1 The impact of the large cost overruns
1. The Department accepted that the £3.1 billion
increase in forecast costs and 9 month average increase in delays
on projects in the last year were not satisfactory. It recognised
that this poor performance would mean that the men and women on
the frontline would be without the capability promised and that
the life of existing equipment would have to be extended. For
example, delays on the Astute submarine programme will mean that
some existing submarines will have to be kept in service longer
than planned. For at least an extra 3½ years the Armed Forces
will have to do without the increased capability to operate in
coastal waters, better intelligence gathering and improved Special
Forces deployment capacity which Astute will offer. The Department
does not yet know if it will need to refit existing submarines
performing similar roles.
2. The cost increases recorded in the Major Projects
Report will occur over a number of years and, given that the Department
has limited resources, will adversely affect the funding available
for other projects. The Military and, ultimately, Ministers will
determine which projects should be reduced in scope, delayed or
have their lives extended through the annual Equipment Planning
process. The process is intended to ensure the Department has
a balanced, coherent and affordable 10-year defence equipment
programme which best meets changing defence priorities. It is
not however designed to identify what new equipment capabilities
are being foregone to compensate for cost overruns and delays
an individual programmes.
3. Four older projects which began before Smart Acquisition
was introduced in 1999, account for 87% of the predicted cost
overruns and 79% of the in-year slippage in the Major Projects
Report 2003. These projects are the Astute Class Submarine; Nimrod
MRA4 aircraft; Brimstone (the Advanced Air-Launched Anti-Armour
Weapon); and the Eurofighter Typhoon aircraft. Figure 1
provides further details on the four projects.Figure
1: The "problem" projects in the Major Projects Report
|Project and main problems
||Implications including total predicted cost and time overruns
||Actions being taken to resolve the problems
|The Astute submarine programme suffered from technical and project management difficulties. The Department and BAE Systems acknowledge that they had misunderstood the risks and costs and underestimated the impact of the move of submarine design from the Department to a Prime Contractor. In particular, they underestimated the shortfall in skills and expertise in submarine design.
||Predicted cost overrun of £1 billion and time slippage of 43 months. BAE Systems bear increased costs of £250 million.
The delay in delivering Astute has meant that the Department does not have the additional capability that Astute will bring - in better intelligence gathering; land attack and improved operation in coastal waters.
|The programme has been restructured with the Department and BAE System sharing the cost increases.
The Department and BAE Systems have addressed skills shortages, project management failings and technical difficulties in using computer aided design
|The Nimrod aircraft programme has had a history of programme management, technical and commercial difficulties.
||The predicted cost overrun is £394 million and time slippage of six years. BAE Systems bear increased costs of £800 million.
There will be three less aircraft than planned.
|The programme has been restructured with the Department and BAE System sharing the cost increases. The Department has staff co-located with BAE Systems and greater access to cost and programme data.
|Brimstone is an air launched anti armour missile. Development has been delayed by 12 months to allow trials of other higher priority weapons (Storm Shadow) to be completed for deployment in Iraq. It has also been delayed a six months to investigate a potential safety issue - a risk of missile collision with the aircraft after launch
||Predicted cost overrun of £139 million and time slippage of 31 months.
||Firing trials are continuing.
|Typhoon is a fighter aircraft with an air defence and ground attack capability. It was approved in November 1987 to be delivered in 1998 at a cost of £17.4 billion.
||Typhoon was delivered in June 2003 (four and half years late) and is now expected to cost £19.7 billion, some £2.3 billion more than approved. 
The aircraft will have limited operational capability by 2006.
|The Department is confident Typhoon will be a very versatile aircraft with great export potential. BAE Systems said that Typhoon represented very good value for money in terms of its capability and its cost.
4. Figure 2 shows that the in-year forecast
overruns on the four projects did not all reflect additional payments
to contractors. Some 43% of the cost increase reflected internal
resource costs, mostly additional interest on capital charges
because of delays to the projects. Interest on capital is a non-cash
cost that reflects the opportunity cost to the Government of the
capital resources the Department has invested, based on the return
the Government could have achieved by using the resources elsewhere.
The Department acknowledged that the introduction of resource
accounting had helped it to recognise that "time is money",
imposing a discipline to get on with a project and helping them
to make time, cost and performance trade-offs.Figure
2: Breakdown of in-year cost overruns on the four older "problem"
||Interest on capital
|Payments to industry
5. Given the scale of the problems on the projects,
and because the Armed Forces still needed the capabilities provided
by the Astute submarine and Nimrod aircraft, the Department had
been forced to adopt the "least bad" option and re-negotiate
these contracts. On whether it was confident that the revised
arrangements would deliver Astute and Nimrod to time and cost,
the Department pointed to a number of encouraging developments
but said it would be unable to give us any firm assurance until
next year. The key
features of the new arrangements are that:
- the Department will bear 70%
of any cost overruns but receive only 30% of any savings, which
looks to be an unfavourable balance;
- design and development has been split from production
and no price has been agreed for the subsequent production stage.
6. The Astute and Nimrod projects are not the only
ones where contract negotiations have run into difficulties. In
2000, the Department reduced the number of Brimstone missiles
it required by 25% and entered discussions with the contractor,
MBDA, over the level of savings that might be released as a result.
Brimstone is being procured under a fixed price contract and the
Department and MBDA have not been able to reach agreement on an
acceptable level of savings. The Department has therefore reinstated
the requirement for the original number of missiles at no additional
cost to the original price. The Department continues to negotiate
with MBDA on other possible options such as allowing MBDA to buy
back 25% of the missiles for sale overseas.
3 Qq 1-2, 92-93, 305-306 Back
Qq 94-97, 178-182; Ev 20-22 Back
Qq 16-22 Back
Qq 2-3 Back
C&AG's Report, paras 3.2-3.15; Qq 77-84 Back
C&AG's Report, paras 3.16-3.23 Back
Qq 28-42, 60-61 Back
C&AG's Report, paras 3.16-3.23; Q 22 Back
C&AG's Report, paras 3.24-3.29 Back
ibid, paras 3.30-3.37 Back
Qq 6-8, 55, 74, 135 Back
Qq 6, 68, 177, 180, 184, 259-268; Ev 39 Back
Qq 25-42, 60-61, 69-72 Back
Qq 44-49, 55, 64, 180 Back