Examination of Witnesses (Questions 40-59)|
WALMSLEY KCB AND
MONDAY 10 DECEMBER 2001
40. Yes, but the footnote is still relevant
at the bottom of page 5 because it says "These figures take
account of revisions to the Major Projects Report 2000 approvals
baseline for 7 projects", and it names the projects, "brought
about by more accurate information on interest on capital charges
(Sir Robert Walmsley) What it would look like without
that I do not know. In some senses that is a question for the
author of the report.
(Mr Banfield) It would not look markedly different.
There are only two of the projects where there was any significant
variation and they are Apache and Merlin Mk 1 and we can provide
figures for both for you.
41. Am I right in thinking that in terms of
the Apache it would then increase the projected overrun?
(Mr Banfield) I will just check the figures for you
and come back to you later on.
42. Throughout the report comments are made
about the increasing inflation costs; I am thinking particularly
of paragraph 1.14 and Figure 5, inflation cited as one of the
major cost increases historically. May I just check? Is any account
taken in the figures you have here of the reduced costs of borrowing?
You mentioned the opportunity costs which are incorporated in
here. Is that taken into account in the figures we have in the
same way as the projections about increasing for inflation?
(Sir Robert Walmsley) We are still working on a six
per cent discounting rate and a six per cent interest on capital
charge. These are figures which are set by the Treasury; I think
they are across government and not just for the Ministry of Defence.
Though sometimes I have to admit in recent months occasionally
I have heard talk of lower figures being possibly contemplated,
for now it is still six per cent.
43. How would that affect your projections here?
(Sir Robert Walmsley) I worry about it a bit. This
is quite a complicated answer and I am not even sure I am going
to make sense to myself but I shall just try it. When you are
looking at projects on a through-life basis, you do not know the
costs you are going to incur in 20 years' time anything like as
accurately as the costs you are going to incur in 10 years' time.
So there is a sense in which discounting long-term future costs
avoids you making optimistic assumptions about what is going to
happen in the long term. I am a little bit worried about equating
costs in the year 2010 with costs which arise in the year 2001
because actually I know that industry, when they are assessing
whether something is a good move or not, use discount rates of
15 or 20 per cent and I think there is an interesting discipline
there. I have to say we are not prohibited from using such rates.
44. On page 4, Figure 1, it seems with the new
system in being the report gives a very favourable account. When
I actually look at the projects, it does not ring true. You have,
for example on ASRAAM, two out of the three performance parameters
worse, Apache two out of the three, the S&T Update two out
of three. What is the increase in time and the cost increase in
the ones which have not gone right, which amount to just below
50 per cent of the projects? Fifty per cent tends to have at least
one of the performance indicators going wrong. Or am I reading
(Sir Robert Walmsley) No, you are absolutely correct.
I have not sat here and tried to claim credit for this report.
What I can tell you is that it is better than it has been in the
past and that does not in any sense mean that we are falling into
the trap of starting to think that a small cost increase is okay.
It is simply better than a big cost increase. I know we have to
continue to work at it, but if you look at Apache, you can see
that as a result of bearing a somewhere approaching £100
million cost increase last year, in an overall sense, if you look
at Figure 2, you will see that Apache is smack in the middle with
a zero cost variance. We had some good luck, which may well have
come to do with exchange rates or whatever. We have now been punished
on Apache as a result of the £/$ exchange rate and we have
had a £17 million charge for inflation. We take the rough
with the smooth and it is absolutely right to say that is unsatisfactory,
but it has brought it back to where it was when it started.
45. In our brief it tells us that the submarine
update has got worse, which you can clearly see in two of the
three. We are told that the cost increase is something like £80
million and there is a 12-month delay. How does that correspond
to the other ones which have got two out of the three with a cross
beside them in terms of delay and cost increase?
(Sir Robert Walmsley) You are absolutely right, there
is an £18 million cost increase on the Swiftsure and Trafalgar
Class Upgrade. I have to say that is to do with the sonar, which
is Sonar 2076, which has proved, probably as some people predicted
but I did not, even more difficult than we expected it to be.
We have taken very serious steps now to re-align that programme.
It will be at sea in HMS Torbay within a month or two. It has
already passed sufficient tests for me to be quite satisfied that
it will give the commanding officer of the ship a safe performance
when he has dived and in not too many months a very good performance.
This is an enormous undertaking and I am desperately sorry that
it has not worked out perfectly. It is not far off. I am not sheltering
behind delays in submarine refits because if they had not occurred,
this sonar would still have been in trouble on the timetable.
46. When I had a quick look through, and I cannot
pretend I have read every word in this report because I have not,
when watching Arsenal versus Aston Villa yesterday afternoon which
was boring enough so I was being bored twice, when I read through
these blue pages, most of them seemed to say late, late, late.
How many of these projects are actually delivered on time?
(Sir Robert Walmsley) I shall be able to answer that
question because there is a graph which will show us. I unfortunately
have read every single word in this report, because I am required
to do so. Table 7 on page 10. We have one which will be delivered
early, which is MRAV, and then we have two ASTORs, which is five
business jets with the world's most advanced surveillance radar
in them which will be delivered on time and Astute, which is a
programme of three attack submarines, which we are currently forecasting
will be on time. Those which are in pale blue down towards the
bottom have all entered service already.
47. So two thirds of the projects tend to slip.
(Sir Robert Walmsley) You make a very powerful point.
I ran a conference with industry for the Defence Procurement Agency
this year, which was an extremely successful event compered by
Mr John Humphrys, who kept us all on our toes throughout a very
stimulating day. The theme of the conference was "Right on
Time". I absolutely acknowledge that we need to get better
at keeping these projects to time. The Chairman's opening question
was: what am I doing about these things? Technology is the biggest
single cause of delay and I have talked about technology readiness
levels, but better project management, seeing these problems coming
before they hit you in the face, is actually quite an important
part of responding to difficulties and this Committee has encouraged
me to use earned value management and that is under way.
48. I remember the last time both you and Sir
Jeremy were here together you told us about the ship which had
been ordered without any sonar and it was added later. That worried
us at the time. What also worries me is cost reduction. Can we
go to page 24 and Figure 17? I am trying to be helpful because
it seems to me that if we are putting pressure on you all the
time to reduce, reduce and reduce costs, you can only achieve
reductions by leaving something off. The ship with no sonar to
chase submarines sounded a bit farcical at the time and you guaranteed
that was not the case, but it is a worrying thing that if scrutiny
committees like ourselves and Government are telling you to cut
back and cut back and you are cutting back and cutting corners
and the equipment is not as it should be, then it should be said.
If you look at Figure 17 it tells us that the stakeholders in
the Department have three cost reduction targets, the first stakeholder
has to look for a £2 billion cost reduction in the Strategic
Defence Review, a £750 million reduction in the Public Service
Agreement and a £200 million reduction in the Business Plan.
How are these figures arrived at? Does someone just say "Let's
save £2 billion here and £200 million there"? How
do you arrive at these figures?
(Sir Robert Walmsley) It sometimes feels a bit like
that but it is not like that. We started off with the Strategic
Defence Review. In round number terms across the 10 years of the
equipment programme there is a £60 billion budget assigned.
I am talking round numbers now. During the discussions on the
introduction of Smart Procurement we were asked what we thought
we could do with this if we were given some freedom to move things
around. We probably talked about trying to do something in the
region of two per cent and somebody squeezed us up to something
a bit closer to four per cent. So there is a bit of "What
do you think you can do?" and you saw with Skynet 5 we took
nearly £500 million out of the programme.
49. You do not say you want to build a ship
without any sonar.
(Sir Robert Walmsley) No, we do not. That is back
to the point which the Chairman raised. I did say it is quite
difficult to go on making cost savings on a properly drawn up
budget. You just cannot do it. If you insist on doing it, then
people will start drawing up budgets which have a little bit more
room in them than they should have. I am very cautious about this
but I was quite happy with the initial thing because it was our
first chance to apply Smart Procurement principles and we have
delivered in our budgetbut I agree that it is only a budgeting
toolthat £2 billion of savings.
50. What about the £750 million?
(Sir Robert Walmsley) We have just about done that
and we shall be struggling now year on year to find another £200
million. I absolutely do not want to get into the position of
perverse incentives, that is to say padding the budget.
51. Why has it said in the business plan that
there will be a £200 million cost reduction for 10 years?
Why ten years and why £200 million?
(Sir Robert Walmsley) It is £200 million for
each annual ten-year planning round. Over 10 years that is an
average of £20 million per annum. I do not see how we can
possibly continue with that for ever unless we have improper budgets.
52. Why was the Strategic Defence Review over
the period 1998-99 to 2007-08 and the Public Service Agreement
over 2001 to 2004? Why over different periods?
(Sir Robert Walmsley) It is the time the agreements
were struck. The Strategic Defence Review reported in July 1998
so our equipment ran for 10 years from that point; so up until
31 March 2008 was the 10-year period. The Public Service Agreement
was struck later.
53. Can we go to paragraphs 3.6 and 3.7 and
I must admit I was getting very confused as the game proceeded?
What is the total cost of reductions? Are we talking about the
£2 billion, the £750 million and the £200 million,
then a further £2.4 billion?
(Sir Robert Walmsley) No; no, absolutely not.
You can add up the three figures, but they occur over different
periods. You can add the £2 billion to the £750 million
and then in theory a further £20 million each year, but I
do not see that going on for ever. What I am much keener on is
keeping an absolute determination to secure the cost efficiencies
which working closer with industry and making sure that projects
work more closely together as well as my teams working more closely
with Admiral Blackham's area. It would be important that you hear
from Admiral Blackham on the subject of costs.
(Vice Admiral Sir Jeremy Blackham) Cost
matters to me a very great deal. The key issue for us always is
the trade-off between costs and capabilities. We set ourselves
a set of key requirements, we then try to negotiate with an IPT
and he with industry to see what we can get for that and then
we have to consider whether what we are getting is sufficient
for the purpose, whether there is a trade-off to be engaged in,
whether we can relax a requirement because the particular eventuality
is sufficiently distant or remote and we can get a better price,
bearing in mind that whatever we save on one project can be spent
on another. There is a constant trade-off going on, but not a
trade-off as far as we are concerned which would produce a piece
of equipment which does not meet the need we foresee for it.
54. The Chairman touched on this point and I
come back to it a little. We are also told that 12 projects accounted
for 70 per cent of the cost reductions. What about all the other
projects which are covered by Smart?
(Sir Robert Walmsley) In terms of major projectsnot
Major Project Report projectsthose are projects which cost
more than £20 million each, there are about 80 or so.
55. What percentage of Smart costs are a percentage
of the total defence budget?
(Sir Robert Walmsley) I mentioned the total equipment
costs over the 10-year period as being around £60 billion,
that is £6 billion per annum. You have seen here that the
total savings add up to something around £3 billion, that
is £2 billion plus £750 million plus £200 million
and that is, as near as makes no difference, five per cent of
the equipment programme.
56. What is the cost reduction on all defence
(Sir Robert Walmsley) The capital equipment programme
is about one quarter of the defence budget, so it is just a little
more than one per cent or so of the defence budget.
57. I did not understand a lot and most of my
questions are based on what I did not understand. Paragraphs 3.6
and 3.7 went on to say that the Department will track 11 projects
which cover 60 per cent of the expected cost reductions to see
whether the forecast reductions are met. What I could not understand
was why the others were not included.
(Sir Robert Walmsley) We could track everything all
58. Presumably you could only get a true picture
if you track everything.
(Sir Robert Walmsley) We do track everything in the
sense that every project's budget is scrutinised, jointly I may
say, by Admiral Blackham and myself once a year on a rather long
hot day in the summer when we do go through the lot. We are tracking
that each project does not slip in a little private budgetary
increase for no purpose. We do track very carefully each project's
budget. In terms of the Smart savings, we decided that we would
separately track what had been achieved on the dozen or so biggest
59. One thing which struck me which I could
not understand was whether when you go for a project you have
the money available. Do you know that you have the money available
or do you plan a project and then hope to get the money eventually
through a general budget or are you certain of having the money
available when you plan a particular project? I got the impression
when I looked at Figure 9, where it talks about changed budgetary
priorities, that when budgets were approved you did not necessarily
know that you had the capital to go ahead with that budget and
you hoped that you might have it at the end of the day.
(Sir Robert Walmsley) I never seek tenders from industry
without the money to pay for an economic tender. That is my working
rule. We do not involve other people in spending money unless
we have the resources to do it, except on a very few occasions
and we then tell them that unless the offers are really attractive
. . . The budgetary process belongs entirely to Admiral Blackham
and he should answer your question.
(Vice Admiral Sir Jeremy Blackham) Perhaps I should
start by saying that I would never go forward to seek approval
for a project if I could not satisfy not just myself but the approval
authorities that we had a budget line which was sufficient to
cover that project. The equipment budget is about £6 billion
a year, it is quite specific, during the period of the spending
review, whenever that is, and an assumption is made as to what
it is likely to be outside that period. It is a given as far as
I am concerned, so I have an equipment budget which runs over
a 10-year period. That budget is made up of a number of lines
which are the project lines and the costs for those are supplied
to me by the integrated project team leaders who have the figures
from their own experience, through consultation with industry,
through the use of the specialist procurement services within
the DPA. There is a string of budget lines. My basic aim is to
produce an equipment programme which satisfies the overall equipment
capability requirement and falls within that budget. Indeed I
am required to produce a budgetary plan every year within the
budget and explain the extent to which it does or does not meet
the capability requirements which have been identified. Every
project has a budget line which is sufficient for that project
to the best of my knowledge at the time we go forward.
2 Note by witness: Without the revisions to
the Major Projects Report 2000 approvals baseline, the forecast
cost variance at Main Gate would be unchanged for Merlin Mk 1
at +30%, and would be -2% rather than zero for Apache. Back
Note by Witness: The £750 million Public Service Agreement
(PSA) target is derived from the £2 billion Strategic Defence
Review target and the new £200 million cost reduction target.
The PSA target represents the value of these savings in the period
2001-02 to 2003-04. Savings against this target are part of the
profile of the £2.4 billion set out in figure 15 of the MPR
2001 report. Back