Oral evidence: Equipment Plan and Major Projects Report 2014 and Reforming Defence Acquisition, HC 1045
Oral evidence, 2 March 2015.
Witnesses
Jon Thompson, Permanent Secretary, Ministry of Defence (MoD); Bernard Gray, Chief of Defence Materiel, MoD; Air Marshal Sir Stephen Hillier, Deputy Chief of the Defence Staff, MoD; and David Williams, Director General Finance, MoD, gave evidence.
Chair
Apologies for keeping you waiting. We are coming to the end of the Parliament so have a lot of business to clear up. Let me start with this: there is some good news and things are moving in the right direction. You can take our questions in the context of our having seen a step change and improvement in performance, which is incredibly welcome. I always tell the story of the first sitting I ever chaired, which was on £8 billion of defence procurement money that seemed to me to have been torn up. So well done on that.
Jon Thompson
Thank you.
Meg Hillier
Enjoy that moment.
Chair
Now I am going to go in. I’m going to start on the budget.
Mr Bacon
You’re going in and you may be some time.
Chair
I’m going to start on the budget, then we will get on to the GoCo, and at the end we want to ask a few questions about Army 2020. What happens if you do not get your 1% real-terms increase?
Jon Thompson
It depends on the SDSR. I think I have said to you several times before that our vision is of a balance between the strategy you are trying to deliver and how much resource you have. Were the resource to be less, I expect that the Government of the day would reset the strategy so that you kept that balance. There is also the question of how much more efficient we can be between strategy and resources, but if the resources did not come through, you would expect the strategy to be redrawn. That would then flow into the equipment plan in terms of what orders we would reduce or what we would not procure in future in order to meet the strategy.
Chair
As you read through the Report, it is so full of ruddy numbers that I found it quite difficult to distil what the key ones were, but it interests me that you are spending a higher proportion of your budget on equipment than you have in the past and than you planned with the Treasury. If my figures are right, you are up to 47%.
Jon Thompson
We are up to 44%, and the long-term plan would reach 47%, if this plan held.
Chair
Okay, so you are at 44% and going up to 47%, and the agreement with the Treasury was to be at 41%.
Jon Thompson
We have the ability to vary it, but yes.
Chair
I understand that, but when you agreed it with the Treasury, it was 41%.
Jon Thompson
Do you want me to explain why that is?
Chair
Go on.
Jon Thompson
The funding agreement with the Treasury is flat real plus 1% on the equipment plan, but it is clearly less than that on the remainder of the budget, so over time you become capital richer, equipment plan richer, and the rest of the budget becomes poorer, so the percentage changes over time.
Chair
Okay. You are left wondering whether, if you do not get your 1% in real terms—I don’t know how much flexibility you have, but it is not a lot—you then start eating into people or the estate, which are the only other two big spending blocks, aren’t they?
Jon Thompson
Yes.
Bernard Gray
Or you have to cut the equipment plan itself.
Chair
Say that again.
Bernard Gray
You have to cut the equipment plan, the people or the estate.
Chair
But your flexibility on the equipment plan is getting less and less, because you are not really ordering much new. You are now just delivering what you have agreed.
Jon Thompson
We have some headroom—£8 billion; it is in the Report—but yes, 37% of the budget is on equipment, 38% is on people, and 10% is on infrastructure, so 85% of the budget is tied up in those three things. You are exactly right. To go back, if the budget did not follow this plan, we would expect the strategy to be redone in a balanced way. That might mean that, after efficiency, you would have to balance both people and equipment.
Meg Hillier
If you find that you do not get the 1%, how long will it take to redo the strategy?
Jon Thompson
You would expect the SDSR to be completed in roughly six months, but it obviously depends. It can take longer, and some in the past have taken longer than that, but in 2010 it was done in roughly six months.
Meg Hillier
What would be the budget implications if it went on longer than six months? Have you factored all that into your calculations?
Jon Thompson
We have a budget set for 2015-16, so we are currently assuming that an incoming Government would redo the SDSR and do a spending review at the same time, through 2015, with a view to starting in April 2016 and setting a 10-year goal such as “Future Force 2025” or some such strategy. You are absolutely right. We are more able to change our financial position the longer we have to do it. That is what happened in the current spending review. Our budget went up in the first year of the current Parliament, and then went down.
Chair
So problem no. 1 is the predication on the 1% real terms increase. Problem no. 2 is looking at that budget and some of the assumptions behind it, and then some of the realities of expenditure, but let us deal with the assumptions first. You are assuming a £6 billion efficiency saving is in there.
Jon Thompson
Yes.
Chair
Let us cut that down into the savings you want in the support and the savings in the capital programme. Let us go to the support first. You are assuming over £4 billion of savings out of the support budget. Yet at the same time your internal guys have looked at less than a third of the budget—just over a quarter—and found that you are spending more than you currently have in your budget. So you are assuming savings while the reality of expenditure is higher than in the budget. I cannot remember the figure. There are so many.
Bernard Gray
They are estimating the total. To be clear, we are not spending more than is in the budget, but there is an assumption over the 10 years that the equivalent support plan will cost £2 billion more than the budget today.
Chair
But the £2 billion is on 28%, not 100%. Or is it £2 billion on 100%?
Bernard Gray
No, they have surveyed 28%, and that is their projection for the 100%.
Lee Summerfield
I am not sure that that is correct. I think the £2 billion is based on the 29% that they have currently reviewed. I do not think they are yet in a position to give an aggregate view, or they do not want to give an aggregate view yet.[1]
Chair
So the £2 billion—if that is mirrored through the whole of their analysis—could become about £6 billion-plus. So there is a bit of a reality check to be had on this assumption that you are going to be able to pull out over £4 billion on the budget, particularly if your internal verifiers are saying that you may be out by £6 billion. What do you say about that?
Jon Thompson
Perhaps I could get Bernard to give you an update on where we are against the £4 billion, because we have some updated information that we can give you. In relation to the £2 billion, you will recall that we have had this debate several times in the past. We do have a contingency of £4.6 billion.
Chair
I am not talking about the £2 billion on capital. We will come back to that. This is the £2 billion extra on support, which has been identified by—I am sorry; I cannot remember the name of the group.
David Williams
CAAS.
Chair
I will come back to the capital saving in a minute.
Jon Thompson
The risk, which is assessed by the independent team, is £3.2 billion on the equipment procurement plan, and £2 billion on the equivalent support plan, so that is just over £5 billion overall.[2] The £5.2 billion is the best information we have, and we have a contingency of £4.6 billion, so there is a gap between those two numbers. On whether we have secured £4 billion, perhaps Bernard can give the Committee an update.
Bernard Gray
So we have been working for the last 18 months, since spending round 13 was settled, on this issue. The current position today is that we have booked and are locked into people’s budget measures, which take £2.3 billion of the £4.1 billion out, so we have already sentenced that and agreed it with the front-line commands—it is actioned—and that comes from a variety of sources that we can talk about if you wish to. We have about a further £1 billion currently being worked on, which we confidently expect to be locked in. That leaves us looking for about £800 million over the 10-year period. Importantly, the period for which the savings start is at the beginning of the next financial year in about a month’s time. So before we have even entered the 10-year period, we have already either actioned or are in the process of actioning three quarters of the total.
Chair
And then the reality check against your own internal projections?
Bernard Gray
In quite a few of those cases, when we go into it, we have found ourselves working from a position that, as you say, is worse than is in the budget. On quite a number of occasions, we have had to do quite a lot of work to get to zero. The £2.3 billion and the £1 billion that I just described are after working off the headroom, which we had to do because the reality of the situation was worse than was budgeted. They are effectively a genuine saving against that target. We expect to do the same around the rest of the portfolio. We have started with the largest projects for obvious reasons—they offer the best focus and the most opportunity—but we are basically working our way down the squash ladder of projects by size, and when we have natural renegotiation possibilities with companies.
Sir Amyas Morse
Can I ask, Bernard, typically, what would you be doing? “Work” is a helpful verb, but what specific measures would you take? Most typically, when you see something that is not costing what it ought to and you are working at it, what are you doing? Are you reducing the amount, and how do you bring that across?
Bernard Gray
We have been working with outside teams and the project teams. We go through benchmarking “should cost”, which is an activity that I am sure you would recognise. We benchmark what it should cost, and how much productive time people are spending. So, on the support activity again and on maintaining things, we look at how much time maintainers on the job actually maintain, as they are employed to, as opposed to wandering around, and so on. We look at the requirement, to see whether we are over-specifying the amount of work we need—the answer is often yes. We also look at how we generate efficiencies out of what they are doing—how we can cut their overhead and reduce their profit margins. On a significant number of projects, we have achieved efficiencies of the order of 20%.
Sir Amyas Morse
So then you need to make sure that those costs actually come out of the projects, as opposed to being taking out on a planning basis?
Bernard Gray
That is correct. We are locking them into contracts and into the front-line command budgets, and our project team budgets by agreement. That is the £2.3 billion that has already been sentenced.
Chair
When you talk about projects, are you talking about support projects or capital projects? Is this all support?
Bernard Gray
Yes, support. For example, there is a planned depth maintenance programme for the support of the tornado aircraft. We took a significant amount of money out of that programme—it is one of the first we addressed—at a natural renegotiation point and reduced the cost of maintaining the known output through to the out-of-service date.
Chair
So both of you are feeling pretty certain on this. The support cost reduction is absolutely key to your predictions of what you can afford to do in terms of capital acquisition, so are you both feeling pretty confident that, sitting here in a year’s time, you will be on course to deliver that? That was my great source of scepticism when I read the Report.
Bernard Gray
I’d say yes. We have to save this money over a 10-year period, and before we get to the beginning of year 1, we have already sentenced over half of it and it is all locked in, and we have another quarter that is in the process of that work, when we have not got halfway down the list of projects yet. The returns will get smaller as we get further down because they are smaller and more fiddly projects, but none the less I feel comfortable that we are going to do it, yes.
Jon Thompson
I feel reasonably confident that we can deliver the £4 billion, yes. I would not have agreed the spending review in 2013 if we didn’t think there was a reasonable prospect.
Chair
I understand the £4 billion, but remember also this other bit, which is potentially £6 billion. You are potentially talking about a £10 billion real reduction in the support programme.
Jon Thompson
I appreciate your opening context. I think this is the seventh time in a row I have been to this Committee. Every time we turn up, we feel in a more confident place. That is not to say that it is without risk, and there is significantly more that we need to do, but do I feel more confident than last year that we can now deliver that particular element of it? Yes.
Mr Burrowes
Is that confidence contingent on the contingency formula?
Jon Thompson
No.
Mr Burrowes
In an earlier answer, you did pray the contingency formula in aid.
Jon Thompson
Yes. I was trying to separate the Chair’s two questions. One is about whether there is risk in the equipment support plan that the cost might go up and the other is about whether we can drive out the £4 billion. Your question was whether we can drive out the £4 billion, and we all think that that is do-able. We can talk about the risk if you want. We can switch to that. Do you want to switch to risk?
Chair
Yes, go on.
Jon Thompson
The best information we have at the minute gives an estimate of risk at £5.2 billion, and we have a contingency of £4.6 billion. Those figures are not too far apart, but there is clearly more work to be done on the equipment support plan, such as identifying the risks for cost growth in that area. Given that it is a £163 billion forward programme, those two figures seem to be not too far apart. We accept that further work still needs to take place in that area. We are better than we were last year, but we are still not 100% with the programmes. That programme continues, and I am sure we will get a better handle on it next year.
Bernard Gray
We have teams continuing to work on that now, and we have a planned programme of activity over the next 12 months.
Chair
We are now coming down to the capital—the actual investment bit of it—and one of the ways in which you have managed to cut spending, for example, is foreign exchange movements. That seems to be a big element of the expenditure saving, which is a bit iffy, because they can go either way. It is hit and miss. That is the first thing. The second thing is paragraph 3.12, which is on page 27, and the demonstration of the savings you are predicting on the submarine enterprise programme—I know the PULSAR is still in concept—and complex weapons procurement. With complex weapons procurement, you are predicting a £1.2 billion saving between 2010 and 2020. We are not quite halfway through that period yet, but you have only got £196 million. Being generous, you are two fifths of the way through and you have one seventh of the savings.
Bernard Gray
May I offer an observation on foreign exchange? We had an exchange on foreign exchange when it went up by £150 million and I said there was not much I could do about it. I am not claiming great credit for the fact that it has fallen by £250 million. That is life and we are not making a big deal out of it; we are just recording what it is. Our basic underlying assumption, which agrees with the NAO, is that the programme is stable. We are not claiming great credit for reductions, much as we did not take great hits for the fact that fuel went up a bit. So far as the other two programmes are concerned, I have different views on each. The submarine enterprise programme has delivered about half of the benefit that we have expected so far. We need to push further, but I am more confident that we have measures identified that will drill out more on that. We are—certainly I am—sceptical about the benefits from the complex weapons pipeline. The point I would make there is that if we do not drill out the benefits from that, we will basically have to work it out through the rest of the equipment savings plan benefits. I view it against the programme as a whole. On specific projects we are achieving a higher percentage reduction than we are required to achieve across the programme as a whole. I am reasonably confident that as we comb through all the details of the equipment support plan, where we are spending £7 billion a year, we will be able to find the £350 million or 5% required to make the plan work. Even if the complex weapons pipeline does not produce as many savings as were advertised for it, I am confident that we can mitigate that in savings elsewhere.
Sir Amyas Morse
Is it the first time that you have gone through the support programme in this much detail?
Bernard Gray
Yes, I think it is—with “you” meaning DE&S. In the previous iterations of this, we have all been focusing on the capital works programme, which has had percentage increases of 20%, 30%, 50% or 100% or whatever, and getting that under control. Now that we have got the capital programme under control, we have been able to dig into the support plan, which is not as volatile. It is about maintaining things, rather than the cost of new things, so it does not change as much. There have, however, been inefficiencies in it. We have not had the data historically that we would have wanted. We have put serious effort into it over the past two years.
Sir Amyas Morse
From the cost reduction exercises that one has seen in the past, would it be reasonable to expect that having gone through it once, the learning from that may mean that you can look for further efficiencies in future?
Bernard Gray
Potentially, yes. But of course, we have to achieve the first milestone first.
Sir Amyas Morse
Of course.
Jon Thompson
If you want to know where we are with the foreign exchange, we are not fully exposed to foreign exchange. We have a four-year rolling hedge, which I attempted to explain to the Committee before.
Chair
There is this ghastly thing that we uncovered somewhere, which is that you are only allowed to trade on a particular day of the month. Is that right?
Jon Thompson
I am sure that the expert to my right can fully explain foreign exchange to you.
Chair
Is that true? It was when we looked at the Foreign Office or something.
David Williams
I do not think that we are only allowed to trade on a particular day of the month. In the rolling arrangement that we have, we go out on one day each quarter to say what our forward requirements are, so that we can lock in a price.
Chair
But you do not speculate.
David Williams
No. We are not allowed to speculate.
Chair
So for one day a quarter, you go out. Is that right?
David Williams
The purpose of the hedge is to minimise financial risk or volatility. It is not for trying to get a gain.
Jon Thompson
It is for planning purposes.
Chair
Yes, but it might not be in the interests of British taxpayers if you are not actually maximising—
Marius Gallaher
There is a lot of risk if you go in any day you like. It is speculative.
Jon Thompson
If you use the Bank of England, one assumes that they are reasonably good at that.
Chair
Okay. I just have one thing to pick up. The Report says, on the submarine enterprise performance programme, that you have only received £200 million of savings. Are you saying that that is out of date?
Bernard Gray
No. We have identified around £400 million of savings on it.
Chair
Page 27, paragraph 3.12.
David Williams
The £200 million on page 27 is as at March 2014, at the end of the planning round covered by our EP.
Lee Summerfield
We have the figures up to March 2014. We have not seen the new figures.
Chair
If you are going to get on top of it now, into the detail, it comes across in the Report that you have not really managed two things. One is the consistency across your teams. If you look at page 20—you get people treating inflation differently and VAT differently. Risk is looked at very differently, and cost modelling is all different. It is very frustrating, to be honest—I am sure it is for you in the Department—to find that this inconsistency is still there four or five years on, because that is bound to be leaching money out. I do not know if Sir Stephen wants to come in on this.
Jon Thompson
Did you say that there were two things?
Chair
The other thing is the underspending, but I will come to that in a minute. Let’s deal with the consistency first.
Jon Thompson
We are more consistent than we were, but clearly there is significantly more to do on, for example, inflation or risk. I am sure that Bernard can say something about the injection of the managed service partners to improve things like earned value management, financial forecasting and so on. We have done quite a lot ourselves. The quarterly performance and risk process has now been going on for 18 months. That has definitely improved our understanding, but there is more to be done. VAT is a much more complex conversation altogether.
Chair
What do you mean?
Bernard Gray
What we are rated for and not.
Jon Thompson
It is not as straightforward as you would think. You have previously had evidence from HMRC, I am sure.
Chair
We have regular evidence from HMRC.
Jon Thompson
Indeed. We have the same relationship with HMRC as, I suppose, many other organisations in which there are various interpretations of the application of VAT on various things that are bought.
Chair
What difference does that make to you? Are we talking about billions?
David Williams
Over a 10-year period, yes.
Chair
What are we talking about?
David Williams
If you are looking at, for example, whether you can claim shipbuilders’ relief on nuclear reactors in nuclear submarines, a yes or no decision is a material variation over a 10-year planning horizon. Actually, that is a relationship between the contractors at HMRC rather than directly between us, but obviously we are very closely interested in the outcome.
Bernard Gray
We have an example where we buy or intend to buy a section of next-generation submarines from the United States, the missile tube compartments. They would be manufactured in the United States and then sent over and incorporated into submarines for us. Shipbuilding is zero-rated for us; the question is whether the section that we buy from the United States, for example, is zero-rated or not. HMRC says it is not. We had assumed that it was, because it is part of a submarine, which is zero-rated. They say it is not. It is that kind of thing.
Dame Anne McGuire
So the MOD carried the liability for the VAT? Or is it, as Mr Williams said, the manufacturer or the builder? Who carries the liability?
Jon Thompson
We do.
Bernard Gray
We do, because, sadly, we have to pay them.
Dame Anne McGuire
So one arm of the UK Government is paying VAT to another arm of the UK Government, which fully funds the first arm?
Jon Thompson
Yes.
Bernard Gray
Well—
Dame Anne McGuire
Thank you, Mr Thompson, that was a really neat answer. Mr Gray obviously wants to finesse it.
Bernard Gray
Only because we get a budget, and if it turns out that VAT is assessed against us when it was not in our budgetary assumptions, there would be an argument about whether we would get the uplift for that, so it may be a way of taxing us.
Dame Anne McGuire
I think I preferred Mr Thompson’s straightforward “yes”.
Chair
It is completely silly. Can’t somebody sort it? Tell me, in a year of your capital budget, how much VAT is in there?
David Williams
I would have to write and let you know, Chair.
Chair
You haven’t got a clue?
David Williams
I haven’t got it on me.
Chair
Have you got a clue what you are talking about?
Bernard Gray
It is all project by project.
Jon Thompson
We are just trying to put across the point that HMRC’s interpretation of VAT legislation for us exposes us to other financial risks one way and another, and we have to make a judgment about that. Sometimes the HMRC ruling goes in our favour, and sometimes it doesn’t.
Chair
What is particularly worrying in this Report—it is an HMRC point, actually—is that paragraph 2.16 says HMRC “have since changed their policy on applying VAT to some projects”. Perhaps you would like to comment on that. That is just daft. We ought to be able to sort that out.
Marius Gallaher
I think HMRC interpret the rules as they find them. They have to be fair, and everybody has to pay tax. We can’t make any exceptions.
Chair
Nobody is asking for exceptions; they are saying HMRC have since changed their policy.
Dame Anne McGuire
Just let me get my head around this. In terms of the overall UK Government, is this a neutral budgeting exercise? To go back to my perhaps simplistic little picture, one arm of the Government is giving out money to another arm of the Government, which funds the first arm of the Government. Is it a mutual exchange?
Jon Thompson
The reason why Mr Gray’s answer is possibly better than my “yes” is that if we are taxed for something we had not assumed, that is an additional cost for us. It does not necessarily result in additional funding for us, so we have less spending power, and the Government, in the end, is ahead overall, I think.
Bernard Gray
But the effective Ministry of Defence budget has gone down.
Dame Anne McGuire
Sir Stephen Hillier?
Air Marshal Sir Stephen Hillier
The consequence of that is that if it takes spending power out, you buy less capability for the front line. While it might be a benefit in financial terms, it is not a benefit in capability terms, obviously.
Bernard Gray
Effectively, it is a budget cut to us.
Chair
That is why it would be interesting to know whether it is something we should worry about or just a little bit on the margin that is irritating.
David Williams
In some ways, it is a bit like the foreign currency point. My interest in the tax position is not that I am trying to minimise our tax exposure. As a Department, we should pay the tax that the rules require us to pay. What I am trying to minimise is the volatility and uncertainty in that level of tax payment. One of the challenges is that, although you can get a preliminary view from HMRC as you are developing a project, it is often only after the contract is signed and they have some engagement through the company that you get a different position. But I am happy to let you have—
Dame Anne McGuire
Sir Stephen Hillier, I thought you nodded.
Air Marshal Sir Stephen Hillier
I was agreeing with David that it is when you get late notice that you get volatility in project forecast costs. That can have a real impact if you are just about to sign a contract for something which is important for military capability and suddenly, as a result of VAT, you have got an unaffordable programme, and you have to make a lot of decisions at very short notice. So it does directly connect the point about volatility and project cost and VAT, and the timeline.
Dame Anne McGuire
Right. Thank you for that clarification.
Chair
Going back to consistency, if you go down that page, at 2.20, what is more worrying is that only three project teams were applying good practice across all aspects of risk management. That is poor. And about half had generated a range of potential costs. The other thing that really worried me—at 2.22—is that typically risks were excluded, where the risk is outside the team’s control, but it is still a risk to the budget, whether or not it is in. You ought to have it in there, in your consideration of the totality of what you are doing.
Bernard Gray
On the last point, we allow for risk at different levels. We want some risks to be held by the project team, which are risks that they can manage. We want some risks to be held at the portfolio level—at my level—because some good things may happen in one area, such as good luck in the foreign exchange, or some bad things may happen in another area, and we need to be able to balance those, but we need some insurance provision at my level, which is the £4.6 billion of risk provision that we put in four years ago. Then we have risk held at the departmental level for overall strategic risk against programmes like nuclear, for example. We want a tiered level of risk. We do not want all of the risk embedded down at the project level, because we hand over all control, then, down to the project level. We would over-provision risk if we were housing it all at that level, because there is some portfolio effect.
Jon Thompson
This is an industry standard way of doing it. Some £10.1 billion is held at the project level, £4.6 billion at the programme level and £2 billion at the organisational level. Those numbers are largely on page 7 of the Report.
Bernard Gray
Overall, while the risk provision process and structuring is good, as far as consistency within the teams is concerned, I agree. What we have done over the last few years is go around and tackle specific problems within what we are doing, to make sure that we have controlled the programme. We are now in the process—through the transformation process we talked about—of trying to put in consistent best practice across the whole of the organisation. In a sense, the first thing to do was put out the fire and, inevitably, that meant going to where the fire was hottest first, rather than saying, “We’ll plan for the long term and ignore the fire.” We put out the fire. I absolutely agree with you that there is not sufficient best practice across the organisation. That is why we put in the transformation process and hired the managed service providers to come in. They will put down a rule set for earned value management, a rule set for accruals and a rule for project risk provision that is mandatory across the organisation. We are strengthening the functions within DE&S—the commercial function, finance function and engineering function—to make sure that we have consistent good practice across the piece. That is the work of the next two to three years.
Chair
Okay. It comes out as well in the underspending, doesn’t it, if you look at figure 5 on page 19? We talked about underspending last year, and this year you have done better, because you have brought forward expenditure, so we welcome that. At least you have not sent money back to Treasury. On the other hand, if you look at those elements in figure 5, a lot of them are in your control and should be eliminated, in the best of all possible worlds.
Bernard Gray
If I may, just looking at the top one first, there are two major issues in there: specific accruals, in one case around the Eurofighter Typhoon, which has been built up over a long period of time, which the finance department regularised and cleaned out and then released. The second one, for A400M, would have been applied in the wrong year, so was reversed out of this year and applied to 2011. Three quarters of Item 1—£550 million of the £680 million—applies to our finance department cleaning up our balance sheet. They are not real world issues—they are us improving the quality of our management information—but your general point that our project teams tend to be over-optimistic about how fast they are going to make progress and call for too much cash in any one year is true. That is part of our improving of estimating across the piece, which is part of the improvement programme. We had set against that at DE&S level and the departmental level an offset, which has been pretty accurate for the last two years, about how much we think they are over-estimating—how much too much they are calling for. We have offset with additional activity that meant we are broadly speaking square on cash but, yes, absolutely, I would like us to be more accurate at the individual project level.
Chair
Before we move on to GoCo I have got one final issue—I do not know about other Members—about the £8 billion. In my understanding, you have only committed a tiny bit of that, haven’t you—under £400 million? Is that right?
Witnesses
Yes.
Chair
Go on, take me through your thinking. What is happening to that? What one worries is if the confidence you have expressed this afternoon does not become a reality you will eat into the £8 billion, and then there will be less to respond to emerging and new challenges.
Air Marshal Sir Stephen Hillier
The £8 billion is unallocated head room. In other words, we are still holding on to it in head office, but we have asked each of the front-line commands to bid in the projects that they would need in order to achieve Future Force 2020. Again, on that base line we have done a provisional allocation by each of the commands, so they are planning into that space, although we have not actually allocated them the money at the moment. The key thing is that the £8 billion is essential to the achievement of Future Force 2020 as it is currently defined, so if that money was not available to us, as Mr Thompson said, we would need to have a discussion about our level of ambition. We have a plan for it, which each of the front-line commands have got. As you say, we will release that money when we need to and when it is clear that it is affordable in our plans. The £400 million you have seen has been part of that process. At this stage we do not need to formally release any more of that, simply because the projects are at that stage of their cycle, and most of that £8 billion is towards the latter part of the planning period.
Chair
Okay, but if you lost some of that on overspending elsewhere, without the savings being achieved or costs going up more than are currently anticipated, you would be in trouble.
Air Marshal Sir Stephen Hillier
There would certainly be a capability impact, but clearly we have also got other layers of protection in the budget. We have got the EP contingency of £4.5 billion and at the departmental level our unallocated provision as well. We would hope that if there were cost increases in programmes which are in the core equipment programme, that is what the EP contingency is for in the first instance. Only after that would you have to start looking at the £8 billion, and, as I say, there would then be a capability impact.
Chair
Okay. I was going to go on to GoCo. Do you want to make a start on that?
Mr Burrowes
The Report mentions in paragraph 13 that “the Department gained a better insight into its business needs within the context of an affordable equipment programme” following GoCo being halted.
Bernard Gray
Are you looking at “Reforming defence acquisition”?
Mr Burrowes
Yes. Reference is made to having learned the lessons. Just taking you back to why in the first place GoCo was recommended, and the root causes of underperformance, I just want to see how much things have improved since the stage of where we were when the recommendations were made. Perhaps you can tell me whether the lesson has been learned. Root cause 1 of underperformance in terms of the case that was made for GoCo in the first place was this overheated equipment programme—this conspiracy of optimism, the equipment programme being overheated, delays, deferrals, and obviously a drain on manpower. We have touched on this area, but how confident are you that that lesson has been learned and we no longer will have such an overheated equipment programme?
Jon Thompson
Okay. So you are looking at paragraph 6, I think, on page 6. Bernard’s original independent report before he joined the Ministry of Defence: three systemic issues. Overheated programmes is definitely a corporate issue, and that is where we are publishing a report and there is a comment on it. The second one is the interface between DE&S and its various customers.
Mr Burrowes
It’s the language of it.
Jon Thompson
And that’s all of us.
Mr Burrowes
I’ll come to two and three, but I want to deal with one first.
Jon Thompson
When Bernard did his original report in 2009, we were, famously, in what Liam Fox described as a £38 billion black hole.
Mr Burrowes
I am happy not to do a history lesson—I just want to know where we are now. We have all said we have learned lessons and we have a better insight into business needs. Given where we are right now, can we confidently say we no longer have an overheated equipment programme?
Jon Thompson
I am confident to reconfirm what the Defence Secretary said—that we had balanced the budget. We have kept the budget stable—
Mr Burrowes
I didn’t ask about the balanced budget.
Jon Thompson
I know you didn’t, but I am trying to answer your question. Do I think the budget is overheated? No. Do I think it is in reasonable shape and balanced? Yes. It has some risks, as has just been pulled out by the Chairman and in other questions, but the equipment plan is in a good place, and we are in a much better place than we were in 2010.
Air Marshal Sir Stephen Hillier
From my perspective, I saw both sides of the divide. In the period up to 2011 and 2012, most of my time, and most of the time of my staff, was spent managing delays and deferrals. It was always just about how you could squeeze the programmes within the budget line. Generally, you did it for a short period, and then things expanded out. Through what we did from SDSR, through the three-month exercise, and into planning round 12, we reduced our requirement to a level we knew would be deliverable, with appropriate levels of contingency. The success of that process means that, since 2012, as far as I can recall, there has been no major exercise to delay and defer projects as a result of budgetary constraints. Inevitably, technical issues come up in projects, and you have to deal with them, but I have not spent my time saying to Bernard, “How can we slow down spend to stay within the budget?” That has given us a balanced, stable and affordable programme, and that has been compelling, not just for the front-line commands, which can plan with confidence, but for industry as well, and we have been able to say to industry, “We have a stable and affordable programme.” That stability has stayed right through the period covered by this Report to where we are today. It has been a really powerful process, and a way for Bernard to comment. I don’t think, as a customer, that we are creating any volatility in the equipment programme. The focus is on delivering that equipment programme.
Mr Burrowes
Six years on, what would your analysis be?
Bernard Gray
I agree with what everybody has said. Although they will not say it themselves, the three people sitting to my right are largely responsible for this. Not only is the requirement stable in terms of the money, but we have not changed our mind about the type of thing we want. Changing the specification, and changing the requirement within that, used to be a hobby. The discipline that Steve and David have imposed on a day-to-day working level, and that Jon has overseen in the Department, has been crucial to us being able to get on with our work. We have today a stable, deliverable programme which is within the risk bounds we talked about earlier.
Chair
Could I just ask one question? On the joint strike aircraft, for example, you may not, thank God, have changed the specification, but have you changed the number you are going for?
Bernard Gray
No
Chair
You have not even changed that. You have not used that flexibility on the number. That’s great.
Jon Thompson
Do you remember that I famously said that, since April 2011, we have not done any of those things, like shift the aircraft carrier to save cash in the short term?
Mr Burrowes
In terms of dealing with the position we are in now, the suggestion was that, between the military and the civilian side, there was an inability to express and maintain an independent position. Everyone was saying, “Yes, yes,” without fully understanding the consequences. Has there been a shift in what was the root cause of these things—this unstable interface between the requester and the deliverer? Has there been a change from when we got GoCo to now?
Air Marshal Sir Stephen Hillier
I am not commenting on the DE&S operating model part of that, but from the customer perspective, there has been a fundamental shift. First, it’s realism—it is fine to have aspiration, but we must be realistic about what is affordable and deliverable. The other thing that has contributed significantly is the move to the delegated operating model, where we are giving the single services—which are ultimately the demanders of these capabilities—the budget and the responsibility. That has changed the culture and the behaviours in a very positive way. I think that the delegated operating model has been a key part of getting those disciplines into the process.
Mr Burrowes
In terms of the benefits that came out of the business case that was made, do you feel that you have enough human resource freedom?
Bernard Gray
That is my end, probably. Just one additional point on stability, one of the arguments in favour of GoCo was that it would then have locked down that set of arrangements that we have just spent five or 10 minutes talking about into a contract. The situation that we are in at the moment does not have that contractual underpinning; it is between one part of Government and another, so it is dependent on that good discipline continuing to be exercised. I absolutely agree with Steve that the front-line commands having a delegated budget encourages them to do that, but the central Department will need to be continually watchful to ensure that discipline is maintained. If there is not the discipline of a contract, it will take the discipline of the Department’s leadership to continue to keep things on track. That is important to recognise going forward—it is not self-policing in that sense. As for DE&S freedoms, we have significantly more freedom to manage our affairs—we might talk about that in a bit more depth in a minute—but it is not as much freedom as if it had been contractualised, although significantly better than it was previously.
Chair
What does that mean? Go on, explain a bit, because the freedom appears to me to be the main change that you have got. I cannot think what else you have got, but your freedom on conditions and salaries is the main one you gained.
Bernard Gray
We are still part of the civil service and we still operate according to civil service recruitment patterns within certain bounds. We operate with—
Chair
What does that mean? Do you mean your processes?
Bernard Gray
Some of the processes and some of the salary bands, for example—we do not have as much flexibility as if the organisation had been contractualised, but we have significantly more freedom than the mainstream civil service.
Chair
Sorry, I am really trying to get a handle on it. How many people have you been able to recruit at the salary levels that you wanted in order to fill those jobs and that might have been a bit higher than existing civil service levels? How many? Give us a feel for it.
Bernard Gray
We have recruited about 750 people in the past 12 months—some of that is managing voluntary outflow, so that is a net situation, and it has not gone up by 750—but I can give you two examples of areas where we have changed pay policy. The first is in relation to airworthiness, where we are required to have engineers who can legally certify that an aircraft is safe to fly. They have to be able to sign those forms submitted to the Military Aviation Authority that say, “Yes, the Typhoon remains safe to fly.” We have been short of about 100 people in that area for several years. About six months ago we put in place allowances, because one of the things that we have to manage is that we want to pay people to do that speciality, rather than having that money bleed into a general pool. We have set up a set of allowances for people doing those tasks, both the people doing the tasks today as well as new recruits, in order to fill that gap. We have started to make progress, having tried and failed to fill the gap of about 100 over the previous three years.
Mr Burrowes
What have you changed in terms of increasing the higher market value of those specialist areas of project management, commercial financial expertise or technical expertise? Give us an example of where you have increased the value to make it more of a market.
Bernard Gray
I will have to write to you with the exact terms, because I cannot quite remember as I sit here. Broadly speaking, in the example that I have just given, which is about a specific type of engineer, we have allowances worth about 20% of salary. We did a similar thing in nuclear engineering a little earlier, and now one of the exercises that we are doing as part of the managed service provider provision is to benchmark all our skills. At the moment, if you are at a particular civil service level—middle management level such as C2—you are paid the same, whatever job you do, whether you are in administration or you are a nuclear engineer. Those jobs command very different salaries in the private sector, and we are benchmarking our salaries against the private sector. That is going on right now. We are competitive in employing administrators, but we are significantly not competitive in employing various classes of engineer. We have tackled some of the hot spots in nuclear and in air-worthiness, where we have real operational problems today, and we are now systematically trying to benchmark our salaries at the right levels. Over the next 12 months we will adjust that for the generality to make sure that we remain competitive.
Mr Burrowes
Do you really think that you have the room for manoeuvre in the spending envelope to be able to recruit the expertise that is needed given that £33 million was lost on the GoCo experiment?
Bernard Gray
Well, £33 million was not lost on the GoCo experiment, but we can come back to that. As your Report says, we spend over £450 million a year on third parties—getting people to come in and do work for us. Occasionally that is because there is a particular specialist skill that it is not worth our keeping in-house but is worth our hiring from time to time. But a significant component is the fact that successive Governments held down the number of people we could employ so we could not have the people on our payroll, and we needed to do the work so we effectively hired contractors to do it. The new arrangement brackets together all of that third-party spend and the spend on all our people on staff, allowing us to push down the amount that we spend on third parties and recruit people on to our staff at the right skill level. We spend about £550 million on civilian staff and £450 million on contractors, and we think that is the wrong balance. That is why we are trying to push down the amount spent on contractors, and why we think that we can afford to recruit people inside a total cost envelope that is falling.
Chair
I am delighted. It is quite interesting because it sounds to me as though these are not high but middle-tier salaries. These are not people who are paid more than the Prime Minister.
Bernard Gray
No, the majority of our problem is not at that level. It is true that the more specialist and the more senior you get, the more out of whack we are, but the vast majority of what we are talking about are people who are paid—in the current circumstances I hesitate to get too far into this—reasonable professional salaries, not super high-end ones, but we have been unable to keep in the medium term people in finance and engineering and our commercial negotiators.
Mr Burrowes
Hopefully they are paid more than MPs.
Chair
Just to get to the bottom of this, because we hear this from a lot of Departments, you are spending half a billion pounds on contractors, and your ambition is to pull that down to what by when?
Bernard Gray
We are still in the middle of the work. We have got in the managed service providers and they are due to deliver their plan in June, working with us. At that point we will have a much better feel for how many jobs we can sensibly pull in, where we can put skills and how much we can reduce that third-party spend. At the moment I have a commitment to Jon and the rest of the Department to pull down the cost of running DE&S in total, and the biggest single target for that is third-party spend because, as you say, it is more expensive than in-house staff, but until we got the freedoms we could not do it.
Jon Thompson
It is worth adding that we put a departmental boundary around this and created a separate organisation. Bernard is the accounting officer for those costs. He will have to produce his own accounts which will be audited by the NAO.
Chair
The £1.3 billion is your responsibility, and you have to bring it down to £1.2 billion.
Bernard Gray
That is correct.
Chair
Have you brought it down at all?
Mr Burrowes
I think the Report said by £9 million.
Bernard Gray
The Report is for the year that ended almost 12 months ago, when we had not started on that change.
Chair
So have you brought it down?
Bernard Gray
We are on track to deliver the £1.3 billion this year. We are not quite at the year end. I expect to be inside my budget.
Stephen Phillips
As far as this piece of work goes, who is conducting it? Have outside consultants been brought in to see how many outside contractors you can get rid of?
Bernard Gray
Well, there is a mixture of us and two serious programme management firms, and an HR firm, and we are managing several hundred—
Stephen Phillips
The answer to my question is in part yes, isn’t it, Mr Gray?
Bernard Gray
In part, yes, but we are taking a strategic view to drive down the total cost.
Stephen Phillips
Who are the three firms—the outside contractors—that you have identified?
Bernard Gray
Bechtel, CH2M Hill, and PwC.
Stephen Phillips
How much are you spending with them?
Bernard Gray
Over the three years, from memory, about £250 million.
Stephen Phillips
£250 million to result in a saving of how much to your 1.3 million staff and contractor budget?
Bernard Gray
We have to live inside of the total cap, so all of that has to come out of the money that we have been allocated. There is no extra money.
Stephen Phillips
Sorry, you are answering a different question from the one I asked. £250 million to save how much?
Jon Thompson
It is £400 million to £450 million over the three years.
Stephen Phillips
So £400 million to £450 million a year is what will be saved.
Jon Thompson
I did not say a year.
Stephen Phillips
I am looking for the annual savings in the DE&S staff and contractor budget that will be generated by spending—
Bernard Gray
It builds up—
Stephen Phillips
Shall I finish my question? I am looking for the annual savings that will be generated by spending £250 million with three outside consultants.
Bernard Gray
It builds up to an exit run rate of around £250 million a year.
Chair
I will tell you the worrying thing. These are the three that were in at the end on the GoCo. This was the consortium.
Bernard Gray
Two of them.
Chair
No? I thought they were.
Stephen Phillips
What about the £33 million, Mr Gray? You said you wanted to come back, and you said it was not wasted. I am interested in that.
Chair
We will come back to that. Let me deal with this £250 million and the contract. I had thought that the contract was won by the guys who had got through on the GoCo. The concern would then be that the inside knowledge of getting involved in a GoCo development helped them gain that contract. Did you run a fair competition?
Bernard Gray
So, the short answer to that question is yes. In order to avoid that concern, we engaged very heavily in the first half of last year with six or seven potential providers, six of whom I believe bid, and we found no objection in the running of that competition, or in the outcome of that competition, from the people who were not successful. We engaged in a very heavy market dialogue to make sure that nobody had any unfair advantage. Indeed, nobody felt that an unfair advantage was being given to others. Nobody complained about it in any way, shape or form, formally or informally, so we believe that we successfully mitigated that problem.
Chair
It just looks a bit odd. They have a contract now for three and a half years, and if you go out again a year before the end of that contract, they will have all the experience, so it will be much easier for them to regain that contract.
Bernard Gray
We would assume that at the end of that period we would have significantly less requirement for them, because what we are doing is trying to embed the kind of processes that you were talking about across the piece to get consistent earned-value management, consistent accruals accounting and so on and so forth through the organisation, so that we do not need to depend on third parties.
Stephen Phillips
Mr Gray, you may not be able to answer this off the top of your head, but this Committee has become concerned that another part of PwC, no doubt, has been helping its corporate clients in the private sector aggressively to avoid the taxes that they ought to be paying to the Exchequer in this country. How much is PwC being paid by DE&S on the contract looking at reducing the cost of your outside consultants?
Bernard Gray
I think I have it somewhere, but I might need to look it up.
Stephen Phillips
That is fine. Perhaps you could write and let us know how much PwC is being paid.
Chair
I think you have a figure there.
Jon Thompson
We do. I just do not remember it.
Stephen Phillips
If you could come back to us by the end of the hearing, that would be very helpful.
Jon Thompson
I can come back to Mr Phillips’s original question, if you like, about the baseline of cost in DE&S and how it goes down, the more it consumes.
Stephen Phillips
That would also be helpful. Thanks, Mr Thompson.
Chair
It would be quite nice to get that if I can. They have got a figure floating around there on PwC—
Stephen Phillips
Why doesn’t Mr Thompson answer that while Mr Gray has a look?
Jon Thompson
So, in ’14-’15, the cost of running DE&S was £1,290 million. The agreement that we reached with the Treasury was that by ’17-’18 that would reduce to £1,079 million. I have got the profile here and if you add it all up it is £392 million in net gain to the Exchequer over the four years after you have taken into account the cost of the three managed service providers.
Stephen Phillips
Did you look at whether you had the expertise in-house to see whether these costs could be reduced without having to pay £250 million to outside consultants, or did you simply let a contract, saying, “Here you go—here is some free money. We know that you will reduce our costs. It will all get swallowed up, so take the £250 million”? It is very odd to those of us who sit on this Committee. Why don’t you just look at how to reduce your costs in-house without going to outside consultants?
Bernard Gray
The answer to your first question is £43 million. In answer to the second question, I think we have comprehensively proved over some decades that we do not have the skills in-house.
Chair
What is odd about the contract, according to the Report, is that you bring in consultants because you do not have the skills in-house, but you do not link the contract to milestones or metrics. According to the Report on page 20, paragraph 2.8, you have not agreed a baseline or the metrics. That seems not a very sensible way of proceeding.
Bernard Gray
To be clear, a complete statement of what we have done is that we have set out milestones and deliverables for the first six months that they are here. So from November to the end of May[3] they have milestone deliverables that they have to come in to us, which include, for example, the plan that I have described for how we are going to roll the thing out over the next three years. The issue then is: what milestones do we set down for the implementation phase of the plan? Until we have the plan written down, it does not seem sensible to us to write down what the implementation milestones are.
Chair
What levers do you have over them to ensure that they agree—
Bernard Gray
We can terminate the contract.
Chair
If you cannot agree the milestones, you terminate the contract without any detriment to us, the taxpayer?
Bernard Gray
There would be some relatively small exit costs, but yes, we can terminate the contract if we do not like the terms.
Mr Bacon
Mr Gray, do you think that you should have these skills in-house? Let’s leave aside for one moment the question of pay, because if, as you say, it has been problem for several decades, there must be reasons for that and I assume one of them is pay. Do you think that these are core skills that you should have in-house because of the nature of your business, or are they the sorts of skills that you would only be likely to need sufficiently sporadically that it is better to buy them in from time to time? I have my prejudice on what the answer to that is, but I would like to hear your answer.
Bernard Gray
The broad answer to your question is: yes, we should have them in-house. But there are two glosses that I would offer to that. One is that we have probably a small number of more highly qualified people coming in from the MSPs now in order to set the thing up correctly in the first place than might be required to run it in a steady state. The second issue, which we touched on earlier, is some particular skills. I will give you an example: we do not design enough ships to have a whole ship architects’ department fully in-house. We only design a Type 26 every couple of decades or something like that, so we are always going to want to go out to the marketplace to firms like BMT to hire some specific skills for jobs that we do infrequently. There will always be some of that, but broadly speaking the kind of skills that we are talking about here are ones that we should have in-house.
Mr Bacon
So am I right in supposing that the key reason for not having them in-house is pay levels?
Bernard Gray
Pay, overall working conditions, career prospects.
Mr Bacon
You have told us in the past about your efforts to reshape and revamp the pay structure to give you more flexibility. Does that revamping give you sufficient flexibility to solve this problem fully?
Bernard Gray
I don’t know.
Mr Bacon
If it has been going on for several decades, then plainly there is an endemic or systemic problem and one might hope that it might require or get a systemic solution and that a big component of that would be pay and the other things, such as the working conditions you mentioned, career prospects and so on. What I am really after is the extent to which this reset that you negotiated with the Treasury has given you sufficient flexibility—you are saying that you don’t know.
Chair
Expand on the “don’t know”.
Bernard Gray
Only because we haven’t done it yet. Our focus is on generating a match-fit, world-class procurement organisation by 2017. That is our objective. We have not yet started down that campaign plan. I am hopeful that we have enough freedom—I mentioned the £450 million and our ability to vary the circumstances—to be able to achieve that end. All of our effort is bent on it, but until I have delivered it I tend not to declare victory. I was reasonably equivocal about the state of the equipment plan until we had worked on it for three or four years; now I can say with some certainty things that I could not say three or four years ago. That is a credible position to adopt. I am putting forward all great efforts to ensure that we get to the position that you describe. Today we believe we can deliver that plan, but we have not yet done it.
Chair
Jon Thompson? Anyone can come back on PwC, then I will go to David.
Jon Thompson
As a member of the DE&S board, I think the view is that we have done the right tactical issues at the minute to address particular skills. Bernard gave you some examples of that. The May DE&S board should get an overall strategy from PwC that will much more fundamentally address the pay and grading skills issue. At that point we want to try and promote, subject to various consultations, a more systemic approach. We have done some tactical moves to strategic.
Chair
Sorry, I didn’t get that—PwC’s contract is £43 million, is that right?
Bernard Gray
That’s correct.
Chair
A lot of money.
Amyas Morse
Shut me up if this is the wrong time, please, Chair. Just going back to what you were saying earlier on, that you were relying on contract to lock this into place, by putting contracts outside the organisation—
Bernard Gray
If we had done a GoCo.
Amyas Morse
If you had done a GoCo, exactly, and you haven’t. So what event would place great strain on these arrangements? Supposing, for example, it was decided to increase defence programme spending, because external events caused you to think that you needed to, or whatever, what would you visualise as putting at risk this approach that you have developed? I am sorry; this is just to enable me to be clear in my mind about things. You have got it in agreement, but what you have been doing for the past few years is controlling, and largely cutting back on, expenditure, so it has been a very strong lesson—if you do not stick to and deliver on plan, you will not get good gear, so you had better be controlling. But if you started worrying—are you worried about that? How would you keep to things? I am responding to what you told us.
Bernard Gray
The worry would be that people—not us, because I think we have a demonstrated track record of not being like that—chose to be over-optimistic. They might not have looked at the medium term. It used to be the case that the Department only looked four years ahead, but we now firmly programme for 10, for example. We used to see a bulge of planned expenditure outside of the fourth year, but we now have much better control of that. So if people were too optimistic, or they accidentally or deliberately underestimated what a project was going to cost, those kinds of behaviours, if they were not properly policed, caught and contained, would represent a threat to the programme. The point about the contract was that if people were on the other end of a contract that caused them financial pain, then they would be very careful about what they allowed.
Jon Thompson
It is possible to switch to a trading model if you have the necessary baseline. If you knew what all the stuff did—that is one of the reasons for going down the time-recording route—logically you could switch into a trading model, in which you gave the budget to the customers and if they wanted more work, under your hypothetical example, they would have to pay more for the services delivered.
Mr Burrowes
You baulked at my suggestion that the £33 million spent on GoCo was lost. Will you respond to that point?
Bernard Gray
About £7.5 million was spent on the GoCo competition itself. We spent that in pursuit of answers which would have contractually locked in savings worth billions—literally. We received one bid which would have saved multiple billions of pounds. We had another bid which was ready to be submitted, but which one of the three members of the consortium decided not to proceed with at the last minute, which also could have saved billions of pounds. So, as far as the GoCo competition is concerned, I am happy that we spent £7.5 million attempting to save the Government, and therefore the taxpayer, billions. Going to the market and seeing whether we could deliver that was a good use of public money. The rest of the money has been spent on setting up the process that we have just spent 10 or 15 minutes talking about: getting us into a position where we can deliver the kind of solution we are talking about inside the Government over a period of three years.
Mr Burrowes
So, are you saying that all the remaining amount would have been necessary to achieve the materiel strategy outcomes of greater human resource freedoms, enhanced processes, improved system and tools, and a more robust customer interface?
Bernard Gray
Understanding in detail how we make all those things work has been the majority of our work over the last three years.
Mr Burrowes
And you don’t think that would have been achieved quicker without going through the GoCo process?
Bernard Gray
I don’t know, but I think that trying to save the Government and the taxpayer several billion pounds was an objective worth pursuing.
Mr Burrowes
Of course—I would be concerned if we did not have that objective, even without the GoCo process.
Bernard Gray
But the GoCo process would have been a way of delivering that. We tried to save the taxpayer significantly more money. In the end, it proved not to be deliverable, but I absolutely think we did the right thing by the taxpayer by trying.
Mr Burrowes
Would any amount involved in going through the GoCo process have been saved by not doing so?
Bernard Gray
If we had not gone down that road, the £7.5 million we spent on the bid would have been saved.
Mr Burrowes
Finally, you have made the case that that was money well spent, because it made some great deliverable savings. Is there any amount that can’t be attributed to deliverable savings that would not have been spent if we had not gone down this route?
Bernard Gray
The £7.5 million did not lead directly to savings, because we were not able to execute a GoCo contract. As to the £24 million that we have spent elsewhere, is it possible to formulate a different way of doing things with the benefit of hindsight? Maybe. I don’t know.
Chair
Just out of interest, how much of the £33 million was spent with consultants?
Bernard Gray
It depends how you count lawyers. They are expensive, but are they consultants?
Lee Summerfield
The split is in paragraph 1.19 on page 16. Some £25 million of the £33 million went on contractors.
Bernard Gray
Contractors includes lawyers?
Lee Summerfield
Yes, it absolutely does.
Chair
What surprises me is why you suddenly changed your mind—I couldn’t quite work out why. I do not want to be overly critical, because the Committee is all for trying to have innovation, but what suddenly led to a change of mind?
Jon Thompson
We pre-agreed with the Defence Secretary that if the competition narrowed to only one initial bid, our joint recommendation would be to stop the competition, because that seemed the prudent thing to do. That is the situation we reached. The bid, we should be clear, was an interim bid—it was not detailed. It would not have been the end of what would have been a planned process that would have involved other stages. We thought the prudent thing to do was to say, “You have a competition in which the market can produce only one result, and we don’t think it is prudent to proceed.”
Chair
The others fell out—
Stephen Phillips
One of the consortia fell out because it was bidding for another Government contract. Is that right?
Bernard Gray
If you are talking about the first one, I am not sure they were ever really in.
Stephen Phillips
You had three people bidding for this GoCo.
Bernard Gray
We had three people express interest at the beginning of that process. But the first of them was somewhat hesitant about whether they were going to participate at all, because of other issues. In my mind, we had two viable external bidders pretty well from the get-go. My personal opinion about the second bidder is based on a number of conversations I have had with people associated with this through the process and subsequently. There were three parties to the consortium—CH2M Hill, Serco and Atkins. They had a deal team, which prepared a bid that was ready to be submitted. Two days prior to the deadline for submission, it was reviewed by the three company chief executives. Two of those companies, Serco and Atkins, wished to proceed, as their bid team wished to proceed, and submit the bid. The chief executive of the third firm, CH2M Hill, didn’t wish to proceed because their appetite for risk had declined substantially over the course of the previous few months. My personal belief is that that was because the company had sustained losses in other parts of its business and was unwilling to take the risk of taking on a GoCo contract, but I don’t know that for a fact. Although the deal team wanted to submit, although the bid was ready to be submitted and although two of the three parties wanted to submit, it was not submitted. We found out 24 hours before the bid was due to be submitted, when they came to see us. They had not raised any concern with either me or the commercial director of the Department in the preceding three or four months, despite the fact that we had a number of top-level meetings with them in the course of tracking the bid’s progress. As Jon said, Jon and I sat down with the Defence Secretary in September, when KBR and the team chose not to join the party, and we had a long conversation about what was a viable competition and what was not. The Cabinet Office did some work on that, and it concluded, based on US models and other things, that two was a viable competition in this kind of area, especially with an in-house alternative proposal available, so we decided to proceed on that basis with two viable bids. It was only with 24 hours to go that it dropped down to a situation where we would be negotiating against one party, which we felt was not an acceptable position.
Mr Bacon
What a pity you weren’t running the letting for the rural broadband programme, too.
Chair
Could you go back to it? It is still on the statute book as a potential, isn’t it?
Jon Thompson
A future Government would have that option. It is not currently our plan.
Chair
What you are going to get out of this trading effort, as far as I can see, is greater flexibility on salaries, but beyond that nothing else.
Bernard Gray
We have some flexibility to run the business in a different style.
Chair
What sort of things? Just explain that to us. It seems to me that wage flexibility is the major change, and it drives me slightly mad that you have to go down the trading company route to get that wage flexibility—looking at the Treasury. We can point to similar things in the Department for Transport, DECC or HMRC when running major capital programmes.
Bernard Gray
I can understand the Treasury’s concern to control public sector pay generally.
Chair
I can understand their concern to get value for money.
Bernard Gray
It is hard when you have 6 million public sector workers, or some number like that, to make sure that public sector pay is controlled. I can understand that, at an individual level, those tools can look quite crude because you are applying it across a work force of 6 million, which is quite hard. I understand their problem. As I described earlier, what we have is not just pay; it is our ability to mirror that market in how we develop people. We will have a cadre in engineering and a cadre in commercial where we can operate and develop those people in a different framework to that of the rest of the civil service. We do not have to apply the same grades, and we do not have to call things the same job. We can think about how we change people’s careers not just in specific pay but in all of their development, which allows people to think about this as a significantly different organisation. That identification with our organisation, as opposed to just being in the generality of the civil service, will be important to them.
Jon Thompson
I was going to say—I have to get off the people point—that it also enables us to contractorise the interface between the customer and DE&S, so we can have support in place for what we call the command acquisition and support plans. So it can say, “We, DE&S, will provide you with these services, and these are the KPIs for those services, which you will be able to use to measure us against our performance.” You are stepping down a route where you could potentially contract that and trade the budget. If you switch the budget off, Bernard, to the customers and move to some sort of charging arrangement, the customer would have both the budget and a set of KPIs. The recommendations from our colleagues are that we continue down that route, and we would agree with those recommendations, which are on page 9, about continuing KPI sets. That takes you further steps towards trading. It would then be for another Government to say how radical you want to be with that trading, but it gives you the option.
Mr Burrowes
Rather than the trading, how much would it have cost to complete the DE&S+ option—to have completed the outstanding work so as to be in a position to make that viable? Did you come to any costing?
Jon Thompson
You mean in terms of spending public money? We don’t think that there is very much that would have continued to have been spent, in that sense.
Mr Burrowes
I mean to complete the work—for that to have been the fall-back option after GoCo.
Bernard Gray
We have taken a lot of what was in it and implemented it. The question is what the boundary around us should be. We have spent a lot of time thinking about what that boundary should be. What we have has, mostly, the characteristics of a trading fund, but for various technical reasons we cannot be a trading fund, so we have taken most of the organisational design components and put them inside a specific entity that gives it a boundary for the Department. From a legal-control point of view, that gives it a shape that gives the Treasury confidence that we could exercise freedoms inside that boundary, and things will not leak out.
Chair
Where are you on Treasury approval? Is this case approved, or are you not at that stage yet?
Jon Thompson
The Chief Secretary signed all of this off in order for it to be stood up in April 2014.
Chair
The whole thing?
Jon Thompson
The whole thing.
Chair
A question to you, Mr Thompson: what would it look like, at the end—what would you want to see, ultimately? I know you might have devolved a bit of your accounting officer responsibility, but how would you measure its success?
Jon Thompson
We would measure its success by continued improvements in the delivery of the programme. Ultimately, we want military capability for the armed forces. We would expect—in fact, the DE&S board also expects—to be able to see improvement in the KPI set, most notably in relation to the equipment support plan. There has been a big focus in this Committee over the years on the equipment procurement plan. How do you then introduce that discipline all the way through the equipment support plan? We will definitely be looking for that. We need continued better financial forecasting, too. You want stability and to nail down some of the consistency issues. We have been reasonably clear as an owner about what we want. A Minister chairs an owners council, so we are clear about what we are expecting. The corporate governance of DE&S has been significantly enhanced. There is a non-executive chair and four non-executives. They lead the implementation of a plan that we corporately agree with DE&S for their delivery.
Chair
Who is the non-executive chair?
Jon Thompson
Paul Skinner. We have also hired four independent non-executives. The board of DE&S is majority non-executive led. There are only two executives, Bernard and his finance director. Steve and I are on; I’m on as the owner, and Steve as the representative of the customers.
Chair
I was going to ask, Sir Stephen, what, as a customer, you would expect from them—how would you measure their success?