think is a deal that can be done which would protect public money overall, because you can cap the financial—

Mr Bacon

Yes. I was about to say: you are not asking for more money; you are asking for greater freedom within the envelope.

Jon Thompson

Correct, and we are prepared to commit to an envelope that decreases in real terms.

Mr Bacon

Despite that—I do not want to mischaracterise your discussions with the Treasury—[Interruption.]

Jon Thompson

I will go a reasonable way in this conversation, but—

Mr Bacon

Your proposition that you do not want more money and you are prepared to agree to a real-terms cut, but that you want freedom within it, is one that I would have thought would be hard for a sensible Treasury to disagree with.

Jon Thompson

Obviously we agree with that.

Chair

Is that right? Can we ask the Treasury?

Marius Gallaher

I am aware that there are discussions going on, but I am not sure where we have got on it

Chair

A non-answer.

Marius Gallaher

We would look at all cost-effective mechanisms.

Chair

Mr Thompson, how much are you spending on consultants in the year we are looking at compared with the previous year?

Jon Thompson

On technical support we spent around £400 million.

Chair

And how much did you spend in the previous year?

Jon Thompson

Around £400 million.

Chair

What does technical support exclude?

Jon Thompson

Technical support includes engineering skills and commercial skills. It is not what I would call consultancy, which is about asking someone to give a second opinion and sticking it on the shelf, which I understand is called shelf wear in the trade. It is about getting people with engineering skills or particular commercial skills who can do a job. To give a view of the numbers, the salary payments were around £900 million, with £400 million on technical support, and we are saying that those two should be put together and capped, and that the freedom should be given to us within that financial envelope. It is breaking new ground.

Chris Heaton-Harris

On this point, I can see that the one risk for the Treasury is that you are then entering a bidding war for particularly good individuals that could escalate to an unbelievable extent.

Bernard Gray

Clearly, the Treasury will be concerned about the containment of overall pay within the public sector. I get that. The issue for us is that certainly disproportionately to other Departments, and sometimes completely unlike other Departments, we have people in these areas of engineering and programme management who are in high demand in the private sector as opposed to Whitehall policy folk who tend to be competing with universities for jobs.

Chair

Actually, to be fair, Mr Gray, the same could be said of DECC, the Department for Transport and the Treasury.

Bernard Gray

To a degree, but a significant minority of public servants are in that space. An issue for us is how best to spend money to control the programme. We are acknowledging that we need more skill in this area. To take up an aside from the Comptroller earlier, when we pay these firms for technical support, we pay significant premiums for the cost of hiring the individual. We are talking about something of the order of a 100% mark-up on someone’s time for going out and having them off our books, as it were, but supplying us with services as opposed to having them on the books.

Mr Bacon

To take an example, let’s imagine an engineer with specialist skills in maintaining an aircraft, whether an existing one or a new one that is coming. What salary might be suitable to retain such a person that you cannot offer? I know this is just picking one example, and there is an enormous range, but paint us a picture, with an example, of a person whom you might like to hire, and what it would cost, and the difference between that and what you are allowed to pay them and what they can go and get by being employed elsewhere—and then presumably we double that to get the mark-up that you were referring to.

Bernard Gray

Okay. This is not me trying to be picky, but the person who does the work on the aeroplane is typically a fitter, and the engineer will be the person running the programme. I will give you one specific example that I hope will make the point, and I hope the individual, whom I will not name, will forgive me. We had somebody running our nuclear weapons programme, until about a year ago, who has now gone to work in the private sector, and—I need to be careful, to protect the individual—he went to work for a 50% premium in the private sector, and we would probably, if we were hiring that person in on a day rate, pay a 100% premium on his money. So, therefore, for argument’s sake, that then takes you to three times what we were actually paying that person, and it was a highly skilled person, and we lost them.

Amyas Morse

I can understand the sense in paying a mark-up for renting people; of course skills are maintained and things like that. I just want to ask, if you had access to the skills you need, would that mean you could descale the headcount you need in some of these teams?

Bernard Gray

My first port of call would be to replace the technical services; so in sweating down that—and actually headcount might rise, within our vote, for the reasons that we have just discussed—there is a separate question around the amount of, I am trying to find a better word, but it will have to be bureaucracy, associated with all of the processes that we have to go through around Whitehall. That is significantly time-consuming, and therefore, to a degree, non-value adding in the production of the programmes. I do not know the degree to which we will be able to streamline that, because it is dependent on other people, including the Cabinet Office, whether we will be able to do that. Compared to a company, we certainly experience a significant amount more frictional bureaucracy that we would otherwise, and cutting down on that core is not really about the task, it is about the administration that goes with the task; so I think about it in two parts.

Chris Heaton-Harris

I can understand the point you are making about the point in the Report about it being “due to a lack of expertise”, and you have answered that point completely fairly; but another part of this paragraph is “because the costing techniques were not kept up to date”, and that strikes me as something that you do not need to re-employ a consultant to fix, on three times the salary that you would employ them for. Equally, the point beneath says, “In ten cases, teams could not adequately link the risks they had identified to the forecast costs of their projects.” That does not strike me as something that expertise brings. That strikes me as a bit of a lack of joined-up thinking within the team, more than anything else.

Bernard Gray

I think the way I would characterise it is that things historically have not been done to the level of due diligence that I would expect in a commercial organisation—people are not expected to do tasks to that level, although I personally feel that they should—and that we are on a journey in importing good practice into the team. To a degree people have not in some cases understood, or in some cases agreed with, the need for it. I am not taking their part in that. I am just saying that actually, getting people to understand that it is possible to get to a higher level of assurance about these things, and that it is worth doing because it releases more money for defence and creates more certainty, has been a significant journey, and I do not think we are all the way there yet. In the quarterly budget challenges that people are going through, we still get people coming into those with propositions that they are not able adequately to support. The situation is improving, but I think there is still further to go.

Mr Bacon

To what extent, if that is a phenomenon—the one you have just described, where people are coming into these quarterly reviews, or three-times-a-year reviews, whatever they are, without an adequate ability to defend what they are proposing and what it would cost—are you trying to feed that back collectively to everyone in this community, and saying, “Did you know, we had somebody who came in last week, who couldn’t begin to defend this, this, or this?” You sound like you have got a significant cultural challenge in persuading these people that it matters. What are you doing internally, rather than just in a case-by-case meeting slapping them down and saying, “This is not good enough” and sending them back to the drawing board, so to speak? To what extent are you taking a more holistic approach about trying to educate them all that this is required?

Bernard Gray

I do not personally think that public hangings are a particularly effective instructional tool for these purposes—

Mr Bacon

You would not necessarily have to use a named example in order to make the point, would you?

Bernard Gray

No, but your proposition, albeit illustrative, was that I might. I am just saying that that is not the approach we have taken. We do have meetings of the most senior 30 or so individuals inside the business once a month, where we take a whole day at the Shrivenham defence college and we go through cases of how we have reformulated programmes, how we are working to sweat out the costs in the equipment support plan and a bunch of other initiatives. We have definitely, over the course of the past 12 months, got people to a space where they are comfortable discussing the problem that they had within their area and how they resolved it, and trying to share that good practice in that kind of way. That is the carrot, which says, “We can support you if you are prepared to get on board with doing it in this way.” Then we have the stick, or the back-stop in the quarterly process, which says, “If people come in trying to arm-wave through some cost increase, they run into the finance director and the board.”

Chris Heaton-Harris

So obviously this Report is going to be quite helpful in that, because we are having a public discussion about the sorts of things you are trying to do in cultural change.

Bernard Gray

Sure, and you do not find us resisting that discussion.

Chair

Can I get back to the Astute, because we did not have an answer to that? Can you tell the Committee this afternoon that you are confident that you will be able to sweat out the £1 billion without reducing the number of submarines that you will have to buy?

Bernard Gray

To be clear, it is more than just the Astute; it is the total submarine programme, against which we have the £900 million and change cost target. As I said, we have already got to half of that. The principal area that I am looking to drive on now is in the BAE manufacturing facilities in Barrow. Again, I would say that that was a work in progress. I have been in fairly intense discussions with them since I started, and it is fair to say that I think we are making some headway, but it is still not where I would like it to be.

Chair

Are you telling me that it is too early to express confidence either way? Is that what you are telling me?

Bernard Gray

I am saying that I have got part way to the target and I am continuing to work it. I do not know whether I will get there, and I will not declare victory on that until I have. I am continuing to work the problem. Part of the problem lies outside my control, but I am continuing to work on forcing efficiency into the company, sometimes against their natural tendencies.

Chair

Okay. Can I just ask a more general question? We want to talk about the underspend a little bit. You have got a £1.2 billion underspend, which is despite an over-programming of about £1 billion. In effect, you added things in to try to deal with that underspend. Again, if we look at the way in which you are bringing costs under control, £2 billion-plus on an annual acquisition programme of £14 billion, or whatever it is, is quite a lot. That is the first thing—what does that say about your ability to control expenditure and costs? The second one, which we are all disturbed about, is the assertion in the Report that you do not really understand where the underspend comes from.

Jon Thompson

We ought to clear up that we did not underspend by—you cannot add those two numbers together to get £2 billion. We over-programmed over the amount of money that we had, and then you fall short of that, so you net the two together. It is correct to say that it is £1.2 billion, but you cannot add the other billion of over-programming on.

Bernard Gray

We then spent a billion of that on other things, so it is a net £200 million.

Jon Thompson

To come back to your question, one of the issues here is exactly the question that you are asking about: what exactly is changing in a project. Is it that you have created a genuine efficiency or a cost saving, or has the risk changed? Risks do not necessarily accrue in easy ways in particular financial years, so what exactly has led us to this particular point requires further significant diagnosis. We have some initial diagnosis—again, through the cost assurance and analysis service in KPMG—but that does not give us a satisfactory answer as far as we are concerned, and it requires more work so that we understand whether, if it is a cost that has just slipped, it is going to come up somewhere else in the programme later on. We have some assurance that the overall cost of the programme has not risen on a 10-year basis; nevertheless, it could be that that risk will accrue at the end of a programme in 12, 15 or 20 years’ time. Quite a complicated diagnosis needs to be made. It is one of three reasons that there could be an underspend, as set out in the Report, but we need a clearer diagnosis of what is really happening.

Mr Bacon

You said we have “some assurance”, but surely the whole point is that if you do not, as the Report says in paragraph 26, have a clear view of why the underspend occurred, how can you have assurance about the future?

Jon Thompson

There is a difference between knowing nothing and having a full answer to your question. I am saying that we are somewhere between the two. We had some initial diagnosis, but that does not provide us with a satisfactory answer to answer your question. It could be one of three reasons, and they are set out in the Report. We need to do further work on which of the three it is.

Mr Bacon

But it is rather surprising to a layperson. You have proposals to spend money in a variety of different areas, on a variety of different programmes, and plainly these programmes are complex. For whatever reason—the three reasons set out in the Report are that the Department believes that “it was the result of a combination of factors, including: better than expected outcomes from contract negotiations; budget being allocated for risks that did not materialise; and the impact of programme slippage.” So, better than expected outcomes, risks that did not materialise and slippage—it will be one of those three things. It is just odd—intuitively odd to the layperson—that you have this proposal to spend money, you do not end up spending it and it is not really startlingly obvious, straight away, why you did not. For most people, in business and in their private lives, if they did not spend money, they would know why not, and here are you saying that you have more work to do to understand why you did not spend it. It is a really big concern.

Jon Thompson

We share your concern, but in answer to the previous questions about the accuracy of project costing, when those costs will land in any financial year and what the financial risks are in those projects, there is still further work to do. There is clearly work to do; we are telling you that that is correct. If in any one financial year you have an underspend, your original data is not exactly in the way that you suggest, and therefore it can be for one of those three reasons. The reason why we are hedging around the question is that I cannot sit here and say to you, “We underspent by £1.2 billion. That is £900 million of slippage, £300 million of risk, and there is no genuine underspend”. I cannot—

Mr Bacon

And that is exactly what I would expect you to be able to say.

Jon Thompson

I can’t.

Mr Bacon

For example, for contract negotiations, if a contract negotiation goes better than expected, and you were expecting to spend £100 and you only ended up spending £91, I would expect you to bank or park that £9 on the right in your spreadsheet and do that for each of the programmes. Of course, some of those contract negotiations might have gone less well than expected, but you would add them all up and have a number, so you ought to be able to say to us, “Of the £1.2 billion, £326 million is accounted for by better than expected contract negotiations.”

Bernard Gray

That’s not what we are talking about. Typically, what is happening here is that you have a contract let some time ago that you are part-way through, and in any given year, how much progress does the contractor make on manufacturing a submarine, an aircraft or whatever it may be? To challenge you slightly, there are three problems that we are dealing with here. One is: what is the total cost of a system, summed up for the programme? The second is: how long is it going to take? The third one, in the jargon, is: what is the phasing? When does that cost arise? The third one has not been a focus of the Ministry of Defence for a long time, because it was so badly over-programmed. Everybody was trying to slow down cash flow, so nobody really understood what industry could or could not achieve by the rate of progress in a year, because we kept applying the brake and telling industry to slow down. When we got into this year, we were not telling industry to slow down on projects, and the project teams did not have accurate phasing of their expenditure. So we think that all three of those issues are pertinent, and we are trying to determine the proportion between them. We have to get back into this. Submarines are a classic. “Okay, we spent £100 million in cash less in submarines in-year than we expected to.” Why did that happen? “Well, BAE did £100 million-worth less work than we expected.” Is that because the work that they had completed on that task was under budget, and therefore we had a genuine gain? Is it because they made progress more slowly than expected, and therefore that cost is just deferred and will arise later? Or have we provisioned against a risk of something going wrong, which did not happen in that year, but might or might not in some subsequent year? We have to go through project by project to figure out what industry is actually doing. It is not in the contract negotiation, but in the progress on the work.

Mr Bacon

That is exactly the sort of thing that I expect programme managers and project mangers would be doing. You mentioned phasing. I accept what you say that hitherto what we have been used to is only one direction—it gets shoved to the right, so that the costs go up, because facilities are not used. The classic example is the carrier: £1.56 billion just in the last Parliament, and there has been more since. I think the same happened on the Astute. Even that, however—even the fact that you can nail it at £1.56 billion—presupposes that you understand the exact cost of that delay, the exact cost of that bit of change to the phasing, as it were. You are saying now that it is more complicated, because we are not telling them to put the brakes on; we might even need to tell them to speed up. To have any underlying understanding of what the implications are, you must have—your programme managers must have—an understanding of what the costs of all this activity are.

Bernard Gray

We have an understanding in aggregate of the amount of work that has to be done. The question is, if they do less work in any one year, are they capable of catching up, or is the work unnecessary? There is a technique called earned value management, which we are going to introduce as part of the reforms. It tracks how much activity has happened versus how much of the budget has been consumed. That has not been standard operating practice in the Ministry of Defence hitherto and it is the kind of tool that will allow us to track in the kind of way that you are describing.

Mr Bacon

I carefully said what the costs are, not what the activity is. One hopes that you would be able to do both and to align one with the other. It is deeply concerning, because underlying all this—at the very deep level or, if you like, at the very top level—the narrative underneath sounds as if you do not have as deep an understanding of all this as you need to, although I accept that there has been some improvement and that things have been brought into balance, which is a very good start. You are still some way off that deep understanding.

Chris Heaton-Harris

I have an extra concern—

Bernard Gray

If I may answer that point, we agree that—it is like peeling the layers of the onion—first, we need to get control over the total entity; then we start drilling into, “Okay, what is happening on a year-to-year basis?” and whether we are accumulating any risk later. Until we stabilise the programme, however, it is really impossible to get to that second level of accuracy. We need more skills to be able to do it, which is why we are making the progressive changes that we are making.

Chris Heaton-Harris

I do not have many concerns about being unable to identify where the costs come, because I can kind of understand the pitch you are going to make. My concern is with Mr Gray saying that you have spent £1 billion of the cost savings, while I know that you do not know where they have come from—[Interruption.] Just then, because you said that therefore we have only £200 million—

Bernard Gray

We have bought other things.

Chris Heaton-Harris

You have bought other things, yes, but because you do not know what form this £1.2 billion takes, you do not know—or you cannot tell me—that part of the £1 billion will be needed because the profile of payments will follow later in whatever project it might have been.

Bernard Gray

That is correct, but we manage under an annual cash-flow target from the Treasury, so we could bring forward other requirements that Steve has and buy them earlier, because they are off the shelf and we can make use of that money in that time. What we are effectively doing is reprofiling the order of delivery of the equipment programme.

Jon Thompson

This is also significantly more complicated because in some financial years we have money that is not allocated to some projects in the form of a contingency or a departmental unallocated provision. We also have unprecedented flexibility with the Treasury to have roll-overs between years in terms of EYF, some of which is top-sliced and some of which is not. It gets incredibly complicated, but the heart of the issue here, I think, is that there is a risk for us that unless we fully understand why we are underspending, we do not have full assurance about the cost of the programme going forward. We accept that.

Austin Mitchell

Margaret said that things seem to be under better control, which of course you would expect because you are ordering less and we are now entering a year when, we hope, we are not fighting a war anywhere. It all looks fairly vague and seat-of-the-pants stuff to me, uninitiated into defence spending. Support costs: you have not supplied the independent review that was promised at the session last year. That is over half the spending, so we do not know that the £4.7 billion contingency is going to be adequate. That is a bit seat of the pants. You don’t know, as Richard elicited, why there was an underspend in the year we are dealing with, but you have compensated for that underspend by over-ordering and over-programming, which is a fairly risky business because the costs could escalate and come home to hit you. The Report then says, to add to those two factors, at paragraph 40 that there is a “significant risk that the Equipment Plan has been under-costed”, and that that suggests “over-optimism at project level.” All that is very vague indeed, when we need much tighter costing of what you are doing.

Jon Thompson

We accept that we need to improve project costing, but there are overall controls and flexibility that we built in, so we are not sitting on £38 billion over-programming. We are sitting on just short of £5 billion-worth of contingency and we have not allocated the entire funding available to us, which is to the tune of £8 billion. There is still some flexibility. If there were to be some horrendous situation that blew out of all control, we have some financial flexibility to move. On the question of the equipment support plan—both the Air Marshal and Bernard may want to add something—it does not have the same financial risks as the equipment procurement plan. It has a much more stable financial base. More than 91% of the cost is on contract for something already in service. Over the next few years, that percentage decreases very slowly—it goes 91%, 89%, 85%, 82%—so significant elements of that, if you are already on contract, are stable. Year-on-year, the equipment support provided has only moved by 0.1%.

Austin Mitchell

Why didn’t you provide the NAO with the data from your independent review of support costs?

Chair

There is a phrase in the Report, Mr Thompson, which says—page 18, paragraph 36—that the “support costs consist of a complex and highly variable set of cost lines that the Department understands less well”. I can understand that the variations may be less than they are likely to be in the capital acquisition programme, but the truth is that this is more than half your programme. According to the Report—unless you are going to quarrel with that sentence—you do not really know where your money is going.

Jon Thompson

I dispute that we do not know where our money is going.

Chair

They “consist of a complex and highly variable set of cost lines that the Department understands less well”.

Jon Thompson

Correct, but that is not what you said. I am sorry, but you said that we did not know where it was going. I dispute that.

Chair

The “understands less well” means that you do not know where it is going.

Jon Thompson

I dispute that. We do know where it is going: 91% of it is on contract, and if you want to go for all that, that is not the point that Mr Summerfield made.

Chair

It might be in a contract, but that does not mean you know where it is going.

Lee Summerfield

May I intervene very briefly? At the NAO, we have seen nothing in terms of the support costs and the work that CAAS has been doing over the past six months or so in relation to the support costs. We were hoping to have that in this Report. We have not had it. We have been promised it for our next engagement, so we should be able to report on it. I think we are probably talking from slightly different perspectives here. We have not seen the support cost element of the work, but I think colleagues here have.

Air Marshal Sir Stephen Hillier

From my perspective, we understand where the money is going, but we think that money could work better for us than it is at the moment. It is about getting more efficient equipment support. The initial work that we have done so far—and we have been at this for the best part of a year to 18 months now—confirms that we can take a significant amount of money, which we can either then use to reinvest or to deal with wider departmental financial challenges. We know where it goes; we just think we can make it work better for us than it does.

Bernard Gray

If I can add, the reason that we can see it is more stable is that the cost of flying a Typhoon this year is very similar to the cost of flying one last year and so on for Type 45s or Challenger tanks or anything else. It is a much more stable thing. You don’t have the same financial risks as you have in the new equipment programme that could treble in cost. We have tackled the problems from the most volatile and most threatening to the defence budget first. Having made significant inroads, with further to go, on the new equipment procurement plan, we turned our attention about 12 months ago to trying to improve performance in the equipment support plan. It is basically stable and therefore it does not present a financial risk. One of the reasons that we are less concerned about it than this Report implies is that we do not think that there is a major risk of some dramatic excursion that could make the programme unaffordable. However, as Steve says, we are trying to ensure that, having got a better grip on the new equipment plan, we drive better value out of the equipment support maintenance area. There are two strands of activity associated with that. The first, which Steve and I started about 12 months ago, is driving down the cost of some of our highest profile programmes, which we will report on in the course of the next Report. The second is the work that CAAS have been doing on the ESP. That work is a first for them. In their near-100-year history they have always focused on new equipment purchase and they have not focused on equipment support. We directed them to do that about 18 months ago, but we suspended the work part way through last year in order to focus their effort on delivering the aircraft carrier renegotiation. We needed those people to do the detailed work. So we paused that work in order to conclude the aircraft carrier project, which is why it is late, and we have then put them back on it. We have not seen, any more than Mr Summerfield has, the results of that work.

Amyas Morse

Before we leave, I would quickly like to mention two things. One is to say that it worth noting—I think I am right in saying this to the defence team—that it should be put on the record that it is likely that next year you will also have an underspend and a plan-over programme to compensate. Is that about right? So that we do not have this next year and when we come along next we are going to have the same situation?

Chair

Will you understand it next year?

Jon Thompson

We have taken on board in this hearing that there is still plenty to do in this area to improve, and that is one of them.

Amyas Morse

I am not trying to be critical. I am just trying to say something. This year we have had a discussion about underspend and using the money for other things. It is quite likely that we will have a similar discussion next year. Is that right?

Jon Thompson

Sure.

Bernard Gray

A smaller number.

Amyas Morse

Right. Okay, good. May I ask one question about support costs? Support costs are linked to equipment activity, aren’t they? In other words, one of the ways that you can control support costs is by flying fewer sorties or by not going to sea as much. Are you concerned that that sort of thing has been happening? Are you getting consistent use of it? It is only all stable if you are using the equipment on a stable basis and not using reduced sortie time as a way of economising on support costs.

Air Marshal Sir Stephen Hillier

We are not seeing that at the moment. It would be the biggest concern of the front-line commands if that were happening. That, for me, puts an extra premium on getting this equipment support review done properly, so that we take the money out in a way that allows the front-line commands to continue doing what they need to do, just doing them in a more efficient way.

Bernard Gray

One observation I would make about that is that we get a demand signal from the front-line commands that says how much activity they want to do. They usually do not conduct that amount of activity, which is mostly training, as you say. Therefore we have to try to manage—it shows up classically in ammunition—how much ammunition we provide, for example, because quite a lot of it gets returned unused. One of the things we are trying to improve in the new delegated model is to make sure that commands are accurately forecasting how much activity they want to do. Typically, it is not us cutting back; it is commands conducting less activity than they predicted before the start of the financial year.

Jackie Doyle-Price

I want to come back to the discussion that you were having with Chris earlier about your ability to purchase and reward appropriate skills within the Department. It seems to me that unless we get this injection of the right skills, we will continue to have this problem; and I would say you are preaching to the converted in that regard. It is certainly my view, having been on this Committee for the number of years that I have, that we are drifting towards a model that is increasingly engaging with the private sector to buy services, but we still have a culture that is rewarding policy rather than those skills. Having said that, I really want to satisfy myself that what you are saying is for real and not just an excuse. I just want to ask a few questions about the internal behaviours in the Department. For your civil servants, do you still have annual increments that are automatic?

Jon Thompson

No, we withdrew that some years ago.

Jackie Doyle-Price

Right. Do you have the ability to reward performance within those envelopes?

Jon Thompson

We do. We significantly changed our performance management system, so that in 2011-12, 98.4% of the staff got a bonus, if you like, which seems an incredibly large amount to me. We changed the policy, so that figure is now 25%. We kept the amount of money broadly the same, so you can get a bonus of approaching 10% for performance.

Jackie Doyle-Price

So you have used what flexibility you have within the system to encourage good performance.

Jon Thompson

Yes.

Jackie Doyle-Price

I have to say that 98.4% is the kind of figure that headline writers out there would get very excited about, but actually it is about rewarding the right behaviours. Of course, there is another element to reward, which is pensions, and it remains the case that public sector pensions are extremely generous compared with their private sector counterparts. In the example that you mentioned, Mr Gray, you said that the private sector employer would have had to inflate pay by 50%. To what extent was that a recruitment figure, and to what extent would that factor in buying out that pension provision?

Bernard Gray

I obviously cannot speak to the motivations in the individual concern, but what I can say is that some of the areas where we are short, which we have been trying to recruit in, are things like airworthiness engineers, nuclear engineers and negotiators for our contracts. Notwithstanding the fact that we want additional freedom, we have been trying very hard to recruit these people and put a significant amount of effort in. We have played up, as much as we can, the advantages of working for us, which have included not only the pension point but relative employment security compared with the private sector. All I can tell you is that most people are not buyers of that proposition. Statistically, we are not recruiting the people in the key skill areas. I can get general administrators, but I cannot get airworthiness engineers.

Jon Thompson

I think the comparison Mr Gray has given you is one of salary as opposed to the whole cost of employment. Clearly if we were to show the whole cost of employment of somebody, the employer’s contribution at 35% or whatever for the civil service pension would add significantly to the cost. It is a salary-to-salary comparison, but there are other factors. The NAO produced a Report on reward in the senior civil service not so long ago, and I suppose what we are doing here is bringing that report to life with some very specific examples.

Jackie Doyle-Price

Do you have the flexibility to recruit people on fixed-term contracts that can then be inflated?

Jon Thompson

We currently have the ability to recruit people on fixed-term contracts.

Jackie Doyle-Price

But is that still within the civil service pay bands, or can you add a premium to that?

Jon Thompson

We have—off the top of my head, the last time I checked—five members of the senior civil service who are on fixed-term appointments with salaries that were pushing right at the boundaries of the civil service pay grades, so right at the top, not at the bottom.

Chair

Five out of?

Jon Thompson

Senior civil service—approaching 300.

Jackie Doyle-Price

So when they come to the end of their contracts, basically there is nowhere for them to go within the organisation, because of the limits to the—

Bernard Gray

They are hired for a job, really.

Jackie Doyle-Price

You mentioned that you are having discussions with the Treasury about this, but what discussions have you had with the Cabinet Office? This really goes to the heart of what we need to do to make Whitehall work in the future.

Jon Thompson

It is a three-way conversation. Clearly, the civil service human resources policy is largely driven from the Cabinet Office, but pay policy is with the Treasury, so you have to have a three-party conversation. Some of the controls are about not just pay, but process and so on, so you have to get into a conversation with the Cabinet Office. We have been transparent with both the Cabinet Office and the Treasury about the negotiations.

Q68Jackie Doyle-Price

Some of the skills that you have referred to are peculiar to the MOD and the industry, but there is a skills deficit across Whitehall for the wider commercial ones, such as project management. Is there any thought about what more can be done to home-grow those skills within the civil service?

Jon Thompson

We are doing that. We have a significant graduate intake and apprentice intake for the 18-plus level. At that age, we are a reasonably competitive employer. Our problem comes with people in their 30s. Civil service pay has been frozen, so there is no annual increment. If people are promoted within a job, they are then stuck on the entry-level grade for that job. There is relatively little inflation uplift, and there is no annual increment, so people in the senior civil service, broadly speaking, have been stuck on the same salary for the past five years. A particular problem is with people on the first rung of the senior civil service—the deputy director level. They cannot get any more money—the person I talked about earlier was at that level—and they have no realistic prospect of a significant increase, but they are in their mid-to-late 30s, they have families and the cost of living is going up for them. In the end, they cannot afford to work for us any more.

Q69Jackie Doyle-Price

And it is basically the generation between 35 and 50 that you are losing. Once you get to 50, it is going to be too expensive for you to give up your pension.

Bernard Gray

Yes. Historically, we hire people as they come out of university or school and keep them for life, but we are getting leeched out in the intervening period—particularly people in their 30s and 40s, as you say. The problem is that those people are the potential future leaders of the organisation. I can home-grow people, but I am probably training people for somebody else unless I can do more to keep people mid-career.

Jon Thompson

There are two excellent Cabinet Office initiatives in this space. One is the so-called pivotal role allowance. We are limited to five people who we can say hold roles that are so pivotal to the organisation that we can reward them with an additional sum of up to £20,000 a year, tied to specific deliverables. That has to be agreed by the Cabinet Office. The other is the Major Projects Leadership Academy. We have had at least four people through each of the six cohorts so far. We have gone a long way in terms of the Cabinet Office’s initiatives, and we have done as much as we can, but we still think that is not enough for a systemic solution.

Mr Bacon

Under the rules, you are allowed to pay them more when they have been through the MPLA and come out the other side.

Jon Thompson

No, not necessarily. I am just saying that that increases your ability and your skill to do the job.

Chair

Mr Thompson, are you working with DECC, the Department for Transport and the Treasury, which face similar problems to you?

Jon Thompson

Yes, we are. There was a meeting of the Department for Transport board and those of us who are involved in this area to talk about these problems.

Chair

Are we looking forward to a Government-wide initiative, rather than an MOD initiative?

Jon Thompson

I cannot speak for the Government; all I can say is that we are trying to do the best we can for the Ministry of Defence.

Austin Mitchell

Just to come back to my “flying by the seat of your capacious pants” argument, I am concerned about paragraph 30, on the equipment plan. I want to know how you are going to stop over-optimistic costing and make good practice consistent among the project team. Paragraph 30 says: “In 11 cases, teams were unable to produce the possible range of costs for their projects…In ten cases, teams could not adequately link the risks they had identified to the forecast costs…Costs”—this is point 3—“that lie above the 50th percentile within a cost model are not built into projects”. Finally, it says: “Risks are also excluded from costs if a project team cannot directly control that risk…from cost modelling”. This will surely lead to over-optimistic predictions, which need to be much more tightly controlled and consistently made.

Bernard Gray

That is definitely the risk; and that is all the work we are doing to try to drill into teams a better understanding of the implications of under-costing the programme. I have had probably four rounds in the last three years of going through programmes, insisting on getting to the bottom of it. We also have the quarterly budget process that the finance director runs in order to track progress on all of that, and we have initiatives such as the one we are talking about on earned value management and getting more skills into the organisation to try to address it, but that is a systematic weakness that we are trying to improve, and it is a work in progress.

Chair

Can I move you on to budget, Mr Thompson? For 2015-16 to 2020-21, you are planning on the basis of 2.7% inflation and 1% real-terms increase—is that right?

Jon Thompson

Yes.

Chair

Is that funding protected?

Jon Thompson

No.

Chair

It is not protected, and you have lost £1 billion in the latest round—am I right? I am looking at page 23, paragraph 45.

Jon Thompson

We have made an assumption which we agreed with the Treasury, but clearly it is for the next Government to make the actual decisions in the 2015 spending review. We are clear that that is a risk.

Chair

Are you planning for that? People are talking about there being greater cuts over that period. Could you cope with that, so that we do not run back to where we were before?

Jon Thompson

Just to be clear, in the wake of the next general election, there will clearly be two processes that need to link together. There will be a new Strategic Defence and Security Review and a spending review. Those two have to come forward with a strategy and a financial plan that match. If there were to be significant financial austerity that were to cut the assumptions that we have made, we would have to go back and revisit the strategy. That is my opinion.

Chair

For me to get my brain around this, if we go to the equipment plan, at paragraph 45 on page 23, in previous times when you appeared before us you had that certainty that you would have inflation and the 1% in real terms.

Jon Thompson

Yes.

Chair

But in practice you were asked to find £1 billion in the latest round of trying to find further cuts. Am I reading that paragraph right?

Jon Thompson

Are you reading paragraph 45 on page 23?

Chair

Yes. It comes up to about £1 billion that you had find from your equipment plan after you had the 2014-15 and 2015-16 spending review—so not the first one, but the second one. Am I right?

David Williams

The SR13 round last year reduced the defence budget in a baselined way by £1.1 billion, resourced—

Chair

Which, again, was not what they said. To wind us back, originally when you did the SDSR on the first spending review, you were told that you would get a 1% real-terms increase, but actually, in practice, Treasury nicked more than £1 billion off you.

David Williams

The billion covers equipment, infrastructure and other operating costs. The element which relates specifically in a baselined way to the equipment plan is really a reduction in our equipment support budget, which is work that we are running through at the moment and looking to deliver through efficiencies. But the undertaking around the 1% real-terms growth then applies from that new lower figure in 2015-16.

Chair

From the new low?

David Williams

Yes.

Chair

Thinking of the discussions we have had over the last three or four years, it is the beginnings of a “Do they mean what they say?”.

Jon Thompson

The other dimension of this question is whether the Department can be more financially efficient, and undoubtedly it can. Some of the plan is to be more financially efficient. So, renegotiating equipment support budgets to try to save £350 million a year is something that we have agreed to.

Chair

I understand that you have got to justify it, but the story we got before was slightly different. The other thing I was going to put to you was that if you have this underspend in the year we are looking at, 2012-13, and you have accepted that we are talking about a likely underspend in the coming year, if you are sitting in the Treasury trying to eke money out, that does not feel brilliant.

Jon Thompson

It is definitely a strategic weakness that we are underspending the budget.

Chair

It is a weakness; you accept that, okay.

Jon Thompson

But I would rather be there than overspending and being here for you doing it the other way round.

Chair

Rather that than an overspend, except remember that you are not getting the equipment.

Jon Thompson

It is quite difficult, isn’t it? You don’t want me to be sitting here with a £38 billion black hole. The system of my overspending the budget means that automatically the accounts are qualified and I am sitting in front of you. Equally, I can’t underspend too far; otherwise I will sit here being criticised.

Chair

I understand that.

Jon Thompson

It is quite tricky. Our aim this year is to get an underspend of under £10 million. Mr Williams has been asked by the board to ensure that he does that.

Chair

I understand that, but I have never in all my years known Treasury to take the view that you have just taken. IPPR estimated when they looked at the further cuts that you are likely to have to lose a further £5 billion. Are you taking that seriously? That is on the overarching Government cuts and the impact they could have on MOD. Have you taken that seriously or does that figure seem completely off the wall to you?

Jon Thompson

It would seem difficult to me that you could do the maths that the Chancellor has put out into the public arena and end up with a £5 billion-a-year reduction in the MOD budget.

Chair

It is difficult to do that?

Jon Thompson

It is difficult for me to see how you get from what the Chancellor has said in terms of balancing the budget, if there were to be a return of a Conservative Government. You are asking me to speculate on who is going to win a general election and what their spending plans would be, which is difficult.

Chair

It is slightly about the general election, but it is going to happen whoever is in. There will be cuts in expenditure however that goes forward.

Jon Thompson

My answer is that you would have to revisit the strategy if the cuts were significant. You would have to deliver the outputs. You would have to revisit the outputs if there were significant reductions in the defence budget. You would.

Chair

Can we look at the urgent operational requirements and the fact that some of that is going to come back from Afghanistan? Paragraph 59 on page 28 suggests that £2.9 billion-worth of equipment could be brought back, but clearly you have not got the money for that. Could you take us through how you are approaching that, please?

Air Marshal Sir Stephen Hillier

The £2.9 billion was the first estimate in the process, and it made the assumption that every piece of equipment that we had in Afghanistan would come back and that we would run it through to the long term, alongside all the other existing Army equipment, which is principally in the Army. Our judgment was that it was not necessary to run on all of that equipment or that it would be affordable, so we trimmed down over time that amount of money to a lower figure. We then looked at what we could afford post-PR12 to start to bring these items into core. As we went through our planning round process, we have so far allocated of the order of half a billion pounds—a little bit more—to the Army to say, “Start to bring the equipment into your core programme.” The Army have accepted that and have also accepted that the delta between that amount of money that we provided from the centre and their ambition is something that they will have to manage within their budget. Under our delegated model, it is for them to look at the range of vehicles—including the ones out of Afghanistan and the ones that they already had—the support budget that they have and the efficiencies they can drive out of it, and manage that in the best way possible. Clearly that is not the full amount of the aspiration, but it is part of our discipline in our process that we should only commit the money we have actually got in the budget, and that is what we have done. Where there is a gap, we are going to have to trim back our aspiration in some areas. It is an ongoing process, but we are much further forward compared with where we were this time last year. As I say, we have committed at least half a billion pounds into that.

Chair

From the taxpayers’ point of view, we bought this equipment. I can understand your departmental view: you have had cuts in your budget and you are trying to save money. You can’t find the money to manage or run the equipment and keep it in good order. Unless you’re telling us that the equipment is such that it’s unusable, it doesn’t really make sense, from the taxpayer’s point of view, having pushed the money out, to then just say, “Actually, in this Department they’ve had cuts and therefore can’t keep the supply going to keep the equipment up to scratch. We’re going to scrap it. Maybe we’ll sell a bit of it, but I bet we won’t in any way get back any of the investment we’ve made, as taxpayers”.

Air Marshal Sir Stephen Hillier

I absolutely agree, and I should have been clear: we are not aiming to scrap some of this equipment. The vast majority of it—the vehicles and the major equipment—is on its way back, and a lot of it is now back in the UK. We are talking about not the money just to keep it, but the money to operate it and train with it and use it subsequently. That is the money I was talking about. The rest of the equipment we can put in storage, and then we will bring it out of storage and bring it into the front-line inventory and use it, according to our priorities and the available funding at the time.

Chair

But storage will cost you as well.

Air Marshal Sir Stephen Hillier

It will, but not of the same order as training with these vehicles.

Chair

If you try to look outside the MOD a bit, is this sensible? Is this a sensible way of handling it all, given all the money that we spent out there?

Jon Thompson

Different approaches are taken by different European countries. Denmark, for example, does not take this approach.

Chair

What do they do?

Jon Thompson

They assume that the defence budget can soak up operational costs of up to 10% of the core defence budget, and after that there is a conversation with the treasury. That is a different strategic approach that could be, and is, adopted in other European countries. That is not the way the system works here; therefore, we are working with the system that the Treasury designed. But you are right: there are different strategic approaches that could be adopted.

Chris Heaton-Harris

In a previous hearing, when we talked about logistics we heard some interesting examples of what was actually being bought and shipped out to Afghanistan, even though there was no need for it.

Chair

Skis.

Chris Heaton-Harris

Toilet roll seems to ring a bell—I think there was 47 years-worth of toilet roll for our visiting operation out there. Have we covered our logistics, so that we are not taking stuff out there that we will not need as we draw down? Secondly, for my peace of mind, can you assure me that we are not going to leave anything out there in a usable form that could be used by people who may not be as friendly to us? In a way, I would much rather see it destroyed completely. I am talking about satellite comms, for example.

Air Marshal Sir Stephen Hillier

To answer the second question first, we’re not going to leave anything out there which is either going to be useful to those we would like it not to be useful to, or that we need for the future. As we’ve covered, we’ve bought a lot of highly capable, very relevant equipment, and we want to get the best use out of it into the future. So, particular areas like sat comm and other capabilities are really important to us. On the first question and the examples, it is not something I am familiar with. I haven’t heard those stories.

Chris Heaton-Harris

I might have just dreamt them. But we certainly did a logistics hearing in which we heard that a number of interesting pieces of kit were being taken out to Afghanistan that were already surplus to requirements.

Chair

Yes, we did.

Bernard Gray

If I remember correctly, I was at that hearing—although I certainly don’t remember any reference to loo roll.

Chris Heaton-Harris

There was definitely something about loo roll.

Chair

I think it was skis, actually.

Bernard Gray

I don’t remember that, either. I’m not saying it didn’t happen, but I certainly don’t remember it.

Mr Bacon

Chris was having his recurring nightmare about the European Parliament and it somehow got conflated, I think.

Bernard Gray

The combination of loo roll and skis is certainly not something I want to get into. We have a comprehensive plan that is being worked between Permanent Joint Headquarters, Northwood, and my organisation, about the return of equipment from Afghanistan. As Steve says, effectively we are triaging it. Some things that are acceptable and potentially useful locally we may sell locally—that are not the kind of things we would want to take out. But the vast majority of anything significant—there is a cost of flying a loo roll back that makes it potentially not worth flying back, but worth selling locally, for example.

Mr Bacon

What about ammunition? Are you destroying ammunition locally?

Bernard Gray

No weapons will stay, and if anything, there may be some destruction locally. But all weapons and ammunition would be brought back or destroyed locally. So there is a comprehensive plan of either destruction locally, disposal locally or repatriation to the UK of all that equipment. We are about halfway through that plan, which obviously has to conclude by the end of this year. That is a subject of regular discussion between us and PJHQ. It is discussed every month in my board meeting with our logistics operation folks.

Chair

Can we move on to some particular projects? Can you tell us what the delays are with Lightning II and the specialist vehicles? Why have you not yet made a decision about those two? On page 7, in para 13, we are told that they could not be looked at because there are delays.

Jon Thompson

This is about the principle that we only begin to measure after we have been through the main-gate decision. That is why those two are not in this Report, and they might not be in the next one either.

Chair

What is the problem?

Jon Thompson

We only measure it from when the main-gate decision is made.

Bernard Gray

We haven’t placed a production order for the scout vehicle and we haven’t yet placed a production order for the Lightning aircraft. Therefore, they don’t come into this population.

Chair

Are these the aircraft that are going on the aircraft carriers?

Bernard Gray

That is correct. We are likely to place an order shortly, but we have not yet placed it.

Chair

So we haven’t placed an order for those at all? I thought we had placed an order for them.

Bernard Gray

We have ordered three test aircraft, which are flying with us now.

Chair

We are flying with them?

Air Marshal Sir Stephen Hillier

We have three test aircraft, and last year we ordered a fourth aircraft to join that series. Those aircraft are flying with UK crews in the US at the moment. Committing in to the first operational squadron is the next approval that we are working through the system.

Chair

We will probably want to ask other questions about the aircraft carriers, but the joint strike fighters is an area where your ability to control costs is much more in the hands of the Americans. I wonder whether you can give us an update there. The last time I looked at this, 98% of the JSF’s software code was not fully up to standard—that was in the summer; I don’t know whether it has got better—and much of it had still not been properly tested.

Bernard Gray

Much of the software had not been properly tested?

Chair

Yes, including that required to fire weapons—that is what my notes tell me.

Air Marshal Sir Stephen Hillier

In terms of the software development, it is worth bearing in mind that the aircraft is still in development, so you wouldn’t expect 100% mature software at this stage.

Chair

I accept that, but are you worried that, according to my brief, 98% of the JSF’s software code was not fully up to standard? I accept that that was in the summer and it may be better now.

Air Marshal Sir Stephen Hillier

We think it is more mature than that. We also maintain close contact with the United States joint programme office. It has confidence that on those sorts of issues—I have heard that figure mentioned—we are much further advanced than that. I don’t want to say that this is a risk-free programme. It would be wrong to say that it is risk-free because it is at that stage of its development, but we think it is substantially more mature than that.