Examination of Witnesses (Questions 220
WEDNESDAY 21 APRIL 1999
220. If equipment disposal receipts can be credited
to individual top level budget holders, why not estate disposal
(Mr Balmer) What we have done so far is to match the
view we took of estates, in that whichever budget holder held
equipment assets which were disposed of they received the benefit
from the sale. These were typically the three PAO areas, the logistic
areas, because that is where surplus or equipment which could
be declared surplus tended to be resting. What we have now done
is to combine that into a single top level budget, so we have
in effect achieved the same result, we have given one top level
budget holder almost all the equipment disposal receipts and I
will be looking to see the extent to which the Chief of Defence
Logistics wishes to keep that as a corporate resource within his
budget or whether he does indeed disaggregate it to the agencies
which store the equipment which is being disposed of.
221. In the document at paragraph 43 under "Land
and Buildings", your estate strategy is really bringing together
units of more than one service into the larger multi-user core
sites. Is this driven by a strategy of increased jointery or is
it purely a value for money exercise?
(Mr Balmer) It is driven by both, Chairman. The Chief
Executive of the Defence Estates, who has put the strategy together,
clearly has in mind an efficient use of the estate and the need
to achieve his disposals target, so that is a clear incentive
for him. But in looking to put people on to a single site to the
extent that will benefit our jointery approach, that will clearly
be a distinct benefit.
222. Do you have any locations in mind or are
you simply stating a general philosophy?
(Mr Balmer) At this stage this is very much a strategy
and once this takes effect the Defence Estates people in conjunction
with budget holders will be looking hard to see what sort of sites
are amenable to this sort of treatment. Their focus of activity
in the short-term again driven by the target for disposals is
to look at high value property, which tend to be in and around
London, and that is a distinct focus of activity.
Chairman: Some of the next questions relate
to an inquiry which is unfolding on Bishopton, so bear that in
mind. We do not want to trick you into anything, so bear that
223. He might not, but I do! In paragraph 48
you identify assets and capabilities that have to be maintained
for specific strategic reasons, and you give an indication of
what they might bedockyards and training facilities. I
would be interested and I am sure the Committee would, and I am
sure most of people who work at Bishopton would, to hear whether
you have a definitive list of those and, if you have not, is there
one under preparation?
(Mr Balmer) I think what paragraph 48 is attempting
to describe, and it perhaps does not do it as accurately as it
might do, is our desire to look hard at the properties which we
own, so that we are constantly striving to make the best use of
our assets and facilities so that if we can find an alternative
use or we can dispose of properties, we do. Where under-utilisation
is apparent we do not have a set document that tells us in a policy
sense what might happen to that property, it is a case by case
approach. So we might find that there is a repair facility which
might be under-utilised in peace time but we want to preserve
for surge capacity in war, or there might be a training area which
is under-utilised for large parts of the year but again might
be too difficult to recreate at a time of crisis. But what we
do not have is a master list of such facilities, we take them
on case by case.
224. You go beyond facilities, do you not, because
you talk in 48 of "certain types of sophisticated weapons
systems". Some of us might feel the things we have to fire
in weapons systems are pretty sophisticated, and that was the
argument raised in a lot of our discussions over Bishopton. You
might be able to suggest this is not a very clear paragraphit
is a bit of a shame somebody did not recognise that before it
was printedbut you are mentioning yourself things over
and above what you have just indicated, and the Committee is entitled
to know what they are and is there a list of them. I would be
interested to know what you consider to be essential for the strategic
defence of this country.
(Mr Balmer) As I have said, this paragraph is talking
about defence assets rather than national assets which might be
used for defence. So this paragraph was not attempting to think
about, for example, things like munitions factories, it was designed
to talk about our own assets. As regards industrial facilities,
we do not have some master list of those which we view as strategic
and those which we do not. We do take a view as to the sort of
facilities we think it is probably important to have available,
but that again is not a complete matrix, that is a sort of check
list against which the Procurement Executive might operate. As
I think has been made clear in the Bishopton case, that facility
would not be regarded as a strategic asset, that is a view we
took when we were looking at the requirements for our ammunition.
As for the sort of raw materials which go into Bishopton, the
single propellant already comes from abroad, a lot of the components
for ammunition are sourced abroad anyway, so it would be quite
inappropriate for us to say that Bishopton itself is a strategic
asset to us. That is not our judgment.
225. But there is a list of industrial units
within the country which you would consider from the MoD point
of view as essential to be maintained and held here?
(Mr Balmer) We have a check list available. I hesitate
to describe it as a master list because it is not designed to
be that, it is a check list for those who are engaged in procurement.
Clearly we do not publish it because it is likely to give rise
to distortions of competition if we were to.
226. Can I develop on to the PFI situation.
You have gone on at great length in the report about PFI. Can
you tell us what you consider to be the long-term effect of PFI
supporting some £7 billion worth of projects for the MoD
long-term on the budget? I would be also interested if you could
tell me what the costs of this would have been had the PFI not
been available? Has some work been done on a cost benefit analysis
of the PFI against funding in other ways?
(Mr Balmer) Our approach to PFIindeed to partnerships
with industry more generally because PFI is a particular subset
of thoseis that whenever we are looking to procure what
might involve some assets we ask is there a way of doing this
on a PPP basis, on a PFI basis, or are the circumstances such
that we have to go for a traditional procurement and buy and own
the asset ourselves? The presumption is that we will look for
a partnership approach first under which industry essentially
funds the asset. Having said that, we are still at a relatively
early stage in this process. We have been very successful in finding
a number of opportunities. We now have a total of 25 completed
projects, all of which in our investment appraisals have demonstrated
delivery of value for money compared to the public sector comparators
against which they were being tested. We have another 46 projects
either in procurement or being considered. That is a total of
90 if you take all of the ones that are currently being looked
at and 46 are actively in procurement. Those projects between
them now cover a very substantial total of capital budget. The
25 completed were probably worth about £1 billion. I do not
know exactly because it is up to the provider who made the capital
investment. Our judgment is that it is certainly of that order.
The projects we have in train are probably one and a half, two,
three billions' worth for the future. Clearly if this programme
proceeds successfully it will at some stage have an impact upon
the way in which our budget is structured.
(Mr Balmer) Because rather than having peaks of expenditure
occurring, we will have a much flatter set of budgets as we pay
a continuing service. Conversely, we will be contracted to pay
that continuing service for quite long periods of time and that
is the basis on which these things make sense. There is a risk,
and some people argue, that the budget will become silted up with
these long-term contracts. Of the examples that we have worked
on so far, and are continuing to work on, our judgment is that
is not a danger. If you look at what we have contracted through
PFI compared to the total of what we are contracting on conventional
procurement, it is still a very small proportion, it is less than
five per cent.
Chairman: Ten years from now somebody is going
to be paying all of these bills.
228. You only have to look at the way in which
health authorities and local authorities have come up against
problems in very short periods of time. If your figures are to
be believed, and you must have a view of what the annual service
charge will be to the MoD supporting £7 billion worth of
PFI capital, servicing that sort of debt must take out of your
budget an enormous amount of flexibility that you once might have
had but you now start with your having to service this enormous
debt. What proportions are you hoping to get into your budget
which will allow you some flexibility to replace that which you
have lost? What do you expect the servicing costs to be for that
enormous debt? Are you suggesting that it will be less than five
per cent of the total?
(Mr Balmer) At the moment distinctly less than five
per cent of the total.
229. For what you have committed to today but
in three years it goes up quite dramatically, does it not?
(Mr Balmer) Indeed it does, if they are all successful,
as we hope they will be, but it will still be quite a small proportion
of the whole. It is not as if the service charges would be entirely
new charges and not displacing anything else. What they are displacing
is regular expenditure of capital. It is not a new level of expenditure
which is an entirely additional burden, it is offset against the
other peaks. Having said that, the point you make is entirely
valid, that over a period as we have these there will be a substantial
commitment to an ongoing service charge. We would have been committed
anyway if we owned the asset and procured it conventionally with
running it on. So the idea of being inflexible I think we have
to take with a certain degree of caution because if we had bought
an asset we would not have wanted to throw it away two years later
because we could not sustain it.
230. Is there evidence to suggest that you will
now have to be paying for it for a longer period to satisfy the
public sector to get involved and they are looking for these contracts
to be extended over extensive periods of time? Have you looked
at whether or not you actually do end up with value for money
where you are paying for procurement issues which you might not
have carried out over such a long period of time?
(Mr Balmer) In every case it is subjected to very
detailed scrutiny to ensure that against the public sector comparator,
which would have been the purchase of an asset and sustaining
it, this delivers better value for money. If that is not the case
then we do not proceed.
231. At what percentage level would you suggest
that you do not proceed? Some of these range from five per cent
to 40 per cent. Is five per cent a cut-off point?
(Mr Balmer) It certainly needs to be an improvement
in value for money terms. The extent of that improvement, if it
is something like 40 per cent, is fairly obvious, you go for it.
If you do the calculation and it comes to one or two per cent
better then you have to look quite hard at the sensitivity of
the assumptions you have made. The budget holder concerned will
conduct that analysis to say what would happen if the figures
went this far wrong or that far wrong. If the judgment on the
risk analysis basis is that the public sector comparator might
in some circumstances be favourable then they may go down that
route. It would be judged on each case.
232. When would you expect this Committee to
be in a position to be able to judge the effectiveness or otherwise
of the current PFI agreed schemes? The first one was agreed when?
(Mr Balmer) Two or three years ago.
Mr Hancock: After what period of time would
you think it would be fair for this Committee to expect to see
some of those looked at fairly tightly?
233. After Mr Balmer retires I suspect.
(Mr Balmer) I hope not, Chairman.
234. After five years?
(Mr Balmer) I might look old and haggard.
235. I am sure you are not. Would after five
years be reasonable?
(Mr Balmer) I think it would depend on each case.
From our own perspective we have a policy of conducting post project
evaluation which we would typically set in train while the project
was in procurement and then a few years later we would test to
see whether we were indeed getting the service that we expected.
What is always difficult in those circumstances is to work out
what you would have spent if you had gone down the public sector
comparator route, but that did not happen. There are techniques
for evaluating that. We conduct those evaluations and if the Committee
wishes to ask about any particular cases we can share them.
236. It would not be an unusual request for
this Committee to say that in the lifetime of this current Parliament
it wanted to examine those 25 agreed schemes to see how much benefit
has actually accrued and whether or not they have stood the test
of a relatively short period of time as benefit to the MoD?
(Mr Balmer) Yes, I think that is entirely fair. I
think it would make sense to leave it until four or five years
have passed to be sure that we are analysing the thing sensibly
and carefully but at that point I think it would be an entirely
sensible thing for us to discuss.
Mr Hancock: Thank you.
237. Mr Balmer, as part of your smart procurement
initiative you have targets of reducing projects, cost overruns
and delays. Can you tell us, are the improvements over the next
three years already allowed for in the procurement budget? What
would be the consequences to the department's finances if, in
fact, the really quite challenging targets are not achieved?
(Mr Balmer) The first point to make is that we expect
to achieve the targets. They are challenging but they have been
accepted by both the Defence Procurement Agency itself and by
the department at large because the customer community has a distinct
interest in this process too. We are acting on the assumptions
that we will achieve the targets. The effect on budgetary allocations
is a rather complex one in that for a given project if it achieves
a target of zero cost growth that is extremely good news. If it
achieves a target of slippage of no more than an average of ten
days a year, and that is less good news although it is better
than some of the slippages we have experienced, it will mean that
the project as a whole is taking longer to achieve even though
the costs are not going up if you manage to negotiate the right
sort of contract. So in overall procurement terms, we may be losing
some military capability for some period, but at least it is not
costing us more money, would be the outcome of that. In terms
of budgetary allocations, we would be saying to the leader of
the integrated project team in the Defence Procurement Agency,
having discussed what the targets ought to be for that project
and what the expenditure is expected to be in a given year, "That
is your allocation, you may now proceed on that basis" and
the customer would agree that. But our experience tells us, and
that is why we have a target of slippage of some period although
not of zero, that things do slip. It is the nature of this business
that difficult development programmes and even some production
programmes do slip beyond what the contractor has agreed and the
project team is assuming. The way we take care of that in thinking
about our cash flow is that the projects are added up to a total,
we know that total will not be spent because experience tells
us it will not be spent, so therefore we block-adjust the total.
We do not take the money away from the project team, we say, "You
have that allocation, you spend it because that is what you are
trying to do".
238. Yes, that is time over run, I am asking
about cost over run.
(Mr Balmer) This is the effect of costs in any given
year, in that if you add up what all the projects expect to spend
in a year, we know from experience that will not happen, that
some of them will slip and therefore save money in that year.
So we reduce our total requirements for cash and the totals in
these documents reflect this, they are lower than the aggregate
of all the projects would suggest. So we already take account
of the fact there will be slippage.
239. But that is as before, is it not? That
has been the case for a number of years?
(Mr Balmer) Indeed.